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.

Gambling Debts Unenforceable in Bankruptcy Court

In a refreshing and insightful opinion, the Wisconsin Bankruptcy Court determined that gambling debts could not be recovered in a bankruptcy court context. The case is In re Jafari --- B.R. ----, 2007 WL 4276535 (Bankr. W.D.Wis. Oct 16, 2007). (Westlaw subscription requred.)

The debtor had incurred debts on gambling markers at a casino in Nevada. The court determined that it was against public policy to enforce debts to gaming institutions.

I have had many clients come in with gambling addiction problems and I think this ruling makes good sense. Such debts should be unenforceable.

Ninth Circuit BAP: Means Test is Starting Point for Chapter 13

One of the raging debates in Chapter 13 bankruptcy circles is whether projected disposable income for above-median debtors (the amount to be paid to unsecured creditors) is determined using figures from Form 22C (commonly known as the means test) or Schedules I and J (actual income and expenses).

The Ninth Circuit BAP has weighed in on this argument with a Solomon-esque (splitting the baby) opinion. The case is In re Pak. Some courts have held that projected disposable income is whatever Schedules I and J say, just like under the old law. In my opinion, that argument does not make any sense because Congress intended something to happen when they changed the law in 2005. The other extreme says that projected disposable income is taken from Form 22C, end of story. This argument is more logical, but probably goes too far.

In Pak, the court determined that Form 22C is a starting point. If there has been a substantial change since the figures in Form 22C were used, then the court can take those figures into account. The rationale is that the word "projected" must mean something. Form 22C only uses income figures in the past. So, if the income significantly changes, the "projected" income would also change. This case at least makes some sense and gives some guidance. Unfortunately, however, there is another case at the Ninth Circuit Court of Appeals that will be decided soon that could overrule Pak. So, we cannot fully rely on the Pak decision in formulating Chapter 13 plans.

Hearings on Allowing Mortgage Modification in Chapter 13

The House Judiciary Committee is holding hearings on "Straightening Out the Mortgage Mess". The question is whether Sec. 1322(b)(2) should be amended to allow modification of home mortgages. Currently, that section does not allow modifications. The reason this prohibition was originally added was because without it, mortgage banks argued that the credit market would dry up for home mortgages.

Predictably, the bankrutpcy folks from NACBA and the National Bankruptcy Conference argued in favor of allowing modification and the Mortgage Banking Association argued against allowing modification.

Interestingly, however, an economist from Moody's, Mark M. Zandi, testified that "there is no reason to believe that the cost of mortgage credit across all mortgage loan products should rise" and that "[p]roperly designed, the legislation could reduce the number of foreclosures through early 2009 by at least 500,000." This has always been my biggest question: (1) would allowing mortgage modifications dry up credit and (2) if not, can Congress be convinced enough by this so that they are willing to pass legislation allowing modification of mortgages? I think that the answer to (1) is "no" for several reasons: (1) before the credit crisis, there was no problem getting a loan in the non-primary residence home mortgage market, (2) there has already been a tightening of credit across all sectors, so we should probably expect a loosening of the lenders want to make money in the future. With some solid data from economists concurring on this point, I think the legislation is in much better shape than it would have been otherwise.

Wells Fargo Agrees to Ground-Breaking Order Effective in All Districts

Wells Fargo, one of the larger mortgage servicers in the nation, agreed to an order in Louisiana Bankruptcy Court that requires Wells Fargo to take substantial steps to make sure that unauthorized fees and expenses are not tacked onto Chapter 13 cases. The full decision is In re Jones, No. 06-01093 (Bankr. E.D. La. Aug. 29, 2007), and can be found here.

The relevant text of the agreement ordered by the Court is as follows:

1. Upon the filing of a chapter 13 bankruptcy petition, the amounts outstanding on a debtor’s loan will be divided into two new, internal administrative accounts. The first account will contain the sums to be paid under debtor’s plan by the Chapter 13 Trustee; typically the pre-petition past due amounts including past due interest, costs, charges, and fees (“Account One”). The opening balance on Account One should directly correlate to the amounts reflected on Wells Fargo’s proof of claim. Account One will also include any amounts added by subsequent court order to the plan for payment by the Trustee during the case’s administration. All payments made by the Trustee will be applied to the reduction of the amounts owed on Account One.

The second account will reflect the principal amount due on the petition date (“Account Two”). No other sums should be owed on Account Two at the start of the case. Account Two will include post-petition interest accrual, post-petition property insurance or property tax expenditures, and other court authorized postpetition charges as provided in paragraph 2 below. A debtor’s regular monthly note payments will be posted to this account, reducing post-petition interest accrual, postpetition property and tax expenditures, and principal. The account’s first posting will typically be the first installment payment due on the loan following the petition date.

Wells Fargo may maintain, post-petition, its customary records on the loan provided that the two new internal accounts shall control the loan’s administration during the pendency of the case.

2. With the exception of post-petition property taxes and property insurance expenditures, Wells Fargo may provisionally accrue, but not assess or collect, any post-petition charges, fees, costs, etc. allowed by the note, security agreement and state law. Post-petition property tax and insurance expenditures may be assessed against debtor’s account and collected after the delivery of a ten day written notice to debtor, debtor’s counsel, and the Trustee. The assessment and collection of expenditures for post-petition property inspections and taxes will not require approval of the bankruptcy court unless a written objection is filed within ten days of the notice of assessment and collection. If authorized by Wells Fargo’s note, security agreement, and state law, the collection of amounts necessary to pay postpetition insurance and property tax expenditures may be made in advance through the use of escrow accounts. If escrows are utilized, Wells Fargo must give a written accounting of the amounts collected at the time it seeks to apply the escrowed funds to payment of the insurance or property tax expenditures.

As to Post-Petition Charges, annually, between January 1 and February 28 of each year during a case’s administration, Wells Fargo shall file with the Court and serve
upon the debtor, debtor’s counsel, and the Trustee, notice of any Post-Petition charges (which do not include property taxes or insurance), accrued in the preceding calendar year. The notice shall contain an itemization describing the charge, amount provisionally incurred, the date incurred, and if relevant, the name of the third party to whom the charge was paid. The notice will also provide a direct reference to the provisions of the note, security agreement, or state law under which Wells Fargo asserts its authority to assess each type of charge.

The notice shall also state that debtors, the Trustee, and any other interested party, shall have 30 days within which to object to any or all assessments outlined in the notice. It shall contain a statement to the effect that debtor may elect to add the charges to his plan with approval of the bankruptcy court, satisfy the charges directly outside the plan, or defer repayment until the conclusion of his case. If no objection to the amounts provisionally assessed is filed, or if filed, upon entry of an order approving some amount of the provisional charges, Wells Fargo may submit a proposed ex parte order authorizing assessment of the Post-Petition Charges as set forth in its notice or as approved by the court, as applicable. However, Wells Fargo may not collect on any approved Post-Petition Charges unless the debtor voluntarily delivers payment separate and above from that due as a regular monthly installment or obtains approval of the court to modify the plan and satisfy the amounts due through periodic payments by the Trustee. If the approved Post-Petition Charges are to be paid through the modified plan, they will be added to Account One and satisfied by the Trustee. If to be paid by the debtor, they may be added to Account Two.

If no provision for payment is made by a debtor, the collection of the approved Post-Petition Charges must be deferred until the close of the case or relief from the stay is obtained.

3. If Wells Fargo does not issue a notice of Post-Petition Charges, in accordance with paragraph 2, for any given year of the case’s administration, then Wells Fargo shall be prohibited from collecting or assessing any charges accrued against the debtor for that year and shall treat the debtor as fully current at the time of discharge.

4. Upon the issuance of a discharge, Wells Fargo shall adjust its permanent records to reflect the current nature of debtor’s account. Provided however, that if debtor elected to defer the payment of approved Post-Petition Charges until the conclusion of the case’s administration, then Wells Fargo shall be authorized to collect said sums in accordance with the provisions of its note, security instrument, and state law.

The court was deciding whether to impose massive punitive damages (in the millions of dollars). Wells Fargo said, "we'll agree to an order like this if you agree not to impose massive punitive damages." So, this order was entered. The order further states: "Wells Fargo also offered to memorialize this agreement into an order of the Court, enforceable in any case pending or subsequently filed before any court in the country." The court took them up on this offer and agreed not to impose a multi-million dollar punitive damage award.

If Wells Fargo fails to abide by this order in any case in the country, they could be subject to punitive damages, because they are disobeying a court order, and more than that, an agreed court order, and even more than that, an agreed court order entered for the purpose of avoiding multi-million dollar sanctions. Wells Fargo better comply or there will be a deluge of suits alleging violation of this agreement.