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.