Who is Mel Watt?

On May 1, President Obama nominated Rep. Mel Watt (D-N.C.) to be the director of the Federal Housing Finance Agency, the conservator for the mortgage giants Fannie Mae and Freddie Mac.

These two entities together currently back a large majority of new mortgages and hold or guarantee about half of all U.S. mortgages. Like other entities immersed in the mortgage market, Fannie and Freddie suffered great losses in the mortgage meltdown and were taken over by the federal government at the end of the Bush administration in September 2008.

Watt could be a key figure in the late stages of the mortgage crisis and in redefining the role of Fannie Mae and Freddie Mac going forward.  So who is this eleven-term congressman and what does he care about most?

Probably the most important points to stress are these:  He rose from humble beginnings through the meritocracy and is a Yale-educated lawyer who likes to immerse himself in the facts.  He is broadly respected at home in Charlotte, N.C., and represents a safe district where he has biracial support.  He carefully listens to the financial services industry, a major player in his community, and one that has supported his campaigns.  Most important of all, he has made working for the economic well-being of African Americans his life’s work, whether as a lawyer in private practice representing minority businesses or as a lawmaker seeking to shore up consumer protection, particularly to strengthen the legal basis for challenging predatory lending, often used against racial minorities and other vulnerable populations.

Adam Levitin awarded the Young Scholar's Medal of the American Law Institute

Congrats to Credit Slip’s Adam Levitin for winning a prestigious honor! Of course, this award is well deserved.

The American Law Institute announced today that Adam Levitin of Georgetown Law Center has been awarded its Young Scholar’s Medal.  ALI says that this honor is “designed to recognize early-career law professors whose work is relevant to the real world and has the potential to influence improvements in the law.”

William Treanor, Dean of Georgetown Law Center, said: "Professor Levitin's work not only has the potential to improve American law, it already has influenced improvements in law in multiple areas across the financial sector."

Justice Goodwin Liu of the California Supreme Court, who chaired the Young Scholars Medal Selection Committee, said, "Professor Levitin's work on the recent financial crisis has helped to guide lawmakers in the areas of housing finance and bank regulation."

National Consumer Protection Week and Disclosure 3.0

It’s National Consumer Protection Week (NCPW)!   Federal, state, local, and nonprofit consumer protection agencies and organizations are making extra efforts to promote consumer awareness. 

First I have to get out of my system thoughts of Tom Lehrer’s song, National Brotherhood Week:

                Step up and shake the hand/Of someone you can’t stand . . .

                It’s only for a week so have no fear/Be grateful that it doesn’t last all year.

But to get back on message, of particular interest to Credit Slips readers is this part of the mission of consumer protection described on the NCPW website:

    "Financial Fraud Scams: American consumers owe a whopping $11.31 trillion dollars in debt and are behind on paying about $1.01 trillion of that amount. Mortgages, student loans, and credit cards account for a large portion of that debt. Consumers are often haunted with huge monthly payments, and fraudsters take advantage of that with debt relief scams, tax scams, and other financial fraud scams. Scams target individuals who are in financial distress, but they fail to fulfill their promises, and typically leave consumers worse off than when they started."

Let me say that Lauren Willis has done a great job on this site recently taking us, patiently and painstakingly, through the many problems with the idea that disclosure can be refined into a digital juggernaut to protect consumers. See here  and here and here.

CFPB's Anti-Abuse Authority: A Promising Development in Substantive Consumer Protection

The Consumer Financial Protection Bureau is doing something promising with its anti-abuse authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  It is going after credit industry exploitation of consumers, particularly when business models involve using confusing terms that disclosure cannot adequately address.  See my paper on this topic. So I was not surprised to see George Will attacking this development.   We can't have smart, effective consumer protection, no matter how popular it might be.

In a column published in many newspapers this week,Will wrote: “The CFPB's mission is to prevent practices it is empowered to ‘declare’ are ‘unfair, deceptive, or abusive.’ Law is supposed to give people due notice of what is proscribed or prescribed, and developed law does so concerning ‘unfair’ and ‘deceptive’ practices. Not so, ‘abusive.’”

The flaws in Will's critique are legion. First, the CFPB has given lots of notice of what it is doing, in a detailed examination handbook.

What’s Up With “Independent Foreclosure Review”: Boondoggle for Consultants and More Foot-Dragging by Servicers

After the robo-signing scandal broke in the fall of 2010, followed by a huge bureaucratic in-fight, a federal interagency review produced the Independent Foreclosure Review Program, announced with great fanfare in April 2011. See here and, here.

The program contemplated that mortgage servicers would have to employ consultants for independent review of their foreclosure and related modification processing errors and then pay compensation to homeowners who suffered financial loss as a result, with awards of up to $125,000.  

So how’s that been going? As of now, the “independent” consultants are racking up bills for hundreds of millions of dollars (by September, a quarter billion to PricewaterhouseCoopers alone), while homeowners—according to American Banker—have so far gotten nothing!

Race and the Housing Bubble

While we wait to see if the second Obama administration will do anything new to help homeowners hit by the lingering mortgage crisis (finally replace Bush-holdover Ed DeMarco at FHFA to make way for debt relief?), there’s time to review a recent development that didn’t get the full attention it deserved.

I am referring to a lawsuit, Adkins v. Morgan Stanley, filed in the Southern District of New York in October by the ACLU. We don’t usually associate the ACLU with consumer protection in mortgage finance, and not surprisingly, it has brought a fresh perspective on the abuses that led to the housing bubble, highlighting race disparity in subprime originations.

Together with the National Consumer Law Center, the ACLU has brought a class action against Morgan Stanley charging that it financed a major subprime mortgage originator, dictated the nasty terms offered, and bought up a big portion of the resulting junk to feed its securitization maw.  The originator was New Century Mortgage Corp., which filed in bankruptcy in 2007.

The plaintiffs are African-American homeowners in Detroit who were sold New Century mortgages and who have ended up facing foreclosure. Also joining as a plaintiff is Michigan Legal Services, which has been swamped with mortgage cases in foreclosure ground zero, Detroit.

The legal theories used include the Fair Housing Act and the Equal Credit Opportunity Act, which are promising because these federal laws cover purchasing loans and also make disparate racial impact sufficient to make out a discrimination case. The 71-page complaint presents data that Detroit-area African-American customers of New Century were 70 percent more likely to end up in subprime loans than white borrowers with similar financial characteristics. The suit seeks a jury trial and disgorgement of ill-gotten gains, among other relief including appointment of a monitor (a good idea given the constancy of race discrimination in US housing finance practices).

Crystal Ball Department: Bankruptcy Filings to Rise in a Few Years

Good times in the economy mean goods times a few years later for bankruptcy professionals who deal with consumer cases.  We saw this from the mid-1990s through the 2000s. The last big party in the bankruptcy world was in 2010 (1.5 million non-business cases filed!), a few years after the end of the last debt binge came to a crashing halt starting in 2007.  The reverse is also true.  Bad times in the economy make for fewer bankruptcy filings a few years later, which is what we have been seeing lately.

Those of us who blog on Credit Slips get frequent calls from reporters asking about bankruptcy filing statistics, specifically:  what do they mean?  Filings, which are mostly consumer filings, have gone down steadily for two years now, so it gets hard to come up with anything new to say, as Bob Lawless recently wrote here.

When filings go down, reporters new to the bankruptcy beat often think that means the economy must be getting better. Wrong. What drives bankruptcy filings is debt.  Decreases in debt are followed a few years later by decreases in bankruptcy, and increases in debt are followed by increases in bankruptcy.  The Great Recession that started in 2007 resulted in a great decline in household debt due to a combination of reduced access to credit and consumers voluntarily cutting back on debt-driven spending because of a lack of consumer confidence.

It’s so old hat to talk about the continuing decline in bankruptcy filings, produced by a long process of household deleveraging (meaning taking on less debt and instead paying off old debt), that I’m going out on a limb with a prediction. We may finally be seeing signs of a reversal in progress—consumer confidence going up, which should drive up debt volume, and presto chango, we’ll see more bankruptcy in a few years. Bankruptcy attorneys, take heart: recovery will mean a return to your good times, too, but a few years hence. 

A Valuable Resource: NCBRC.org

Sometimes we forget that, with all its flaws, consumer bankruptcy is still a remarkable institution, providing meaningful relief to more than two million Americans a year (counting co-debtors and dependents). The system’s singular feature is that most individuals can find a private attorney to represent them at a relatively low flat fee, typically worth it in light of the benefits of a bankruptcy discharge to most debtors.  In other areas of consumer law, it is much harder for individuals to find a private attorney.  Despite changes in bankruptcy law in 2005 that increased the cost of access to the system, the consumer debtor bar has figured out how to deliver services for reasonable fees.

If the need to appeal arises, however, the affordability equation often breaks down, a problem made worse by the wretched drafting of the 2005 law, creating hundreds of difficult new legal issues.  A debtor in bankruptcy may have a good legal case on appeal but no way to pay a private attorney for the expense of researching and writing a brief and preparing for oral argument.  An appeal adds thousands of dollars of additional cost.  The National Consumer Bankruptcy Rights Center was formed to address this problem, helping to protect debtors’ rights as well as the integrity of the consumer bankruptcy system by making sure that cogent arguments are made at the appellate level.  NCBRC (pronounced Nic-Bric) provides assistance by either working directly with debtors’ attorneys or by filing amicus (friend of the court) briefs in courts throughout the country.

Anyone interested in consumer bankruptcy law should find NCBRC’s web site, www.ncbrc.org, useful as a resource, both for its bank of briefs and its blog about important consumer cases.

Some Advice from the IMF: Cramdown Mortgages in Bankruptcy

The International Monetary Fund has focused its critical gaze on us. Just in time for the holiday marking the end of our colonial period, the IMF has completed its "Mission to the United States of America."  See here.  The IMF has held up its neocolonial mirror and found us problematic: "The U.S. recovery remains tepid."  Anyone disagree? Annoying to have outsiders tell us the truth.

There are many recommendations about how we could reinvigorate our economy. Notably, at number 10, there is this:  "Consideration should also be given to allowing mortgages on principal residences to be modified in personal bankruptcy without secured creditors’ consent (cram-downs)."

Happy Independence Day!

Fighting Foreclosure Fatigue

Folks in Washington tell me there is a general sense of “foreclosure fatigue” in our nation’s capital. It’s just so boring to keep thinking about all the people losing their homes year after year. Can’t we move on to something new? This attitude goes along with a failure to do anything meaningful to get out of the five-year-old mortgage crisis, still very much with us. More charitably, the people who would like to do something see no political opening in an election year.

Looking back on all that time, there has been no shortage of good ideas; what has been lacking is will. Remember principal write-down in bankruptcy (aka, cramdown)? Peter Swire, who coordinated housing finance policy at the National Economic Council in 2009-2010, recently admitted that the administration should have pushed for it early on. “Cram-down, on balance, today, would have been a good idea,” he said.

Katie Porter Named Independent Monitor for California's Part of National Mortgage Settlement

California Attorney General Kamala Harris has appointed Credit Slip's own Katie Porter as independent monitor for California's part of the national mortgage settlement. The five financial institutions involved in the settlement have committed to provide California homeowners with up to $18 billion in benefits in the settlement. Katie will be monitoring on behalf of the California AG to ensure that they comply. For details, see http://oag.ca.gov/news/press_release?id=2646 and http://www.latimes.com/business/money/fi-mo-banks-settlement-20120315,0,5768422.story. Congrats to General Harris on a wise choice!

Now for the local news: Although Katie won’t be commenting here on the national settlement or California’s part of it as a Credit Slips blogger, she will still be able to comment on other issues involving consumer credit and consumer bankruptcy, as time permits. She will also continue to be a law professor at the University of California-Irvine. We also wouldn't be surprised if she builds some empirical research into the monitoring process, given her commitment to data-driven legal enforcement and policy-making.

HUD Inspector General fills in some details on robo-signing and other abuses

For those without enough reading after the legal document dump on Monday in the national mortgage settlement (see http://www.creditslips.org/creditslips/2012/03/national-mortgage-settlement-details-posted-on-the-web.html), there's more. Also released Monday were five audit reports about the robo-signing and other abuses in the foreclosure processes of the five financial institutions involved in the settlement. http://www.hudoig.gov/reports/featured_reports.php These reports indicate that higher ups were directing many of the abuses, evaluating line employees based on high volume production of documents without concern for their accuracy.

National Mortgage Settlement Details Posted on the Web

So maybe there is a settlement after all. Details have been posted on the National Mortgage Settlement web page today. http://www.nationalmortgagesettlement.com/ I won't try to summarize all this here immediately, but stay tuned for analysis of the good, the bad and the ugly. News outlets are reporting that settlement documents were also filed in federal court in Washington, D.C., today. The documents filed include a complaint and five consent judgments with hundreds of pages of detail on the settlement but much less on the underlying offenses. The settlement with state and federal regulators was announced February 8, and details have been eagerly awaited since then.

NACBA warns of student loan "debt bomb"

At its annual Capitol Hill Day in Washington this week, the National Association of Consumer Bankruptcy Attorneys sounded an alarm about the growing student loan problem, calling it a “debt bomb.” NACBA released a survey of its members indicating that more potential clients these days have unmanageable educational loans and are facing aggressive collection efforts. See http://www.nacba.org/Legislative/StudentLoanDebt.aspx. It has become common for people to have two mortgage-size debts, one for a home and another for an education. The educational loan problem is looking something like the one a few years back with subprime mortgages.

Absent “undue hardship,” very hard to establish, student debt can be a life sentence because these loans are not dischargeable in bankruptcy. NACBA supports making private students loans dischargeable again (as they were before the 2005 law). Beyond that, it favors going back to the pre-1990 approach of allowing discharge of any student debt after five years. If the education isn’t paying off enough to make the loan repayable after that much time, something has to give so that people can get on with their lives--and some day buy a home, start a family, and save for their kids’ education and their own retirement.

As a participant in the Capitol Hill Day, I found congressional staff reacted very sympathetically. They are mostly young people carrying big student loans or with friends who have them. They know how hard it is to manage this debt even when you have a decent job. They easily recognize what a big problem this is for their generation and even more so for the next one. This issue isn’t going away.

Congressmen Raise New Questions About FHFA Resistance to Principal Reduction

The heat is cranking up on the seat of Edward DeMarco, acting head of the Federal Housing Finance Agency and a holdover from the last administration who has been standing in the way of a meaningful response to the mortgage crisis. FHFA is conservator of FannieMae and FreddieMac, owners or guarantors of a large percentage of US home mortgages, and thus in a position to direct the mortgage giants to take steps that would save taxpayers money, provide relief to struggling underwater homeowners, and revive the US economy. Congressmen Elijah Cummings and John Tierney yesterday released a smoking letter to DeMarco explaining that his agency's own analysis shows that a principal reduction program could save taxpayers $28 billion. http://democrats.oversight.house.gov/images/stories/Cummings_Tierney_DeMarco.pdf Even more revealing, they say a FannieMae whistleblower has disclosed that FHFA was poised to implement a pilot program along these lines just before the November 2010 election but then pulled back for political reasons. Things seem to be getting more interesting. Could we finally see some movement on this critical issue?

How to Address Apparent Racial Disparity in the Consumer Bankruptcy System

The article discussed in the N.Y. Times story today is heavily empirical. It is also deliberately light on the prescriptive. Bob Lawless, Dov Cohen and I did make two modest proposals: (1) that a question about race of the debtor should be included on the form for a bankruptcy petition to make it possible to confirm (or disprove) the finding that African Americans file in chapter 13 at a much higher rate than debtors of other races (about double in the data we have), and (2) that all actors in the bankruptcy system—judges, trustees, attorneys and clients—be educated about the apparent racial disparity and the possibility that subtle racial bias may be producing it. The Times certainly helped with the second one!

Beyond that, we leave it to others and to each of us individually to come up with policy responses. In my view, Henry Hildebrand, a longtime chapter 13 trustee in Tennessee, got the big picture exactly right; he is quoted in the Times story as saying we should “use this study as an indication that we should be attempting to fix what has become a complex, expensive, unproductive system.” He will probably reappraise his views if he finds out that I agree with him! Those of us who participate in or study the system know that its complexity is onerous.

Principal Write-Down Pilot Program in Massachusetts

A Boston nonprofit, Boston Community Capital, is teaming up with some financial institutions, in particular Bank of America, in a pilot program that has the effect of writing down mortgages to close to home value. http://www.npr.org/2012/01/02/143601604/in-mortgage-crisis-some-banks-agree-to-cut-losses

BCC says it works with qualifying homeowners and banks to buy underwater homes, either in short sales or at foreclosure, and then sells them back to owners at just above current market value. The nonprofit takes the risk of making the resale and allows those buying back to use their own lender or a mortgage company that BCC works with. See the program’s FAQs: http://www.sunhomehelp.org/faq/sun

BCC is playing a gatekeeping role as far as who qualifies (there must be an ability to pay the written-down loan but an inability to pay the original loan). Also, BCC may have better credibility with distressed homeowners than financial institutions such as B of A do. The pilot is supposed to test whether such a program can be run without promoting “strategic default,” according to the NPR story.

Principal write-down is much needed relief to stabilize the housing market and reduce the lose-lose impact of foreclosure, so this is a pilot worth watching. A concern, however, is whether we can trust any reports that come out about it. There does not seem to be any neutral third-party such as an academic researcher studying what happens in the program. Also, a supposed fact cited in the NPR story is unattributed and highly doubtful—that 30 percent of private home loan modifications last year involved principal write-down. That certainly wasn’t true of the government-sponsored Home Affordable Modification Program, so if true about private modifications, it raises even more questions about the troubled HAMP.

People Are Not Corporations, and Financial Journalists Are Not Ordinary People

It is getting really old, the exasperation of entitled financial journalists that ordinary folks are not walking away from their underwater homes as much as they supposedly should. The latest to sound this tired refrain is James Surowiecki in The New Yorker (Living By Default, Dec. 19, 2011), who also makes the clichéd comparison to corporate decisions to shed debt using chapter 11 bankruptcy. He calls on underwater homeowners to do "the smart thing" by walking away.

According to Mitt Romney, “Corporations are people.” Whether or not you agree with that proposition, what is empirically true when it comes to debt is that people are not corporations. People don’t view walking away from debts that they can afford as a no brainer if it improves the bottom line. They agonize. They feel bad. They care about their homes and neighborhoods. Walking away is extremely painful, not a simple financial calculation. And, oh by the way, the further down you are in the 99 percent, the more likely that the financial calculation is negative, given impact on credit reputation from defaulting on a mortgage when your income is low. (On the other hand, many people worry about their credit reputations way after they have hit bottom and bankruptcy could actually improve their access to credit, more evidence that people don't take bankruptcy or any other form of walking away lightly.)

Is the Jig up for MERS?

The Mortgage Electronic Registration System (MERS) has been the target in a lot of lawsuits during the mortgage crisis for its shoddy, opaque practices. But because these suits tend to be brought by borrowers in default, the courts have been willing to stretch the law to dismiss plaintiffs' claims. Something new is going on now. The Delaware Attorney General on October 27 sued MERS, a Delaware corporation, for deceptive trade practices for sowing confusion among investors and consumers and running an extra-legal registration system riddled with errors. The Delaware AG, Beau Biden, son of the vice president, is invoking the importance of transparent recording of property interests as a central part of American democracy since the colonial era. Some other AGs and other public officials are pursuing similar legal theories. The argument is that nothing is more important to our democracy than secure property rights recorded in transparent public records, and that the mortgage industry should not be permitted to take this away from us. To read about this new development, visit the Delaware Department of Justice web site, at http://attorneygeneral.delaware.gov/

Financial Stability Board Calls for Effective Consumer Finance Protection

The Financial Stability Board, an international organization operating under the auspices of the G20 countries, this week issued its Report on Consumer Finance Protection. http://www.financialstabilityboard.org/publications/r_111026a.pdf FSB emphasizes the link between international financial stability and consumer protection, particularly in the mortgage markets. It calls for regulation to assure assessment of borrowers’ ability to pay and to police credit product features that increase risk. The report engages in some comparative analysis and identifies national regulatory architecture that has been particularly effective, such as that of Australia. The report is part of an initiative to stimulate more international discussion of effective means of consumer protection, particularly concerning credit. FSB increasingly sees consumer protection as part of its mission to assess and address vulnerabilities in the international financial system. The report is worthy and sensible. Of course, implementation, primarily by domestic regulation of financial institutions, is a huge challenge.

Mortgage Documentation Issues Close to (My) Home

The Arizona Supreme Court currently has under review a mortgage documentation case, Vasquez v. Saxon Mortgage, Inc. Just by chance, the Court was on its annual visit to the University of Arizona law college, where I teach, for the oral argument on Sept. 22. So of course I was in the audience at the argument, along with my students from our new Mortgage Clinic and a related course, called the Mortgage Crisis. We’ve been analyzing and debating the opposing arguments since.

Brain-Injured Marines and For-Profit Colleges

Military personnel have long been targets of predatory creditors, going back to the moneylenders who followed the Roman legions. More recently, payday lenders clustered storefronts around military bases. The latest development is that subprime operators are hawking degrees at for-profit colleges to former and current service members.

Holly Petraeus, who heads up service member affairs in the federal Consumer Financial Protection Bureau, has a powerful account in an op ed for the NY Times of the targeting of current and former military personnel by for-profit colleges, including some seriously brain-injured Marines at Camp Lejeune, N.C. Appointing Petraeus, whose husband David is CIA director and former commander of American forces in Iraq and Afganistan, to this post was a stroke of genius. When general consumer protection arguments fail to get much traction, finding some military victims seems to help get the message across.

"Homeowners Need Help"

That's the headline of the lead editorial today in The New York Times.  The Gray Lady urges the Obama Administration to adopt solutions that reduce principal to restore homeowner equity as an essential step to economic recovery.  Principal pay down in bankruptcy gets a mention.  

Principal Pay Down in Chapter 13 as a Means of Foreclosure Prevention

As we have discussed recently, here and here, the Federal Housing Finance Agency has asked for ideas about how to dispose of foreclosed properties in bulk.  But there is no reason we shouldn’t take this request as also encompassing reducing foreclosed inventory by preventing foreclosures to begin with.  FHFA has the power to implement either type of program for loans or properties controlled by Fannie or Freddie, the government-sponsored entities under FHFA conservatorship.

So let’s talk about the idea of Principal Pay Down (PPD) in chapter 13 bankruptcy as a foreclosure prevention strategy.  FHFA could direct the GSEs to go along with chapter 13 plans that propose to pay down principal over five years, thus affecting a broad swath of home mortgages.

Here are the elements of PPD

The US Government and the Foreclosure Crisis: Out of Ideas or Out of Will?

It’s old news that federal housing agencies need better ideas about what to do about the foreclosure crisis.  The new development is that they realize it and have issued a blunderbuss “RFI” (request for information) seeking ideas from anyone willing to write in by September 15 describing business structures for the government to off-load foreclosed properties it is holding, particularly in “large scale transactions” to deal with the scale of the problem of lingering “inventory.”  See here.   An RFI is something short of an RFP (request for proposals).  Indeed, this new RFI is careful to note the distinction and also that there may never be a call for actual proposals.   So let’s not get too excited.  Furthermore, the problem of the continuing foreclosure crisis seems to be less about ideas than about will to act.  Most disturbing, the RFI does not even allude to the possibility of beefing up foreclosure prevention as an important way to stem growth in the volume of unsold and vacant foreclosed homes.

So first, what is the government looking for?  Specifically, the Federal Housing Finance Agency (FHFA), in consultation with Treasury and HUD, seeks new options for selling foreclosed one-to-four unit properties held by Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA).   Bulk sales might be for resale, rental or demolition.

For-Profit Higher Education Industry Sues to Block Weak “Gainful Employment” Rule

Last week the Association of Private-Sector Colleges and Universities (aka the Career College Assn.) filed suit in U.S. District Court in Washington, D.C., to block enforcement of the U.S. Dept. of Education’s “Gainful Employment” regulation, issued in June.  See here for the complaint.   The for-profit colleges are challenging the agency's authority to issue that regulation.  It requires that, to be eligible to receive federal grant and loan funds, the colleges must show that 35 percent of former students are paying something (even $1) on their student loans (or that they must meet other benchmarks set in terms of debt to income).

So let’s back up and put this issue in context.  There is lately a general unease about whether the cost of higher education is worth it, even though income rises and unemployment decreases steadily with successive degrees (except that PhD’s are more likely to be unemployed than those with professional degrees, hardly a surprise).  See here.   

New Resource: NCLC's Bankruptcy Mortgage Project

The National Consumer Law Center has launched a useful new resource for the bankruptcy community called the Bankruptcy Mortgage Project. See here. Those likely to find it handy include judges, consumers, trustees, mortgage servicers, attorneys, and academics. The website, created with a grant from the National Conference of Bankruptcy Judges’ Endowment for Education, collects all sorts of documents related to mortgage issues in consumer bankruptcy cases. It thus provides easy, free access to various local rules, forms, general orders, and court opinions.

Mortgage Modification Mystery

Media reports have recently focused on big banks spontaneously offering mortgage modifications, even including principal reduction, to borrowers who are not in default and who haven’t even asked for them. See here.  The banks mentioned, JPMorgan Chase and Bank of America, both took over a lot of nasty mortgages from failed financial institutions (Washington Mutual and Countrywide Financial).

The modifications seem to be going in particular to current but underwater customers with pay option ARM mortgages (which allowed debtors not to pay for a while and add skipped payments to the principal).  Industry analysts have explained the banks’ actions as getting ahead of a problem that could affect their stock prices.  See here.  Apparently banks have been quietly modifying current mortgages for years, and hundreds of thousands of people, maybe more, have gotten improved deals this way.

But there is still a mystery.  Why don’t the banks wait for a missed payment or at least a request before making an offer?

Responsible Lending as an Emerging International Norm

The International Association of Consumer Law, with participants present from six continents, has been meeting at Brunel University in West London the last few days, hearing presentations from regulators, industry representatives, consumer advocates, and academics.   http://qwww.brunel.ac.uk/bls/research/events/ne_41734   Not surprisingly, regulation of consumer credit has been a prime focus, giving some perspective on US struggles to achieve more effective consumer financial protection. 

Professor Iain Ramsay of the University of Kent in the UK reported on initiatives for international cooperation to enhance consumer financial protection.   The G20, World Bank, Financial Stability Board, and Organization for Economic Co-operation and Development are all on board with this goal, seeing it as an essential part of a program to ensure that the international financial system is safe and sound.  The OECD is expected to issue draft principles of consumer financial protection soon, and comments will be invited.  Given the primarily prudential role of these organizations, balance from other sectors will be important.

Ramsay raised an underlying and overlooked question:   what is the economic and social value of consumer credit?

Ransom Argument--Not Very Edifying

The very first case argued today, the opening day of the 2010 Supreme Court term, was Ransom v. MBNA. Ransom presents an issue at the heart of the bankruptcy means test. The question for the Court is whether an above-median-income debtor in chapter 13 who does not currently have a car payment can take the IRS allowance for vehicle “ownership expense” as part of the means test. This issue also arises in chapter 7. You can find the transcript of the oral argument here. http://www.supremecourt.gov/oral_arguments/argument_transcripts/09-907.pdf

As with any oral argument, it is hard to know what to make of it as far as prediction as to the outcome. I will refrain from critiquing the lawyers’ arguments. I will merely note that Katie Porter recently asked why the government was involved and that although an answer to that question was not forthcoming, the government lawyer did end up serving the function of presenting a simple argument that the justices could (barely) follow.

The Thorne-Porter Financial Education Study

Last week, a short item was posted on a bankruptcy listserv about the excellent new paper by Deborah Thorne and Katherine Porter, Debtors’ Assessments of Bankruptcy Financial Education, available on ssrn.com.  Despite the insights of the paper about the wisdom (or lack thereof) of the requirement of financial management education in bankruptcy and about how to improve the education as long as it remains a condition for bankruptcy discharge, the listserv item (predictably) unleashed a lot of venting by consumer bankruptcy attorneys.  I share their pain, but I still feel strongly that the paper is extremely valuable (a dream from a researcher’s point of view, for how much light it sheds).

Don’t Let Servicers Be Mortgage Relief Gatekeepers (Again)

Thanks to Chris Mayer for taking the time to comment on my earlier posting and for providing more information about his mortgage relief and stimulus proposal (with Glenn Hubbard). First, let’s focus on his statement that, “Servicers must run any program, but ours would be directed by the Treasury Department and would require compliance.”  HAMP, the administration’s troubled mortgage modification program, is run by the Treasury Department and theoretically requires compliance by participating servicers, but that is very different from actual compliance. Servicers, as I noted before, have done “a terrible job” under HAMP, to quote Secretary Geithner, who nonetheless has refrained from invoking enforcement powers. Debtors frequently experience a run-around trying to get a HAMP modification.

Mortgage Relief for All; But Who’s Paying??

Glenn Hubbard is the dean of the Columbia Business School as well as the former chairman of the Council of Economic Advisors under President George W. Bush. That resume is what makes so puzzling his op ed (with a Columbia colleague, Chris Mayer) in yesterday’s Sunday NY Times: Op-Ed Contributors:  How Underwater Mortgages Can Float the Economy. Maybe I shouldn’t be surprised that their proposal seems unhinged from reality.

The Good, the Bad and the Ugly of Mortgage Servicing and Implications for Mortgage Modification

It looks as if the mortgage cramdown--er, modification--legislation will be sitting around for a while, at least until the stimulus package gets through Congress. So it seems worth talking about its reference to making "payments of such modified loan directly to the holder of the claim" instead of through the Chapter 13 trustee. Although this language was still in the manager’s version of the bill (H.R. 200) as of last week, apparently discussions continue in Washington about whether this is the best policy approach.

A big reason for needing trustees in the picture is to keep track of mortgage payments, because servicers make a lot of errors. There are apparently new servicing companies that are trying to avoid the problems that have been rampant in the industry in the past—dare we hope that some good servicers are coming on line? But no doubt there are still many of the bad (careless) and the ugly (those who are deliberately charging unreasonable or illegal fees during bankruptcy). I'd be interested to hear whether anyone is seeing improvement in this industry since the new focus on its shortcomings.

As a policy matter, the argument for payment of mortgage obligations through the Chapter 13 trustee, rather than directly, is that this approach likely makes it easier for debtors to complete their plans and keep their homes without an expensive fight at the end about whether they are up to date on payments. Putting Chapter 13 trustees in charge of disbursements gives debtors the benefit of their superior record-keeping ability and understanding and their leverage with servicers because of their continuing relationships. While lawyers in areas that have not had a practice of conduit payment of regular mortgage amounts through the trustee often oppose that approach on the assumption that trustee fees will make plans infeasible, the evidence seems to be that conduit payments result in the percentage fee going down. Most trustees already top out on the compensation they are allowed by law. Lower percentage fees in conduit trusteeships may mean that most debtors do not have a problem with feasibility, although unsecured creditors may get paid less. There may be some debtors at the margin who won’t be able to afford a plan if they have to pay trustee fees, but courts could make exceptions in such cases on feasibility grounds (feasibility can cut in different directions depending on the case).

Calling All Article 9 Supernerds--Negative Equity and State Law

What’s a blog for?  For law professors, a key attraction is to float a question you don’t have time to write a law review article about.

As a matter of state (not bankruptcy) law, should a loan be considered all purchase money if the lender makes a consolidation loan for purchase of collateral and also for paying off an old obligation, all secured by the collateral being purchased?  In particular, what are the policy implications for Article 9 purposes of defining purchase money obligation that broadly?

In bankruptcy, the definition of “purchase money security interest” determines the scope of the “hanging paragraph” in chapter 13--specifically, if “negative equity” on an old loan is rolled into a new purchase money loan, whether the whole loan should be treated as a purchase money obligation so that it can’t be crammed down (assuming that is the treatment under the hanging paragraph).

Under state law, the question of the meaning of “purchase money obligation” is not confined to car loans or even consumer loans.  The definition sets the scope of special purchase money provisions in Article 9 that extend to commercial finance for purchase of equipment and inventory.  Should the leap-ahead priority for purchase money obligations apply to rolled in negative equity?   Could this have perverse effects?  In the case of consumer loans for items outside certificate of title laws’ reach (i.e., collateral other than cars and boats), should automatic perfection extend to “negative equity” on some other old loan the balance of which is rolled into a loan for purchase of a washing machine or a diamond ring?

Mortgage Cramdown--Layering On Complexity

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.

Treatment and the European Perspective: Why Don't We Ask Whether US Debtors in Bankruptcy Have Other Social Problems?

European debt adjustment systems have built in an assumption that people with debt problems also have higher incidence of other social problems—substance abuse, family dysfunction, weak impulse control, and perhaps also mental health problems such as depression and anxiety.  Social work has long been part of their systems for addressing problems of debtors, before and after European countries adopted laws beginning in the late 1980s to give debtors a discharge, generally after completion of rather long repayment plans (to show rehabilitation into more moral ways of behaving, while living at a subsistence level).  The European view has been that other problems drive overindebtedness, which in turn makes those problems worse.

In the US, we don’t seem to be giving much attention to these questions.  Is anyone aware of studies of US debtors in bankruptcy to see if they have higher incidence of other social problems such as those listed above?   And have Europeans empirically studied their theory that deviance drives debt?

Is Greed Good? The Professor vs. The Senator

This is going to be really big picture. It's about the differences between formal economic theory, on the one hand, and ordinary thought about economic questions, on the other. It pits the views of an anonymous college professor (as reported by a freshman student) against the views of a famous US Senator (as reported by CNN). 

I have a 19-year-old son (with a different last name from mine) who is a freshman in college, taking first-year college economics from a teacher who received his PhD at Wharton and worked in various business economics jobs before returning to academe. My son is finding the dismal science, well, uninspiring. He almost dropped the course after the first class because he thought he was being asked to become a true believer and study "theology rather than religion." My husband and I encouraged him to stick it out, and we pointed out that the online syllabus showed that the second lecture was about the question whether economics is the "the dark side," so maybe he was going to get more than one perspective. Here's the e-mail we got home after the second lecture:

Subject:  why economics is the dark side

I thought I'd update you on that lecture you both seemed so excited about.

Prof. [X] explained that Economics is a valuable tool for modeling social interactions, but cautioned against too much faith in the market. He pointed out that unfettered capitalism can lead to the accumulation of capital in the hands of an elite minority, who can use their wealth to influence the creation of political, social, and economic structures that subjugate large portions of the populace and interrupt the free flow of resources to further concentrate power in the hands of the few.

oh wait, no, that's not what he said, that's the truth.

According to Prof. X, many are skeptical of Economics and capitalism for the following reasons:

1) Traditionally, the upper class has scorned participation in business, making commerce the province of a minority without political rights, who become scapegoats for social ills (Jews are the best example of such a group, but Indian and Chinese diasporas are other good examples).

2) Moralists hate economists because they think it's wrong to say people are motivated by greed.

3) Marx is a synthesis of the above two attitudes. Marx was a big ol'  anti-semite, and this explains his skepticism for capitalism (oddly enough, the fact that Marx was a non-practicing Jew didn't really come up).

Ah! intellectual sophistication.  [End of e-mail]

Good Government (Under Threat) Down Under

Australia has a bankruptcy system worth studying. Among other merits, it collects and publishes more facts about its system on line than any other.  http://www.itsa.gov.au/dir228/itsaweb.nsf/docindex/about+us-%3Epublications-%3Epublications?opendocument

Prior to 1996, Australia probably had the most sensible bankruptcy system in the world. Bankruptcy is simple enough there that people can file without paid professionals to help them. Rather than means testing that adds costs and thus bars destitute debtors at the threshold, Australia imposes a "surplus income" payment requirement on debtors who file in bankruptcy and have income above a relatively low threshold. Last year, just over 15 percent of Australian debtors had to pay something to get a discharge, while the rest of debtors weren’t burdened with a complicated "means test" to get into bankruptcy.

There is only one problem with this story; it was too good to be true. In 1996, Australia amended its law to create a "debt agreement" option. It sounded great; family members and neighbors would pitch in to help debtors negotiate with creditors to work out their debts and avoid the "stigma" of bankruptcy. But commercial debt administrators revved up operations to promote this option, and within a few years, they were charging hefty fees and getting a lot of poor people to use it. Well over half of those who proposed debt agreements failed either to get their proposals approved or to complete their plans. Sound familiar?

Is Financial Education a Good Idea and Whose Idea Is It Anyway?

Educators find it hard to be against education, and I am no exception to that rule. But some evidence from JumpStart Coalition, which promotes financial education for young people, is cause for pause. Its last survey of high school students, conducted among 5775 12th graders in 37 states in 2006, found that those who had taken a financial literacy course actually did slightly worse on its financial literacy test than students who had not taken a course. See www.jumpstart.org/fileuptemp/2006GeneralReleaseFinal%202.doc (Thanks to Professor Lauren Willis of Loyola of Los Angeles School of Law for pointing out this information in an excellent presentation on financial literacy education at the Association of American Law Schools annual meeting in NYC earlier this month.)

There are many possible explanations for the JumpStart survey result. JumpStart also found that kids from more affluent families did better on the test. It is not surprising that factors and influences other than taking a course have a lot to do with learning about finances. It is also possible that the courses the students took were not very good, either in the content or teaching methods.

JumpStart’s list of "corporate partners" gives you a pretty good idea of who wants to promote the idea of "financial literacy."  http://www.jumpstart.org/advisor.cfm  The many financial institutions on this long list presumably think financial education will not have much effect on the willingness of consumers to pay lots of interest and fees on high balances of various kinds of debt. Rather than push for financial education, maybe financial institutions should work on offering simpler products that are easier to understand and compare.