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Mortgage Cramdown--Layering On Complexity

posted by Jean Braucher

Chapter 13 is already too complicated, and cramdown legislation will make it more so and lead to a new round of litigation and expense that will stand in the way of keeping people in their homes. By all means, Congress should enact mortgage cramdown, but it should take up bankruptcy simplification immediately after that if it really wants people to hold on to their homes in chapter 13.

Katie Porter has already noted the problem of high noncompletion rates in chapter 13 as a reason for suspecting that mortgage cramdown will not “save” many homes. See Cramdown Controversy #2--Will I "Succeed?" The problem is that the impact of the pending cramdown legislation could be small given the messy state of bankruptcy law since the 2005 changes.

The 2005 law has substantially increased the expense of bankruptcy, deterring and delaying its use among the worst off. The chapter 13 filing fee has gone up to $274.  “No look” attorneys’ fees of at least $3,000 are the norm in chapter 13 (see http://www.gao.gov/new.items/d08697.pdf at 25-26), and this is a bargain price considering what lawyers are expected to do under the new law.

Mortgage cramdown will add the difficulty of a valuation hearing, with experts engaging in a swearing contest about the value of a home for which, in many cases, there currently is no market. Cars have various “book” values that can be used to set default measures of value in bankruptcy, but there is no similar simple approach to valuing homes to save on litigation costs.

The bills add a lot of complexity of various sorts. S. 61 and H.R. 200 both would layer on a ridiculous, unnecessary third "good faith" test in chapter 13. The debtor already must file in good faith and propose a plan in good faith, yet the bill’s drafters felt compelled to add an additional requirement that the modification be in good faith. This would stoke litigation over whether it is bad faith to pay the value of the home if the debtor could "afford" more ("afford" always being a malleable concept), with an open question about what other expenses should be taken into account when deciding what the debtor has available to pay for an underwater home.

It would be much better for Congress to explicitly state what it wants—for example, whether just paying the home’s value is fine, with excess disposable income (if any) going to other secured debts (such as cars) and then unsecured debts.  Furthermore, it would be a good idea for Congress to state that if home and car payments use up all the available income over regular expenses, it is not “bad faith” to pay zero to unsecured creditors.  Congress should be heading off the inevitable arguments that just paying for collateral in chapter 13 is not good faith.  If chapter 13 is going to be a mechanism to save homes from foreclosure, many debtors will have nothing left to pay old unsecured debts.  Unfortunately, some judges and trustees have used a good faith test to push for rule-of-thumb amounts of unsecured debt repayment in chapter 13 whether or not that is feasible, contributing to a high noncompletion rate (historically, about two-thirds of chapter 13 cases).

I agree with Katie Porter that the provision in the bills for direct payments by debtors to claim holders is a mistake.  It is unclear whether this would always be required, or whether this language just gives courts discretion to allow direct payment.  In most cases, Chapter 13 trustees are needed to make sure that payments actually get credited appropriately to debtors’ accounts.  If the problem is feasibility of plans due to paying trustee fees on mortgage amounts, Congress could provide for a lower trustee fee on those payments. Without the trustees involved in record-keeping, debtors will face huge cost and difficulty at case closing to try to show that they really are current on their mortgages.  Most trustees now make it a default practice that mortgage payments be made through them, and this has saved on trouble for debtors, trustees and judges.    

Another aspect of the bills that is troublesome is that the debtor must have already received a notice of foreclosure in order to cramdown.  This prevents debtors from taking charge of a hopeless situation and getting it resolved; they would have to wait for the lender to send a foreclosure notice before they could make use of chapter 13 to modify their mortgages.

The elimination of credit counseling for debtors who have received a notice of foreclosure is a step in the right direction, but if Congress paid attention to GAO reports, it would repeal the credit counseling requirement entirely. http://www.gao.gov/new.items/d07778t.pdf   It represents a cost in money ($50 per debtor) and inconvenience way in excess of very minimal benefit.

Mortgage cramdown would also add to the complexity of other issues currently making their way through the appellate system, particularly issues concerning means testing and treatment of car loans.  (For more discussion of these issues, see my recent paper, A Guide to Interpretation of the 2005 Bankruptcy Law at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1307250.)

Means testing allows above-median-income debtors in either chapter 7 or chapter 13 to include their secured debt obligations as part of their expenses, yet with cramdown on a home possible, the debtor might not have to pay the full secured debt in chapter 13.  This will lead to a new round of litigation over additional layers of means testing, whether under the “good faith” or “totality of the circumstances” tests in chapter 7 or the “projected disposable income” or various “good faith” tests in chapter 13 when the debtor might be able to cramdown.

And then there will be the ironies of allowing cramdown on underwater home mortgages while perhaps not allowing cramdown on seriously underwater car loans, particularly the most risky subprime ones.  If the car lender rolled in a big wad of debt from the last car (known as “negative equity”), making the debt severely undersecured from the outset, it doesn’t make a lot of sense to treat that debt as fully secured under the “hanging paragraph” while cramming down a similarly undersecured home loan.  I am among those who think it is ridiculous—both as a matter of law (see http://www.nacba.org/s/45_50fc1f2acc4e329/files/PeasleeSupportBrief.pdf) and policy—to treat paying off your last car as part of the purchase money for your next one. As a policy matter, this is very risky credit, and it does not deserve preferred status (disallowing cramdown).

All this is to suggest that we desperately need a fresh start for bankruptcy reform, and layering mortgage cramdown on the 2005 mess will just make this more apparent.  The complexity of the law stands in the way of its use at an affordable price and makes it hard to mobilize the bankruptcy system for this crisis.

Comments

Jean,

The complexity point is well taken. I wonder what I'll have to cut from my class to spend more time on cramdown next year. But I disagree with your argument that it will add significantly to expense because of valuation fights. If the legislation passes, there will be a handful of initial cases before each judge or in each district in which debtors and creditors test what the regime will look like. But it will quickly become apparent how cramdown will work and what the parameters will be. After that, debtors and creditors will agree on valuations consensually, rather than waste time and money on valuation fights.

I believe Jean and Katie are correct. Have we all not experienced interpretation of "poorly" drafted law after October 2005? Have we also seen a uniformity of case law decisions that are different based on the intent of the stated language of the law? If not, then possibly looking back to issues of value or cram down from 1979 to 2005 may help. With the utmost respect to Adam, I think you may want to consider more time in your "cram down" class next year because there will not be a handful of cases and there will not be a uniformity in decisions..in my opinion.

I'm looking into getting certified to do Appraisals myself.

The judge can hear the evidence on an Objection to Confirmation or Objection to Valuation. In today's digital era, it shouldn't be that hard to compile and present the evidence. We are used to the complicated stuff. Yes 2-3 hundred bucks for an Appraisal can be steep for some debtors but is completely unequal to the potential benefit.

I think they just need to choose one of the many good faith tests that we already have. I think we may have a few at first (locally) but you soon settle into a groove. (the only way to make money in this biz) Even with the 2005 fiasco. You just need one (for the most part) to make it to your Cir.

Here anyway all they would need to do is keep their job for 5 years (given there was enough income to support at least a 1-10% plan payment. We have wage withholding order here (quasi voluntary).

Our local judge actually mentioned 0% plans from the bench when commenting why anyone close to the median would choose file a 7. (given the heck you would get from the UST)

Having already been accused offsite of being a tool of the mortgage industry, let me repeat that I am for the legislation, especially if it is clarified in two ways--one, to make it plain that zero percent plans are not in bad faith if the debtor commits disposable income to the plan and that all goes to secured creditors, and two, to state that the possibility of cramdown should not be part of means-testing in either chapter 7 or chapter 13.

I hope Adam and Patches are right that valuation won't be a big deal. But without book values (as with cars), it seems that both sides will need experts, and litigation of the fact question of valuation could require hearings to probe the basis of experts' opinions. So the cost may not be just that of an appraisal for each side, but the cost of deposing, presenting and cross-examining those expert witnesses. Sure, it would be nice if everyone would negotiate a stipulated value, but if mortgagees want to be intransigent and make it hard to cram down, it seems possible they would make a big fuss over valuation. If they were inclined to negotiate, it seems they would do so before sending a foreclosure notice and ending up in bankruptcy. If bankruptcy is needed to get a lender to the table, I wouldn't count on negotiation happening.

Thus, the best argument for the legislation is the hope that it will produce more negotiated workouts outside bankruptcy, which could be a more accessible route to mortgage relief for debtors than bankruptcy itself. Before sending a foreclosure notice and thus triggering the debtor's right of cramdown in chapter 13, mortgagees might want to propose making a deal. They should be able to make a better deal then--the debtor would be less likely to be represented and less likely to have a lowball appraisal at the ready. But this brings us back to the whole reason for the legislation to begin with--the slowness with which the industry has been dealing with setting up workout programs, perhaps impeded by the complexity of arrangements with servicers, particularly where the loan is in a securitized pool. And if chapter 13 is too expensive for many debtors, the cramdown bill won't help much. Worth a try! I think the concerns about ex ante impact on credit costs and availability are overstated; the bigger worry is little impact on actually helping people stay in their homes. That might be more likely to happen if the bankruptcy system wasn't burdened with the complexity and thus expense of the 2005 law.

The subject of servicing is one to which I hope to return.

This fascination with a bankruptcy solution is nothing less than alarming.

It presupposes the path to solvency and economic recovery lies with an already overloaded judiciary process that is statistically a failure.

Chapter 13 cases usually wind up in dismissal, not discharge and passing the buck (literally) to the bankruptcy system is only rewarding the perpetrators - who happen to be the loan originators, the securitization enablers and in some cases the opportunistic borrowers. All of them walk away with the blessing of Washington while we pay the price for what lobbyists have bought for their clients over the years.

Borrower bankruptcy simply penalizes the survivors instead of going after the people in the institutions who put the schemes into motion and kept them running.

Why are they getting a free pass - and in some cases even taxpayer dollars?

Oh wait - I already answered that when I mentioned lobbyists.

Hey Jean, nothing wrong with representing the Mortgage Industry looks like they need the help also. Some of my very good friends and an (ex) or 2 work for the "dark" side. (I love to poke fun) Heck, I'm 3 days from closing myself after several failed attempts.


Sure, we will have a fight or 2, maybe several. Working for a volume firm, we most likely will shy away from low balling (it's too expensive). Low balling suggests an element of negotiation or trying to get something maybe we should not. Ninety percent of the people we see feel bad about "the poor people" at the finance companies that were so kind as to lend them a little cash.

Actually I haven’t seen too many homes that we could actually “Cramdown” in that the tax appraisal which is (usually) low (but is getting worse) is more than what is owed on the property. Unless we recapitalize an arrearage claim of 20-30k (rare but I do see them from time to time) it is under those circumstances where we might see a valuation issue. Most people would jump for joy if they could only get a fixed rate and shove arrearages to the end of the note (something they are just not getting from servicing companies nor can they get from another lender if they just got into the home with no money down). I see a lot of former fixed notes refinanced into home equity variable rate mortgages, even after the debtor(s) has(have) lived in the home for years. I saw one the other day where the couple had been living in the same home for 17 years. I think though it is different here in STX as opposed to Las Vegas or California. We didn’t have the rapid appreciation (although it felt like it to us) that other States saw. Truly a “Snowflake” situation depending on where you live and the “Homestead” laws if any.

Jean's comment about the dreaded hanging paragraph in 1325(a), insulating car lenders, is well taken. How odd. If the debtor keeps the old car and files, the lender's debt is written down to value. If the debtor buys a car then files, then the lender on the old car is paid in full, and the lender on the new car is treated as fully secured. That's a real Alice in Wonderland moment, now isn't it?

I concur most definitely. Its more like bizzaro world to me where everything is backwards.

I wish that we can treat 1325(a) as not actually being in there since it technically doesn't (or didn't at first) have a cite reference number. Is it a "cramdown" value if you are actually paying through a 13 the actual amount of the "sales" price of the vehicle and not the full amount of the loan? Before we went on a "something between whole sale and retail leaning towards retail" valuation scheme (still do on vehicle notes over 910 days).

So if the dealership sells the trade in for more than what they gave the debtor credit for but the debtors still has to pay the full amount they financed through their plan. Doesn't that muck up 1325 as well? I mean is it really fair to double dip in that situation? (which I see a lot of, mostly with sub prime borrowers)

it seems that both sides will need experts, and litigation of the fact question of valuation could require hearings to probe the basis of experts' opinions. So the cost may not be just that of an appraisal for each side, but the cost of deposing, presenting and cross-examining those expert witnesses. Sure, it would be nice if everyone would negotiate a stipulated value, but if mortgagees want to be intransigent and make it hard to cram down, it seems possible they would make a big fuss over valuation. If they were inclined to negotiate, it seems they would do so before sending a foreclosure notice and ending up in bankruptcy.

I think that you could get around the mortgage appraisal problem if Congress funded a salaried special master appraiser for the bankruptcy courts. Sure, the mortgagee could yell and scream and have hissy fits. But this is expensive, and unlikely to be availing. And the bankrupt won't have to hire their own expert.
. . . and then there's always Zillow. . . .

I like Zillow but it seems recently the values are a bit high. I know they give you a range and it is a great tool. Still, there is nothing better than "local" knowledge.

I see a lot of former fixed notes refinanced into home equity variable rate mortgages, even after the debtor(s) has(have) lived in the home for years.

it shouldn't be that hard to compile and present the evidence. We are used to the complicated stuff. Yes 2-3 hundred bucks for an Appraisal can be steep for some debtors but is completely unequal to the potential benefit.

Given the huge interest in this topic I`ll be cranking up some more pointers on how to tackle this issue , taking in account different use cases.

You have to wonder if we’d just be better off letting 20% of homeowners get tossed out of their homes (they can move in with friends or family) and a third of the banks in the country go broke. Then it would be over in a couple of years, the gamblers would lose, the savers would win, and we could rebuild. What’s going on is death by a thousand cuts and it will last for 10-20 years.

Quite interesting and informative. Thanks for sharing.

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