Debating judges' role in foreclosure remedy

Debating judges' role in foreclosure remedy

Marcia Coyle / Staff reporter

The National Law Journal

February 23, 2009

WASHINGTON - Congress and the president have been immersed in attempts to solve the economic and housing crisis. Will judges soon take their turn?

President Obama's recent proposal to address the rising tide of home foreclosures calls for legislation to allow bankruptcy judges under Chapter 13 of the bankruptcy code to modify the terms of home mortgages when families run out of other options.

Legislation to do just that has stalled in the House and the Senate for the past two years because of opposition by Republicans and the lending industry. Has the foreclosure landscape — by 2012, one in every nine homeowners will have lost homes to foreclosure, according to a Credit Suisse Securities analysis — changed sufficiently to break the back of this determined opposition?

"I am encouraged," said Ellen Harnick, senior policy counsel at the Center for Responsible Lending.

"I think there is a strong sense across the board that this is needed, but industry opposition has really been the issue. It's surprising because the current situation might have made you think opposition either would have gone away quietly or failed to matter significantly."

But David Kittle, chairman of the board of the Mortgage Bankers Association, said "cramdown" (reducing the creditor's secured claim to the current value of the property) makes no sense in any shape or form.

"We've defeated it twice," he said. "We acknowledge the environment and landscape have changed, but there is nothing good about filing for bankruptcy. Our Congress should not be in the business of encouraging people to go into bankruptcy."

Bankruptcy legislation is a "funny animal," making predictions difficult, said bankruptcy scholar Mark Scarberry of Pepperdine University School of Law, an opponent of current bills to modify home mortgages in bankruptcy.

Odds of passage greater now

"Certainly with Democratic gains in the Senate and the president endorsing it, the odds of passage are much, much greater," he said. "It does seem the president is recognizing some economic realities with loan modifications, and if thought of seriously with respect to bankruptcy, what emerges won't be what we saw before. I think there is room for compromise."

And, if the new bankruptcy authority becomes law, will bankruptcy judges be able to handle a likely surge in Chapter 13 filings?

One lending industry representative contends that reform would delay resolution of the foreclosure crisis for years, especially if millions of borrowers file for Chapter 13 relief.

Each of the judiciary's 368 bankruptcy judges managed an average of 2,630 filings in the 12-month period ending June 30, 2008, and that was without cramdowns, he noted in recent congressional testimony.

But "a more neutral analysis of this is to think back to 2005, about the time bankruptcy law got changed," said bankruptcy scholar Robert Lawless of the University of Illinois College of Law.

"There were two million filings that year, and the system did handle those. There weren't any reports of major problems."

More strain under Chapter 13?

The 2005 surge was predominantly Chapter 7 filings, he noted. A surge in Chapter 13 filings would place more strain on judicial resources because there is a greater need in Chapter 13 for judicial oversight and greater chances of litigation over issues.

"Another part of this is it would be pretty much a one-time surge," Lawless said. "Nobody contemplates an extremely high level of filings for years into future. So I think it would be 'pollyannaism' to say bankruptcy courts could handle this modification with current resources and nobody would notice, but I also think it's wrong to predict dire consequences for the bankruptcy courts if the legislation is passed. The court system would easily survive it."

Details of what President Obama would like in the Chapter 13 proposal are sketchy. His proposal only says that Chapter 13 write-downs should be a final option; debtors must first ask their lenders/servicers for a loan modification and certify they have made reasonable efforts to cooperate with the lenders; and the write-down would only apply to existing mortgages under Fannie Mae and Freddie Mac loan limits.

Three weeks ago, the House Judiciary Committee reported to the full House H.R. 200, which would give Chapter 13 bankruptcy judges the authority sought by the president and which incorporates proposals forming the basis for Citigroup Inc.'s recent support of the legislation. A nearly identical bill — S. 61, sponsored by Senator Richard Durbin, D-Ill. — is pending in a Senate committee.

The opponents' concerns

Pepperdine's Scarberry, the Mortgage Bankers Association's Kittle and Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, voice their own and the lending industry's arguments that the legislation will result in higher mortgage interest rates, increased down payments and higher closing costs and encourage people to go into bankruptcy.

If cramdown is to be a last-resort option, the legislation needs to have some type of "filter" to ensure that, said Scarberry and Talbott.

"The president's plan largely relies on reduction in interest rates as opposed to reduction in principal and that makes a lot of sense," Scarberry added. "We should let the president's plan, other than the bankruptcy part, go forward and see how it works."

Proponents see a solution

But Harnick, consumer groups and consumer bankruptcy attorneys counter that the Chapter 13 reform is an essential part of resolving the housing crisis because it reduces the loan principal to the fair market value of the house and makes payments affordable.

"We've said from the beginning this is one of the only methods that will solve the problem, cost taxpayers nothing and write the value of these homes to where investors will want to take a risk," said bankruptcy litigator Carey Ebert of Fort Worth, Texas, who is the president of the National Association of Consumer Bankruptcy Attorneys.

Harnick agreed. "What is essential is that homeowners who can't get the relief they need through negotiating with the lender or the servicer need a mechanism, and bankruptcy is the only mechanism anyone has been able to come up with to deal with that," she said.