Wall Street Journal Reports Principal Residence Cram Down Proposal is "Gaining Steam"

Today's Wall Street Journal reports that the proposal to grant bankruptcy judges the power to rewrite or "cram down" primary residential mortgage is "gaining steam." It futher reports that this proposal is gaining momentum in the Democratic controlled Congress as evidence mounts that the current voluntary foreclosure mitigation programs are falling short. For example, The Hope for Homeowner's program was supposed to help 400,000 homeowners avoid foreclosure, but so far only 37 homeowners have signed up due the narrow eligibility requirements.

The cram down proposals would give the Bankruptcy Judges the power in certain circumstances to reduce principal, reduce interest rates, and extend terms. Bankruptcy Judges presently have the power to modify mortgages that are not secured only by a principal residence, such as a vacation vacation home, but they are prohibited from modifying mortgage secured only by a lien on a debtor's principal residence.

As previously reported Senator Richard Durbin and Congressman Brad Miller announced recently that they will introduce the cram down bill on the first day of the new Congress. It is widely expected that the mortgage cram-down provision for principal residences is likely to be as part of Congress's economic-stimulus package in early 2009. The Wall Street Journal even reports that the he National Association of Home Builders is now saying the cram down proposal is worth considering.

Proponents of bankruptcy reform note that about one in six houses in now worth than the amount owed on the mortgage, ie. "under water" and that only a program that reduces the principal owed and restores equity to homeowners is likely to stem the tide of foreclosures. Proponents of bankruptcy reform also note that without bankruptcy reform mortgage servicers are having difficulties modifying mortgages that have been carved up and sold to investors as part of mortgage backed securities as the mortgage servicers as uncertain of their liabilities in agreeing to a modification. Indeed recently Countrywide and Bank of America were sued by mortgage certificate holders due to their contention that they will bear the economic brunt of the settlements reached with the various Attorney Generals.

"Securitization Facilitated Predatory Lending"

Professor Kenneth C. Kettering of the New York Law School recently reviewed the legal foundations and product growth of asset "securitization" in his article Securitization and its Discontents: The Dynamics of Financial Product Development, 29 CARDOZO L. REV. 1553 (2008).

Interestingly enough, Professor Kettering lists various articles dating back as far as the year 2002 where critics contended that mortgage securitization faciliates "predatory" lending and misleading disclosures . One of the earliest proponents of this thesis was Kurt Eggert's article Held Up in Due Course: Predatory Lending, Securitization, and the Holder in Due Course Doctrine, 35 CREIGHTON L. REV. 503 (2002). Other articles cited are Kathleen C. Engel & Patricia A. McCoy, Turning a Blind Eye: Wall Street Finance of Predatory Lending, 75 FORDHAM L. REV. 2039 (2007), Christopher L. Peterson, Predatory Structured Finance, 28 CARDOZO L. REV. 2185 (2007), David Reiss, Subprime Standardization: How Rating Agencies Allow Predatory Lending to Flourish in the Secondary Mortgage Market, 33 FLA. ST. U. L. REV. 985 (2006).

Massachusetts Appellate Court Affirms Preliminary Injunction against Foreclosure of Subprime Mortgages

In a landmark decision, the Supreme Judicial Court of Massachusetts issued it opinion on December 9, 2008 unanimously upholding the lower court's order in the case of Commonwealth v. Fremont Investment & Loan & another, 452 Mass. 733 (2008)(Botsford, J.) preliminarily enjoining subprime mortgage lender Fremont Investment & Loan from foreclosing on any "structurally unfair" loan without further prior court approval and a final hearing on the merits. The lower court's ruling of February 25, 2008 was reportedly the first of its kind in the nation that restricts a subprime lender's ability to foreclose based on unfair or deceptive loan origination misconduct.

The trial court issued the preliminary injunction upon a finding of a likelihood of success on the merits that Fremont's loans were "unfair" based on four characteristics of the loans. Massachuetts General Laws c. 93A, section 2 (a) makes unlawful any "unfair or deceptive acts or practices in the conduct of any trade or commerce." It is noted that in a similar manner, Florida's Deceptive and Unfair Trade Practice Action provides in section 501.204(1), Florida Statutes (2008) that (1) Unfair methods of competition, unconscionable acts or practices, and unfair or deceptive acts or practices in the conduct of any trade or commerce are hereby declared unlawful. The four characteristics found by the court as establishing unfairness were

• 1. the loans were ARM loans with an introductory rate period of three years or less
• 2. they feature an introductory rate for the initial period that was at least three per cent below the fully indexed rate
• 3. they were made to borrowers for whom the debt-to-income ratio would have exceeded fifty percent measured on the fully indexed rate, and
• 4. the loan-to-value ratios was 100% or the loan featured a substantial prepayment penalty.

The court reasoned that "Fremont as a lender should have recognized that loans with the first three characteristics ...were 'doomed to foreclosure' unless the borrower could refinance the loan at or near the end of the introductory rate period, and obtain in the process a new and lower introductory rate." The court also found that the fourth characteristic, the prepayment penalty, "would make it essentially impossible for subprime borrowers to refinance unless housing prices increased..." The court's preliminary injunction required Fremont to work with the Attorney General to "resolve" their differences regarding foreclosure, presumably through a loan workout.
Most of the involved Fremont loans, which were procured through independent mortgage brokers who received a commissions, were subsequently sold to the secondary market with Fremont acting as servicer for the purchaser. The majority of Fremont's subprime loan products were adjustable rate mortgages with fixed interest for the first two or three years which then adjusted every six months to a higher variable rate. The court found that Fremont determined loan qualification based on a debt-to-income ratio of fifty per cent or less based on the payment at the introductory rate not the payment that would ultimately be required after the introductory period. Furthermore, Fremont offered loans with no down payment by providing a first mortgage at eighty percent financing with an additional "piggy-back loan" providing twenty percent.

The court's order does not bar foreclosure nor relieve borrowers of their obligations to repay their loans, but it requires Fremont to "explore alternatives to foreclosure" and then seek approval of the court to foreclose which may not be granted, leaving the preliminary injunction in place until the Attorney General has the opportunity to have a final hearing on the issue of unfairness.

Bankruptcy Mortgage Bill to be Reintroduced Again in January

Senator Richard Durbin (D-Ill.) held a press conference today where he announced that he will reintroduce on the first day of the new 111th Congress the "Helping Families Save Their Homes in Bankruptcy" legislation. This legislation would amend the bankruptcy laws to allow modification of mortgages secured only by a "principal residence" to assist struggling mortgage borrowers. It is also reported that he will seek to have this legislation included in the economic stimulus package that will be considered in the first weeks of the new Congress.

It is also reported that House Financial Services Committee Chairman Barney Frank told participants at a Office of Thrift Supervision conference on Monday that he expects lawmakers may revive efforts to change bankruptcy law early next year if foreclosure rates are not on the decline.

Investors Sue Countrywide

Investors in securitzed mortgages sue Bank of America’s Countrywide unit for $8.4 billion Insurers, banks and others claim lender’s mortgage-modification agreement with 15 states will shortchange debt-holders

By Neil Roland

December 1, 2008 3:00 PM ET

Bank of America’s Countrywide unit was sued for $8.4 billion by owners of mortgage-backed bonds who allege that the bank plans to pass on to them the costs of a regulatory settlement over misleading sales practices.

The suit was filed in New York state supreme court by Greenwich Financial Services Distressed Mortgage Fund 3 in Greenwich, Conn., which resolves distressed mortgages.

The fund represents dozens of insurance companies, banks, endowments and sovereign wealth funds that own securitized mortgages sold by Countrywide Financial, fund owner William Frey said in an interview.

The complaint seeks class-action status on behalf of thousands of holders of subprime and other mortgages that are to be reduced as part of Countrywide’s settlement with the attorneys general of at least 15 states, including California, Texas and Florida.

It alleges that Countrywide plans to pass on most or all of the mortgage reductions to the trusts that bought the securitized loans from the bank. The trusts in turn sold the securities to investors to pay Countrywide.

Bank of America, which acquired Countrywide on July 1, will likely absorb any costs involved in settling the suit—if the case is indeed settled—because Countrywide has so little money left, said Christopher Whalen, managing director of consultancy Institutional Risk Analytics.

“I wish [Bank of America chief executive] Kenneth Lewis would come clean on the true costs of remediating and absorbing Countrywide,” Mr. Whalen said in an interview. “The disclosures so far have been very meager.”

Countrywide is required to purchase all loans that it modifies under the settlement, the suit contends. The lender has said that these mortgages “are not subject to repurchase,” according to the complaint.

The $8.4 billion settlement in October, which may become the largest predatory lending agreement ever, resolved allegations that Countrywide misrepresented loan terms, loan payment increases and borrowers’ ability to afford loans.

Countrywide has said the loan modification program, which could help as many as 400,000 borrowers keep their homes, would be ready to start today.

Bank of America spokeswoman Shirley Norton said today the company hasn’t yet received a copy of the bondholders’ complaint.

Still, she added, Bank of America is “disappointed in this attempt to halt a program intended to keep as many as 400,000 at-risk families in their homes.”

“We are confident any attempt to stop this program will be legally unsupportable,” her e-mail said.

It’s not clear that bondholder are looking to short-circuit the mortgage modification program. In fact, the suit states that “plaintiffs make no complaint about the settlement between the attorneys general and Countrywide.”

Countrywide, once the largest provider of subprime mortgages in the U.S., faces a host of lawsuits related to its sales practices and sale to Bank of America. The lender was headed by Angelo Mozilo—now under investigation by the Securities and Exchange Commission—before it was acquired by B of A in July.

That $2.5 billion takeover vaulted Bank of America to the top of the U.S. mortgage lending industry. Countrywide made almost one of every five U.S. home loans last year, and reported almost $4 billion in loan losses during the second quarter.

In October, Countrywide settled a suit by Bank of New York Mellon, the world’s largest custodian of financial assets, over $2 billion in notes. The lender agreed to offer $980 per $1,000 in principal. Bond investors were concerned that Bank of America would hold on to the best assets of Countrywide while assigning debt to a new company created by the acquisition.

In addition, MBIA Insurance sued Countrywide in October, alleging that the lender fraudulently induced the bond insurer to guarantee bonds that have cost it more than $459 million.

A number of borrowers have also taken Countrywide to court. In addition, the company’s shareholders sued Countrywide in February, seeking more money from its takeover by Bank of America.

Securitization litigation