Wednesday, October 28, 2009

In re Olga: of Bankruptcy and Foreclosure

Posted on Calculated Risk:

An article by a person named Morgenson appeared in the New York Times last weekend, calling to our collective attention a New York bankruptcy case that adds to our collective knowledge of our collective foreclosure problem. Driven by a suspicion that the article would have helped us understand more if it had been written by someone other than the aforesaid Morgenson, your intrepid foreclosure correspondent dug into the record and filed the following report.

Picking on Poor Gretchen

First, for recent arrivals, there is a long and honored history at this site of Picking on Poor Gretchen. In this case I want to congratulate Morgenson, as it appears she did break this story herself rather than picking it up, unattributed, from bloggers. Let me also say I am not necessarily the best person to carry on the tradition of Picking on Poor Gretchen. I experimented with journalism in my youth, and I know how difficult it can be to get enough actual facts in a short time to fill up the number of column inches your editor is expecting from you.

But the more I thought about the Times article, the harder it was to escape the conclusion that Brad Delong is right – the print dinosaurs are doomed, and they have done it to themselves. The first few paragraphs of Morgenson’s purported article are appallingly fact-free and hyperbolic, or as Tanta put it, “Morgenson’s valid points are drowning in a sea of sensational swill.

The article begins:
FOR decades, when troubled homeowners and banks battled over delinquent mortgages, it wasn’t a contest. Homes went into foreclosure, and lenders took control of the property.

On top of that, courts rubber-stamped the array of foreclosure charges that lenders heaped onto borrowers and took banks at their word when the lenders said they owned the mortgage notes underlying troubled properties.

* * *
But some judges are starting to scrutinize the rules-don’t-matter methods used by lenders and their lawyers in the recent foreclosure wave.
Morgenson deserves credit for finding this story, but it is hardly the first foreclosure-gone-wrong story of the decade, or even of the “recent foreclosure wave.” Morgenson has apparently forgotten the redoubtable Judge Boyko, who dismissed some Ohio foreclosure complaints in 2007 based on somewhat similar facts. We know Morgenson covered that story, so it is not clear to me whether the “decades” of judicial neglect and rubber stamping occurred before 2007 or after. But, well, whatever.

So What Happened In This Case?

Most of the sensational swill is in the first few paragraphs of this Times story. Once you get past the first third, Morgenson’s facts are basically correct. Unfortunately, much of the context is missing. For example, one of the things you would never guess from reading the Times article is that it matters whether you’re talking about a bankruptcy case or a foreclosure case. That is Takeaway Lesson Number One from this case: Bankruptcy is different from foreclosure.

The purpose of a foreclosure case is usually to allow a lender to take back collateral after the borrower stops paying on a loan. It should not be a surprise that lenders often win such cases, frequently by default. By contrast, the purpose of a bankruptcy case is to allow the debtor to restructure debt, distribute the available assets fairly among creditors, and extinguish debt that can’t realistically be paid. It should not be surprising that debtors “win” bankruptcy cases more often than foreclosure cases, especially if the debtor can show the lender has not followed the rules.

I will call the debtor in this case “Olga.” Her last name is redacted because she doesn’t seem to be seeking publicity. Olga filed bankruptcy under Chapter 13, which is a section of the bankruptcy code allowing individuals with regular income to develop a three or five year plan to pay their debts under supervision of a trustee. The debtor is protected from bill collectors, and most debts that can’t reasonably be paid are discharged. Chapter 13 theoretically allows the debtor to keep a mortgaged home if the debtor can catch up on payments within the plan period. The bankruptcy judge does not have the power to change the loan contract much, though, so many people can’t keep their homes using Chapter 13 unless the lender can somehow be “persuaded” to modify the loan.

But Olga was willing to try. She gave notice to creditors and filed a plan, among other things, and her mortgage servicer (PHH Mortgage Corp.) filed a proof of claim with a schedule stating how much was allegedly owed on Olga’s house. Olga’s lawyer noticed that PHH’s paperwork was not very complete, so he sent some information requests. He was not satisfied with the response, so he filed a motion to have PHH’s proof of claim expunged.

Olga’s Motion to Expunge

Mortgage servicers have important rights under the various contracts associated with the loan, but the servicer frequently is not, and PHH in this case was not, the actual owner of the note or the mortgage. In addition, the paperwork provided by PHH was woefully incomplete. Woefully incomplete paperwork can mean something different in bankruptcy than it does in foreclosure.

When your paperwork is woefully incomplete in a foreclosure case, you can ask for a delay or you can drop the case or have it dismissed, and you usually get another chance. Bankruptcy, by contrast, is kind of a one-shot deal by nature. The judge will add up all the debts, add up all the money available, approve a plan, and that’s it. Very limited do-overs.

Olga’s motion listed a number of problems:

  • PHH didn’t own the note.
  • The owner of the note was not joined in the proceeding.
  • PHH did not file all the documents necessary to show that it was authorized to bring the claim by the holder of the note.
  • PHH therefore is not the real party in interest and had no standing.
  • The documentation for the securitization trust that probably owns the note probably severely limits the way notes and mortgages can be handled, but
  • The mortgage documentation was not provided, so there is no way to know if it was assigned properly.
  • The note was provided, but it had an endorsement dated after the bankruptcy filing.

    These items are explained a little bit more in Olga’s Response to the lender’s objection to her motion to expunge the proof of claim, which is a pretty good summary of things borrowers might want to think about when they are considering whether to contest foreclosures. MERS was a nominee at some point, but was not directly involved in the case.

    My impression is that Olga’s lawyer did not expect the proof of claim to be expunged, and was primarily interested in getting more information and forcing the lender to negotiate. Bankruptcy Judge Robert Drain had other ideas – he expunged the claim.

    The Aftermath

    This is probably not the end of the story because, as Olga’s lawyer explained, a title company probably will not insure the title if Olga tries to sell the house without taking any further action. Judge Drain did not explain much in his order, but what seems to have gotten his attention is the likelihood that the note and mortgage really never were properly assigned to the securitization trust.

    Takeaway Lesson Number Two from this case is that, if Judge Drain is right, this is not a nothingburger. This could apply to a large number of securitized mortgages based on the language of the securitization documents themselves, not on the quirks of local law. The decision has been appealed to the district court, so we will likely find out more unless the case settles.

    Morgenson also noted that this decision was by a “federal judge.” It is probably worth noting that bankruptcy judges are not quite the same as U.S. District Court judges. Bankruptcy judges are not appointed for life, they only have jurisdiction over matters that are related to bankruptcy, and their decisions are appealable to a District Court judge, as happened in this case. But bankruptcy judges have a lot of power over core bankruptcy matters. This particular judge was the one who slashed executive compensation in the Delphi case.

    In my opinion, Takeaway Lesson Number Three is this: lenders would probably have been better off with a reasonable cramdown provision in the bankruptcy laws. As Tanta explained in her cramdown post, home mortgages were often modified in bankruptcy proceedings before 1993. Morgenson’s claim that all types of court proceedings have uniformly favored lenders “for decades” is wrong, but the bankruptcy laws got a lot worse for consumers in 1993 and again in 2005. In the absence of reasonable solutions imposed by a bankruptcy judge, lawyers for debtors and home mortgage lenders sometimes act like Reagan and Brezhnev, threatening each other with nuclear options and hoping none of the tactical warheads go off prematurely. Which is what seems to have happened in this case.
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