Why Bankruptcy Professionals Care About Credit Default Swaps

This is a great article from the American Bankruptcy Institute regarding credit default swaps and why they are important to bankruptcy professionals. (Membership required to access article.)

A credit default swap (CDS) (essentially) is a contract in which the holder of the indebtedness (the creditor) pays a third party to guarantee payment of the debt. When a "credit event" occurs (e.g., default in payment), the third party is required to purchase the debt from the original creditor with a given period of time. The parties (creditor and third party) are swapping risk for return. The creditor will get less interest on the debt, but is guaranteed full payment of the principal, so the risk goes down. The third party shoulders the risk of default, but gets the increased interest to compensate for the risk.

So why does this matter in the bankruptcy arena? If a debtor calls a lender trying to workout a loan modification and the lender has a CDS on the debt, they will tell the debtor: "Why should I work out a modification with you? I'm going to get paid in full for this debt." Now, once the debt is swapped to the third party, the third party may or may not be willing to work out a loan modification based on the reason the third party bought the CDS. However, in the confusing morass of figuring out who owns the debt and which of the possible owners might be willing to work with him, the debtor usually gets discouraged and figures there is no way to save his home.

This is yet another reason why allowing mortgages of personal residences to be modified in bankruptcy makes a great deal of sense.

Modern Money Mechanics

Modern Money Mechanics is a workbook originally published by the Federal Reserve Bank of Chicago. (First publication in June 1961; last updated June 1992; now out of print.) This little pamphlet does a fantastic job of describing exactly how our money system works in the U.S. Most people have no clue how this works, but the effect of monetary policy on our everyday lives is a hot issue right now and for those who want to know, this is a good resource. (For a link to the PDF version of the workbook, click here.)

Particularly fascinating is the expansion and contraction of the monetary supply made possible by the fractional banking reserve system. You could end up with $90,000 worth of assets and liabilities based on $10,000 in deposits.

New Bill Introduced to Allow Mortgage Modification in Bankruptcy

Senator Durbin recently introduced S. 3690 that would allow modification of mortgages in Chapter 13 bankruptcy. The operative text of the legislation is as follows:

SEC. 103. HELPING FAMILIES SAVE THEIR HOMES IN BANKRUPTCY.
(a) Special Rules for Modification of Loans Secured by Residences.--
(1) IN GENERAL.--Section 1322(b) of title 11, United States Code, is amended--
(A) in paragraph (10), by striking ``and'' at the end;
(B) by redesignating paragraph (11) as paragraph (12); and
(C) by inserting after paragraph (10) the following:
``(11) notwithstanding paragraph (2) and otherwise applicable nonbankruptcy law--
``(A) modify an allowed secured claim secured by the debtor's principal residence, as described in subparagraph (B), if, after deduction from the debtor's current monthly income of the expenses permitted for debtors described in section 1325(b)(3) of this title (other than amounts contractually due to creditors holding such allowed secured claims and additional payments necessary to maintain possession of that residence), the debtor has insufficient remaining income to retain possession of the residence by curing a default and maintaining payments while the case is pending, as provided under paragraph (5); and
``(B) provide for payment of such claim--
``(i) in an amount equal to the amount of the allowed secured claim;
``(ii) for a period that is not longer than 40 years; and
``(iii) at a rate of interest accruing after such date calculated at a fixed annual percentage rate, in an amount equal to the most recently published annual yield on conventional mortgages published by the Board of Governors of the Federal Reserve System, as of the applicable time set forth in the rules of the Board, plus a reasonable premium for risk; and''.

As I have opined before (and here and here), there are many reasons why allowing mortgage modification in Chapter 13 makes a great deal of sense. Here are a couple more reasons:

1. Almost all of the mortgages in this country are held in trusts. Each of these trusts has a whole panoply of parties responsible for various aspects of the mortgage, many of which have conflicting interests. Often, the various parties to the trust don't want to act for fear of being sued or don't want to act in a way that is in the interest of the investors because that is against that parties' interest.
2. These trusts are known as REMIC trusts and are given special tax treatment. That tax treatment can be threatened if too many of the mortgages are modified.

By allowing mortgages to be modified in Chapter 13, both of these sticky conflicts are avoided and the Bankruptcy Code can accomplish what it was intended to do: give the debtor a fresh start and treat all creditors fairly.

Mortgage Companies Afraid to Modify Mortgages Because of Securitization Mess

This article from the New York Times has an interesting quote:

So far, many companies have been reluctant to aggressively reduce payments because they are afraid that borrowers might default again or that investors in mortgage securities might file suit.

Almost all of the mortgages out there have been securitized. Click here for a colloquial explanation of mortgage-backed securities. This means that the mortgages have been pooled and sold to a trust, and shares of the trust have been sold to investors. The trusts hire servicers to interact with the borrowers. Those servicers are bound by a pooling and servicing agreement, which usually provides a maximum amount of mortgages that can be modified in any particular trust. Usually, the number is around 5%. Default numbers for many of these trusts are climbing over 30% now, so there are a lot more than 5% of the mortgages that need to be modified.

However, the lenders are afraid to modify, because they might get sued by the investors. So, they are sitting pat, doing nothing, while millions of homeowners are losing homes that could have been saved with a reasonable loan modification. This is another great reason to allow modification of mortgages in Chapter 13 bankruptcy. This would remove the whole servicer/investor dynamic and would rely entirely on the value of the house. The investor couldn't sue the servicer, because it was the bankruptcy court that modified the mortgage

Bloomberg: It's Easier to Keep a Second Home in Chapter 13 than your Primary Residence

Interesting analysis on Bloomberg.com stating that it is easier to keep your rental or beach house than your primary residence. Unfortunately, this is true and, in my opinion, should be changed. Currently, the law allows you to modify mortgages on real property if the real property is not the principal residence of the debtor. If, however, the residence is the principal residence of the debtor, you can't modify it and are stuck with the terms, however horrific. Following is the story from Bloomberg:

Buy a Beach House for Shelter When Going Bankrupt: Ann Woolner

Commentary by Ann Woolner

Oct. 17 (Bloomberg) -- Say an absentee landlord owns the house next to yours. Neither of you keep up your mortgage payments.

If you both declare bankruptcy, chances are better that he would keep his place than you yours. However beloved your home or settled your family is in the neighborhood, you can't force your mortgage holder to change its terms to escape foreclosure.

The landlord can.

Bankruptcy law favors the landlord over the homeowner when it comes to modifying mortgages. It's easier to hold onto a second home at the beach -- and a boat to go with it -- than your home sweet home.

Backward? Absolutely.

A speculator with slum properties all over the city, who owns a place in Manhattan and a house at the Hamptons, gets better treatment under bankruptcy law than a salaried worker's family with only one, modest bungalow.

``Current law permits modification of any type of debt in bankruptcy except for a single-family principal residence,'' says Adam Levitin, who teaches law at Georgetown University.

``You can modify credit-card debt. You can modify student loans. You can modify debt on a yacht,'' points out Levitin.

The one item that bankruptcy can't force a creditor to alter is the loan on the roof over your head. And yet, that's the debt most deserving of modification to help the economy recover and to offer some sense of stability to the debtor.

Vacant Houses

As vacant houses scar neighborhoods and each day brings 10,000 new foreclosure filings, the surplus of empty abodes drags down an economy made sick by reckless lending.

The housing bubble's burst deflated home values below what some folks owe on them. But they still owe it, unless the lender agrees to alter the mortgage.

Otherwise, even in bankruptcy, homeowners still must meet those monthly payments toward the full principal and interest or find themselves out of their home and into somebody else's rental property, if they can afford the rent.

As foreclosures soar, so do bankruptcy filings -- almost 29 percent more in September than the year before, according to the American Bankruptcy Institute.

``We expect 1.1 million new cases by year end,'' the institute's executive director, Samuel Gerdano, said in a statement earlier this month.

Same Treatment

Why not give the primary home mortgage the same treatment in bankruptcy that goes to the second home and to every other debt obligation?

Presented with the chance to do that in April, the U.S. Senate rejected it 58-26, refusing to make it part of the housing bill. The yeas were all cast by Democrats; most of the nays came from Republicans. (Neither of the senators running for president cast votes, although Barack Obama co-sponsored it and has a similar proposal as part of his economic revival plan.)

``If the federal government is going to ride to the rescue of investment banks on Wall Street, it should also provide some relief to those who are about to lose their homes on Main Street,'' said the bill's sponsor, Democrat Richard Durbin, Illinois's other senator.

Way back then, the only rescue the government rode in for was that of Bear Stearns Cos., which was sold in March to JPMorgan Chase & Co. with help from the Federal Reserve.

Unimaginable in April were all the subsequent bailouts. But bankrupt homeowners are still waiting for help.

When Congress was voting on the super-duper, $700 billion bailout plan early this month, Democrats tacked the Durbin amendment onto it, where it stayed for days until it finally was sacrificed to woo Republican votes in the House.

Industry Opposition

The opposition stems from the mortgage industry, which says if lenders never know whether the original terms of the loan could be changed by a bankruptcy judge, interest rates on primary homes would soar by 1.5 percentage points.

``That's just laughable on its face,'' Levitin says. He says interest rates on loans for investment property tend to be only 0.38 percentage points higher than for primary homes mainly because of the extra risk that the borrower won't repay.

It will take a law to undo the restrictions imposed on home mortgages by the 1978 bankruptcy code.

``The sad thing is we've been pushing for this for about a year and a half, two years,'' says Henry Sommer, president of the National Association of Consumer Bankruptcy Attorneys.

``It probably could have somewhat ameliorated the crisis we are facing now,'' says Sommer, who practices in Philadelphia.

Maybe next year.

In the meantime, if you find yourself in bankruptcy and have two homes, don't expect your lender to cut you a deal on the one where you live.

But you just might be able to get a break on the beach house. And wouldn't that be more pleasant than that rental property next door?

(Ann Woolner is a Bloomberg news columnist. The opinions expressed are her own.)

To contact the writer of this column: Ann Woolner in Atlanta at awoolner@bloomberg.net.

Forrest Gump Explains Mortgage-Backed Securities

O. Max Gardner, III, one of (if not the) premier consumer bankruptcy lawyers in the country apparently spoke with Forrest Gump recently and got the following explanation of the mortgage mess:

Mortgage Backed Securities are like boxes of chocolates. The criminals on Wall Street stole several chocolates from the boxes and replaced them with turds that looked liked chocolates. Their criminal buddies at Standard & Poors, Moodys, and Fitch rated these boxes AAA Investment Grade gourmet chocolates, fit for a king so they could obtain the highest price and worldwide distribution. The boxes were then sold all over the world to investors and kings who loved gourmet chocolate. Eventually while eating their gourmet chocolates, the Kings and investors picked a "chocolate" out of the box to eat; bit into the chocolate and discovered it was a turd instead of a gourmet chocolate and thus, the fraud is exposed! Word spreads fast amongst the world's kings and investors who enjoy gourmet chocolates and suddenly no chocolate lover, loves or trusts American chocolates anymore around the world or wants to buy a box of American chocolate. The fear of eating turds spreads to Belgian and Swiss chocolates too. No one wants to eat turds! Suddenly, there is no market for gourmet chocolates and the fear spreads to chocolate milk, covered strawberries, and anything mixed with or made of chocolate!

Hank Paulson now wants the American taxpayers to buy up and hold all of the boxes of the turd-infested chocolates for $700 billion dollars until the worldwide market for chocolates return to normal. Yet, the turds are still in the boxes waiting for someone to bite into them again. Meanwhile, Hank's buddies who helped him make a billion dollars on turd infested boxes of gourmet chocolates, the Wall Street criminals who stole all the good chocolates, are not being investigated, arrested, or indicted.

Forrest's Mama always said: "Sniff the chocolates first, Forrest".

Surprise!! Bankruptcy Filings are Up Again.

Last year (2007), bankruptcy filings for the Eastern District of California were up almost 100% over the previous year. This year (2008), they will be up almost another 100% over last year (i.e., about 400% over 2006). Here are the nitty gritty numbers. This doesn't show any sign of cooling off anytime soon.

Application of Mortgage Payments

The First Circuit recently decided the In re Nosek appeal. The case involved a lady who suffered substantial damages because a mortgage company misapplied payments received during the bankruptcy case. The Bankrtuptcy and District Judges both held that she was entitled to substantial damages under the Bankruptcy Code. The First Circuit agreed that it was a difficult circumstance for the debtor, but found no part of the Bankruptcy Code that provided a remedy for her. In doing so, the First Circuit stated as follows:

Morever, even if such a threat had been demonstrated by those practices, there was no language in Nosek's Plan, as it was confirmed, or in § 1322(b), that addressed how Ameriquest was to apply the payments it received from Nosek or from the trustee. Under such circumstances, the Plan would have to be amended to prescribe the accounting practices necessary to protect Nosek's right to cure before Ameriquest could be sanctioned for a violation of an order of the bankruptcy court.
In the absence of such specificity, there was no violation of § 1322(b) or the Plan and therefore no basis upon which to award Nosek damages under § 105(a). Because the bankruptcy court's judgment in the adversary proceeding is vacated, the order confirming Nosek's Third Amended Plan, which was based on the erroneous damages award, also must be vacated.

The court also acknowledged that new code section 524(i) was relevant to the discussion at footnote 15: "Congress's enactment of § 524(i) of the Bankruptcy Code
confirms the widespread nature of these problems and the difficult
issues that courts have faced addressing them."

Section 524(i) creates a new remedy for a debtor where the plan provides that mortgage payments are to be applied in a particular fashion and the creditor fails to do so. That section provides as follows:

The willful failure of a creditor to credit payments received under a plan confirmed under this title, unless the order confirming the plan is revoked, the plan is in default, or the creditor has not received payments required to be made under the plan in the manner required by the plan (including crediting the amounts required under the plan), shall constitute a violation of an injunction under subsection (a)(2) if the act of the creditor to collect and failure to credit payments in the manner required by the plan caused material injury to the debtor.

I think the Nosek case gives a prime example of why it is important to include language in a plan that explains how payments should be applied. I will post langauge I am currently using below, but I would note that at least one judge has rejected this language and I do not make and recommendation or warranty regarding these plan provisions:

7.11 - Application of Payments. Confirmation of the plan shall impose a duty on the holders and/or servicers of claims secured by liens on real property (1) to apply the payments received from the trustee on the pre-petition arrearages, if any, only to such arrearages; (2) to apply the direct mortgage payments, if any, paid by the trustee or by the debtor(s) to the month in which they were made under the plan or directly by the debtor(s), whether such payments are immediately applied to the loan or placed into some type of suspense account; (3) to notify the trustee, the debtor(s) and the attorney for the debtor(s) of any changes in the interest rate for an adjustable rate mortgage and the effective date of the adjustment; (4) to notify the trustee, the debtor(s) and attorney for the debtor(s) of any change in the taxes and insurance that would either increase or reduce the escrow portion of the monthly mortgage payment; and (5) to otherwise comply with 11 U.S.C. Section 524(i).

7.12 - Notice of Additional Charges. The holder and/or servicer of a mortgage claim ("Mortgage Creditor") shall provide to the debtors, debtors' attorney and trustee a notice of any fees, expenses, or charges which have accrued during the bankruptcy case on the mortgage account and which the Mortgage Creditor contends are 1) allowed by the note and security agreement and applicable nonbankruptcy law, and 2) recoverable against the debtors or the debtors' account. The notice shall itemize the fees, expense or other charges. The notice shall be sent annually, beginning within 30 days of the date one year after entry of the initial plan confirmation order, and each year thereafter during the pendency of the case, with a final notice sent within 30 days of the filing of the trustee's final account under Bankruptcy Rule 5009. The failure of a Mortgage Creditor to give such notice for any given year of the case's administration shall be deemed a waiver for all purposes of any claim for fees, expenses or charges accrued during that year, and the Mortgage Creditor shall be prohibited from collecting or assessing such fees, expenses or charges for that year against the debtors or the debtors' account during the case or after entry of the order granting a discharge.

7.13 - Mortgage Current Upon Discharge. Unless the Court orders otherwise, an order granting a discharge in this case shall be a determination that all prepetition and postpetition defaults with respect to all Class 1 mortgages have been cured, and that the mortgage account is deemed current and reinstated on the original payment schedule under the note and security agreement as if no default had ever occurred.

Is the Proposed Bailout Good . . . Or Really Bad?

For average Americans watching from the sidelines, the proposed mortgage bailout looked like something straight out of the Communist Manifesto. Perhaps that is why it was so unpopular everywhere but Wall Street and Washington, D.C. As this author describes, the bailout does look like something Karl Marx would have approved.

In his Communist Manifesto, published in 1848, Karl Marx proposed 10 measures to be implemented after the proletariat takes power, with the aim of centralizing all instruments of production in the hands of the state. Proposal Number Five was to bring about the “centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly.”

If he were to rise from the dead today, Marx might be delighted to discover that most economists and financial commentators, including many who claim to favour the free market, agree with him.

The author goes on to point out that only the Austrian School of economics realistically opines that the boom cannot go on forever. Interestingly, I have been reading a history and analysis of the Great Depression by Murray N. Rothbard, called America's Great Depression. You can download a PDF copy of the book from the Mises Institute (which embraces the Austrian School of economics) here. Rothbard was (and may still be) with the Mises Institute. The essential premise of the book is that there will always be a boom and bust cycle in the economy and that government intervention can lengthen the boom cycle, but when the bust cycle comes around it will be much worse. That is what we saw with the Great Depression and it looks like that may be what is happening now.

CCBA Institute - September 18 & 19, 2008

The Central California Bankruptcy Association 22nd Annual Institute will be held this week, September 18 & 19. The Institute brings bankruptcy professionals together from all over central California to discuss various bankruptcy issues. You can download the Institute flyer and program here. There is also a golf tournament held in conjunction with the Institute. Check out the website for more information about the Institute and how to join the CCBA.

Goodbye Negative Equity!

One of the changes under the 2005 BAPCPA is that car creditors' claims cannot be valued (i.e., paid only the value of the car or other collateral) if the car was purchased within 910 before the bankruptcy filing. This cut down significantly on the amount of cars that could be valued in Chapter 13.

One problem that came up was the problem of "negative equity," i.e., when a car is traded in and is worth less than what is owed on it, the dealership will often roll the extra debt into the new purchase. So, for example, if you trade in your 2002 car worth $5,000 when you owe $10,000 on it, your new car loan would be $5,000 more than it would have been otherwise. I will frequently see clients with $5,000, $10,000 or even $15,000 in negative equity on a vehicle. The question is whether the "negative equity" can be valued at its true worth (zero) or whether the whole amount of the loan has to be paid.

The Ninth Circuit addressed this question in In re Penrod, adopting the dual status rule. The dual status rule means that the portion of the debt allocable to negative equity may be valued because it is not "purchase money" and the portion of the debt that is not for "negative equity" cannot be valued. This ruling makes the most sense practically, because in most of those situations, the Debtor would not be able to afford the car with negative equity, whereas the Debtor could afford the car if the "negative equity" could be removed from the amount of the debt.

Bankruptcy Filings in Fresno are up 100% YTD

Bankruptcy filings in Fresno are up almost 100% year-to-date over 2007. I know that I am incredibly busy and it looks like everyone else in the bankruptcy field is too. Interestingly, Chapter 7 filings are up 115.7% and Chapter 13 filings are up only 44.1%. This is probably because more people are just letting the house go instead of trying to save it in a 13.

Judges Scrutinize Mortgage Docs, Deny Foreclosures

The Wall Street Journal's Law Blog has an interesting article entitled, "Subprime Legal: Judges Scrutinize Mortgage Docs, Deny Foreclosures." The article addresses one of the most common problems in mortgage lending and more specifically in foreclosures: who owns the note? These notes are transferred around so much, there is a significant question as to who owns the note and as to whether the foreclosing party has the right to be foreclosing on the property. The article also addresses several other common problem with many of these foreclosures. The full text of the article follows:

It’s been about nine months since several federal judges in Ohio issued the
widely-read foreclosure dismissals that shined a light on sloppy paperwork
done by companies that specialize in handling foreclosures.

Since then, the WSJ reports tonight, other judges across the country have
caught on and are carefully scrutinizing mortgage documents filed as part of
foreclosures and dismissing cases based on mistakes they’re finding, which
borrowers might be able to exploit when facing foreclosure. (For another good
read on judges and lawyers working to staunch foreclosure, click here for a
recent NLJ story.)

Among the issues hitting snags among the judges, according to WSJ:

“Backdated” mortgage assignments: Assignments, documents that transfer ownership of the mortgage, are executed after the foreclosure process has begun but state that they are “effective as of” a date prior to the foreclosure action. Some judges are dismissing those cases, saying attempts to retroactively assign the mortgage aren’t valid.

Suspicious multiple hats: Employees for mortgage companies are signing affidavits stating
they are employees of one company, but other mortgage documents say they work at
another firm. In some cases, an employee claims to work for companies on both
sides of a transaction, prompting one skeptical judge to ask for that person’s
work history for the last three years.

Shared office space: In foreclosure filings, one judge has found that numerous mortgage-related companies, including units of Wall Street banks, all claim to share the same address: a suite of a West Palm Beach, Fla., building. “The Court ponders if Suite 100 is the size of
Madison Square Garden to house all of these financial behemoths or if there is a
more nefarious reason for this corporate togetherness,” the judge wrote in a
recent decision.

Brooklyn Crusader: The judge making Madison Square Garden references is Brooklyn’s own Arthur M. Schack (pictured) of Kings County Supreme Court, who has dismissed dozens of foreclosures sua sponte because of shoddy documents or suspicious patterns he notices in the filings. Schack, 63, a former counsel to the MLB Players Association who is known for peppering his rulings with pop culture references such as Bruce Willis movies, says barely any of the foreclosures he has denied eventually are completed.

In one of his foreclosure dismissals, Schack (Indiana, New York Law School) cited the film
“It’s a Wonderful Life” to make the point that homeowners now deal with “large
financial organizations, national and international in scope, motivated primarily by their interest in maximizing profit, and not necessarily by helping people.”

In an interview, Schack, a Brooklyn native, told WSJ: “Taking away someone’s home is a serious matter. I’m a neutral party and in reviewing papers filed with the court, I have to make sure they’re proper.”

Fresno No. 9 Nationally in Foreclosures

According tothis report from RealtyTrac.com, Fresno has the 9th highest foreclosure rate in the nation for the last quarter.

NACTT Mortgages Best Practices

The National Association of Chapter Thirteen Trustees put together a committee of Chapter 13 trustees, mortgage servicers, mortgagees and creditors' and debtors' counsel to come up with best practices for servicing mortgages in Chapter 13. Click here for the NACTT Mortgages Best Practices on the NACTT's website. The best practices are repeated below:

MORTGAGE BEST PRACTICES

NACTT Mortgage Committee

The NACTT Mortgage Committee is comprised of Chapter 13
trustees, mortgage servicers, mortgagees and creditors' counsel. The committee's
mission is to foster communication between the parties, resolve differences and
to recommend best practices of conduct for all stakeholders. Our goal is to
improve the bankruptcy system. Although the committee recommends the practices
set forth below, we recognize that there may be other acceptable procedures.
Therefore, we remain open to further discussion and review.

BEST
PRACTICES FOR TRUSTEES and MORTGAGE SERVICERS IN CHAPTER 13

If
servicers/mortgagees include a flat fee cost in the proof of claim for review of
the Chapter 13 plan prior to confirmation and for the preparation of the proof
of claim, it should be reasonable and fairly reflect the attorney's fee
incurred.

If Servicers/mortgagees include attorney fees for pursuing
relief from stay, such fees should be clearly identified as well as how such
fees are to be paid in any agreed order resolving a Motion for Relief from Stay
or any other matter before the court.

Servicers/mortgagees should
analyze the loan for escrow changes upon the filing of a bankruptcy case and
each year thereafter. A copy of the escrow analysis should be provided to the
debtor and filed with the Bankruptcy Court by the servicers/mortgagee or their
representative each year.

Servicers/mortgagees should not include any
pre petition cost or fees or pre petition negative escrow in any post petition
escrow analysis. These amounts should be included in the prepetiton claim amount
unless the payment of such fee or cost was actually made by the servicer.

Servicers/mortgagees should attach a statement to a formal notice of
payment change outlining all post petition contractual costs and fees not
previously approved by the court and due and owing since the prior escrow
analysis or date of filing whichever is later. This statement need not contain
fees, costs, charges and expenses that are awarded or approved by the Bankruptcy
Court order. In absence of any objection or challenge to such fees, the trustee
should take appropriate steps to cause such fees to be paid as part of Debtor's
Chapter 13 plan.

Servicers/mortgagees should supply and maintain a
contact for debtor's counsel and trustee's for the purpose of restructuring,
modifying a mortgage, or other loss mitigation assistance including a short sale
or deed in lieu of foreclosure. The contact should be an individual or group
with the ability to implement or assess with objective criteria a loss
mitigation modification after filing of a chapter 13 petition with the goal of
keeping the Debtor in the house and the success of the bankruptcy.

Mortgage servicers should provide a dedicated phone line and contact for
Chapter 13 Trustee inquiry use only.

Mortgage servicers should monitor
post petition payments. If the mortgage is paid post petition current then the
servicers/mortgagees should not seek to recover late fees. No late fees should
be recovered or demanded for systemic delay but should be limited to actual
debtor default.

Pre petition payments should be tracked as applied to
pre petition arrears, post petition payments should be tracked as applied to
post petition ongoing mortgage payments.

Servicers/mortgagees should
file a notice and reason of any payment change with the court and provide same
to the Debtor

Servicers are required to file with court a notice of any
protective advances made in reference to a mortgage claim, such as non escrow
insurance premiums or taxes. Such notice should be provided to the debtors and
filed with the court.

Servicers/mortgagees should review the Trustee web
site or NDC for payment discrepancies with their system prior to the filing of a
Motion for Relief from Stay in Trustee pay jurisdictions.

Servicers/mortgagees should review the Trustee web site or NDC at the
close or discharge of the bankruptcy for payment discrepancies with their system
in Trustee pay jurisdictions.

Servicers/mortgagees should clearly
identify if the loan is an escrowed or escrowed loan and break out the monthly
payment consisting of Principal, Interest, Escrow and PMI components.

Servicers/mortgagees should identify nontraditional mortgage loans in
their proof of claims. Loans with options should identify on the proof of claim
the type of loan as well as the various contractual payment options available
during the bankruptcy to the borrower/Debtor.

Trustees should initiate a
communication with mortgage servicers when questions arise in a review of a post
petition escrow analysis.

United States Trustees and Trustee Education
Network should modify the requirements of the financial management class
regarding adjustable rate mortgages, the calculation of mortgage escrows and, in
particular, the potential of increased mortgage payments resulting from
increased taxes, interest rate hikes and/or mortgage premiums.

Trustee
voucher checks, check stubs or vouchers provided with any other form of payment
contain the following information, except to the extent prevented from doing so
by local rule:


1. The Name of the debtor and case number.


2. The trustee's claim number.


3. The mortgagee's
account number (to the extent provided on the proof of claim).


4. If
the mortgagee account number is not available, e.g. not contained on the proof
of claim, at least one other piece of identifying information e.g., property
address.


5. The amount of the payment.


6. Whether the
payment is for the ongoing mortgage payment or the mortgage arrearage.


7. If for the mortgage arrears, the balance owing on the arrears
claim after application of the payment.


8. If the trustee has set up
a separate claim for post-petition charges of the mortgagee, that the voucher
clearly identify that fact.


9. If any portion of the payment on
arrears is intended to pay interest on the mortgage arrears, the amount of that
interest portion of the payment.


10. If the mortgage is to be paid
off during the bankruptcy under the confirmed plan through payments by the
trustee, e.g., a total debt claim, the portions of each payment which represent
principal and interest, and the balance owing on the claim after application of
the payment.

There is a movement among servicers to redact all but the
last four numbers of the mortgagors' loan numbers on proofs of claim, because
those claims are public records. While mortgage servicers in general want as
much information as possible on the vouchers, the mortgage servicers on the
Working Group felt that if the voucher had the bankruptcy case number, the name
of the debtor and the redacted loan number from their filed claim, they would be
able to post the payment. Using the account number to the extent provided in a
filed proof of claim also insures that trustees are not disclosing information
on their website that is not already disclosed in the public record.

Voucher Narrative re Payments: The Working Group places particular
emphasis on No. 6 above. The voucher should identify if a payment is for the
regular mortgage payment or for the mortgage arrearage in consistent language.
While Chapter 13 trustee disbursement applications focus on the claims to be
paid, mortgage servicer computer systems focus on their mortgagor account
number. Posting of receipts, whether or not the account is in bankruptcy, is
typically handled by a Cash Processing group or department of the mortgage
servicer. Those departments focus on the account number on the voucher and the
narrative on the voucher for that account number to determine if the payment is
for the regular mortgage payment or the mortgage arrearage.

Mortgage
Arrearage Claims: When filing their initial proofs of claim, mortgage servicers
should state their mortgage arrearage up to the date of the filing date of the
bankruptcy petition, unless the plan or trustee indicates otherwise, or local
rule provides otherwise. The Chapter 13 Trustee will use the mortgage arrearage
claim to set up the arrearage balance on the claim, which in turn will show up
as the "balance" on the voucher check, absent objection to the claim.

Thorough Servicer Analysis

In In re Stewart, ___ B.R. ___ 2008 WL 2676961 (Bankr.E.D.La. July 9, 2008) (Westlaw access required), Judge Magner did a thorough review of Wells Fargo's mortgage servicing procedures in bankruptcy. These procedures are probably similar to those of most servicers and are instructive for dealing with mortgage servicers. That analysis is below:

Loan Administration

Ms. Miller explained that Wells Fargo administers 7.7 million home mortgage loans. [FN16] The management or administration of these loans is accomplished through several computer software packages, some owned by Wells Fargo, some licensed from third party vendors. Entries on the loan account are tracked with a licensed computer software platform commonly known as Fidelity Mortgage Servicing Package or Fidelity MSP. Fidelity MSP provides extremely sophisticated computer software for the management of home mortgage loans and is one of the largest providers of this service nationally. When a payment is received on a mortgage loan, it is entered into the Fidelity MSP system and then deposited. Fidelity MSP applies the payment to a borrower's account; in this case, satisfying outstanding fees and costs first.

In this Court's experience, virtually every home mortgage executed in the United States contains provisions that determine when payments are due, when they are considered late, what fees or charges may accrue if late, when a default can be declared, the remedies available on default, and which collection fees or charges are recoverable after default. In addition, most notes and mortgages provide fairly clear directives regarding the application of payments between principal, accrued interest, fees, costs, and amounts due to satisfy insurance and property taxes. Mercifully, most home mortgage loans have relatively standard, predictable language. However, the right to assess certain charges or fees on late payment or default is often at the discretion of the holder of the note. How this discretion is exercised is subject to guidelines not contained in the note or mortgage.

In this Court's opinion, the exercise of that discretion may be impacted by the relationship between the holder of the note and the party that administers its collection. In the present financial market, almost every home mortgage loan is packaged with thousands of other loans and sold to investors assembled on Wall Street. The securitization of mortgage loans allows the original lender to immediately recover the amounts lent, providing it with liquidity and reducing its risk of default. The investors that acquire these bundled loans or portfolios are most often not banks or credit unions, the traditional members of the lending community. Instead, they are investment or brokerage houses; insurance companies; hedge, pension, or mutual funds; and other investment groups. They then hire a loan service provider to administer the loan portfolio.

*6 The securitization of home mortgage loans has divorced the lending community from borrowers. Not only are the new holders of the mortgage notes nontraditional lenders, but a mortgage service provider is a buffer in the relationship between lender and borrower. The holders of notes do not see themselves as lenders, but investors in an asset. They have little interest in the relationship between lender and borrower except as it might affect their return on investment.

Mortgage service providers administer notes for a fee. The terms of their agreements with investors, as well as the guidelines the investors set for administration of the loan, have ramifications for the borrower. Most servicing agreements allow the service provider to charge a flat fee, usually stated as a percentage of the portfolio under administration. All principal and interest payments collected are paid to the note holder. Usually, fees are additional income to the service provider while costs are simply a pass through, or reimbursable items. In addition, servicers invest the "float," or funds held on deposit, and retain earnings on that investment. Therefore, amounts held in escrow or in debtor suspense are an addition source of revenue for the servicer. While a mortgage service provider and note holder's interests are closely aligned, they are not perfectly aligned. It is in a mortgage service provider's interest to collect fees and hold funds, both of which generate additional income for its account. Conversely, a note holder or investor is interested in the collection and application of payments to principal and interest.

Since many fees and charges are imposed at the discretion of the lender and must be "reasonable" under the law, servicing agreements may establish guidelines for the exercise of that discretion. [FN17] In this case, Wells Fargo did not produce its servicing agreement. Therefore, the exact terms of its relationship with Lehman Brothers and the financial incentives available to Wells Fargo are not in evidence.

In any event, Ms. Miller testified that once the guidelines for management of a loan are determined by the loan's investor, Fidelity MSP imports the guidelines into its internal logic. [FN18] For example, if investor guidelines suggest the assessment of a late charge every time a payment is fifteen (15) days past due, the Fidelity MSP system will automatically assess a late charge if payment is not posted to the account within fifteen (15) days of its due date.

Other charges or fees are assessed against the account by virtue of "wrap around" software packages maintained by Wells Fargo. These software packages interface with Fidelity MSP and implement decisions based on their own internal logic. For example, if a borrower is delinquent in making a payment, Wells Fargo's computer system may automatically send a demand letter to the borrower. Guidelines might also recommend a property inspection if a loan is past due. If such an event occurs, the computer system will automatically generate a work order for an inspection, allow the vendor to upload the completed report, generate a check to the vendor for the inspection, and charge the customer's account--all without human intervention.

*7 When a loan is involved in foreclosure, bankruptcy, or other litigation, Wells Fargo manages that loan through its Bankruptcy Department located in Fort Mill, South Carolina. Ms. Miller is the Vice President who oversees this department of 375 people.

The transfer of loans involved in a bankruptcy to Ms. Miller's department begins with America InfoSource ("AIS"), a third party vendor hired by Wells Fargo to provide daily information regarding new bankruptcy filings that may potentially involve Wells Fargo loans. At the inception of this relationship, Wells Fargo supplied AIS with a listing of every credit relationship it held or serviced, as well as certain fields of information (debtor's name, address, social security number, etc.) on each borrower. The information is updated daily as Wells Fargo acquires new relationships and old ones are closed.

AIS scans the electronic databases of all the bankruptcy courts in the country and attempts to match debtors to any of the information supplied by Wells Fargo. If a match is made for one field of information, Wells Fargo is immediately notified. The notification provides Wells Fargo with the debtor's name, address, social security number, the bankruptcy court, case number, chapter type, and judge assigned. Once notified, Wells Fargo verifies that the debtor is a borrower. To verify the "match," Wells Fargo scans the information supplied by AIS against its own records. Ideally, three fields or pieces of information will be verified and matched. [FN19] If a three field match is not secured by Wells Fargo's internal computer system, the system will reject the borrower and a manual match will be attempted. This is one of the few times any human being touches or reviews a loan's electronic record.

Once Wells Fargo's computers have verified the AIS borrower match, the program automatically activates a system within the Fidelity MSP software platform called a Bankruptcy Work Station ("BWS"). This sub-part of Fidelity MSP is allegedly infused with computer logic designed to manage a loan during a pending bankruptcy. The supervision of that loan then falls to Ms. Miller.

Once a borrower's status as a bankruptcy debtor has been confirmed, the Fidelity MSP/BWS automatically advises counsel for Wells Fargo when a loan is referred for legal action. Who is selected to represent Well Fargo is dependent on who owns the loan. If a loan is owned by Wells Fargo, it is automatically referred to one of its national counsel; either Brice or McCalla Raymer. If held by one of the federal agencies, Wells Fargo will refer the loan to a firm on an approved list supplied by the agency. If held by a private investment group, that group can specify counsel or can delegate the responsibility to Wells Fargo as the service provider. If the loan is managed by national counsel, local counsel are retained to physically file pleadings and make court appearances when necessary. Local counsel are not given access to either the electronic files or accounting history but receive all of their information from national counsel. They typically do not have direct client access and may even be prohibited from contacting the service provider or note holder by their retainer agreements. [FN20]

*8 Once the BWS notifies Brice that it has been retained, Brice is given immediate access to Wells Fargo's mainframe computer platform. In addition, the computer automatically searches different parts of Wells Fargo's multiple software packages and compiles a storage file where counsel can obtain all the information necessary to perform his or her duties. For example, when a loan is owned or serviced by Wells Fargo, the documents evidencing the initial loan transaction are kept in pdf format under a software platform called FileNet. FileNet is scanned for copies of the note, mortgage, recordation certificate, and other relevant closing documents. Those electronic files are then assembled in a storage file for counsel's use. The Fidelity MSP system, containing the loan's account history, is open to review by counsel. iClear, another computer program, contains copies of the invoices that represent costs billed to the loan. [FN21]

The first task of counsel, once a bankruptcy is filed, is to prepare a proof of claim. Because counsel has direct access to Wells Fargo's complete loan accounting, as well as the documents that support its debt and security interest, national counsel prepares the proof of claim without ever speaking to a Wells Fargo representative. In fact, Wells Fargo testified that it does not review any proof of claim prior to its filing. Wells Fargo's testimony was that only after filing was the proof of claim reviewed for accuracy. [FN22] Other legal assignments are executed in a similar fashion.

For example, when a loan goes into postpetition default, the BWS automatically notifies legal counsel of this fact. Legal counsel then prepares a motion for relief utilizing information obtained from the Fidelity MSP system and BWS, including attaching any necessary documents to support the motion and the financial allegations of the default. The motion is typically filed without Wells Fargo's input or review. Wells Fargo testified that it does not maintain records of the legal documents filed on its behalf but relies exclusively on counsel for this service.

The logic utilized by the BWS in its decision making process is both detailed, court, and even judge specific. For example, if under local rules, or even local custom of a particular district or judge, a motion for relief may not be filed until the loan is at least ninety (90) days past due, the computer can be adjusted to notify counsel of the need to file a motion for relief when the debtor's account is past due ninety (90) days rather than the typical sixty (60). Other adjustments to the system can be made to eliminate fees or charges prohibited by a particular jurisdiction or judge within a jurisdiction. In summary, Fidelity MSP and BWS allow Wells Fargo to input the individual demands of a particular investor or note holder as well as a court district or even judge.

Mr. Fear Will Be Presenting at Two Local Bankruptcy Seminars This Summer/Fall

Mr. Fear has agreed to speak at two local bankruptcy seminars this fall. The first is sponsored byNBI, and is entitled "Nuts and Bolts of Bankruptcy Law." It is scheduled for August 22, 2008. The second is sponsored by Sterling Education Services on Landlord-Tenant Law and is scheduled for October 30, 2008.

Indymac--Exhibit A of What Went Wrong in the Mortgage Lending Business

This is a good piece from the Center for Responsible Lending on what went wrong with IndyMac Bank. Most people have blamed brokers for these kinds of shenanigans, but it looks like the banks were involved too, or at least they knew what was going on.

Lenders create a bankruptcy monster - MSN Money

Here is a good article from MSN Money on lender abuses. The author points out the paradox that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") was intended to curb debtor abuses, but the real abuses that needed to be curbed were creditor abuses.

Good Information on Life After Bankruptcy from Consumer Credit Counseling Services

Consumer Credit Counseling Services is one of the few legitmate debt counselors out there. They have a good post on Life After Bankruptcy that you can access here.

One of the things they mention is your credit report after bankruptcy. Debts that are discharged in banrkuptcy must be reported on the credit report as "$0" in the balance column and they are allowed to put "Discharged in Bankruptcy" in the notes column. If creditors are continuing to report a balance, that could be a violation of the Fair Credit Reporting Act. A nationwide firm called the
National Consumer Bankruptcy Litigation Center is attempting to rectify this problem by bringing suits all over the country for violation of the discharge injunction by these lenders for failing to report a $0 balance.

Home Prices Down 26% in CA; Really, It's a Good Thing!

L.A. Land : Los Angeles Times : California freefall: Home prices down 26% in February: "In the San Fernando Valley, losing a home to foreclosure is now almost as common for families as buying a home." That is a shocking statement. However, the drop in home prices is a good thing.

The California real estate market was going up too fast to support home ownership for the average person. At the peak, homes in the Fresno area were averaging around $290,000 and incomes were around $45,000/year. There is no way someone making $45,000 a year can pay a $290,000 mortgage. Now, that same house is selling for $140,000-175,000. It might be possible for someone making $45,000 to pay a $140,000-175,000 mortgage, or at least it is in the realm of possibility. My thought is that the prices will stabilize around that level and then will begin their gradual drift upward, probably no more than 2-3% a year. That will allow for a healthy economic situation where the housing market opens up for a lot of people.

The other side of the coin, however, is that a lot (and I mean a lot) of people bought or refinanced their houses to the max within the last 5 years. Consequently, there are a lot of people out there who owe $300,000 on a house that is now worth about $200,000. And it won't be worth $300,000 for ten years or more. So, what are those people going to do? Some of them might have taken out unsecured loans in that amount and have the income to pay the loans. But many of them are not going to have the income to swing the payments on those loans for the long haul. I predict that many of them are going to walk away from their homes, unless the mortgage companies agree to write down the loan amount. I think we will see a steady stream of these folks for the next 5 or 6 years, many of whom will need to file bankruptcy if they can't get a mortgage modification.

For consumers caught in this trap, the only good thing is that everyone's credit will be in the tank, so if banks want to lend, they will have to lower their standards in the future and it will be easier for these people to purchase a house in the future (at the new lower values).

Debtor Audits Suspended

The United States Trustee's office has suspended Debtor audits because the most recent budget provides no funding for debtor audits. More information can be found at http://www.usdoj.gov/ust/eo/bapcpa/debtor_audit/.

Stunning jump in California foreclosures

In the fourth quarter of 2007, there were 31,676 residence foreclosures in California. During the same quarter in 2006, the number was 6,078. That is an increase of 421.2 percent and is the most number of foreclosures since DataQuick began tracking foreclosures in 1988.

The main reason for the number of foreclosures is that everyone shut their eyes and held on for the ride during the crazy housing inflation from 2001-2006. If more lenders had been questioning the ridiculous increase in values (especially when compared to incomes), the level of inflation might not have occurred. There is no doubt that housing prices needed to climb (they had been stagnant for about 10 years before that), but 25% a year for 5 years is ridiculous. There is no way the median house value can be $250,000 in an area where the median income is $40,000 ($3,333/mo.), because the majority of those people cannot realistically afford a $2,000/mo. house payment. That is equal to 60% of the gross wages. After taxes are taken out and the mortgage is paid, the family would only have about $800/mo. to live on. There is no way our incomes in the Fresno area could support that.

Modifying Mortgages in Chapter 13

Interesting article in the Kansas City paper. This quote from the article, however, does not comport with reality:

Joseph Mason, who teaches finance at Drexel University, said Durbin’s bill "is
akin to taking away real value from the lender and giving that value to the
borrower."

Taking away "real" value. What real value? There is no real value there to support many of these loans. Durbin's bill would allow the Court to put a "real" value on the house (not some inflated value by an appraiser who is a friend of the loan broker) and then allow the court to fix reasonable terms for the mortgage. If this bill is not passed, most of the homes that would have been saved will go to foreclosure. Quere, Mr. Mason: what do you think the "real" value will be when 25-50% of real estate listings are REO (listed by bank after foreclosure)?

Dealing with this problem in bankruptcy is the best place to do it for the following reasons:

1. Bankruptcy is a last resort. Nobody wants to file bankruptcy. So only those who are most desparate for the relief will file, thus limiting the number of people taking advantage of this relief.
2. Bankruptcy provides a built-in mechanism to determine if people should be eligible for the relief of modifying the loan. There is no better mechanism out there for determining what people should qualify for a modified loan.
3. All of these modifications would be supervised by the bankruptcy court. The bankruptcy court is pre-equipped with the knowledge and resources to properly vet requests to modify loans. The bankruptcy court does it all the time in contexts other than home loans. (And in Chapter 12, it even supervises modification of home loans.)
4. A Chapter 13 plan takes a lot of doing to finish. Debtors would have to comply with every provision and make every payment on time for 5 years to get the relief of a modified loan. Anything else would result in dismissal of the case and vitiation of the relief requested.

The Durbin bill makes a lot of sense. We will see if it gets enough traction in Congress.