Don't Let Judges Fix Loans

By ALAN SCHWARTZ

In his housing plan, President Obama has asked Congress to give bankruptcy judges the authority to rework the terms of mortgages and allow more people to stay in their homes. Though the president’s idea sounds appealing, there are at least three reasons it is misguided.

First, the proposal would swamp bankruptcy courts. There are only about 300 bankruptcy judges, and they are already busy with an increasing number of bankruptcies. Clearing millions of new mortgage cases will take a long time and thus have little immediate effect on the foreclosure crisis. In addition, the flood of new cases would delay the resolution of business bankruptcies, to the detriment of the economy.

Second, many debtors will be disappointed. Consider the parties’ incentives. Debtors will argue for low home values while lenders will argue for the opposite, to minimize their losses. Lenders will win many of these valuation contests: they have more expertise than individuals in making their case and greater resources.

Finally, the proposal worsens economic uncertainty. A major cause of the financial crisis is that many banks do not know what their assets — and particularly home mortgages — are worth. Valuing homes is simple when prices are stable. An appraiser can look at prices in a neighborhood and plausibly infer that a particular house is worth about as much as similar houses there.

But even experts do not know how to value individual houses when a large number of them are in default, and thus potentially for sale, and cash is tight for prospective buyers. Under the president’s proposal, however, bankruptcy judges who are not experts at valuation would be required to price individual houses. Valuation thus will likely be a shot in the dark, inevitably affected by a judge’s personal sympathies. The arbitrariness of valuing single homes in bankruptcy will further increase the already considerable uncertainty regarding the value of the banks’ “toxic assets.”

There are many things that can be done to help debtors retain their homes. It would help, for instance, to change regulations to let loan administrators modify mortgages without fear of liability from the mortgage’s ultimate holders. What won’t help, however, would be to put bankruptcy judges in the business of reworking bad home loans.

Alan Schwartz is a professor of law and management at Yale.

Copyright 2009 The New York Times Company. All rights reserved.

Loss Mitigation in the Southern District of New York

In recognition of the mounting number of foreclosures on residential and commercial properties in the current shaky economy, the United States Bankruptcy Court for the Southern District of New York adopted a Loss Mitigation Program on December 18, 2008, which became effective on January 5, 2009.

The Loss Mitigation Program is intended to facilitate consensual resolutions for individual debtors whose residential real property is at risk of loss to foreclosure, avoid the need for bankruptcy litigation, reduce costs to debtors and secured creditors and enable debtors to reorganize or otherwise address their most significant debts and assets under the Bankruptcy Code.

"Loss mitigation" is intended to describe the full range of solutions that may avert the loss of a debtor's property to foreclosure, increased costs to the lender, or both, and may include loan modification, loan refinance, forbearance, short sale, surrender of the property in full satisfaction, or some combination of these agreements.

Any individual or joint debtor filing for relief under Chapter 7, 11, 12 or 13 of the Bankruptcy Code is eligible to participate in the Loss Mitigation Program, provided that they possess real property or a cooperative apartment that is used as a principal residence.

A party may request (or the Bankruptcy Court may order) a Chapter 13 Trustee to participate in loss mitigation. At any time a party may request (or the Bankruptcy Court may order) the appointment of an independent mediator. However, it is unclear which party or parties will be responsible for the cost of mediation.

Parties are encouraged to request loss mitigation as early in the case as possible, but loss mitigation may be initiated at any time. Loss mitigation may be initiated by the debtor, by a creditor or by the Bankruptcy Court. Parties may object, in which case the Bankruptcy Court will hold a hearing.

When a Loss Mitigation Order is entered:

1. Creditors are authorized to contact the debtor directly, with the presumption that such communications do not violate the automatic stay.

2. Except where necessary to prevent irreparable injury, loss or damage, a creditor shall not file for relief from the automatic stay during the loss mitigation period.

3. In a Chapter 13 case, the deadline by which a creditor must object to confirmation of the Chapter 13 plan shall be extended to permit the creditor an additional two weeks after the termination of loss mitigation, including any extension of the loss mitigation period.

At the beginning of the loss mitigation process, the Loss Mitigation Parties should discuss the following:

1. The time and method for conducting the loss mitigation sessions.

2. The types of loss mitigation solutions under consideration by each party.

3. A plan for the exchange of required information prior to the loss mitigation session, including the due date for the debtor to complete and return any information request or loss mitigation paperwork that each creditor may require.

At any time during the loss mitigation period, a Loss Mitigation Party may request a settlement conference or status conference with the Bankruptcy Court. Loss Mitigation Parties may request an extension of the loss mitigation period. If party does not consent, the Bankruptcy Court shall schedule a hearing to consider whether further loss mitigation sessions are likely to be successful.

A Loss Mitigation Party may request that the loss mitigation period be terminated and state the reasons for the request. The Bankruptcy Court may schedule a hearing to consider the request.

The Loss Mitigation Parties shall provide either a written or verbal report to the Bankruptcy Court regarding the status of loss mitigation within the time set by the Bankruptcy Court in the Loss Mitigation Order. The Loss Mitigation Parties must seek Bankruptcy Court approval of any resolution or settlement reached during loss mitigation.

To learn more about how the Loss Mitigation Program can protect your residence from foreclosure, please contact Jim Shenwick.