Our active readers at Credit Slips already started debating the second controversy about the pending cramdown legislation: is the failure rate of chapter 13 too high to make mortgage modification in bankruptcy a very useful tool? To briefly reprise that discussion and add my own gloss, there are longstanding lamentations that chapter 13 is a poor system because a minority of debtors completes the repayment plan and receives a discharge. The academic studies suggest the number is about 33%; I believe the National Association of Chapter Thirteen Trustees thinks it is about 40% (one wonders why the US Trustee Program doesn't carefully track this and publish it?)
So lots of chapter 13s fail. But what conclusion should we draw from that fact? This is a broad question and one that I'm exploring in a new empirical research project. I do not believe that chapter 13s "fail" just because they do not reach discharge. For now, let me narrow that concern to whether cramdown legislation is sound policy. A couple of observations:
- The failure rate for chapter 13 may be, at least to some unknown degree, a result of housing affordability problems. Tara Twomey, John Eggum, and I have a forthcoming paper showing that over 70% of chapter 13 homeowners in our 2006 sample spent more than 1/3 of their incomes on mortgage payments, the HUD benchmark for unaffordable housing. If cramdown lets debtors reduce their mortgage payments, it may permit more debtors to confirm plans and give debtors needed flexibility in adjusting their budgets to the normal ups and downs of life. Put another way, the low chapter 13 completion rate may be an effect of the inability under current law to modify mortgages, which is all the more reason to permit such modification.
- Lots of people are going to have upheavals in their lives just because that is life. As one of our Credit Slips commentators said: "Chapter 13 cases fail primarily because '_____ happens' in the 3-5 year term of the plan. Debtors live and die; they change jobs; they lose jobs; they move; they buy and sell homes; they get married; they get divorced; they have kids; they lose kids; they get sick; etc. — all of which impact their financial circumstances." These circumstances would occur and be problematic regardless of how we structured the mortgage relief–that is, they would hamper non-bk court modifications too.
- One benefit of modifying mortgages in bankruptcy is the potential to actually monitor what happens. IF the Administrative Office of the US Courts and the US Trustee Program release the needed data, scholars and advocates can track these cases. How many debtors are seeking modifications? What kinds of terms are courts granting? How are these debtors faring? Such data has been scarce of non-existent for the voluntary modification programs. What data do exist, such as those that Alan White examines, seem to me to indicate that a very high fraction of modifications are doomed to failure.
Comments
13 responses to “Cramdown Controversy #2–Will I “Succeed?””
I have a very real question that I’d love an answer to – offline in e-mail is perfectly fine.
Re: the “Will I succeed?” aspect of a 13. I just watched a friend of mine go through a horrendous 13 process thanks, in large part, to the two attys she hired. The 1st closed up shop mid-filing on her w/o notifying the friend or disclosing that she wasn’t licensed to practice in the state. The atty that took up the case apparently didn’t bother to determine whether or not the mortgage servicer properly allocated the friend’s payments and the trustee payments. It appears that ALL of the money being paid out by friend was still being applied strictly to arrearage. That being the case, unbeknownst to friend there was never any hope of her ever keeping the house.
Now, three months after losing the property to foreclosure, friend STILL receives monthly mortgage statements and demands for payment from the servicer. She also receives notices of force placed insurance. I’m waiting for the call from her telling me that she received another foreclosure notice on a property that’s already been FCd.
I fully understand that the rate of success of a 13 plan, whether a cramdown is involved or not, depends, in part, on the borrower’s desire and ability to restore the loan through the plan. And I realize that the situation I’ve outlined may be somewhat of an isolated incident. But what if it’s not? How is ANY borrower going to be able to successfully complete a plan if/when the servicer fails/neglects/refuses to properly incorporate the terms of the plan into the borrower’s loan terms?
Mr. Dillon,
The servicers always apply payments to the arrears, even when there is a confirmed Chapter 13 Plan telling them not to. They claim that their software doesn’t permit them to do otherwise. And, somehow, they haven’t been able to fix their software despite decades passing since the problem first became apparent.
It is a problem.
Part of what concerns me is that this is just a small “local” servicer as opposed to a Litton/Ocwen/Saxon/SPS/EMC etc.
Truth be told, I’m tired of watching servicers, in general, blame their “software” for not being able to do anything. I would be willing to bet that, after a few criminal convictions, software would miraculously re-write itself…
Professor Porter is correct and on target. However, and just a point, by the time modification authority applies if a residence is the suject of a notice that a foreclosure may be commenced the consumer will likely be moving. I have seen and in part agree in the language of BAPCPA being poor, but either the Senate or House, or even both, may want to get the wording right this time around.
Very enlightening discussion here – I really appreciate the hosts of this site.
One key question that seems to be coming up is whether this cramdown legislation will help or hurt the unsecured debt holders. If the mortgage is going to be crammed down to current market value, with the excess treated as an unsecured loan, does that mean that credit card companies are worse off because the unsecured loan balance is higher or might they actually be helped by the fact that the mortgage payment has been crammed lower?
I am interested in learning more about how the proposed changes to bankruptcy law allowing cramdowns would increase the annual number of bankruptcy filings nationally, especially since it looks increasingly certain that congress will change existing bankruptcy law.
All experts agree that enactment of changes allowing cramdowns in bankruptcy would increase the total number of filings, but some people raise the question of whether debtors would effectively be able to use the threat of bankruptcy to renegotiate the terms of their mortgages without having to actually file. My specific question is the following.
As a practical matter, out of all the homeowners currently threatened with foreclosure, what portion of them do you think would be able to renegotiate their mortgages outside of bankruptcy by using the threat of filing for bankruptcy and getting a judge imposed cramdown? In other words, what legal or practical roadblocks would hinder a negotiated adjustment to their mortgage with their lender and require them to file bankruptcy to get the terms of their mortgage altered?
Pooling and Servicing agreements (legal hurdle). And Servicers are not set up to make massive amounts of loans. It is like originating and closing on a new home loan. I say “like” because almost the same amount of documentation and often the same amount of time is needed. Plus the investors may not allow the servicers to write down principal in every case. They may just allow it under a particular set of circumstances. Most of the “workouts” I am currently seeing are forbearance agreements often raising payments in the short (or long) term to make up for missed payments (not even touching interest terms or maturity date). The investors may not allow a “Option” ARM to be remade into a 30 year fixed. Option ARMs generate a massive amount of amortized interest over the life of the loan thus they (Option ARMS) are higher risk in turn generating a higher possibility for a lager return.
A Bankruptcy “Option” cuts right through the Pooling and servicing agreements (Federal Law)and if a BK Judge rewrites the mortgage terms the Servicer won’t have to worry about being sued by the investors.
The “threat” of cramdown may get the investors to say “Hey Servicer, lets do a better job at these reworks otherwise it will be out of our hands”, you know how everyone likes control. If the Servicer sucks at reworks (most of them are) the investor will pull their Mortgage contracts and give them to a Servicer that will be better at it.
(just a blogging participants opinion and not a legal one. Void where prohibited) j/k 😉 sorry its been a very crazy day on the front lines of this “Mortgage Mess”/”Credit Crunch”/”Recession”.
Robert: I think unsecured creditors may get higher percentages with the legislation. Especially if a Judge rewrites the mortgage so that the debtor is only paying 30% of his/her/their income on Mortgage stuff (P&I, insurance and taxes). So the short answer for me anyway is “Better”.
You all are on a roll!: New story out on MSN on Mortgage Mods. Props on the quotes.
http://www.msnbc.msn.com/id/28642344/
I didn’t know Prof. Warren was on that committee. Guess I missed it. Congratulation! Great work! She has to be swamped, and I thought last Friday was bad. People are already asking me about the legislation.
One thing I didn’t quite get was this quote for the Story: “One key change would restrict the provision to existing mortgages, preserving the bankruptcy exemption for new first mortgages”. Key word for me is “FIRST”. That word may open up some worms in regards to all the 80/20s I see…. Maybe ???? I guess unless that “20%” matures in the following 5 years.
The problem with these “failure” statistics is that many, many people file chapter 13 simply to buy a few weeks before moving out. Because the chapter 13 is so easily dismissed, there is preceived to be little risk. In the San Fernando Valley, something like 30% of the chapter 13s are pro pers and I doubt if more than a few will result in confirmed plans this year. They all fail. In addition, I believe many cases, filed with attorneys, are dismissed at the 341(a) because the first plan payment is not made. So taking out the pro pers and the cases that should not have been filed because there was no chance in the first place, I suspect the failure rate is not that high.
Prof. Jon Hayes
http://www.lawprofessorblogs.com
Wow, why would anyone want to file their own bankruptcy, unless they know the “ropes”? It’s not like an uncontested divorce you know.
I saw on your blog Prof. Hayes that you all have a “help” desk manned by a paralegal and a rotating attorney to help with Pro Se debtors’ filings. I say you all but I mean in your area, CA? How do those work out? Like you said above? I said it on a previous post but there are many ways to “win” without a discharge.
I’ve been following this thread the entire mortgage modification story with great interest. I’ve read several papers of various competing viewpoints as well as Congressional testimony on both sides of the issue. I have one observation and one question.
Observation: one argument continually presented in favor of the strip-downs on primary residences is that they are already done on second home and investment properties. This is presented as if this were an issue of fairness and that such strip-downs during bankruptcy proceedings were common. In fact, the dont appear at all common (despite the article in today’s WSJ mentioning a case) because the person has to pay the entire secured portion within the 3-to-5 year Ch 13 plan. This type of mortgage acceleration, even stripped down, would have to be almost impossible for the average person in Ch 13 to do.
Which leads to my question: Is there any available data on the number of strips downs of investment properties and second homes actually occur? And how many of those are successful?
And one more question (as long as I have the floor): Who takes the loss now on the stripped down mortgage? The servicer? Is that passed on to the mortgage-backed security investor or is the loan required to be bought out of the pool?
Thanks for any insight. It just seems to me that if we’re comparing a relatively rarely used procedure under entirely different payment terms and trying to extrapolate to a case where we expect (and indeed encourage) exceptional use, then we ought to be pretty careful we present all the facts.
I am sure someone else will get more into this than I. Bob and Adam are the stats men.
To me anyway it’s not that “cramdowns” on investment homes are currently available and that it’s “unfair” so to speak. It is a matter of coming up with a way of providing relief to the people whose homes are the cruxes of so many investments without pumping in billions of dollars. If the loans don’t perform it has a trickle up effect. If it were not for the pooling of these mortgages which did provide temporary liquidity(then shoved into the CEOs pockets), banks would be more willing to renegotiate these loans just to keep them performing. With Servicers and the Pooling agreements, those remedies have become all but impossible, or rather impossible to enact expeditiously. A “rewrite“ option” would be like a tourniquet. It will stop the bleeding. Get them performing! Even if the Banks take a minor hit on the front end they still have 30 years to still make a profit. Even if a BK judge wrote down the principal interest etc… There will still be a profit. It’s just won’t be a “home run” but at the very least a “double”. To me a “loss” is not making as much as you put in. What we are talking about here is not making as “much” profit as originally proposed.
I’m monopolizing the comments so I will stop now… Sorry.