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[110 Senate Hearings]
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S. Hrg. 110-511
THE LOOMING FORECLOSURE CRISIS: HOW TO HELP FAMILIES SAVE THEIR HOMES
=======================================================================
HEARING
before the
COMMITTEE ON THE JUDICIARY
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
DECEMBER 5, 2007
__________
Serial No. J-110-62
__________
Printed for the use of the Committee on the Judiciary
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44-330 PDF WASHINGTON DC: 2008
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COMMITTEE ON THE JUDICIARY
PATRICK J. LEAHY, Vermont, Chairman
EDWARD M. KENNEDY, Massachusetts ARLEN SPECTER, Pennsylvania
JOSEPH R. BIDEN, Jr., Delaware ORRIN G. HATCH, Utah
HERB KOHL, Wisconsin CHARLES E. GRASSLEY, Iowa
DIANNE FEINSTEIN, California JON KYL, Arizona
RUSSELL D. FEINGOLD, Wisconsin JEFF SESSIONS, Alabama
CHARLES E. SCHUMER, New York LINDSEY O. GRAHAM, South Carolina
RICHARD J. DURBIN, Illinois JOHN CORNYN, Texas
BENJAMIN L. CARDIN, Maryland SAM BROWNBACK, Kansas
SHELDON WHITEHOUSE, Rhode Island TOM COBURN, Oklahoma
Bruce A. Cohen, Chief Counsel and Staff Director
Michael O'Neill, Republican Chief Counsel and Staff Director
C O N T E N T S
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STATEMENTS OF COMMITTEE MEMBERS
Page
Durbin, Hon. Richard J., a U.S. Senator from the State of
Illinois....................................................... 1
Feingold, Hon. Russell D., a U.S. Senator from the State of
Wisconsin, prepared statement.................................. 153
Sessions, Hon. Jeff, a U.S. Senator from the State of Alabama.... 4
Specter, Hon. Arlen, a U.S. Senator from the State of
Pennsylvania................................................... 3
WITNESSES
Bennett, Thomas, Bankruptcy Judge, U.S. Bankruptcy Court for the
Northern, District of Alabama, Birmingham, Alabama............. 17
Cox, Jacqueline P., Bankruptcy Judge, U.S. Bankruptcy Court for
the Northern District of Illinois, Chicago, Illinois........... 15
Mason, Joseph, Associate Professor, Drexel University,
Philadelphia, Pennsylvania..................................... 10
McGee, Nettie, Chicago, Illinois................................. 5
Scarberry, Mark, Professor of Law, Pepperdine School of Law, and
Resident Scholar, American Bankruptcy Institute, Washington, DC 12
Sommer, Henry J., President, National Association of Consumer
Bankruptcy Attorneys, Philadelphia, Pennsylvania............... 20
Zandi, Mark, Chief Economist, Moody's Economy.com, Inc., West
Chester, Pennsylvania.......................................... 7
QUESTIONS AND ANSWERS
Responses of Thomas Bennett to questions submitted by Senators
Durbin and Sessions............................................ 36
Responses of Jacqueline Cox to questions submitted by Senators
Durbin and Specter............................................. 51
Responses of Joseph Mason to questions submitted by Senators
Brownback, Sessions and Durbin................................. 56
Responses of Mark Scarberry to questions submitted by Senators
Specter, Durbin and Sessions................................... 74
Responses of Henry Sommer to questions submitted by Senators
Brownback, Durbin and Specter.................................. 89
Responses of Mark Zandi to questions submitted by Senators
Durbin, Brownback and Specter.................................. 98
SUBMISSIONS FOR THE RECORD
American Bankers Association, Washington, D.C., statement........ 101
Bartlett, Steve, on behalf of the Financial Services Roundtable,
Washington, D.C., statement.................................... 113
Bennett, Thomas, Bankruptcy Judge, U.S. Bankruptcy Court for the
Northern, District of Alabama, Birmingham, Alabama, statement.. 117
Chemerinsky, Erwin, Alston & Bird Professor of Law, Duke
University, School of Law, Durham, North Carolina, letter...... 131
Consumer, civil rights, labor, retiree, housing, lending and
community organizations, joint letter.......................... 135
Consumer Federation of America, Allen Fishbein, Director, Housing
and Credit Policy, Washington, D.C., letter.................... 137
Consumer Mortgage Coalition, Anne C. Canfield, Executive
Director, Washington, D.C., letter............................. 139
Cox, Jacqueline P., Bankruptcy Judge, U.S. Bankruptcy Court for
the Northern District of Illinois, Chicago, Illinois, statement 145
Leadership Conference, on Civil Rights, Wade Henderson, President
& CEO, Nancy Zirkin, Vice President, Director of Public Policy,
Washington, D.C., letter....................................... 155
Mason, Joseph, Associate Professor, Drexel University,
Philadelphia, Pennsylvania, statement.......................... 157
McGee, Nettie, Chicago, Illinois, statement...................... 162
Mortgage Bankers Association, Washington, D.C., statement........ 165
National Association of Home Builders, Washington, D.C.,
statement...................................................... 177
Scarberry, Mark, Professor of Law, Pepperdine School of Law, and
Resident Scholar, American Bankruptcy Institute, Washington, DC 182
Sommer, Henry J., President, National Association of Consumer
Bankruptcy Attorneys, Philadelphia, Pennsylvania, statement.... 194
Stein, Eric, Center for Responsible Lending, Durham, North
Caroline, statement and attachments............................ 205
Zandi, Mark, Chief Economist, Moody's Economy.com, Inc., West
Chester, Pennsylvania, statement............................... 233
THE LOOMING FORECLOSURE CRISIS: HOW TO HELP FAMILIES SAVE THEIR HOMES
----------
WEDNESDAY, DECEMBER 5, 2007
United States Senate,
Committee on the Judiciary,
Washington, DC
The Committee met, Pursuant to notice, at 2:29 p.m., in
room 226, Dirksen Senate Office Building, Hon. Richard J.
Durbin, presiding.
Present: Senators Specter and Sessions.
OPENING STATEMENT OF HON. RICHARD J. DURBIN, A U.S. SENATOR
FROM THE STATE OF ILLINOIS
Senator Durbin. The hearing will come to order.
Good afternoon, and welcome to this hearing of the Senate
Judiciary Committee on ``The Looming Foreclosure Crisis: How to
Help Families Save Their Homes.''
I want to thank Chairman Patrick Leahy for scheduling this
important hearing and permitting me to chair it. I believe I'll
be joined by some colleagues during the course of this hearing,
and they will play an active part in the interrogation, as well
as follow-up questions.
America's mortgage crisis is not just your neighbor's
problem, it is everyone's problem. It is putting families out
on the streets, driving down home values, and sending our
economy into a tailspin. It is a crisis that demands an urgent
response.
Home ownership is a pillar of our society and an integral
part of America's economy. But the mortgage melt-down means
thousands of families are losing their homes. Millions more are
at risk of foreclosure, and up to a third of all home-owning
families in this country may see their homes lose value.
Why is this happening? The reasons are clear. During the
heyday of the real estate bubble, through a combination of bad
information and aggressive brokers and bankers, too many
families signed up for bad mortgages. For a while, many
homeowners were able to keep up with their mortgage payments
because home values were on the rise, or because adjustable
rate mortgages had not yet re-set to higher interest rates. But
many of these same homeowners are now struggling as housing
prices have dropped and the adjustable rate mortgages have
begun to re-set.
Whatever the reason that families may find themselves
unable to pay their mortgages, the effect of foreclosure is the
same: it's a disaster for the family, and for the neighborhood,
and for our country.
The Center for Responsible Lending estimated, a year ago,
that 2.2 million homes might be lost to foreclosure in the
coming months ahead. That estimates now looks conservative. The
impact of home foreclosures is not limited to families who are
put out on the street. Treasury Secretary Paulson said earlier
this week, ``Homes in foreclosure can pose costs for the whole
neighborhood, as crime goes up and property values decline.''
The Center for Responsible Lending recently released new
estimates on the lost home value that the foreclosure wave will
cause for neighboring families. The Center predicts that,
nationwide, 44.5 million families will experience a loss in
home value because of foreclosures in their neighborhoods.
Forty-four point five million homeowners represent one-third of
all residential homes in America. These families will see
property values decrease by an average of $5,000.
Some metropolitan regions will be particularly hard hit. In
Cook County, Illinois alone, the Center predicts that around 2
million homeowners will lose value in their homes because of
neighborhood foreclosures. Somewhere between two-thirds and 85
percent of all Cook County homeowners will be affected by the
50,000 or 59,000 foreclosures in that county. These homeowners
will lose, collectively, $15.7 billion in home value, an
average of $7,000 a home.
These are astounding numbers. Home foreclosures pose other
problems as well. The U.S. Conference of Mayors issued a report
projecting the foreclosure crisis will result in 524,000 fewer
jobs next year, a drop in consumer spending, a loss of billions
of dollars in local, State, and Federal tax revenue, and a
slower growth rate for our U.S. GDP.
This foreclosure crisis is looming over our entire economy
right now. It is time to do something. The government, mortgage
lending industry, and the nonprofits who help homeowners have
to work together to save as many homes as possible. I am
pleased that in Congress, we are now talking about how to
tighten lending standards so we won't repeat this type of
market melt-down, but there is more work to do. In the
meantime, many families are already in a desperate struggle.
I have introduced the Helping Families Save Their Homes in
Bankruptcy Act. This legislation can help save the homes of
about 1 out of every 4 facing foreclosure, about 600,000
families who have nowhere else to turn.
Today, a bankruptcy judge in Chapter 13 can change the
structure of any secured debt except for one: the mortgage on a
home, a principal residence. When this exception was added to
the law almost 30 years ago, mortgages were largely 30-year,
fixed-rate loans that required 20 percent down, and were
originated by a local banker who personally knew the homeowner.
In 1978, when this provision was added to the Bankruptcy Code,
it was rare, if ever, that a mortgage would be the source of
financial difficulty that sent a family into bankruptcy.
Well, a lot has changed since 1978. Now, unregulated, out-
of-town mortgage brokers sell exotic, ``no-doc'', interest-
only, ``2-28'', or other exotic mortgages to families with few
questions asked. The mortgages are then securitized by the big
banks, sold into secondary markets to investors who have no
knowledge of the homeowner or their financial situation. Risk
is dispersed, but so is responsibility.
In 1978, when a family realized it might begin having
trouble making a house payment, it could go down to the local
bank and work out a new plan to keep up. Today, families
struggle to even get a straight answer from somebody on a
telephone about what's happened to their mortgage. We need
another solution for families who are losing their way in this
brave new world of complicated mortgages. We need to provide
families with more leverage so that banks will work harder to
come up with reasonable compromises.
Bankruptcy has to be the last resort. I believe it is. But
changing how family homes are treated in bankruptcy will help
hundreds of thousands of families who would otherwise be out on
the street. Who wins? Who wins in a foreclosure? All of the
money that is being spent so that someone ends up with a home
that can be worth no more ultimately than the fair market
value? Do bankers really want to cut grass and wash windows? I
don't think so. If we can keep the family in the home under
reasonable terms, that's the best outcome.
My bill would allow bankruptcy judges to work out mortgage
payment plans with the homeowners and the banks, and also
protect those families from excessive fees. Under my bill, only
families that desperately need the help will file for
bankruptcy, and only reasonable mortgages will result. The bill
will facilitate dealing with each family situation
individually, and yet it would provide a method for processing
the massive volume of needed modifications that the banks'
voluntary work-out procedures simply cannot handle. It does not
create a new government bureaucracy, and it wouldn't cost the
taxpayers a penny.
This afternoon, I look forward to learning more about the
current state of the mortgage market and discussing how we
might make those changes to the Bankruptcy Code. Before I
recognize him, I want to thank my colleague, Senator Arlen
Specter from Pennsylvania. He and I have been talking this over
for the last several months, and it was his suggestion that we
have this hearing. I am glad we did. A lot of attention is
being paid to this, as it should be. This is a national issue
of great consequence. I thank Senator Specter for his
continuing interest, and I give him the floor.
STATEMENT OF HON. ARLEN SPECTER, A U.S. SENATOR FROM THE STATE
OF PENNSYLVANIA
Senator Specter. Thank you very much, Mr. Chairman, for
that excellent background on the problem, and those generous
words.
It is true that Senator Durbin, I, and others have been
talking about this problem for a long time. We are very close
to the same approach, with one difference. That is, Senator
Durbin's bill would all the bankruptcy courts to cram down, or
modify the principal obligation. My bill would deal only with
the interest.
My thinking has been that on the adjustable rate mortgage,
people didn't really know what they were doing and they were
getting involved in financial transactions which were a
surprise to them, where they expected to pay a given amount and
then suddenly they found the adjustable rates are much higher
and something they could not afford.
Some of these transactions, I think, border, if not cross
the line, of fraud and misrepresenting to homeowners what was
going to happen. With the principal sum, it's a little
different. I think they knew what the principal sum was. But it
is really anomalous that the Bankruptcy Code allows secure
transactions to be modified by the bankruptcy court, but not
first mortgages.
I noted with interest a notation from a concurring opinion
of Justice Stevens in Nobleman v. American Savings. He wrote it
this way, and he lays it out in very succinct terms: ``At first
blush, it seems somewhat strange that the Bankruptcy Code
should provide less protection to an individual's interest in
retaining possession of his or her home than of other assets.
The anomaly is, however, explained by the legislative history,
indicating favorable treatment of residential mortgages was
intended to encourage the flow of capital into the home lending
market.''
So the concern that I have had, and candidly expressed to
Senator Durbin, is that if we make a modification of the
principal home, then the lenders will be reluctant to loan
money for the principal home for fear that there will be
another action by Congress to move the goal post. But when he
and I talked about this, we were of the same mind, that we
ought to know what the experts thought. We can sit and
speculate about it, and our staffs, which are more astute than
we, could work on it, but that it would be a good idea to hear
from some of the experts.
This hearing has been set for the afternoon, which is sort
of tough on our schedule. We ordinarily have these hearings in
the morning. This is a major, major problem in this country.
The lack of attendance of the 19 members of the Judiciary
Committee doesn't signify any lack of concern, but only that
people are occupied with many other matters. I personally will
stay as long as I can, but we will be following your testimony
very, very closely.
The President has addressed the subject. Treasury Secretary
Paulson has. Secretary Jackson has. I believe this is a matter
that the Congress ought to act on very promptly, so we're going
to move the ball ahead with this hearing today.
Thank you, Mr. Chairman.
Senator Durbin. Senator Specter, thank you very much.
Senator Specter. Senator Coleman is a cosponsor of my bill,
and I would like to thank him for joining.
Senator Durbin. Thank you.
This matter is before the full committee, the Judiciary
Committee. It customarily would have been before the
Subcommittee on Administrative Oversight and the Courts.
Senator Sessions of Alabama is the ranking Republican member on
that, and I would invite him now if he'd like to make an
opening statement.
STATEMENT OF HON. JEFF SESSIONS, A U.S. SENATOR FROM THE STATE
OF ALABAMA
Senator Sessions. I thank you for having this hearing. I'm
a very strong believer that one of the most fantastic things
about living in America, is that the average citizen with a
decent job can borrow $100,000, $150,000, 6, 7 percent
interest, pay it off over 30 years, and move into a nice house,
at least in most areas of the country. It's more than that in
some, for sure. So, I think it's a great privilege we have. It
used to be rather simple. There weren't many different kinds of
mortgages and loans that you took out. Now we've gotten very
complicated.
I think it's worthy of Congress to consider how we do this.
But I do know that we're not going to change the law of supply
and demand. If we make too many rules, particularly on the back
end in court, we're liable to reduce the amount of money
available for the average person to borrow to buy a house that
he can raise his family in and retire in. So, that would be my
concern as we go forward. We ask those questions to make sure
that we are addressing the problems that we now face in the
best way possible.
Thank you, Senator Durbin.
Senator Durbin. Thank you, Senator Sessions.
Before we turn to the witnesses, I want to briefly enter
several statements into the record. I have a letter in support
of my legislation signed by a diverse group of consumer, civil
rights, labor, retiree, housing, lending and community
organizations. Without objection, they letter will be entered
into the record.
I also have been asked to submit statements for the record
from the following organizations: the American Bankers
Association; National Association of Home Builders; and the
Consumer Mortgage Coalition. Without objection, they will also
be entered into the record.
Now we will turn to our witnesses for their opening
statements. I am honored to welcome this distinguished panel.
Each witness will have 5 minutes for an opening statement. You
will see the timer in front of you turn red when the Capitol
Police are about to arrive. Since we have a large panel, I ask
you to please try to stay within 5 minutes if you can. Your
complete written statements will be made part of the record.
I'd like to ask the witnesses, with the exception of Ms.
McGee, who may remain seated, if they would please rise and
raise their right hands to have the oath.
[Whereupon, the witnesses were duly sworn.]
Senator Durbin. Let the record reflect that the witnesses
all answered in the affirmative.
Our first witness is Ms. Nettie McGee. Ms. McGee is a
great-grandmother who has lived in Chicago for the last 53
years. She is now retired after a career of working in a
picture frame factory. In 1999, at the age of 65, Ms. McGee
bought her first home on South Aberdeen, on the south side of
Chicago. Now she is in danger of losing that home because of an
increase in her mortgage interest rates.
Ms. McGee, I know it was a great sacrifice for you to come
out here, and I thank you very much. I know it is also hard to
talk about this situation, but believe me, you are speaking for
many, many people who can't be here today. We wanted to hear
your voice and your story as part of this record. Please
proceed with your statement.
STATEMENT OF NETTIE MCGEE, CHICAGO, ILLINOIS
Ms. McGee. Senator Durbin, members of the committee, thank
you for inviting me to speak before you today. My name is
Nettie McGee and I've lived in Chicago, Illinois for 53 years.
I live in a home I waited my entire life to own. Now the
interest rate on my mortgage is going up 3 percent and my
payments are $200 more each month. I am here to ask you to
please help me save my home.
In 1997, I began renting my current home on South Aberdeen
Street. I rented it for 2 years with an option to buy. When I
finally bought my first home in 1999, for $80,000, I was 65
years old. I made the payment for 6 years. I had a fixed rate
mortgage and I knew what to expect each month: it was $735
every month. I was able to make my payments and pay my taxes. I
could afford all of my bills.
Then in October of 2005, the sheriff came to my door to
tell me that my backyard was going to be sold for auction for
$5,000 because of an unpaid tax bill. I paid the taxes on my
house every year. I just didn't know that I had two tax bills,
one for my house and one for my backyard. The tax bill for my
backyard had been sent to an address across town for years,
since and before I moved in. I was desperate to keep my
backyard and my beautiful trees, but I had to pay the city
$5,000 and I had to do something fast because I would lose my
yard.
I didn't have $5,000 in the bank. I live on Social Security
and I get some rent from my daughter. Then I saw a commercial
on TV about refinancing your home. I thought if I refinanced, I
could get money to pay the tax bill and keep my yard. I called
the number and a broker came to visit me the next day. He wrote
down my personal information, and a week and a half later he
called me and asked me to come down to sign the papers.
After I arrived at the crowded office, I was taken into a
small room, handed about 40 pages, and told where to sign. The
woman in charge of the closing stood over me and turned the
pages as I signed them. The whole process took about 10
minutes. I thought I was signing a fixed-rate loan. Then, with
no explanation of the loan, I was sent out the door. The
mortgage company paid the taxes to the county.
Then, to my surprise, they called me a few days later to
come back and get a check for $9,000. I didn't know they had me
borrowing the extra $9,000. When I asked about it, the mortgage
company said that I could use it for bills. I thought it was a
good idea, so I used the money to pay some bills and fix my
plumbing problem. I started paying the loan back. The payments
were about the same as my original loan. It's been difficult at
times, but I have never missed a payment.
A month and a half ago, in October of this year, I got a
letter from my mortgage company that said that on December 1,
my payment was going up from $706 to $912. I called the
mortgage broker, but he doesn't work there anymore. I thought I
signed a fixed-rate mortgage. I had no idea my payment would
jump almost 25 percent. My interest rate went from 7.8 to
10.87, and eventually it will go higher.
I don't know how to make my payments now. They are higher
than my Social Security check. The only reason I can get by now
is because my daughter pays me a little rent. Right now, my
lawyers from the Legal Assistance Foundation in Chicago are
trying to help me negotiate with my lender, but we don't know
if the bank will agree to lower my interest rate back where it
was before.
I know I will lose my home that I waited my entire life to
own if I can't get my original rate back. Many people who could
originally afford their mortgage payments are losing their
homes because they have an adjustable rate mortgage. Please
help people like me, please, who waited their entire lives to
own their homes. Please help me.
Senator Durbin. Thank you for that great statement, exactly
5 minutes. You're a model for the rest of the witnesses. Thank
you so much, Ms. McGee.
[The prepared statement of Ms. McGee appears as a
submission for the record.]
Our next witness is Mark Zandi. Mr. Zandi is the chief
economist and co-founder of Moody's Economy.com, Inc., where he
directs the company's research and consulting activities.
Moody's Economy.com provides economic research and consulting
services to businesses, government, and other institutions. Mr.
Zandi received his B.S. from the Wharton School at the
University of Pennsylvania, and his Ph.D. at the University of
Pennsylvania.
Thank you very much for joining us today. We look forward
to your testimony.
STATEMENT OF MARK ZANDI, CHIEF ECONOMIST, MOODY'S ECONOMY.COM,
INC., WEST CHESTER, PENNSYLVANIA
Mr. Zandi. Thank you for the opportunity to be here today.
I am the chief economist and co-founder of Moody's Economy.com.
We're an independent subsidiary of the Moody's Corporation.
These are my own personal reviews and do not represent those
held by, or endorsed by, Moody's.
I will make six points in my remarks. First, the Nation's
housing and mortgage markets are suffering an unprecedented
downturn. Housing activity peaked over 2 years ago, and since
then home sales have fallen by over 30 percent, housing starts
by 40 percent, and house prices by 7 percent. Over half of the
Nation's housing markets are currently experiencing substantial
price declines, with double-digit price declines occurring
throughout Arizona, California, Florida, Nevada, the northeast
corridor, and the industrial midwest.
Further, significant declines in housing construction
prices are likely into 2009 as a record amount of unsold
housing inventory continues to mount, given the impact of the
recent subprime financial shock and its impact on the mortgage
securities market and, thus, mortgage lenders. There is now a
broad consensus that national house prices will fall by between
10 and 15 percent from their peak to their eventual trough.
Even this disconcerting outlook assumes that the broader
economy will avoid recession and that the Federal Reserve will
continue to lower interest rates.
The second point. Residential mortgage loan defaults and
foreclosures are surging, and without significant policy
changes, will continue to do so through the remainder of the
decade. Falling housing values, resetting adjustable mortgages
for recent subprime and all-day borrowers, tighter underwriting
standards, and most recently a weakening job market, are all
conspiring to create the current unprecedented mortgage credit
problems. Even if mortgage loan modification efforts soon
measurably increase, I expect approximately 2.8 million
mortgage loan defaults, the first step in the foreclosure
process, in 2008 and 2009.
Of these, 1.9 million homeowners will go through the entire
process and ultimately lose their homes. The impact on these
households or communities in the broader economy will be
substantial. Foreclosure sales are very costly after accounting
for substantial transaction costs and can serve to
significantly depress already reeling housing markets are
foreclosed properties are generally sold at deep discounts to
prevailing market prices. In much less stressful times, these
discounts are estimated to be between 20 and 30 percent.
Point three. There's a substantial risk that the housing
downturn and the surging foreclosures will result in a national
economic recession. The stunning decline in housing activity
and prices will combine with rising gasoline prices, crimping
consumer spending, and the job market appears increasingly weak
as it struggles with layoffs in housing-related industries.
Regional economies, such as California, Florida, Nevada, and
much of the industrial midwest, together, accounting for well
over one-fourth of the Nation's GDP, are, in my judgment,
already in recession.
The turmoil in the housing and mortgage markets also
threaten to further up-end the fragile global financial system,
with very clear negative implications for the U.S. economy.
Estimates of the mortgage losses global investors will
eventually have to bear range as high as $500 billion. The
losses recognized so far to date are now more than $75 billion.
If the U.S. economy does slide into recession, then of course
house prices will decline. Foreclosures will rise to an even
more serious degree.
Point No. 4. Without a quick policy response, mortgage loan
modification efforts are unlikely to increase enough to
forestall a surge in foreclosure. A recent Moody survey of loan
servicers found that very little modification had been done, at
least through this past summer. This highlights the substantial
impediments to modification efforts. Some tax, accounting, and
legal hurdles appear to have been overcome, but large
differences in the incentives of first and second mortgage
lienholders and the various investors in mortgage securities
are proving very daunting.
Given the overwhelming number of foreclosures, loan
servicers are also having difficulty appropriately staffing the
modification efforts. While the total economic benefit of
forestalling foreclosure is significant, these benefits do not
accrue to all parties involved in determining whether to
proceed with the loan modification.
A recent initiative by the Treasury Department in the
Nation's lenders to freeze interest rates on re-setting
subprime ARM loans is a good step, but should not forestall
passage of your legislation, the Helping Families Save Their
Homes in Bankruptcy Act. If the Treasury plan is successful in
helping many borrowers, then these borrowers will not avail
themselves of the opportunity to avoid foreclosure and Chapter
13 provided by this legislation. If, however, Treasury's
efforts are unsuccessful, which may very well be the case, then
this legislation will prove invaluable.
The fifth point. Senator Durbin's legislation, which would
give bankruptcy judges the authority in Chapter 13 to modify
mortgages by treating them as secured only up to the market
value of the property, would significantly reduce the number of
foreclosures. An estimated over one-fourth of homeowners likely
to lose their homes between now and the end of the decade,
equal to an estimated 570,000 homeowners, would benefit from
this legislation.
This calculation is based on the number of homeowners who
face a first payment re-set through the end of the decade that
would meet the means test required in the 13 that are still
current on their mortgage loans. This would be very helpful in
reducing the pressure on the housing and mortgage markets and
will measurably reduce the odds of recession in the coming
year.
Note that in order to limit any potential abuses in the
Chapter 13 modification process, Congress should provide firm
guidelines to bankruptcy courts, such as providing a formula
for determining the term to maturity and the rate of a
property's market value.
Finally, this legislation will not significantly raise the
cost of mortgage credit, disrupt secondary markets, or lead to
substantial abuses by borrowers. Given that the total cost of
foreclosure to lenders is much greater than that associated
with a 13, there's no reason to believe that the cost of
mortgage credit across all mortgage loan products should rise.
Simply consider the substantial costs involved with
navigating through 50 different State foreclosure processes in
contrast to one well-defined bankruptcy proceeding. Indeed, the
cost of mortgage credit to prime borrowers may decline. The
cost of second mortgage loans, such as piggy-back seconds,
could rise as they are likely to suffer most from bankruptcy.
Such lending has played a clear contributing role in the
current credit problems.
There is also no evidence that the secondary mortgage
markets will be materially impacted as other consumer loans
already have similar protection in 13 and have well-functioning
secondary markets. However, the non-conforming residential
mortgage market has already effectively been shut down in the
wake of the financial shock and will only revive after there
are major changes to the process. The changes proposed in this
legislation are immaterial by comparison.
It is also unlikely that the abuses by borrowers will
increase as a result of the legislation, given that a work-out
in a 13 is a very financially painful process. Indeed, the
number of filings has remained surprisingly low since the late
2005 bankruptcy reform, likely reflecting the now much higher
cost to borrowers in a 13 proceeding. Short-term investors, or
flippers, those who have borrowed heavily, looking to make a
quick profit in the boom, would certainly not consider 13 a
viable solution to their problem.
The housing downturn is intensify, foreclosures are
surging. A self-reinforcing negative dynamic of mortgage
foreclosures begetting house price declines, begetting more
foreclosures, is under way in many neighborhoods across the
country. The odds of a full-blown recession are very high.
There is no more efficacious way to short-circuit this
developing cycle and forestall a recession than passing this
legislation. Thank you.
Senator Durbin. Thank you, Mr. Zandi.
[The prepared statement of Mr. Zandi appears as a
submission for the record.]
Senator Durbin. Professor Joseph Mason is an Associate
Professor of Finance at Drexel University's LeBow College of
Business in Philadelphia, and a senior fellow at the Wharton
School. Before joining Drexel, Professor Mason spent 3 years at
the Office of the Comptroller of the Currency. Professor Mason
has an M.S. and a Ph.D. from the University of Illinois, and a
B.S. from Arizona State University.
Professor Mason, you may proceed.
STATEMENT OF JOSEPH MASON, ASSOCIATE PROFESSOR, DREXEL
UNIVERSITY, PHILADELPHIA, PENNSYLVANIA
Mr. Mason. Thank you, Mr. Chairman, Ranking Senator
Specter, and members of the committee, for the opportunity to
be here today. I am pleased to appear before you to talk about
this foreclosure crisis and the legislative options for
addressing the economic and social concerns arising from that
crisis.
People only file for bankruptcy if they are, first,
vulnerable--i.e., they have debt greater than their assets--and
second, only if some financial shock occurs that prevents them
from keeping debt service payments current. The typical shocks
that cause bankruptcy--divorce, illness, accident, and
addiction--have all increased over the last several decades and
are particularly prevalent among individuals in their 30's, in
a time when they have the highest debt load of their lives.
With the advent of subprime mortgages, we must now add
adjustable rate mortgage payment shocks to the list of classic
influences.
The question today, therefore, is to what extent
legislative intervention can, and should, insulate individuals
from the payment shocks in their mortgage contracts. I offer
you three main conclusions from an economic perspective.
First, mortgages and other real assets are poor candidates
for bifurcation in bankruptcy because they can be fully
expected to regain value later on in the life of the contract.
Hence, bifurcation of a debt secured by real estate may be
considered a taking, in a sense, not applicable to fully
depreciable assets.
The reason a bifurcation makes sense for a fully
depreciable collateral, is that the value of that collateral is
decreasing throughout the life of the loan. If a court
bifurcates a claim on an automobile loan, the automobile is not
expected to ever be worth more than the market value
established by the courts at that time.
For real estate, even in today's market conditions, the
value of the collateral can be expected to grow in the future,
so that bifurcating the claim is akin to taking away real value
from the lender and giving that value to the borrower. The
concept is especially egregious in real estate markets that are
highly sensitive to economic or market conditions. High-flying
real estate markets of 1980's returned handsome profits for
investors after the relatively brief market disruptions of the
late 1980's and the recession of 1991.
The Case-Schiller Mortgage Price Index, which begins in
January 1987, shows that Boston home prices hit a high of 75.53
on the index in July 1988, and retreated thereafter, only to
reach and exceed that level again in May, 1997. Boston now
stands at an indexed level of 170.73, providing 127 percent
total return for a buyer who bought at that January 1987 peak,
or 4.2 percent annual return since 1987.
Los Angeles, similarly, peaked at an index level of 100 in
June, 1990, and after a similar hiatus reached that level again
in January of 2000. Los Angeles now stands at an indexed level
of 254.79, which provided a buyer at that previous peak, 155
percent total return, or 5.7 percent annually since 1990.
It's important to point out, these are worst-case returns
obtained from buying at the top of the market and holding. The
cases do not account for the fact that the investment made by a
home buyer is leveraged so that an investment of 20 percent
down, along with periodic payments, is enough to obtain the
full gain of the property value.
Second, legislative changes to enable bifurcation of
mortgage contracts will increase the cost of credit to mortgage
borrowers to cover the expected aggregate value of judiciary
settlements. The cost of mortgage credit can be expected to
rise to levels on par with other secured non-mortgage credit,
like automobile loans, and unsecured credit, like credit cards.
The problem, however, will also extend to secondary markets
for securitized loans that have been devastated by uncertainty
over the last year. Since the ability to bifurcate mortgages
will extend to contracts already written and sold in
securitized pools, existing loans will decline in value by the
risk difference employed in the spread between non-real estate
and real estate secured credit. That means that the value of
residential mortgage-backed securities will decline further as
well.
In the event that markets will not be able to adequately
ascertain the impact of judicial intervention, they will impose
an additional ``Lemons'' discount above and beyond that already
imposed on the market for fundamental opacity and ratings
agency malfeasance to account for the maximum possible effect a
priori. Knock-on effects will reverberate through
resecuritization markets like those for CDOs and SIVs.
The point is that judicial adjustment will add further
information difficulties to an already uncertain market
environment. The effect will not be limited to changes in
bankruptcy law. Loan modifications will have a similar
influence. For additional background on that, you can see Marty
Feldstein's op-ed in today's Wall Street Journal.
In addition, changing the nature of mortgage priority in
bankruptcy further incentivizes the shift away from building
equity in one's own home by paying down the mortgage. If
mortgage debt is tax-exempt and can be discharged in
bankruptcy, it becomes even more advantageous for consumers to
maximize their mortgage debt relative to the value of the home.
Addressing Senator Session's opening remarks, as a result
of similar incentives we face a generation that stands to enter
their retirement years without the historically largest
retirement asset, their home equity, intact. Poorly funded
401(k)s, pension funds that will eventually have to face up to
subprime mortgage losses in their own portfolios, and Social
Security will not make up for that shortcoming, which will
therefore create a tremendous drag on economic growth and
social well-being.
Last, the act of bifurcating mortgage credit will increase
the cost of bankruptcy to cover appraisal and other
transactions costs needed to establish the fair market value of
the underlying real estate, imposing yet another cost on filers
above and beyond those imposed in the Bankruptcy Abuse,
Prevention, and Consumer Protection Act that went into effect
on October of 2005.
In the case of bifurcating the automobile loan mentioned
previously, the judge need only look at a Kelly Blue Book to
establish a reasonable market value for the collateral asset.
In the case of a mortgage, however, getting the fair market
value is not so simple. The judge will have to order an
appraisal of the property to assess a fair market value. That
will cost approximately $300 to $500, and the cost would be
expected to be paid by the debtor.
In addition to the cost, however, the accuracy of
appraisals also has to be considered. The fact is, appraisals
have not been very accurate in recent past. Appraisals skewed
to the high end fueled recent over-borrowing and home price
inflation, causing much of the present-day mortgage market
difficulties. An industry experiencing such difficulties, which
has contributed so much to the recent mortgage crisis, is
hardly a reliable basis for a substantial component of
bankruptcy law.
In conclusion, the U.S. economy continues to experience
very real problems stemming from the mortgage crisis. The
problems originate in a variety of unsafe and unsound practices
in the mortgage industry, ranging from predation to
speculation. It is easy to see the need to address predation in
the mortgage industry. It makes sense to seek judicial remedies
that have the power to nullify contractual terms that violate
terms of the Real Estate Settlement Procedures Act, the Truth
in Lending Act, the Homeowner Equity Protection Act, and/or
other laws and regulations relating to the mortgage industry.
Giving the judiciary the power to fully bifurcate mortgage
contracts, however, sets the stage for potential abuse of the
bankruptcy system to further speculative purposes and further
incentivizes cashing out home equity rather than sustainable
home ownership.
Senator Durbin. Thank you very much, Professor Mason.
[The prepared statement of Professor Mason appears as a
submission for the record.]
Senator Durbin. Our next witness is Professor Mark
Scarberry. Professor Scarberry is a Professor of Law at
Pepperdine University College of Law in Malibu, California,
currently the Robert Zinman Resident Scholar at the American
Bankruptcy Institute in Alexandria, Virginia. He graduated from
Occidental College in Los Angeles, and the UCLA School of Law.
Thank you for joining us today. Please proceed.
STATEMENT OF MARK SCARBERRY, PROFESSOR OF LAW, PEPPERDINE
SCHOOL OF LAW, AND RESIDENT SCHOLAR, AMERICAN BANKRUPTCY
INSTITUTE, WASHINGTON, DC
Mr. Scarberry. Chairman Durbin, Ranking Member Specter, and
members of the committee, I am Mark Scarberry, Professor of Law
at Pepperdine University and Resident Scholar at the American
Bankruptcy Institute, or ABI. I teach and write primarily on
bankruptcy law and am pleased to appear today to speak on the
bankruptcy bills dealing with the mortgage crisis.
ABI is a nonpartisan, nonprofit association of over 11,000
professionals who represent both debtors and creditors in
consumer and businesses cases. ABI is not an advocacy group and
does not lobby. It is a neutral source for bankruptcy
information and a resource for Members of Congress and their
staff. As a professor and ABI resident scholar, I can give my
views, but they should not be taken as the ABI's views.
You have a chart I prepared comparing the four pending
bills. A key difference between the two Senate bills is that
Senator Durbin's, S. 2136, allows a Chapter 13 plan in some
cases to reduce the amount of an under-secured mortgage to the
value of the home without the consent of the mortgage holder, a
result that is called ``strip-down'' or sometimes ``cram-
down''. Senator Specter's S. 2133 would require consent of the
mortgage holder before a strip-down could take place. The Code
currently does not permit home mortgage strip-down under
Chapters 7, 11, or 13.
Now, a side point. Bankruptcy courts may not be able to
handle the needed volume of cases on a one-case-at-a-time
retail basis. Congress, instead, could use its bankruptcy power
to help Secretary Paulson as he seeks a wholesale solution that
could help hundreds of thousands of homeowners like Ms. McGee.
Mortgage servicers may lack authority to modify mortgages
on such a wholesale basis as is sought by the Secretary.
Legislation under Congress's bankruptcy power may be
particularly appropriate to validate such agreements if made
per Treasury guidelines and to immunize servicers from
liability for making such agreements.
Now, no Circuit Court had permitted home mortgage strip-
down in Chapter 13 until 1989. By 1993, strip-down was becoming
so widely used that it threatened to further damage the already
weak home lending industry. But that year, the Supreme Court,
in Nobelman, held that Section 1322(b)(2) prohibited home
mortgage strip-down in Chapter 13. The next year, Congress gave
home mortgages in Chapter 11 cases the same protection. S. 2136
would remove that protection in some Chapter 13 cases.
Allowing home mortgage strip-down in Chapter 13 would, in
fact, treat holders of home mortgages worse than other secured
creditors. If a secured credit's lien is stripped down under
current law, the stripped-down amount must be paid off, with
interest, during the Chapter 13 case over no more than 5 years.
As a practical matter, a debtor cannot strip down a first
mortgage on a substantial vacation home because the payments
needed to pay off the stripped-down amount over 5 years would
be too large.
S. 2136 would let a debtor pay off a stripped-down home
mortgage over a period that could be nearly 30 years. Strip-
down, thus, would become feasible, but primarily only for home
mortgages, with the lender forced to accept a court-determined
interest rate for that very long period.
Indeed, after the 2005 amendments, the other major kind of
secured consumer debt, purchase-money auto loans, may be
stripped down only if the loan was made more than two and a
half years before the petition filing date, which is at least
half the life of a typical auto loan. Home mortgages, thus,
would be treated worse than car loans.
Home mortgage strip-down would substantially change the
risk characteristics of home mortgages. Permitting strip-down
would likely cause difficulties in the secondary market that is
so important to the availability and affordability of home
mortgages, and it would cause unjustified harm to holders of
home mortgages and mortgage-related securities, including
investors of modest means, through their retirement plans.
Under the approach in S. 2136, home mortgage holders would
receive little benefit from the upturn in the real estate
market that ordinarily follows a downturn. Under current law,
in many cases the mortgage holder benefits from appreciation.
Some financially distressed debtors can tighten their belts,
make their current mortgage payments, and use Chapter 13 over 5
years to make up any missed payments. When the market recovers,
the mortgage holder benefits from the increased value backing
the full amount of its mortgage and may suffer no loss at all.
Under S. 2136, such debtors typically could, in fact,
qualify to strip down their mortgages, despite provisions
designed to prevent them from doing so, and I think they would
opt to do it. The later upturn then will provide equity for the
debtor rather than a restoration of value to the mortgage. Home
mortgage strip-down thus eliminates the up-side potential and
dramatically changes the risk characteristics of the mortgage.
And note that under current law, even after a foreclosure, the
mortgage holder can hold the property and wait for it to
appreciate.
Compounding the problem, losses from strip-down probably
are not covered under private mortgage insurance if there is no
foreclosure. Strip-down would deprive home mortgage holders,
likely, of the benefit of insurance protection that they
bargained for.
Changing the risk characteristics of home mortgages
retroactively likely would depress further the value of
existing home mortgages. Increased risk would mean increased
interest rates on new mortgages to compensate for the risk, and
denial of mortgage credit to some who presently qualify. There
would be a further shadow cast on the trustworthiness of
American mortgage-backed securities with implications that
would be disturbing, given that such securities are held
worldwide by investors who count on the protection of vested
property and contract rights under American law.
My written statement includes specific substantive and
technical recommendations for the legislation, should Congress
choose to move forward. I'd be happy to discuss those in
response to questions.
The final point. Let me add that many Chapter 13 plans
fail. Under section 1325(a)(5)(b)(2) of the current law added
in 2005, any modification of the mortgage holder's lien would
be reversed if the plan were not successfully completed, even
if the failure involved a debt other than the home mortgage,
such as a priority tax claim.
Thank you again for the opportunity to appear today. I'd be
very happy to answer any questions.
Senator Durbin. Thank you, Professor Scarberry.
[The prepared statement of Professor Scarberry appears as a
submission for the record.]
Senator Durbin. Our next witness is Judge Jacqueline Cox at
the U.S. Bankruptcy Court for the Northern District of
Illinois, based in Chicago. Judge Cox has served as a Federal
Bankruptcy Judge since 2003. From 1988 to 2003, she served as
Judge of the Circuit Court of Cook County. Judge Cox has also
worked in government service in the office of the Cook County
State's Attorney, the City of Chicago Law Department, and the
Chicago Housing Authority Law Department. She received her
undergraduate degree from Cornell and her law degree from
Boston University.
Judge Cox, thank you for joining us. We look forward to
your testimony.
STATEMENT OF JACQUELINE P. COX, BANKRUPTCY JUDGE, U.S.
BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF ILLINOIS,
CHICAGO, ILLINOIS
Judge Cox. Thank you, Senator Durbin, Senator Specter, and
Senator Sessions. I genuinely appreciate the opportunity to
address the Senate on protecting home ownership and helping
families deal with burdensome home mortgages. I speak for
myself, however. I do not represent the Judicial Conference of
the United States or the Administrative Office of the Courts.
Because home ownership represents economic inclusion in the
American dream, and because of the disparate impact of the
mortgage crisis on African-Americans and Latinos, passage of
the Durbin bill is critical. The Bankruptcy Code generally
allows reorganizing debtors in Chapters 11, 12, and 13 to
bifurcate secured debt.
The plan strips down claims to the value of the collateral.
The balance, the amount of the claim that exceeds that value,
gets treated as an unsecured claim. In the Chapter 13 context,
the unsecured amount would be paid under the plan by a
percentage generally based on the debtor's income.
Section 1 of the Helping Families Save Their Homes in
Bankruptcy Act will, for the first time since 1978, allow a
debtor to modify mortgage debt if the debtor's income is
insufficient to pay the mortgage. This income limitation is
important. It limits this extraordinary relief to those
homeowners who need it. Homeowners who can afford their
payments will not receive a windfall. Allowing the strip-down
of mortgage debt to the collateral's fair market value reflects
the economic realities of the lender's situation. The lender
who forecloses a loan will recover the value of the home and
may receive a deficiency claim when the debt exceeds the value
of the home.
When Americans purchase homes, the most important
consideration is affordability. Most of us anticipate modest
future increases in income but cannot afford mortgage interest
debt that increases up to 40 percent. The Durbin bill interest
rate section allows the debtor to pay the strip-down amount at
an interest rate equal to the rate published by the Board of
Governors of the Federal Reserve system regarding the annual
yield on conventional mortgages with a reasonable premium for
risk.
Under the U.S. Supreme Court decision in Till v. SCS
Credit, Chapter 13 debtors now follow a similar standard when
adjusting interest rates on non-residence secured debt. I will
quote from the Supreme Court: ``Taking its cue from ordinary
lending practices, the approach begins by looking to the
national prime rate, reported daily in the press, which
reflects the financial market's estimate of the amount a
commercial bank should charge a credit-worthy commercial
borrower to compensate for the opportunity costs of the loan,
the risk of inflation, and the relatively slight risk of
default. Because bankruptcy debtors typically pose a greater
risk of non-payment than solvent commercial borrowers, the
approach then requires a bankruptcy court to adjust the prime
rate accordingly.''
I quote the Supreme Court to emphasize that interest rates
are adjusted in our proceedings routinely. In fact, since the
2004 Till decision I have heard only two or three hearings
involving disputes over interest rate adjustments. The Bar and
the financial services community have very little trouble in
this regard.
The Durbin bill also waives the pre-petition credit
counseling requirement which was added to the Bankruptcy Code
by the Bankruptcy Abuse, Prevention, and Consumer Protection
Act. Because most debtors facing foreclosure, probably because
of fear or denial, wait until the week of a foreclosure sale to
seek bankruptcy relief, credit counseling offers them no help.
The briefing that debtors are required to receive outline the
opportunities--I paraphrase the statute--outline the
opportunities for available credit counseling and assist them
in performing a budget analysis. Once a foreclosure is pending,
it's too late for those kinds of relief.
I am particularly supportive of the bill's section 201,
which combats excessive fees. It allows fees, costs, and other
charges to be added to the secured debt only if notice of such
additional charges is filed with the court within a year of
when they are incurred, or 60 days before the conclusion of the
plan. This policy reflects the practice of our bankruptcy
court. We have a very similar provision in our model Chapter 13
plan.
The bill allows a plan to waive prepayment penalties. This
assists those debtors who can arrange to refinance their
obligations under more favorable terms, and we see a lot of
that in Chapter 13. Such penalties do not compensate lenders
for costs, they only serve to punish debtors.
I agree with the position of the National Bankruptcy
Conference in remarks presented to the House of Representatives
in October. On behalf of that organization, Attorney Richard
Levin compared the plight of homeowners today to the plight of
family farmers in the 1980s. There is clear precedent for
Congress to solve this mortgage crisis by allowing debtors to
bifurcate or strip down mortgage debt. That was done for the
family farmers and it enabled lenders to renegotiate farm debt
to reflect falling land prices. The good work of Senator
Charles Grassley and Representative Mike Synar created Chapter
12. I ask that Chapter 12-style adjustments that include home
mortgages be applied to Chapter 13 for the same reasons.
In conclusion, I support passage of Senator Durbin's
Helping Families Save Their Homes in Bankruptcy Act. A lot of
the provisions are things we do routinely. They are not new. We
just don't do them for home mortgages. I agree that there would
be a lot of them, but I think we can do them. As in the family
farmer case, once the bankruptcy community sets a model of how
to do these things, more of the modifications will be made in
out-of-court situations. I believe this bill provides a
sensible and much-needed modification to the Bankruptcy Code.
Thank you very much.
Senator Durbin. Thanks, Judge Cox.
[The prepared statement of Judge Cox appears as a
submission for the record.]
Senator Durbin. Our next witness is Judge Thomas Bennett.
Judge Bennett has served as a Federal Bankruptcy Judge for the
Northern District of Alabama since 1995. He is currently
president-elect of the National Conference of Bankruptcy
Judges. From 1980 until his appointment, he was a partner with
the law firm of Bowles, Rice, McDavid, Graff & Love in
Charleston, West Virginia. He holds undergraduate, graduate,
and law degrees from West Virginia University. Following his
graduation from law school in 1976, he served as law clerk for
the Honorable John R. Brown of the Fifth Circuit Court of
Appeals.
Judge Bennett, thank you for being here. We look forward to
your testimony.
STATEMENT OF THOMAS BENNETT, BANKRUPTCY JUDGE, U.S. BANKRUPTCY
COURT FOR THE NORTHERN DISTRICT OF ALABAMA, BIRMINGHAM, ALABAMA
Judge Bennett. Thank you, Senator Durbin. I want to thank
you and Senator Specter and Senator Sessions for inviting me.
I'm not going to repeat what I've already submitted in my
written comments. What I would like to do, is maybe expand on
some things that I think may be misperceived and make some
comments. Feel free to interrupt me if you want to.
One of the things that I want to follow up on, was a
statement by one of our prior witnesses. It's something that I
have written down: why is bankruptcy the ticket to get this
relief? There really is a bigger picture here, in my opinion.
In order to get this relief, you have to file bankruptcy. I
would suggest to you that there are a group of people that
otherwise would not have to file bankruptcy that will be forced
to file bankruptcy to get this relief. It's a fact that should
be looked at.
Senator Sessions. When you say ``forced'', you mean a
lawyer would advise them that it only makes common sense that
they file bankruptcy? Is that what you mean?
Judge Bennett. If you faced the prospect of losing your
property because you cannot afford the increase and you only
have the ability to forestall that by filing bankruptcy, you'd
have to file the bankruptcy if you wanted to preserve that
property. This particular type of relief could be made
available to a broader segment, is my point, potentially, that
otherwise would not have to file bankruptcy. I point this out,
because in the context of bankruptcy there are certain
dynamics. Those people that are filing bankruptcy because they
have overall financial difficulties that go beyond just
mortgages will file bankruptcy anyway. They will have to.
Those that only have to deal with the increase in the
mortgage cost and don't have other financial problems would not
otherwise necessarily have to file bankruptcy if the bill were
structured in a fashion that gave a broader scope than simply
looking at bankruptcy. That's why it's a fact that you ought to
look at--I would suggest you look at.
There are two principal areas in the other comments that I
want to expand on that have been made by others. One, rises out
of my comments, my written comments. There are really two
stages of losses in a bill that writes down mortgages. The
first stage is the stage that exists today with respect to any
mortgage. If there is a loss on the market, it's there. The
testimony of the others is correct. If you have to foreclose
the mortgage today, you will suffer a loss. If that loss is in
bankruptcy on a write-down, you will suffer that loss. A
significant difference is the second loss.
The second loss that occurs under a restructuring of
principal, particularly over an attenuated time frame, is with
respect to what would be the fully secured portion of the debt.
When you restructure a debt over an up to 30-year period that
is currently not a 30-year obligation, that fully secured debt,
if the interest rate is below the market rate, will be
significantly impaired. That is on somebody that just holds all
payment streams. The current mortgage structure is such that
there are multiple payment streams.
When you take a payment stream on what will be a written-
down mortgage to its fully secured value and you bust those
streams up, as they have done, into interest and principal, and
some of those interest streams can be broken down and some of
those principal streams can be broken down, and then you drag
out the payment for 30 years, on some of those--particularly
interest--streams it is very possible that they become
worthless, despite the fact that the debt may be fully secured.
It's because of the interest rate discount factors. This is a
very, very complex problem. It is not simply just writing down
the principal up front. There is a second tier of write-downs
that really has to be given serious consideration.
The pooling factor, when you pool these mortgages, the
pooling is designed to take care of some of the risk that I've
told you about. In fairness to you, you should look at the
mitigation that is caused on those losses by pooling or
packaging of these streams of income. But it is a very serious
issue. That's one.
The next is--and there is testimony that you've received--
there really is no evidence that the interest rate and cost of
interest and supply of credit has changed. There are examples
in prior periods. But I would tell you, it's really like
comparing apples and oranges. The reason is this: the
discussion should always be on what would have otherwise been
there. When you know the cost of something goes up or the
supply decreases, you will not, in the future, be able to say,
look, I told you so, because in the dynamics of what is going
on here you could have two impacts. You could actually have
lower interest rates.
But what you need to know is, how much lower would they
have otherwise gone but for legislation that may go awry? You
could have higher interest rates. The question, though,
becomes: how much lower would they have been had the
legislation not been passed?
Likewise, the supply of credit could generally increase.
The real question is, how much more would it have increased but
for the legislation? The supply could have decreased. The
question may be how much less it would have decreased but for
the legislation, and giving historical examples will not
demonstrate that. That is another issue that is of serious
consequence.
What I would like to also address, is that I think there is
merit in something. Where I'm coming from, if I were you, I
would ask me what would I do. What I think, is there needs to
be a pause for a while. As much as I may hate to admit this, it
may be somebody that is from a different political background
than I that has suggested something.
I think it is maybe wise to pause for a short time frame.
It might be 60, 90 days, something, to try to stop what's going
on, leave everything where it is at this point in time. Maybe
stop foreclosures on an interim basis. But a short enough time
frame to get it better fixed so you develop a broader picture.
It may entail fixing of interest rates or not allowing changes
in interest rates for a short time.
But my main thrust is, what you are getting ready to do may
have much more serious, much broader implications than what
people may contemplate. We as lawyers and judges are very bad
when we deal with words and understanding what are really
multi-variant dynamics. That's the main thrust of what I want
to do, not to tell you not to do something, because these are
difficult times for many people.
The difficult times sometimes require we do things we may
not otherwise do, but we need to do them in a context and a
framework, I think, that addresses the overall picture, not a
segment of the picture. We need to do it in a way that does the
least amount of harm, and hopefully a lot more good, than the
greater amount of harm.
I would like to say that there is another category of
people here that we will never know exists without some very
quantitative analysis, and that is if what is done by the
legislation forces write-downs and converts over to a fixed
interest rate and causes the cost of credit to increase
incrementally enough, there will be people who would never have
had to have gone to bankruptcy or elsewhere to restructure
mortgages.
The numbers? I can't tell you. But what will happen is,
they may have otherwise potentially been able to pay their
mortgages without having legislation. The incremental cost
adjustment could be such that they now face the same problem of
people that you wanted to help, but because of what's occurred
they now are pushed into that group you want to help. So, it's
a really complex problem that I don't think, in fairness to
what people may perceive is my side or the other side, that a
rush to judgment on these benefits--those are my principal
points. I mean, I don't want to belabor what I've already said.
Senator Durbin. Thank you very much, Judge Bennett.
[The prepared statement of Judge Bennett appears as a
submission for the record.]
Senator Durbin. Our final witness is Henry Sommer,
supervising attorney at the Pro Bono Consumer Bankruptcy
Assistance Project in Philadelphia; president of the National
Association of Consumer Bankruptcy Attorneys; former head of
the Consumer Law Project of the Community Legal Services in
Philadelphia, where he worked for 21 years; Editor-in-Chief of
Collier on Bankruptcy. He served as lecturer at University of
Pennsylvania Law School received his undergraduate degree from
Harvard, and his law degree from Harvard as well.
Mr. Sommer, thank you.
STATEMENT OF HENRY J. SOMMER, PRESIDENT, NATIONAL ASSOCIATION
OF CONSUMER BANKRUPTCY ATTORNEYS, PHILADELPHIA, PENNSYLVANIA
Mr. Sommer. Thank you, Mr. Chairman, Senator Specter,
Senators Sessions. Thank you for inviting me to testify today.
It is now quite clear that our country is facing
approximately 2 million mortgage foreclosures over the next few
years. These foreclosures are already having widespread effects
in neighborhoods across America, as well as in financial
markets, and those effects will get much worse in the months to
come. Not only will millions of people lose their homes, but
other homes in the vicinity will decline in value as a result
of nearby foreclosures, causing an enormous loss of wealth to
most American homeowners.
It is also clear that it is within the power of Congress to
prevent hundreds of thousands of these foreclosures and the
ripple effect they'll cause throughout the economy.
Senator Durbin's proposed legislation, S. 2136, which would
make modest changes in the Bankruptcy Code, could save as many
as 600,000 families from losing their homes. Allowing families
to modify their mortgage debts and reduce their payments would
utilize an existing, efficient, well-established, and
predictable template to prevent foreclosures and it would not
require the use of government funds to bail out homeowners or
lenders. No other legislative proposal has the potential to
save nearly as many homes.
The basic principle underlying the bill, that liens are
reduced to the extent they exceed the value of the collateral
and the payment terms modified to reflect a fair rate of
interest, is popularly known as ``cram-down''. The concept is
one of longstanding importance in bankruptcy law. Essentially,
it simply permits the debtor to buy back an asset from a
creditor's lien at the current market value that anyone else
would pay for it. The principle is fundamental to the way the
bankruptcy laws reflect economic reality.
The basic underlying fact in these cases is that bankruptcy
does not cause the loss to the creditor. The debtor's inability
to pay has already caused the loss. The loss already exists as
a matter of economic reality, whether or not the creditor has
recognized it on its books. If cram-down is not permitted for
debtors who cannot pay their mortgages, debtors and creditors
have several other alternatives: there could be foreclosure;
there could be a short sale of the property; there could be a
deed in lieu of foreclosure; or there could be a voluntary
modification to terms similar to cram-down. In each of these
scenarios, the creditor will take a loss equal to, or greater
than, what would occur with the cram-down.
I understand that industry lobbyists have been arguing that
such legislation is unnecessary because: 1) lenders will solve
the problem through voluntary modifications; and 2) the
legislation would cause interest rates to increase
dramatically. Neither of these arguments has merit.
First, voluntary modifications are not being made in any
significant numbers. When I testified in the House 8 months
ago, an industry witness testified that such efforts were well
under way to solve the problem. But now even the Secretary of
Treasury has recognized the inadequacy of the industry's
response. That inadequacy was predictable for the same reasons
that the current administration effort and any voluntary
modification program would be inadequate, reasons I have
detailed in my written testimony.
With respect to the claim that interest rates would
increase by 1 to 2 percent on all mortgages, the fact is that
legislation such as this has no measurable impact because,
again, ability to pay, not the bankruptcy law, is what is
causing the losses. In the current mortgage situation, as I
discussed previously, the lenders will suffer the losses,
perhaps greater losses, even if this bankruptcy legislation is
never enacted. You have to remember that the alternative to
cram-down is not the debtor paying the loan according to its
terms. The alternative is foreclosure.
Industry lobbyists have also argued that enactment of S.
2136 would bring uncertainty to the financial markets. Just
like the losses that they claim would be brought about by the
legislation, that uncertainty already exists. It would be hard
to imagine how this bill could bring even a small fraction of
the uncertainty that the lenders themselves have already
caused. If anything, allowing modification in Chapter 13 will
foster more certainty and stability because it will create a
predictable template for dealing with defaulted mortgages.
I also hope you will remember that those who are making
those projections are the same people who not long ago told
this Congress that there were no problems with abuses or
excesses in subprime mortgage lending that needed regulatory or
statutory action. The people who now say they are so concerned
about risk are the same people who saw no problems when it was
repeatedly pointed out that they were giving loans without even
determining
whether borrowers could pay those loans. In other words,
these are the people who created this mess and are now
suffering billions of dollars of losses, not because of any
bankruptcy laws, but rather because of their poor ability to
predict what would happen in the mortgage market.
The mortgage modification remedy in S. 2136 is narrowly
tailored. It will not be used where it is not needed because
there are strict eligibility requirements based on the
stringent means test enacted in the 2005 bankruptcy bill. A
family that cannot afford a feasible plan to repay a modified
mortgage will not be eligible to have its plan confirmed.
S. 2136 will help the many families who refinanced their
homes with predatory mortgages, often because they were
deceived into refinancing an affordable mortgage into one they
could not afford, and especially the many families who in fact
qualified for better terms all along. It will help their
neighbors, whose homes will not lose value because of
foreclosures on their block, as well as their local governments
who will not suffer a precipitous loss in their property tax
base.
In conclusion, Congress has an opportunity to prevent
hundreds of thousands of families from losing their homes if it
acts soon. Providing resolution in such cases is more likely to
rationalize and stabilize the market rather than destabilize
it.
Thank you.
Senator Durbin. Thank you, Mr. Sommer.
[The prepared statement of Mr. Sommer appears as a
submission for the record.]
Senator Durbin. Senator Specter has another meeting to go
to, and I'm going to allow him to ask first if he'd like to,
and I will follow him.
Senator Specter. Thank you very much, Mr. Chairman. We
started off by saying this was a very complex issue. As we've
listened to seven witnesses, it's become even more complex.
Professor Scarberry, you suggest that the bankruptcy courts
can't handle this on a case-by-case basis. If one of our bills
is adopted and the bankruptcy courts are faced with the
gigantic flood, will they be unable to adjudicate these issues?
Mr. Scarberry. I don't know for sure. I think it would mean
a very substantial increase in caseload, and depending--
Senator Specter. Judge Cox, Judge Bennett, you're
bankruptcy judges. Can you handle it?
Judge Cox. I would definitely put my arms around it. As I
indicated in my remarks, by the lawyers and the financial
services industry, testing us for a few cases, finding out
exactly what we do, how the U.S. trustee would set up
guidelines on how mortgages--
Senator Specter. So you think, after you ruled in a few
cases, they'd know better and could handle it themselves?
Judge Cox. They would know better and they would be guided
by those out of court.
Senator Specter. Judge Bennett, what do you think?
Judge Bennett. I think, on the volume, in the short term it
would be difficult, in the long term it's handleable. Yes.
Judge Cox. Yes.
Senator Specter. Short term?
Judge Bennett. Short term.
Judge Cox. Our U.S. Trustee's Office is excellent in
getting these sorts of things organized. They're excellent.
Senator Specter. Professor Scarberry, you have your hand
up.
Mr. Scarberry. One of the difficulties is that S. 2136
refers back to the Chapter 7 means test, which includes a good
number of ambiguities and has given rise to a great deal of
litigation. I think the bankruptcy judges here might agree that
they have not been the easiest provisions to apply, and in fact
have in some cases been counter to what was intended.
Senator Specter. Wouldn't it be wise to, at least at this
moment, freeze interest rates so that people like Ms. McGee are
not facing this variable adjustment which comes as such a shock
before we adjourn for Christmas and come back and we're in
gridlock on some other matters and nothing happens? That at a
minimum, if some administrative action can be taken to freeze
the interest rates, that that would provide some relief right
now? What do you think, Ms. McGee? Would you like that?
Ms. McGee. Sure. [Laughter].
Senator Specter. I thought I'd get a direct answer from
you.
Judge Bennett. Senator, may I say this?
Senator Specter. Go ahead, Judge Bennett.
Judge Bennett. I mean, in fairness to everybody, I think
that a short-term potential freeze on foreclosures so that they
don't impend at this time frame, it gives a breathing spell to
analyze and to get a game plan that really encompasses
everybody--
Senator Specter. So you're for a freeze?
Judge Bennett. For very short term, yes.
Senator Specter. How long?
Judge Bennett. Well, 60, 90 days. With people working,
potentially, it could--I can't tell you off the top of my head.
Also, an interest rate holding for short term, I think, would
give everybody a chance to analyze a lot of things that may not
have been looked at fully.
Senator Specter. What I'm trying to get a handle on, and
perhaps it's not handleable, as to the real question as to
whether this cram-down will affect the future markets, as
Justice Stevens said in the Supreme Court decision, that in the
long term effect it will increase costs.
Professor Mason, you say in your testimony that investors
are likely to impose a lemons discount, so that it will have an
effect. Mr. Sommer, you think that it will be fine to have the
cram-down and the market will adjust to it. Is there anything
you can really grab ahold of, any empirical evidence which
would give us some sense of, if not certainty, reasonable
likelihood, aside from just the opinions? You are experts and
we value your opinions, but opinions are not as valuable when
we seek to legislate on something harder. What can you say, Mr.
Sommer, that's more definitive?
Mr. Sommer. Well, obviously there's no certainty to these
predictions. But I will point out that cram-down on cars did
not exist before 1978, and no one has ever suggested that car
interest rates went up after it was adopted in 1978. Cram-down
was limited somewhat on cars in 2005. No one has suggested that
interest rates went down as a result. In 1986, Congress passed
the Family Farmer Bankruptcy law, which permitted cram-down on
farm loans and farm mortgages, and no one has suggested that
farm interest rates changed. So we have those examples.
I think the real issue is, we're talking about a very--even
though it's a large number of foreclosures, in total we're
talking about a very small part of the total market. We're not
talking about wiping them out completely. What we're talking
about is--
Senator Specter. Mr. Sommer, aren't cars, as a depreciable
asset, very, very different from homes?
Mr. Sommer. Cars are different from homes. But I think
that--
Senator Specter. So different that the analogy is inapt?
Mr. Sommer. Well, I don't think it is because the
fundamental principle of bankruptcy is all based around
liquidation of assets. Remember here, the alternative is
foreclosure. There's going to be a liquidation. It's not like
the homeowner is going to keep making payments while the
property increases in value. It's not like the mortgage
company, if it forecloses, is going to hold onto the property--
Senator Specter. Excuse me. My time is almost up. I want to
give Professor Mason a chance to answer that question.
Mr. Mason. I wanted to address your points about the lemons
discounts, and in particular the evidence that we have for that
lies in George Ackerloff's Nobel Prize-winning work in the
economics of asymmetric information discounts and premiums that
are invoked in markets. There is a very clear understanding:
you add more uncertainty to a market, the price is going to
react. Right now, you're getting ready to enter the earnings
season where banks report their earnings, in particular, the
year-end earning season where we're looking for annual reports
to give us some notion of the losses on bank balance sheets.
Senator Specter. What does all that mean?
Mr. Mason. If you freeze interest rates on adjustable rate
mortgages right now you're going to add further uncertainty to
the value of those holdings on bank balance sheets and fuel
this crisis even further.
Senator Specter. So you are against the freezing?
Mr. Mason. Right now is, in fact, a low point in the
adjustment cycle for adjustable rate mortgages. Next spring,
that will accelerate.
Senator Specter. Before my red light goes on I want to
start a question to Mr. Zandi. You testified that cram-downs
will significantly decrease the number of foreclosures. Why do
you think that? People won't foreclose when they go into a
bankruptcy court, they have their principal sum go down?
Mr. Zandi. I think borrowers, given the choice of a Chapter
13 bankruptcy or a foreclosure and losing their home, will take
the Chapter 13 bankruptcy. The number of folks that would
benefit, that would apply under the means test, would be about
500,000 to 600,000 people. Yes.
Senator Specter. I have great sympathy for the Chairman. I
like to help the Chairman, when my light goes on, to stop.
Senator Durbin. Well, spoken like a former Chairman.
Senator Specter. One who aspires to be a Chairman again.
[Laughter].
Judge Cox. We understand.
Senator Durbin. We hope that God will answer your prayers,
but not too soon.
[Laughter].
If I might, I'm trying to put this in context. We're
talking about 500,000 or 600,000 people who may be affected by
this bill. We're talking, I think, roughly about 130 million
mortgage owners in America. We are talking, as I see it, less
than one-half of 1 percent. I've heard speculation here that
this is going to warp the market. It's going to have this
dramatic dislocation in trying to figure out the credit future.
But that ignores the obvious. Doing nothing has an impact on
the market, too. It has an impact on Mrs. McGee and a lot of
other people.
I'd like to go back to your point, Mr. Zandi. If I heard
you correctly, you said that a foreclosure sale--and I'll let
you correct me if I'm wrong--will result in a price that is 20
to 30 percent below fair market value. Is that what you said?
Mr. Zandi. That is correct. The literature on this subject,
some of it coming from the Federal Reserve, suggests, in normal
times, not stressful times like the one we're in today, the
discount is 20 to 30 percent.
Senator Durbin. And there is also a cost associated with
foreclosure itself.
Mr. Zandi. Quite significant. The cost of maintenance, the
realtors involved in selling the home. Many, many other costs.
Senator Durbin. And like a banker from one of the biggest
financial institutions in America recently told me over dinner,
bankers don't like to cut grass.
Mr. Zandi. They don't.
Judge Cox. They don't.
Senator Durbin. Well, they're stuck with a situation
cutting grass on a property in foreclosure until they get it
sold.
Mr. Zandi. Exactly. Right.
Senator Durbin. They have to hire somebody to do that, as
one example. So the point I'm trying to get to is, all the
arguments that have been made by some, that this is creating a
real hardship on financial institutions, ignore the obvious.
Foreclosure is a real hardship on financial institutions.
They're going to lose money. Our outcome is based on a crammed
down/stripped down discount, whatever you want to call it, no
lower than fair market value. That is the bottom line here. It
seems to me like it is a reasonable bottom line.
Judge Cox, a point was raised earlier, and I think it was
by Mr. Scarberry, about how difficult it would be to come up
with fair market value of property. Do you have to cope with
that challenge?
Judge Cox. We don't have that much of a problem. Sometimes
people bring in expensive appraisals. Sometimes they just put a
real estate broker on the stand and talk about prices in the
area. It can be done cheaper than that.
Senator Durbin. And if it's disputed, I mean, you can take
more than one appraisal.
Judge Cox. We hear those matters all the time.
Senator Durbin. So that is not an issue.
Judge Cox. That is not a big problem.
Senator Durbin. You mentioned coming up with an interest
rate, you said earlier, was something you could calculate.
Judge Cox. By the Board of Governors of the Federal Reserve
Board. The interest rate published for today is 6.1. We add
premiums for cars. We could add a premium for loans. These
issues are never disputed in our court. We never have hearings
on these. That is not difficult for the financial services
market and the debtors and the debtor's bar to do.
Senator Durbin. If God would smile down and decide that
this bill should become law, would it be an incentive or a
disincentive for financial institutions to renegotiate the
terms of a mortgage before foreclosure and bankruptcy? Anybody
have an opinion?
Judge Cox. I'm not sure that will happen without some sort
of immunity for a suit from their shareholders and bondholders,
but I think that by having debtors come into bankruptcy,
certainly shields the lenders from those sorts of civil
actions.
Senator Durbin. Any other thoughts on that?
Mr. Scarberry. It would certainly encourage that sort of
thing. I tell my students all the time that one of the key
functions of bankruptcy law is to provide a backstop for
consensual negotiations. Certainly in Chapter 11, that's the
case.
But to go back to a point, Mr. Chairman, that you made
earlier, that this is a small percentage of loans, I might
analogize that to saying that it only snows 1 percent of the
time, but when it snows you really want to have your warm
weather gear. So, these are the mortgages on which the need to
look to the protections of the real property secured
transactions laws is important. If that protection is taken
away when it's needed, that has a substantial effect,
especially when what is taken away is the up-side, and the
possibility occurs that during a severe market downturn, the
up-side is removed.
Senator Durbin. But that's the point I want to get to. You
are arguing that real estate, unlike the car, is an appreciable
asset. It can appreciate in value. Historically, that is what
has happened and we hope it will continue to happen. But
ultimately in a foreclosure, you are making a sale at that
moment in time. You are selling at that moment in time at fair
market value, knowing that if history serves you, 10 years from
now that property is going to be worth more. That doesn't mean
you're going to get that much more when you sell it.
Mr. Scarberry. Mr. Chairman, that depends. That depends,
first of all, on whether there is a foreclosure. And to the
extent that this bill creates moral hazard and people end up
using it to strip down mortgages, where they could--but for the
bill, and they would but for the bill, in some cases--tighten
their belts and use existing provisions of Chapter 13 to keep
their homes, there wouldn't be a foreclosure.
It also assumes that there would not, under these
circumstances, be further developments. Typically the bank is
going to buy at the foreclosure sale, so there's no actual
money, in many of these cases, that changes hands. If they
decide that they want to set up a subsidiary to handle rental
property and wait out a couple of years until the market
recovers, they have that option now.
Mr. Mason. No, they don't have that option. Even under
Gramm-Leach-Bliley, banks don't have a real estate option.
Mr. Scarberry. Well, most of these aren't held by banks at
this point.
Senator Durbin. But I really struggle with this notion that
when it comes to immoral conduct, it's always the consumer.
Mr. Scarberry. Oh, no, no. No.
Senator Durbin. In this circumstance here, I'd like to ask
Mr. Sommer, do you think these people would race into
bankruptcy court because the Chapter 13 work-out under Durbin
might be available?
Mr. Sommer. We find people who, even when we advise them to
file bankruptcy, don't want to do it. It's really the converse.
Senator Durbin. And it's harder to do it today than it was
before we changed the law.
Mr. Sommer. It's harder. And for this particular remedy
they would have to pass the--they would have to live under the
expenses set by the means test, 2005 means test. Only then, if
they didn't have enough money to pay their mortgage, could they
use this remedy.
Senator Durbin. Well, I think that if the prospect on the
horizon that we've heard about the economy going into a
tailspin, I've heard the word ``recession'' from several
different witnesses here, how many financial institutions out
there are looking at that and viewing it as a sanguine result?
That has to be something that is painful to anticipate. If we
can slow down, as Senator Specter has suggested, what is coming
and stabilize the situation, it's got to be in the interests
not only of homeowners, but also of financial institutions.
Judge Bennett. Senator, may I say something? I think if it
can be done properly, yes. My concern is, it's not being done
properly. What's happening--let me give you an example. If you
strip down the mortgage to its principal balance, you are then
going to refinance, theoretically, under your proposal, up to
another 30 years. The interest rate that you use on that could
actually be negative, be bad for the borrower in certain
instances. It already occurs in cars right now, that car
dealers are coming in that sold cars at zero percent interest.
Under our current statutory framework, they asked for the
increase to the market rate. The bill, the way it's structured,
for instance, does not apply to these teaser rate loans only.
It applies to the broad market. But my bigger point here is
that when you then subdivide all of the ownership, who owns
what makes a big difference. Second, the whole structure of
what's going on for a 30-year period is far more dramatic--up
to a 30-year, I should say--than what are short-term loans.
Third, we need to bear in mind that, unfortunately, in all
bankruptcies the failure rate is astoundingly high. We can
disagree on what failure or success is, because sometimes
success is restructuring, being able to hold onto the property
and dismissing the case. So, dismissal numbers are not that
great.
Senator Durbin. Judge, I'm sorry to interrupt you. My time
is up.
Judge Bennett. I'm sorry.
Senator Durbin. I would note that Senator Sessions has
another meeting to go to, and I'd like to yield to him at this
point. We can return to this after Senator Sessions.
Senator Sessions. Thank you, Mr. Chairman. It certainly is
highlighting the complexity of the problem we're dealing with,
the amount of money that has been brought forth to allow
borrowers to buy houses. I mean, lenders are out to make a
profit. They write the contracts that help make themselves a
profit and protect their interests in every way they can, but
the lender puts the money out. They give $100,000, $200,000,
$500,000 and they can't do that if we have a problem and make
it too difficult to get the repayment.
That's why I will offer three letters here for the record.
One is from Mr. Clark, former Comptroller of the Currency, and
Mr. Isaac, a former FDIC Board Chairman, and Mr. Powell, FDIC
Chairman, and the Mortgage Bankers Association, and from the
Securities Association.
I'd just point out that these pieces of legislation have
the tendency to increase interest rates. I think Judge Bennett
said, I don't know exactly what the interest rate will be, but
if you put a burden on it, Mr. Mason, an uncertainty, you say
whatever it will be, it will be a little bit higher. Is that
right?
Mr. Mason. Yes.
Senator Sessions. One of the letters said it could be 2
percent. Do you think that is excessive? Would you give an
opinion on that?
Mr. Mason. I don't think that would be excessive at all.
The problem is, with the amount of uncertainty markets can't
accurately price, so they throw up worst-case scenario--
Senator Sessions. Well, Ms. McGee indicated, what, a 3
percent increase in your interest rate, resulting in a $200 a
month increase in payment? One percent can easily be $100 a
month for the average borrower. So half a percent, even if it
went up only a half a percent, could be $50 a month for the
average borrower. So we've got to be careful about this, is all
I'm saying.
Now, with regard to the question of 600,000 foreclosures
perhaps being avoided, does that contemplate 600,000 more
bankruptcies being filed to avoid the foreclosures? If I could
get an affirmative answer there.
Mr. Mason. Yes.
Senator Sessions. So we're talking about really moving
foreclosures into Chapter 13 bankruptcies. But you can file
Chapter 13 now, right, without this legislation? Professor
Scarberry, maybe you could tell me. Put it down here where the
horses can eat it, I guess. What does this mean? I mean, what
are the forces at work here? You talk about moving. Who is it
going to help? What is the overall economic impact?
Mr. Scarberry. That's a big question, Senator Sessions.
I'll try to answer it. Who is it going to help? It will help
the homeowner who is able to make payments at a court-
determined interest rate on a mortgage on the value of the
property, but not able to make the mortgage payment that is
called for under the contract, or even a mortgage payment at an
appropriate interest rate on the full amount of the debt. So,
it would help that person.
Senator Sessions. Now, you indicated earlier, did you not,
that this could cause them to lose their appreciation?
Mr. Scarberry. No. It could cause--and the Chairman and I
were having a discussing a moment ago--
Senator Sessions. I'm sorry I missed it.
Mr. Scarberry.--as to whether the holder of the mortgage is
harmed by not having the possibility of benefitting from
appreciation in the future. So if we catch the value of the
property when it's at a low point and fix the amount of the
mortgage there, then if the property appreciates the debtor
gets the equity from the appreciation and the mortgage holder
is still stuck with the loss. One conceivable possibility would
be to have some sort of revaluation several years down the road
in which the value of the property is considered to get--
Senator Sessions. There's no free lunch there. If you cram
down the value of the property, somebody loses.
Mr. Scarberry. Somebody loses, yes.
Senator Sessions. And if it goes to the lender, more
lenders in the future are going to charge higher interest
rates.
Mr. Scarberry. I don't see any other way, Senator Sessions.
If risks are increased and costs are increased, then interest
rates will be higher than they otherwise would have been. I
think that simply follows.
Senator Sessions. Now, I supported cram-down for
automobiles. I think it makes sense. I think we came pretty
close. Senator Durbin was articulate on that issue, I know,
when we discussed it, and Senator Feingold. I think we came
close to the right amount there. But it does appear to me that
since homes tend to be generally upward and you can have
periods of decline, that it is less appropriate.
Judge Bennett, you've been at this a while. Would you
agree, whether you should or not, it's less appropriate than in
an automobile?
Judge Bennett. I'm going to leave the policy decisions to
those that make those. I will tell you what I think from an
economic point of view. The answer is, the risk and the
uncertainty is far greater than on what are shorter term and
smaller dollar amounts. So, from that point of view I think I
would tell you that by pushing these out at longer terms with
bigger dollar volumes and with interest rates, that really--and
I could tell you the experience of interest rates on cars is,
it's prime plus 1, 2 or 3. Realistically, in the real market,
the credit quality of the people who get prime or prime plus 1,
2, or 3 are not bankrupts. So, the idea that the interest rate
on the cram-down really reflects the market rate misses the
point in the real world.
Senator Sessions. You mentioned in your written statement,
Judge Bennett, and discussed--you suggested, I'll just say it
that way--that we're putting a lot of police pressures on
bankruptcy judges to make decisions that that's not their
training or their normal requirement. Did you say that? Would
you discuss what you said in that regard?
Judge Bennett. Well, let me tell you my framework. The
framework of what I did, was to set forth, here are some over-
arching issues that are of more economic significance. Here's a
comparison of the two bills. If you look at what I did, I
really laid you a blueprint out on each bill as to where I
think there are interpretation and other problems. So if you
want to take those into consideration, you can structure around
those. I did that in more of a bipartisan sense to tell you
where I think there are interpretation problems.
What I think, and have always thought and used to tell my
clients, you can always file bankruptcy but you cannot unfile.
In that sense, I think right now--I don't think the economists
of this world--and I'll take the fall for being one of those in
a prior life--really know where we are headed, necessarily, and
really know whether the mortgage issue is the cause or the
symptom, or whether it's both. I really urge caution until we
get a better picture, and we do the whole picture. I think that
something will ultimately have to be done. That's where I come
from.
Lawyers and judges are not professionals in these areas.
What we are, are professionals at arguing positions for our
clients and resolving positions. The function of the legal
system is not necessarily solely to get it right--hopefully we
do most of the time--but is to bring finality to an issue. From
that point of view, our training is not in other things. I
would suggest that if you look at the car issues and the real
market rates that would be paid out on these, that the cram-
downs on cars are effectively well below market rates of
comparable credit risk. That same thing will happen in the
context of mortgages, which means that the risk of loss for
those that hold a residual portion of the cram-down mortgage
will be under-paid and will be a further diminution of the
value, if that answers your question.
Senator Sessions. Professor Scarberry?
Mr. Scarberry. Senator Sessions, you asked a moment ago
about the 600,000 cases. I would suggest caution in assuming
that the litigation in those cases will be similar to the
litigation over car loan strip-downs or cram-downs. In a car
situation, you may be arguing about $1,000 in difference. In a
home mortgage situation, you may be arguing about $50,000 or
$100,000 or more. With the incentive to litigate, and the
greater uncertainties in valuation for real property,
especially when so few properties are being sold, it seems to
me we have a potential for a very large amount of litigation in
a very large number of cases.
That's why I suggested that it might be useful for Congress
to think about using the bankruptcy power to assist in
resolving this problem, not in bankruptcy cases, but through
the process that Secretary Paulson has attempted. So, perhaps
in a sense I'm reflecting on what Judge Bennett said. To do
this in a Chapter 13 creates all sorts of problems and it may
not be the best way to do it. In particular, as I pointed out,
unless the Congress changes the provision that was added in
2005, if the Chapter 13 fails for any reason before the end of,
typically, 5 years, the modification of the mortgage will
disappear.
So, failing to pay priority tax claims or other sorts of
things--perhaps that's a technical aspect of the bill. But to
tie this to a 5-year payment plan, which tends to be how you
deal with other kinds of debts, may not be the best way for
Congress to use the bankruptcy power here, to help in a
situation where I think there needs to be something done.
Senator Sessions. Go ahead.
Mr. Mason. If I can jump in for just a moment. I'm not sure
that addressing this in bankruptcy is really the most effective
way, but as I've said before, I'm not sure that modifying the
terms of all existing mortgages is appropriate either. I think
that Senator Durbin raised an extremely important point that I
want to come back to, which is the foreclosure system in the
United States.
It's not clear, when we're working on a bankruptcy, that
the property will be foreclosed upon. From an economic point of
view, if it was economical for the lender to restructure the
loan on behalf of the borrower, that would be carried out. I
wrote an article on this that was picked up in The Economist
and cited very widely.
Senator Sessions. In other words, they would do it on their
own because it's in their own self interest. They don't want to
have another house in the inventory. If they can't get a price
for it, they have an incentive themselves, or selfish interest,
to refinance.
Mr. Mason. Precisely. Precisely. And given that the matter
is in bankruptcy should be a flag to the lender that we're
getting pretty close to a foreclosure point here, and if it's
economical we can still negotiate in a bankruptcy court,
notwithstanding anything that this committee might do. So it
strikes me that the market should be working and there
shouldn't really be an issue.
I think the bigger issue that is sometimes lost in what
we've been talking about with the mortgage crisis, is the
foreclosure system, because in the U.S. we're going to put this
house on the market and auction it off for cash on the barrel
head to an individual buyer. Oftentimes, even if that
individual who was just foreclosed upon might have some amount
of cash, let's say it's 70 percent of the market value, they
would even be locked out of the bidding process. We don't have
a chance for banks to buy the home back because banks can't own
real estate.
As a banking specialist, that was one power that was left
out of Gramm-Leach-Bliley. They can't own real estate and
couldn't lease it back. But it strikes me that there is a
tremendous opportunity here, a tremendous market opportunity
for the market to purchase real estate and, in fact, lease it
back to the existing occupant to fight the urban blight
problem.
Now, I'm not saying, give that power to the banks. But I am
saying that there could be a role in fixing this foreclosure
system to allow greater efficiencies in bidding, similar to
structures that we do see in Europe where properties are placed
on the market, and, say, 100 properties at a time, a
corporation will buy them, will maintain the homes, and will
lease them to occupants so that they do not go idle.
Senator Sessions. Thank you.
Mr. Chairman, this is an able panel on an important issue.
Thank you very much.
Senator Durbin. Thank you, Senator Sessions, for being part
of this. I have a few more questions.
Ms. McGee, what is going to happen to you if you lose your
home?
Ms. McGee. Well, I really don't know.
Senator Durbin. You're living on Social Security, right?
Ms. McGee. Yes. That's my source of income. But I was
hoping that somebody would come up with an idea or something
today, not only for me, but to help people who--I got in this
situation on my own, you know. But now they're talking about
bankruptcy. I don't think I could afford bankruptcy. You know,
I couldn't afford bankruptcy. So then that means that if I
can't pay the mortgage, I lose my home. Then I go where?
Senator Durbin. Have you seen any homes in your
neighborhood or where you live that have gone through this?
Ms. McGee. Well, not right where I live, but where my
granddaughter lives at 69th and Hermitage, there are five
foreclosed houses in one block. One block. It's all over, you
know. But mine will be next, I guess.
Senator Durbin. I hope not.
Ms. McGee. I don't know. I don't know what to say or what
to do.
Senator Durbin. Professor Scarberry, who wins in a
foreclosure?
Mr. Scarberry. I don't think anyone wins. I don't think
anyone wins in a foreclosure.
Senator Durbin. But you raised a point that somebody raised
to me, which I want to try to bring out on the record here,
about some insurance.
Mr. Scarberry. Yes. Well, my understanding--I'm not an
expert on this. I have spoken to people who are involved in it,
and the committee should look more closely, and perhaps others
here know more about private mortgage insurance, which often is
required on loans where not very much money is put down, often
less than 20 percent.
Private mortgage insurance ordinarily, as I understand it,
only pays to the mortgage holder if there is a foreclosure. So
to the extent that the lien is stripped down in a Chapter 13,
and that there is no foreclosure, the mortgage holder suffers a
loss, but does not get the benefit of the insurance that they
bargained to receive and that went into the pricing of the
whole mortgage.
Now, that, it seems to me, is a problem. Now, perhaps there
could be some sort of--on the other hand, if too much is asked
of the private mortgage insurers, their ability to handle the
load--again, it's not my area. One would question, if we have 2
million foreclosures, how a private mortgage insurance system
is going to work.
Senator Durbin. It's a legitimate policy question, probably
beyond the Judiciary Committee, and something that we shouldn't
ignore.
Mr. Scarberry. And so it does seem to me that if the
process of securitization of mortgages, with the dividing up of
the rights to the various income streams and to so many
different forms of securities, if that has resulted in there
being no one who can really negotiate the loan modification
with the homeowner because the servicer says, ``oh, well, I
can't do that. I would do it if I owned the mortgage, because
it makes sense, but it would hurt this security holder who has
the right to the first bit of the interest.''
It seems to me it would make sense for Congress to say
there will be someone who can act, it will be the servicer, and
the servicer will act, perhaps, to try to get the best value
overall, and if that hurts some of the securities, it hurts
them. But that seems to me to be something that might be very
useful.
Senator Durbin. One of the goals here was to hope that
passing this would encourage work-outs so that people wouldn't
have their homes lost, that Ms. McGee and others might find
some terms or interest rates that they can live with. But as
you just described the situation, as the paper moves further
and further away from the original transaction and the only
protection for the ultimate paper holder is insurance that
depends on foreclosure, it strikes me that you've just created
a disincentive for a work-out in the negotiation.
Mr. Scarberry. Well, yes. Yes, you have. So in that sense I
understand your initial question: who wins in a foreclosure. In
a sense, the beneficiary of the private mortgage insurance may
gain from a foreclosure.
It is true that mortgage originators--and others, perhaps
Professor Mason will know a lot more about this than I do--have
taken back some of the risk by way of reinsurance. So, I think
it's very complex. But initially, at least, it would seem that,
absent a foreclosure, the loss will be borne by the mortgage
holder, not by the insurance company. The insurance coverage,
essentially, has been rendered worthless.
Mr. Zandi. Senator Durbin, can I pipe in for just a second?
Senator Durbin. Sure. Go ahead, Mr. Zandi.
Mr. Zandi. There are certain investor groups that do
benefit in a foreclosure, and that's why the modification
efforts are not working. There's a market failure because of
the way the securities are structured. Certain investor groups
want the process to go through foreclosure and the losses to be
realized because they won't suffer the losses, the folks who
took on the most risk in the securities will. So they have no
interest whatsoever to see these things modified, and that's
why they're not happening, and that's why there's a failure in
the marketplace. That's why the Treasury Secretary has put
forward his proposal, because he realizes it's not going to
happen in a significant way.
Senator Durbin. I think that's the point Mr. Sommer made.
Mr. Zandi. Yes. That's exactly the point. Yes. So there is
a market failure here and you can't let the market do it by
itself because it's not going to happen. It's not going to
work.
Senator Durbin. Anyone like to comment on that before
summation?
Mr. Mason. I'd like to address that a little bit more
accurately. There aren't security holders that will benefit
from foreclosure. In fact, the problem is really more
accurately characterized by Professor Scarberry: nobody really
wins here. But the problem is that nobody wins in a
modification in the sense that the servicing structures are
built so that the serving contracts that pay the servicer to
send out the bills and make the phone calls aren't written to
handle any of the activities that we see in modification.
So let's say a servicer goes ahead and, let's say I'm late
on my loan, the servicer calls me, we have some talks, we work
some things out, they freeze my interest rate for a couple of
years, or maybe permanently, who knows. But we work some things
out and I keep paying the mortgage. Well, they've just incurred
some additional expenditures in that activity. The problem is,
nowhere in their contract do they get to recover those
expenditures because I didn't go into foreclosure.
Senator Durbin. Do you acknowledge and concede the earlier
point, that the sale and foreclosure is going to be at a loss
to fair market value; that the foreclosure proceeding itself is
an expensive undertaking; that a financial institution is not
in the business of cutting grass and selling property?
Mr. Mason. I do. I completely concede.
Senator Durbin. Conceding all those points, doing nothing
is expensive to someone in this process who is the ultimate
mortgage owner, right?
Mr. Zandi. There's obvious winners in modification. Obvious
winner. The borrower is the obvious winner. The community in
which the borrower lives is an obvious winner. The economy is
an obvious winner because house prices aren't going to fall
quite as much. The costs of foreclosure are substantively
greater, by anyone's measure, to modification. Those benefits
have to go to somebody. They're going to go to the borrower,
they're going to go to the lender, they're going to go to the
servicer, and they're going to go to the investor. So, there
are significant benefits to modification of a foreclosure.
Mr. Mason. Now, that being said, that borrower is a winner
and it's not clear that every borrower out there deserves that
status. There are certain borrowers that--
Mr. Zandi. Now, that's a different argument in a different
story, in a different point.
Mr. Mason. There are certainly borrowers like the one
sitting at this table that has been truly harmed by the
mortgage system, by abuses and by predatory practices. Those
borrowers certainly need redress. But we have also had a
tremendous amount of speculation.
Senator Durbin. Well, I might just add, though I have my
differences, and have had many with the administration, I
talked to Secretary Paulson yesterday. What they are proposing
is certainly not paying homage to the sanctity of the contract.
They know that we cannot continue these contracts. We've got to
either not allow a re-set or come to some sort of--eliminating
pre-payment penalty, whatever it takes, that is going to step
into this situation and say it has to stop. This is not good
for this Nation for this to continue.
Mr. Mason. I also want to point out another thing that Ms.
McGee mentioned in her testimony. There are these fundamental
problems with the mortgage closing practices under RESPA, where
she was put in a room for 10 minutes with 40 pages of paper.
There was no way possible she could read, much less digest the
terms of the contract. Giving her that contract, a firm
contract 2 weeks beforehand might have given her a fighting
chance where she could show that to her daughter, or her
friend, or her friend's friend, or an attorney.
Senator Durbin. Oh, no. Having been an attorney at
closings, I can just tell you, I'm sure Ms. McGee's daughter is
a very smart young lady, but give me a week with it and I might
be able to make some sense out of it.
I'll just say this. Let me close by saying this. I had a
meeting today with the realtors. We talked about a lot of
things, including this issue, obviously. I am hopeful, at the
end of the day, that we not only deal with this crisis, but
look prospectively. There ought to be a simple, simple sheet
that you put in front of a borrower which says this is how much
you're borrowing, this is the interest rate, it is either
permanent or it's going to change, here is your pre-payment
penalty if there's going to be one.
Now, this debate was started a long time ago by the first
man I ever worked for, Paul Douglas, who initiated Truth in
Lending. I am sure Senator Douglas, if he saw that stack of
papers pushed in front of Ms. McGee, or Senator Proxmire, who
ultimately passed the bill, would consider this a great victory
for consumers. We've got to get to the point where consumers
have some basic information so that they know what they're
getting into. The moral hazard argument, I think, is applicable
if in fact people are informed and make a bad decision. In most
cases, people are not informed.
Mr. Mason. Let me just say, that's very true, but I've seen
the development of the Schumer-Box for credit card contracts
and I've seen the terms in credit card contracts move beyond
the Schumer Box, so that what you've legislated to be presented
no longer contains--accurately--represents accurately the
important terms of the contract. So I am worried about
prospectively is the industry moving beyond these requirements.
Senator Durbin. Being a legislator means being hopeful, so
we're hoping that we can do better.
Mr. Scarberry. Mr. Chairman, the idea of a single sheet
very clearly setting forth terms, it seems to me, is crucial.
One of the problems with mandating disclosure is, the more
disclosure you mandate, the harder it is to read and the less
is actually conveyed. So that seems to me to be an extremely
valuable approach.
Senator Durbin. My thanks to the entire panel. To Ms.
McGee, for your sacrifice in coming here. We hope that we can
help you work this out. To the judges, for coming and giving us
an important perspective, and to all the members of the panel.
Thank you very much.
This meeting of the subcommittee, or the full committee,
will stand adjourned. There may be some written questions sent
your way. I hope you can respond to them in a timely way for
the record. Other members who wish to make statements and put
them in the record will be given that chance.
We stand adjourned.
[Whereupon, at 4:18 p.m. the hearing was adjourned.]
[Questions and answers and submissions for the record
follow.]
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