Cuts for the Already Retired

By MARY WILLIAMS WALSH

Retired police and firefighters from Central Falls, R.I., have agreed to sharp pension cuts, a step thought to be unprecedented in municipal bankruptcy and one that could prompt similar attempts by other distressed governments.


If approved by the bankruptcy court, the agreement could be groundbreaking, said Matthew J. McGowan, the lawyer representing the retirees.

“This is the first time there’s been an agreement of the police and firefighters of any city or town to take the cut,” he said, referring to those already retired, who are typically spared when union contracts change. “I’ve told these guys they’re like the canary in the coal mine. I know that there are other places watching this.”

As cities, towns and counties struggle with fiscal pain, there has been speculation that they could shed their pension obligations in bankruptcy. Some have said it might, in fact, be easier for local governments to drop those obligations than it is for companies, which use a different chapter of the bankruptcy code. Large steel companies, airlines and auto suppliers like Delphi have terminated pension plans in bankruptcy.

“But it’s a fight that municipalities haven’t been willing to fight,” said David Skeel, a law professor at the University of Pennsylvania who writes frequently on bankruptcy.

Municipalities have been reluctant because public pensions are protected by statutes and constitutional provisions meant to make them nearly airtight. And even if the rules could be broken in bankruptcy, that would present a different problem. Local officials who want to cut pensions do not, as a rule, want to shortchange their bondholders for fear of not being able to borrow in the future — yet bankruptcy law requires that both types of creditors be treated equitably.

Rhode Island sought to sidestep the issue with a law that gave bondholders more protections than retirees. Central Falls’s retirees used that issue to gain some bargaining power, extracting a commitment from the state to seek extra money for the next five years. The extra money is not a sure thing, though, and would not cover all the cuts to the retirees over those years.
The last American city to work its way through Chapter 9 bankruptcy was Vallejo, Calif., which finished the process this year. It had to navigate similar stumbling blocks. Initially, it planned to cut its workers’ and retirees’ pensions, but it changed course when California’s giant state pension system, which administered Vallejo’s plan, threatened a costly and debilitating court battle.
Vallejo instead cut pay, health care and other benefits, as well as city services and payments to its bondholders, and left the pensions intact. Even though the bondholders faced a loss, all parties eventually agreed they had been treated equitably, and the state passed a law making it easier for Vallejo to continue borrowing.

The episode strengthened the perception that public retirement plans were unalterable, even in bankruptcy.

“Central Falls is undermining that,” said Mr. Skeel, who wrote about Vallejo’s bankruptcy for a coming issue of The University of Chicago Law Review.

Central Falls had little choice. For years, its government failed to contribute enough to its police and firefighters’ pension fund, and the fund effectively ran out of money this fall. The city, which had also promised the retirees comprehensive health benefits, could not cover the pension and health payments out of its general revenue.

The police and firefighters have known for months that drastic cuts were looming. Last month, the unions representing active workers negotiated new contracts, which called for workers to complete at least 25 years to receive pensions, instead of 20. Workers will also have to meet much more rigorous standards to qualify for disability pensions.

Until now, 60 percent of Central Falls police officers and firefighters have retired on full disability pensions, drawing the inflation-protected and tax-free payments even when they embarked on new careers. One of them, at 43, has become a prominent personal-injury lawyer and can be seen in television ads shooting baskets and pretending to fall down a manhole. That retiree, Robert Levine, a former police officer, said his disability was the result of an on-duty car crash where he was not at fault, and that his pension had been granted lawfully after his condition was certified by three different doctors.

The retirees, who are not represented by the unions, voted in favor of their pension reductions last week. The cuts would be up to 55 percent of each retiree’s benefits, which now vary widely, from about $4,000 to $46,000 a year, depending on final salary, years of service and other factors. A few retirees would give up more than $25,000 a year. Central Falls’s police and firefighters do not participate in Social Security.

The new agreement also reduces the annual cost-of-living adjustments and requires retirees to start contributing toward the cost of their health benefits. But it does not take disability pensions away from retirees — something that could become a sticking point.

In the negotiations, the state’s revenue director promised to seek money from the state — enough to pay most retirees a supplement of several thousand dollars a year for five years.

Having recently enacted a big and painful package of pension cuts for state workers and teachers, Rhode Island legislators say they are in no mood to help a city’s retirees who stripped their own pension fund, often collecting disability pensions when they were well enough to work.
The retirees’ lawyer, Mr. McGowan, won support for the state money by threatening to challenge a state law enacted just before Central Falls declared bankruptcy last summer. The law protects holders of general-obligation bonds issued by Rhode Island and its municipalities by giving them priority in bankruptcy. Without the law, investors could find themselves subject to the same losses as the retirees.

The state law was intended to prevent a contagion effect, in which Central Falls’s bankruptcy would frighten investors away from other cities’ bonds, driving up borrowing costs across the state.
The idea of shielding municipal bondholders during bankruptcy is controversial, however.
“It’s not clear to me that you ought to be protecting bondholders,” said Mr. Skeel. “It seems unfair to me that you’re singling out one type of creditor to bear the burden, and another type not to.”
Mr. McGowan, the retirees’ lawyer, said he had threatened to sue Central Falls’s bondholders on the argument that the state law had given them a “voidable fraudulent transfer”— an abusive deal that could be undone by a bankruptcy court. He said the state did not want such a challenge, so it agreed to push for pension supplements.

Theodore Orson, who represents Central Falls’s state-appointed receiver in the bankruptcy, said negotiations would have been impossible without the law. He said he thought Chapter 9 should be amended to give cities the ability to shield their bondholders if they could show a compelling need to do so. But that would take an act of Congress, and federal lawmakers, at odds over their own debt and deficit, show no interest in taking on the cities’ fiscal woes.

“One thing I think we’ve demonstrated in Rhode Island is, we really have a functional state government,” Mr. Orson said. “We are pulling together and making what we believe to be difficult decisions that you don’t see Congress making right now.”

Copyright 2011 The New York Times Company.  All rights reserved.

Pre-judgment and asset protection planning

In these trying financial times, many clients are calling Shenwick & Associates and asking about pre-judgment or asset protection planning. While it is always best to do asset protection planning or pre-judgment planning as far in advance as possible, many clients are concerned about planning opportunities after they have been served with a summons and complaint or in cases where a judgment is soon to be entered. Again, it must be emphasized that pre-judgment planning should be done years in advance of a lawsuit or entry of a judgment.

However, New York law does allow for some planning opportunities:

1. The New York State Debtor and Creditor Law provides for a $150,000 homestead exemption (in Kings, Queens, New York, Bronx, Richmond, Nassau, Suffolk, Rockland, Westchester and Putnam counties). This allows a debtor who owns real estate to retain up to $150,000 in equity if his or her primary residence is foreclosed upon after payment of mortgages on the property. If the debtor is married, then the debtor’s partner (if he or she also holds title to the property) would also receive a $150,000 homestead exemption, for a total of $300,000.

2. If a couple is in fact married, and they are contemplating a divorce, a debtor may be able to transfer non-exempt property to his or his spouse pursuant to New York State’s equitable distribution law. The granting of the divorce would be deemed consideration for the transfer of the property from both spouses to one spouse pursuant to a New York divorce.

3. Whole life life insurance policies. New York State law provides that the cash surrender value component of whole life life insurance is exempt from the reach of creditors.

4. A motor vehicle is exempt up to the amount of $4,000 in equity.

5. A debtor may want to consider purchasing an annuity. A debtor is allowed to purchase a $5,000 annuity within six months of an action, and an unlimited amount if the court determines that that amount is necessary for the reasonable requirements of the debtor and the debtor’s dependent family. Accordingly, if a debtor is a senior citizen and/or is married and supporting minor children, exemption of an annuity greater than $5,000 may be upheld by a court.

6. Finally, qualified retirement plans (401(k)s, pensions, Roth IRAs, IRAs, 457(b) plans for government employees and Simplified Employee Pension Plans (SEPs)) are all deemed spendthrift trusts under New York law. Accordingly, if a debtor has an existing qualified retirement plan and a history of making payments to that plan, they may want to consider continuing to fund that plan. Pre-judgment planning is a complicated area of the law, and is heavily dependent on the facts and circumstances of each individual case. Individuals who feel that they may be in need of pre-judgment planning are encourage to contact Shenwick & Associates.

Village Voice: NYU Students-Debt and Debtor

Walking around Greenwich Village, it's easy to find reinforcement for the popular stereotype of New York University as a rich-kid school. On a fall evening, the bars and restaurants near the campus can feel completely overrun with a swarming mass of fashionably dressed students splashing out on Mom and Dad's credit card, apparently heedless of the recession and living the downtown dream.

Lyndsey always resented that stereotype. That's not to say she doesn't acknowledge some truth to it, but she knew it didn't apply to her. Like so many undergraduates, she came to NYU because it was her dream school, but it wasn't a dream she came by easily. Lyndsey financed her NYU education in large part with loans, which she is now paying back a little at a time.

When Lyndsey is done paying them, she will be 54 years old, and she will have spent more than a third of a million dollars on her undergraduate education.

During her college years, as it became clear to Lyndsey just how deep in the hole her education was going to put her, she dialed back her living expenses to a bare-bones survival budget. She moved out of the overpriced university dorm and into a tiny apartment off campus, dropped out of the meal plan, and put herself on a strict $20-a-week regimen for food and entertainment.

"I joined clubs just because they had food at the meetings," Lyndsey says. "I knew all the popular meeting places, and I always had tinfoil and plastic bags with me to snatch up anything on the table. If I came across a leftover pizza, I'd take the whole thing and put it in my bag. When I did buy groceries, it was in Chinatown, and I'd haggle for everything. I'd buy things that I didn't even know what they were, just because they were cheap."

Upon graduation, it became obvious to Lyndsey that what she wanted to do with her life—why she'd gone to NYU and into debt—wasn't going to pay the bills as her loans started coming due.

"My dream career was to be a cinematographer on films about nature, to be involved with shaping how the public perceives nature and our relation to it," Lyndsey says. "It became clear that that wasn't going to pay nearly enough. I had a six-month grace period after graduation to get a job and start paying back those loans, so I got work that paid better in a field completely different from why I wanted to go to school in the first place."

And so began a blurred, twilight existence that has lasted years for Lyndsey. She works nine-to-five in a surgical-simulation lab at a medical school, then rushes home to immediately start her other job, working until 10:30 as tech support for a company in California.

"It's pretty murderous," Lyndsey says. "There's no time in my day to think, to breathe, to eat, to shop for groceries. Weekends I try to catch up on laundry, get groceries, cook as much as possible, and see my friends if I can."

Still, the punishing work schedule was better than the alternatives Lyndsey sometimes considered. "I'm basically trying to avoid the more extreme ways of doing it: stripping and prostitution," she says. "Stuff you can't tell your parents and your friends about."

Working 70 hours a week, Lyndsey was able to stay on top of her $1,232 monthly loan repayment and even put a little aside. But it wasn't sustainable: She was chronically exhausted, her relationships were suffering, and she was miserable. Earlier this year, her boyfriend moved out, and she found herself scrambling to make rent by placing a rotating series of Craigslist roommates on the couch of her one-bedroom apartment in South Williamsburg.

Now the possibility of getting behind on her loans, or even defaulting, seems perilously close. But there's no way out. Bankruptcy wouldn't clear her obligations, and if she falls behind, the bank wouldn't just come after her, but also after her mother, who took on much of the debt. Their salaries could be garnished and so could her mother's Social Security benefits.

Lyndsey doesn't want to use her full name in this story. She's worried that if she ever does default on her loans, her comments might be used against her in court. Worse yet, she says, they could be used against her mother.

But even trapped in this untenable situation, when she's asked if she wishes she hadn't gone to NYU in the first place, Lyndsey doesn't have a simple answer. She's angry at NYU, feels used and misled by the school, sure. Yet she's got nothing but good things to say about the schooling she received.

"Would I want a different education? I have to say, the education I got was pretty great," Lyndsey says. "I got to know this city that I love. And going to NYU has made people look at my résumé that wouldn't have if I went to UMass Amherst. Do I wish I hadn't gone to NYU at all? It's not that easy."

In the clutches of the great recession, after the home-borrowing bubble burst, the education-borrowing bubble lives on. Teenagers continue to borrow tens and hundreds of thousands of dollars to finance their educations, even as they increasingly find there aren't jobs waiting for them on the other side. Down in Zuccotti Park, Occupy Wall Street protesters are talking about demanding student-loan forgiveness.

In some respects, NYU is the poster child for the excesses of 21st-century student debt in America. Although most NYU undergraduates haven't borrowed as much as Lyndsey (who owes $165,000 and will end up paying $350,000 because of interest), the average student is still a whopping $35,000 in debt when they graduate, a figure $11,000 higher than the national average. In fact, NYU creates more student debt than any other nonprofit college or university in the country. The only schools putting students into more debt are the kind of for-profit diploma mills currently being investigated by the United States Senate.

But at the same time, NYU's status as an iconic and prolific generator of student debt is an awkward fit with the populist outrage of national education funding activists and Occupy Wall Street protesters. Prospective NYU students have less-expensive options, and NYU isn't exactly positioning itself as an affordable institution for the masses. In fact, its tuition is so high and its financial aid so low precisely because the university is on a multi-decade spending spree, attempting to launch itself into the highest tiers of elite universities with a state-of-the-art campus and top-notch faculty.

That sort of aspirational spending—the idea that, as former NYU president L. Jay Oliva once said, "There's no way to get excellence, other than buying your way into it"—is, of course, only the institutional mirror of the aspirational spending NYU's students are doing when they pay their tuition bills. For many, the belief that a diploma from a prestigious school like NYU can catapult a student into a higher socioeconomic register makes NYU's staggering tuition seem worth it.

There is a significant difference between these double strands of big dreams and lavish spending, though: NYU is financing its dreams with student tuition. The students are financing theirs with enormous loans that can weigh on them and limit their options for decades to come.

Why does NYU put its students in so much debt? Some of the answers are obvious and come quickly to the tongue of university spokesmen when asked the familiar question: NYU is in the heart of New York City, one of the most expensive real estate markets in the world. Everything is more expensive here, from buildings to salaries to food and laundry.

School officials also point to the school's relatively meager endowment. At $2.5 billion, NYU's endowment sounds like a lot until you start comparing it with those of the big-name schools with which NYU competes: Five miles uptown, Columbia has $7.8 billion. Yale has almost $20 billion. Harvard has $32 billion.

Schools like these can use the interest accrued by their massive endowments to help cover their costs, lessening their reliance on tuition and increasing the generosity of their financial aid. Princeton funds nearly half of its operating budget with its endowment. At NYU, the figure is 5 percent.

But while NYU pleads poverty to its students, it's worth understanding why its endowment is so small. For one thing, NYU hasn't been around collecting compound interest for as long as some of its ivy-covered brethren. It was founded in 1831, nearly 200 years after Harvard. And for much of its history, NYU wasn't exactly serving the sort of old-money elites and future captains of industry that could be counted on to give generously to their alma mater.

For most of the past century, NYU was a modest regional commuter school. Most of its operations were in the Bronx, in a spacious, conventional campus in University Heights. But faced with a financial crisis in the early 1970s, the school's board of directors began implementing a sort of moon-shot effort to save the school. If the challenge was to go big or go home, NYU was going to go big.

It sold the Bronx campus, now home to Bronx Community College, and rebranded itself as the school in the heart of downtown. President John Brademas launched a billion-dollar fundraising campaign. But contrary to conventional doctrine, NYU socked little of the money away, instead going on a spending spree, expanding the university's Greenwich Village footprint, and upgrading its existing facilities.

Longtime residents fought back against this construction boom and the institutionalization of their neighborhood, but though the resistance to NYU's ongoing expansion is still noisy, in decades of struggle, they have had little success in reining in the NYU juggernaut.

The development was mostly for dorms and academic buildings, but NYU's holdings also include a lot of swanky faculty housing, which, combined with a generous war chest, have helped to lure big-name professors who would never have considered NYU 30 years ago.

The spending spree struck many at other universities as risky and dangerous. Spending so much and saving so little allowed NYU to grow rapidly in size and stature, but it left the school with little to fall back on in hard times and placed an outsize share of the burden of running the school on the backs of students.

Still, by most measures, the strategy was an unqualified success. Forty years after its near bankruptcy, NYU's Hail Mary transformation is complete. The Bronx now far behind, the school is firmly entrenched in the Village, with 15 million square feet citywide. It has a world-class faculty and now competes for some of the best students in the world.

But the school isn't stopping its spendthrift strategy. It's not even slowing down. If anything, NYU's metastatic expansion is only speeding up. Last year, the school announced plans to grow its space by another 40 percent, further saturating the Village and expanding into Brooklyn and Governors Island. And the school isn't confining itself to New York City. Last year, it opened NYU Abu Dhabi, a sort of clone of itself in the United Arab Emirates. In 2013, the school plans to do it again, this time in China. These global forays are for the most part funded by their host countries, but many students see this relentless focus on growth as coming at their expense.

NYU's thirst for money to fuel its rocket ride to the top has certainly led it to some unsavory places. In 2007, then-attorney general Andrew Cuomo busted the school for a kickback scheme involving student loans. When students were accepted to NYU, the school would direct them to Citibank as its "preferred lender" for all private loans. In return, Citi would kick back a percentage of its loans to the school. NYU's take amounted to $1.4 million over five years.

Citi did offer lower rates than the seven other institutions that vied to be NYU's preferred lender, and NYU says the money was plowed back into student aid anyway. But the relationship was still unsettlingly cozy.

Lyndsey, the alumna who will have paid $350,000 for her NYU education, went to Citibank for her private loans because NYU directed her there. When she was accepted in 2003, she was ecstatic. That enthusiasm dimmed somewhat when she saw the meager financial aid package NYU was offering her. If she wanted to attend her dream school, she'd be paying for 90 percent of it with loans.

Despite living in a swanky suburb northwest of Boston, Lyndsey's parents were hardly wealthy. Her mother ran a café, where Lyndsey often helped out. Her father worked in sales for the telecom industry but had lost his job, and the past few years had been difficult. Lyndsey's mother had never gone to college. Her father is English, and had no familiarity with the American university system.

"We relied on the University to help explain it to us," Lyndsey says. "We didn't take it lying down. We called financial aid to ask what was up. They told us that NYU has a fairly high dropout rate, so to protect themselves, they don't offer a lot of financial aid the first semester, but we could expect the financial aid to increase in future semesters."

With that reassurance, Lyndsey and her mother inked promissory notes to Citibank. But when the second semester started, Lyndsey's financial aid didn't change. The next year, tuition went up, and her aid actually went down.

"The relationship with Citi just shows how little incentive NYU had to limit their tuition or offer me better financial aid," Lyndsey says. "They were getting my $40,000 in tuition plus a 15 percent kickback for everything I borrowed. Everybody was winning: NYU was getting paid; the bank was getting a guaranteed revenue stream of 8.5 percent interest guaranteed by the government. Everyone was winning but me."

The feeling that her education financing had turned her into an indentured servant made Lyndsey political. Her activities have connected her with a network of other NYU students and alumni saddled with crushing debt and looking to do something about it. A Facebook group she runs called "The $100,000 Club" for students with six figures of debt has more than 60 members. Some students have staged publicity-ready actions like storming into the NYU bursar's office and attempting to exchange their diplomas for a full refund.

In 2009, the "Take Back NYU" occupation of the school's student center was motivated in no small part by frustration at ever-increasing tuition and the administration's refusal to reveal meaningful details about how it spends its money. But these were larded up with nearly a dozen other demands, including opening the school library to all and offering 13 scholarships to Palestinian students. By the time the occupation ended, it had become caricatured in the media as an unfocused tantrum by privileged kids.

Last winter, the NYU debt protest movement got another shot in the arm as MTV's Andrew Jenks used NYU as the backdrop to his "Casualties of Debt" demonstration. On a cold February day, Jenks organized students in Washington Square to don Anonymous-style masks and T-shirts emblazoned with their amount of debt.

The event was long on theatricality, but Jenks wasn't exactly a terrific spokesman for the movement. When MSNBC's Dylan Ratigan asked him what the masks were all about, he said, "We're all wearing masks to show that as a whole, right now, we may not be doing enough, and we sort of have these blank faces, and we're looking around, and we're not sure what to do."

A more cogent perspective came from Charlie Eisenhood, then an NYU senior and the editor of school's unofficial newspaper, NYU Local.

"When you think about it, people trying to make a financial decision that's going to affect the next two decades of their life when they're 17 and 18 years old is crazy," Eisenhood told Ratigan. "A lot of the time, they don't understand what they're getting into, and it's really up to the universities and Congress to make sure that the banks and the universities are focused on making sure these young students are making financial decisions that aren't going to leave them penniless when they're 25 and 30 years old."

Talking to the Voice this fall from Abu Dhabi, where he is working for NYU, Eisenhood elaborated: "It seems to me that the libertarians are off-base when they say, 'Well, they're adults, they should know better,'" he says. "There needs to be more information from universities and the government and even from banks—you know, 'Are you sure you want to take on this debt to get this degree? It's not free. It seems free now, maybe, but you're going to have to pay it back.'"

That call, for NYU to take more responsibility for educating prospective students about the realities of debt, is actually one that the university has heeded to some extent.

In 2009, NYU called more than 1,800 of 7,300 accepted students whose scholarship packages wouldn't come close to covering their tuition and asked if they were really sure that going to NYU was such a good idea.

But that gesture generated its own backlash. Some students who received the calls told the press they found them discriminatory, and an editorial in the student-run Washington Square News worried the calls would discourage lower-income students from enrolling. "If promising and motivated students choose not to attend, and any student able to pay the bill fills their spot, NYU risks undermining both its prestige and its socioeconomic diversity," the piece stated. "NYU must turn inward and ask itself which quality it values more in its students: motivation, or financial solubility?"

In this instance at least, NYU found itself damned either way. If it made it easy for students to finance their educations with massive loans, it was guilty of economic exploitation and collusion with banks to create a generation of highly educated wage slaves. If it took steps to counsel students about the real consequences of those loans, it was shutting the door to a transformative opportunity to the people who could most benefit from it.

As much as students and activists blamed the university for greasing the wheels on their precipitous roller-coaster dive into crippling debt, many were profoundly uncomfortable with the idea of the university doing anything that would limit enrollment to students who could put cash down on the spot.

Zac Bissonnette, a UMass graduate who wrote Debt-Free U: How I Paid for an Outstanding College Education Without Loans, Scholarships, or Mooching off My Parents, was unimpressed by what he saw as an ineffective infantilism in the NYU debt protests.

"Protesting the amount of money you decided to borrow in order to go to NYU is sort of like moving to New England in the middle of January and then holding signs protesting the cold temperatures and abundant snow," Bissonnette wrote on Daily Finance. "NYU students have a legitimate concern—the amount of money that they're borrowing is insane—and the way that they should handle it is to vote with their feet. Transfer to another school. Deprive NYU of its source of revenue and save yourself in the process. But voluntarily borrowing huge amounts of money to give it to a school while simultaneously shaking your fist at it doesn't help anyone."

Bissonnette's critique is a striking one, because it brings home what makes NYU's debt debate different from the national one. If states are gutting funding for public universities, as they are, that has profound implications for access to education in this country. If a burgeoning industry of for-profit schools is going to extraordinary lengths to put those most in need of education into massive debt for often worthless degrees, that's criminal.

But if NYU thinks it can fund its ascent to the top tier of universities by charging massive tuition and offering minimal student aid, it's not as though prospective students don't have other options. Schools with even better reputations than NYU have more generous aid packages, and there are literally scores of other colleges that offer "the New York experience" where you won't have to put your life in hock for a diploma. Yet last year, 42,242 students applied to the school—the largest applicant pool ever. What gives?

Talking to undergraduates and recent alumni, it seems the answer has a lot to do with youthful optimism and with a vision of their lives that extends through their happy days of schooling in the great metropolis but perhaps not much further.

"Students go to NYU because it's in New York City," Eisenhood says. "When I applied, they had a question on their application: 'Other than living in New York, why do you want to attend NYU?' And I was like, wow, that's actually really hard. I forget what I said—'Great research opportunities,' or something, but I didn't really believe it."

But as much as NYU sells itself on its location, it has some strong programs to recommend it. The university's Stern School of Business is ranked number five among undergraduate business programs by U.S. News & World Report, and students can reasonably expect that between their degree and some well-chosen internships at New York firms, they will be well-poised for a career that will allow them to easily pay back any debt they take on.

Other NYU programs, if equally well-regarded, can't promise the same financial return on investment, but that doesn't stop students from signing on for the ride. Ryan Hamelin, in his last semester of a film and television major at NYU's Tisch School of the Arts, has borrowed roughly $24,000 per semester to finance his education but feels confident he'll be able to make the $1,000 monthly payments when he graduates. He's pulling together his portfolio in the hopes of getting some directing gigs. If that doesn't work out, he plans to fall back on crewing for shoots across the city, something he has already done a bit of.

Early last semester, the reality of his financial situation—even for graduates of the celebrated Tisch program, the jackpot of a directorial gig right out of college is rare—finally sank in. "I was thinking, 'Shit, why did I do this?'" Hamelin says. "I was having anxiety attacks about it."

Now, with a few months to go before his first payments come due, Hamelin is more reconciled to where his path has taken him. "Once this kicks in, I don't see myself being able to do the things I want to be doing for a number of years, which is really a drag," he says. "But that's what you get when you go to NYU: You get NYU, and you get paying for NYU. I'm not going to go down to Wall Street and yell and scream and hope that will make my debt go away."

Lyndsey says she isn't wishing for her debt to go away. "I never want to not pay for what I got," she says. But there are government actions that would make her life easier without giving her a free ride.

"Even changing the interest rate on the PLUS Loans to 3 percent would cut my repayment time in half," Lyndsey says. "Or give us the right to refinance. Banks are borrowing money for free right now, and students are locked in to paying banks back at 8 percent or more."

Since she graduated, Lyndsey has paid back about $40,000 of her loan. But because her loans carry 8.5 percent interest with no chance of refinancing, that $40,000 has put only a tiny dent in her actual balance.

"Do I wish I had been more savvy about how financial aid worked? Of course I do," Lyndsey says. "I'm now guaranteed locked into the system for the rest of my working life to make money for Citibank."

And sure, sometimes Lyndsey fantasizes about what would have happened if she hadn't gone to NYU or to college at all, if she had instead spent her money on high-end film equipment and made the kind of documentaries she had in mind when she enrolled at the university.

But like many NYU students mired in debt, she doesn't think that should be the only choice—between an NYU education and a lifetime of debt or forgoing the university entirely.

"There are so many people with so much potential, and they're going to school because they have visions of what they want to do and be and accomplish and contribute to the world," Lyndsey says. And because of the way we're doing things now, they get locked down, and they have to pay these bills, and they don't get to follow through. And that's a waste."

Copyright 2011 Village Voice, LLC. All rights reserved.

Covet Thy Neighbor’s Apartment: Chapter 7 Bankruptcy Trustees selling rent-stabilized, rent-controlled and unsold units from co-op and condo conversio

As if the economy was not bringing enough bad news to debtors, recent developments in the Southern District of New York (which covers New York (Manhattan), Bronx, Westchester, Putnam, Rockland,Orange, Dutchess, and Sullivan counties) are making it more difficult to file for personal bankruptcy. A recent case, In re Goldman, Case No. 11-11371 (SHL), involved an attempt by a Bankruptcy Trustee to sell the rent stabilized co-op unit of a long-time resident at 420 Riverside Drive in the Morningside Heights neighborhood of Manhattan. The case was a Chapter 7 bankruptcy filing assigned to Judge Lane, who recently entered a consent order permitting the Bankruptcy Trustee to have the U.S. Marshals Service evict Mr. Goldman from his apartment, and then the rights to the lease on the co-op unit would be sold back to the landlord, who would pay the Bankruptcy Trustee $60,000 when the apartment was delivered free and clear of all tenancies, including that of Mr. Goldman, the rent-stabilized tenant.

In the way of background, this is the third decision permitting a rent-stabilized apartment to be sold by a Bankruptcy Trustee to a landlord in the Southern District of New York. The other two cases are In re Stein, 281 B.R. 845 (Bankr. S.D.N.Y. 2002) and In re Toledano, 299 B.R. 284 (Bankr. S.D.N.Y. 2003). In both of these cases, the debtors lived in luxury apartments just south of Central Park–171 West 57th Street, Apartment 3C and 230 Central Park South, Apartment 9/10B.

Many people will be surprised by these decisions, however the Bankruptcy Code and Rules seem to allow the result. Section 541 of the Bankruptcy Code states that when a debtor files for bankruptcy, a hypothetical estate is created, and all property of the debtor (with certain exemptions created by state and federal statute) is owned by the Bankruptcy Trustee. Section 365 of the Bankruptcy Code allows a debtor or a Bankruptcy Trustee to assume and assign (sell) a lease to a third party. Additionally, bankruptcy is federal law, and federal law generally primes (supersedes) state law. When you put this all together, the transaction looks as follows:

A Bankruptcy Trustee will review a bankruptcy petition and determine how many years the debtor has lived in the apartment, the rent that the debtor is presently paying under the rent-stabilized lease and the market value rent if the apartment was not rent-stabilized. The Bankruptcy Trustee will then contact the landlord or owner of the unit and offer to evict the tenant and deliver the apartment broom clean for a certain sum of money.

In the Goldman case, the landlord and the Bankruptcy Trustee entered into a stipulation that was “so ordered” by the Bankruptcy Court, which provided that the landlord would pay the Bankruptcy Trustee $60,000, which would be held in escrow until the Bankruptcy Trustee had the U.S. Marshals Service evict or remove the debtor from the apartment and delivered possession of the apartment to the landlord. The Bankruptcy Trustee receives a commission and legal fees are paid to the Bankruptcy Trustee’s counsel. The balance of the monies is distributed to the debtor’s unsecured creditors. While the result may seem harsh and surprising to many, three Bankruptcy Judges have ruled that these sales are allowed. None of these cases have been appealed to the Second Circuit Court of Appeals or the Supreme Court.

An individual who is contemplating filing for bankruptcy and lives in a rent-stabilized unit must go through the following analysis:

1. How many years has the debtor lived in the apartment?
2. What rent are they paying under the rent-stabilized lease and what is the market value rent if the apartment was vacant and not rent-stabilized?
3. Is the apartment in a gentrifying area or a high income area, such as the Upper East Side, Central Park West or Central Park South?
4. Has the apartment building recently undergone a condo or co-op conversion? And did the debtor decline to buy the unit, and therefore become a non-purchasing tenant?

There is one recourse for the debtor. The Bankruptcy Code allows the debtor to match the offer (in this case, $60,000) and pay that money to the Bankruptcy trustee to keep the apartment unit. Few individuals filing for bankruptcy have that type of money, however they may be able to borrow that money from friends or family to keep the unit. Additionally, if a husband and wife are married and only one elects to file for bankruptcy, or two people who are unmarried live in the apartment and both names are on the lease, since the Bankruptcy Trustee would only be able to assign the unit for the individual who filed for bankruptcy, the result may be that a landlord would be unwilling to pay a significant sum of money in that scenario, because the other party remaining in the unit would still be rent-stabilized. However, other than those two scenarios, this situation is a significant risk, and we are seeing more and more of these cases.

It would seem that either the New York State legislature or Congress needs to address this issue, and create some type of a safe harbor. Again, debtors in rent stabilized apartments must proceed with caution and consult an experienced bankruptcy attorney before filing for bankruptcy. Any individuals who are contemplating bankruptcy and live in rent-stabilized or rent-controlled apartments or unsold rental units in buildings that are being converted to condo or co-op ownership should feel free to contact Shenwick & Associates for an analysis of their situation.

"Means test" standards vs. actual expenses

It sounds like a cliché, but here at Shenwick & Associates, every bankruptcy case really is different. Every debtor has their own unique story of how they got into debt, what type and amount of debt they have, their living conditions and many other factors, which we need to apply the law to so we can provide them with the relief they seek.

In one recent case, we had a young single man (let's call him "Doug") who lived in Brooklyn and earned a substantial income. He had filed for Chapter 7 bankruptcy a few years ago, but the case was dismissed because he was earning too much to qualify for Chapter 7 bankruptcy.

In 2005, Congress radically amended the bankruptcy laws through the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), which introduced a new form, Form 22, the "Statement of Current Monthly Income." There are actually three different forms, depending upon whether the debtor is filing for relief under Chapter 7 ( Form B22A) (the "Means Test"), Chapter 11 ( Form B22B) or Chapter 13 ( Form B22C) of the Bankruptcy Code. For Chapter 7 debtors, Form B22A includes a means-test calculation, which is a complex six page calculation of expenses and disposable income that a debtor must complete if he or she is above the median income for their state and family size. If their disposable income is above $11,725 over a 60 month period, the presumption of abuse arises, which means that it would be presumptively abusive to allow them to liquidate their debts under Chapter 7 of the Bankruptcy Code. In this case, they must file for relief under Chapter 11 or Chapter 13 of the Bankruptcy Code. Form B22C includes calculations to determine the length of a Plan (36 or 60 months) and the amount of disposable income the debtor must pay into the Plan each month.

Doug came to us to determine what his disposable income would be in a Chapter 13 Plan. Although he had a condo, it was "underwater" (the liens on the condo exceeded the fair market value of the apartment), so he was going to have to surrender the unit to his secured creditors and rent an apartment. However, the rents he was being quoted by brokers far exceeded the IRS mortgage/rent standard for one person living in Brooklyn ($1,297). The question was-could we also deduct the differenhttp://www.blogger.com/img/blank.gifce between the actual rent he was going to have to pay and the mortgage/rent standard?

There is very scant case law on this question, and no appellate courts appear to have considered the issue yet, but according to the Bankruptcy Court in the Eastern District of Kentucky, the answer is no, not without special circumstances. In , 382 B.R. 85 (2008), the debtors filed a joint Chapter 7 bankruptcy petition that reported annualized current monthly income of $83,022.36 on their Means Test. The applicable median family income for 2 persons in Kentucky was $41,560. The allowable mortgage/rent standard for 1 or 2 persons living in Boone County, KY was $842/month, but the Shinkles' actual rent was $1,500/month.

So, the Shinkles claimed an adjustment of $658 on Line 21 of their Means Test, which allows debtors to claim an additional expense if they contend that the process set out in Line 20 of the Means Test does not accurately compute the amount they are due under IRS Standards. Without this adjustment, their Chapter 7 case would have been presumptively abusive. The legal issue before the Court was if the Shinkles should be entitled to claim their actual rental expenses on the Means Test, in excess of the IRS standards.

In its discussion, the Court looked to the plain language of § 7070(b)(2)(B) of the Bankruptcy Code, which provides:

"In any proceeding brought under this subsection, the presumption of abuse may only be rebutted by demonstrating special circumstances, such as a serious medical condition or a call or order to active duty in the Armed Forces, to the extent such special circumstances that justify additional expenses or adjustments of current monthly income for which there is no reasonable alternative. In order to establish special circumstances, the debtor shall be required to itemize each additional expense or adjustment of income and to provide - documentation for such expense or adjustment to income; and a detailed explanation of the special circumstances that make such expenses or adjustment to income necessary and reasonable."

The United States Trustee contended that the Shinkles had not demonstrated such special circumstances. The Shinkles argued that allowed amounts for rent or mortgage expenses are guidelines and not "set in stone," that a condition of Mrs. Shinkle's employment was that she reside in Boone County, and that any slight reduction in rent they could derive from moving would be offset by the costs of moving and forfeiting their opportunity to own the house they were renting.

The Court cited two cases where special circumstances were found–In re Scarafiotti, 365 B.R. 618,631 (Bankr. D.Colo. 2007) (debtors' son needed to be in a specific school to address mental and emotional difficulties, which justified a modest increase in the debtors' housing allowance) and In re Graham, 363 B.R. 844,847 (Bankr. S.D. Ohio 2007 (the debtor husband had to move 800 miles from his wife and her two children from a previous marriage in order to find gainful employment, but the debtor wife could not join her husband because of the constraints of her shared custody agreement. These debtors were allowed to claim a second set of housing expenses for the husband). The Court found no such special circumstances in the Shinkles' case.

For more information about the Means Test in Chapter 7, disposable income to fund a Plan in chapter 13 and getting relief through the bankruptcy process, please contact Jim Shenwick.

NYT: The Case for Hiring a Lawyer

By JOSEPH PLAMBECK

First-time buyers in New York City confront a series of choices: co-op or condo, high-rise or walk-up, a second bathroom or just steps from the subway? But there seems to be consensus on at least one decision — whether to hire a real estate lawyer.

In New York, unlike most places in the United States, it is customary for buyers to seek the representation of a lawyer throughout the purchasing process. Although this is not a legal requirement, some longtime real estate agents say they have never witnessed a deal completed without the buyer’s having a lawyer on hand.

“I would never, never have a situation where a buyer did not have an attorney,” said Deanna Kory, a senior vice president of the Corcoran Group. “Without question, there is too much to understand. You can’t understand it on the fly.”

Buyers in New York City rely upon lawyers because real estate transactions can be extraordinarily complicated. In addition to the usual concerns about contracts, liens and titles, New York’s numerous co-ops have financial statements and meeting minutes that require scrutiny. Buying a condo, and even a single-family home, can be equally knotty. Not to mention that the sellers on the other side of the table usually come armed with their own lawyer.

And then, of course, there is the simple fact that real estate in New York is expensive. Making a bad deal can jeopardize huge amounts of money.

“You’re signing the largest check you’ve ever signed,” said Gary L. Malin, the president of the brokerage Citi Habitats, “and you want to make sure that you’re not missing something. To not engage an attorney — you’d feel naked in the process.”

Lawyers also provide a necessary buffer in what can be an emotional process. Peter Graubard, a real estate lawyer since 1994, said lawyers were able to provide an objective assessment even while advocating for buyers.

“I’m really the only involved party whose fee doesn’t depend on the deal closing,” Mr. Graubard said. “I get paid for my lack of a conflict of interest.”

Mr. Malin, who worked for a short time as a real estate lawyer before joining Citi Habitats, says it is especially important for first-time buyers to have a lawyer on their side. A real estate agent can help with some aspects of the process, but a lawyer is the one who performs crucial due diligence and helps finish the deal.

At the start of the buying process, the lawyer helps negotiate the contract. Michael P. Kozek, a lawyer at Jeffrey S. Ween & Associates, says that most of the drafting is done by the seller’s lawyer, but that there should be a chance to review the terms and try to adjust them.

The buyer’s lawyer will also dig into the information available about a property, looking at a co-op’s finances and the minutes of its board meetings. Some buyers with a background in finance believe they can handle this part by themselves. But, Ms. Kory said, they may not know the customary tax breaks and accounting methods used by co-ops, which can lead to serious misunderstandings.

Michael W. Goldstein, a lawyer who has handled residential real estate deals for more than 20 years, says an experienced lawyer is also easily able to spot in the board’s minutes any issues that may percolate into problems. Perhaps there is talk about a loud resident who is to be the buyer’s neighbor, or discussion of a balky boiler that may need expensive repairs not accounted for in the building’s capital improvement plan.

Because experienced real estate lawyers see a lot of contracts and know the customs, they can also help cut through roadblocks. For that reason, Ms. Kory said, it is usually a mistake to hire a lawyer who does not have extensive familiarity with residential deals.

Lawyers and real estate agents both say that the best way to find a lawyer is through word of mouth, in the best case from a friend or a family member. But if that option is not available, real estate agents are often happy to refer someone with whom they have worked.

Ms. Kory says she often advises clients to talk to two or three lawyers, and then choose one, before making any offer on a home. That might seem premature, she said, but having good representation lined up can help ensure that you get the home you really want.

“Having a lawyer makes you look more capable of following through on the deal,” Ms. Kory said. “Even if you are the only one bidding, you will come across stronger if you have all your ducks in a row.”

Buyers should have a few simple questions ready for prospective lawyers. First, ask about residential real estate experience — generally, more is better. Find out about experience with closings for homes similar to yours, or even in the building you are considering. Then find out how much of the work would be done by the lawyer personally, and how much (and which parts) would be handled by a paralegal.

And ask if the charge will be a flat fee or based on an hourly rate. In general, residential real estate lawyers in New York charge a fee, often between $1,500 and $2,500. More complicated or expensive deals, like buying a multifamily brownstone, for example, can take the tab closer to $5,000.

In most cases, that fee will cover a few hours of face time with the lawyer, his or her presence at the closing and a few conversations over the phone. The lawyer will spend several additional hours examining the paperwork and performing due diligence. The buyer also receives something else: more peace of mind.

“The reality is that most people are not well versed in real estate law,” said Mr. Malin of Citi Habitats. “There are a lot of things that could potentially go wrong in the process. And you could very likely regret not spending the money.”

Copyright 2011 The New York Times Company. All rights reserved.

Altneratives to bankruptcy

Here at Shenwick & Associates, we keep a close eye on the news related to bankruptcy, and one news story that caught our eye was about the recent drop in bankruptcy filings. In New York and New Jersey, bankruptcy filings were down by 5 percent from May 2011 to June 2011.

Although filing for Chapter 7 or Chapter 13 bankruptcy is usually the best solution for our clients, there are two alternatives to bankruptcy for debtors:

1. Do nothing. Although this isn’t really a viable solution, it’s a path commonly taken by debtors who think that inaction and time will make their debt magically disappear. In actuality, what will likely happen is that the creditor will commence an action against the debtor in civil court. If the action is not answered, a default judgment will be entered against the debtor. In New York State, a judgment is valid for 10 years (which can be renewed once for another 10 years), and can be enforced against a judgment debtor’s income and assets.

2. An out–of–court workout with the creditor. An out–of–court workout is a voluntary or consensual negotiation with the creditor to reduce the amount of debt the debtor owes to the creditor. In our experience, the biggest discounts can be gained by agreeing to pay the creditor a lump sum, rather than making monthly payments over a year to 18 months. The agreement between the creditor and the debtor should always be memorialized in writing, and should always provide fixed terms for payments (i.e. twelve payments of $500 made each month by the debtor to the creditor), rather than requiring payments in perpetuity from the debtor to the creditor.

There are a number of pros and cons to attempting an out–of–court workout:

Pros:

• The debtor can save the legal fees in filing a bankruptcy petition (which could range from $2,000-$4,000) and the Bankruptcy Court filing fees ($299 for a Chapter 7 case).

• A workout may be a less negative factor on the debtor’s credit report and lower their FICO score less than filing for bankruptcy would.

• A workout provides psychological relief to the debtor in not filing for bankruptcy and lessens the “embarrassment or failure” factor.

Cons:

• Bankruptcy provides a solution for all of a debtor’s creditors, but in an out–of–court workout, each creditor has to be negotiated with individually-what if an agreement can’t be reached with all creditors?

• Who will do the negotiating with the creditor-the debtor, a CPA or an attorney? (CPAs and attorneys will charge a fee for this work)

• It takes substantial time and effort to draft, review and revise and file the documents needed to expedite a workout: a settlement agreement, a release, a satisfaction of judgment and a stipulation of settlement or stipulation of discontinuance of the action (if the creditor has commenced litigation).

• Under § 108 of the Internal Revenue Code, debt relief is considered income and is taxable. This is “phantom income,” for which the creditor will have to file a Form 1099-R with taxing authorities. For example, if a debtor owes $10,000, and reaches an out–of–court workout with a creditor for $4,000. The $6,000 difference between the original debt and the settlement is taxable debt relief income, which must be included in the Debtor’s tax return for the year in question.

To discuss the best strategies for dealing with your personal and business debt and to avoid judgments that will encumber your income and assets, please contact Jim Shenwick.

NYT: Saving on Real Estate In a Down Economy

By EILENE ZIMMERMAN

From 2009 to 2010, the commercial real estate market in the United States seemed bottomless. Whether seeking manufacturing, office or retail space, those looking to lease or buy were in the driver’s seat, said Fred Schmidt, president and chief operating officer for Coldwell Banker Commercial in Parsippany, N.J. After the supply of space hit a peak in the fourth quarter of 2010, he said, the market began a slow recovery — “but it’s definitely still a tenant’s and buyer’s market.”

Many small businesses have taken advantage of the market to negotiate more favorable lease terms or lower rents or to move to better space. Some were able to buy a building, a pipe dream for many in the prerecession real estate market. Still, putting together a deal requires timing, cash and market savvy. The best deals take time and tenacity, so start looking long before your lease expires, said Brian Netzky, president of Interstate Tenant Advisors in Lincolnwood, Ill. “Don’t be reactive, because then no matter what the economy is like, you’re in the worst position.”

Below are several examples of small-business owners who have taken advantage of one bright spot in a dark economy.

PAYING CASH UPFRONT Tired of paying rent for office space, Andrew E. Samalin called a broker last year and started looking for a building to buy. At the time, Mr. Samalin, a principal in an investment firm, Samalin Investment Counsel, was paying a high $4,500 a month for 700 square feet in suburban Mount Kisco, N.Y. In March 2010, he found a building in nearby Chappaqua that had been built in 1865 and needed work. The previous time it had been up for sale — at the height of the market — the asking price was $1.3 million. This time, Mr. Samalin saw an opportunity.

The seller would take only cash, so Mr. Samalin offered $600,000. After his offer was accepted, he put up $250,000 in cash for renovations. “I knew I could get the mortgage financing in place later,” he said, “but if I offered the cash upfront, I could get a really good price for the building.” The mortgage came after renovations were complete, because then it was less risky for the bank.

Mr. Samalin’s mortgage payment is now $3,500 a month. But he had enough extra room to take in a tenant, who pays $2,400 a month, reducing Mr. Samalin’s portion to $1,100. Because of the Small Business Jobs Act of 2010, the entire cost of the renovations was tax deductible. Mr. Samalin said he feels pride in owning a restored historical building, and his staff and clients love the space. “I consider this one of the greatest deals of my life,” he said.

NEGOTIATING AGGRESSIVELY Mark Censits, owner of an upscale wine, beer and spirits shop, CoolVines, wanted to move his Princeton, N.J., location — 350 square feet on the outskirts of town — to a bigger, better location. In 2007, when the market was still strong, he found 1,500 square feet in the center of town. The building’s opening was delayed for three years and by the time it was ready for tenants last fall, the market was tanking. “I was able to reopen discussions twice, each time negotiating more aggressively,” he said.

Because there were few creditworthy tenants bidding, Mr. Censits used CoolVines’ record of success — and the expectation that it would bring foot traffic — to persuade the landlord to lower the price from about $41 a square foot to $35.

The soft market also prompted Mr. Censits to move another location, this one in Westfield, N.J. “I knew if we were ever going to expand, this was the time to do it,” he said. The original Westfield store was 750 square feet and cost about $54 a square foot. Mr. Censits found a new location that offered 2,400 square feet downtown with parking, and is located between Williams-Sonoma and Banana Republic stores.

Feeling confident after the success of his Princeton negotiations, Mr. Censits started with a lowball offer of $33 a square foot; he got the space for $37, and the landlord agreed to freeze the rent for three years. After that, increases are limited to 2 percent annually for the seven years. “I also got him to do a significant amount of demolition to the place — probably $50,000 worth — so we could build it out the way we wanted,” Mr. Censits said.

PAYING LESS FOR MORE Three years ago, when the lease on his manufacturing facility was ending, Scott Pievac thought he was ready to buy new space for the Sam Pievac Company, which makes retail displays and fixtures and was founded by Mr. Pievac’s father. At the time, however, prices were high and inventory low, so he continued to rent in Santa Fe Springs, Calif.

This year, when he started shopping around again, he found few people wanted to sell in the middle of a downturn. But with the help of a broker, he located an old Firestone tire storage plant for sale in Chino, about 25 miles away. The price was $65 a square foot, a great deal, he said. “That building would have been $100 a square foot five years ago. It had been on the market a week, and they had five offers.”

Several factors converged in Mr. Pievac’s favor. His broker introduced him to the broker representing the sellers, and they found they had mutual friends. The Sam Pievac Company had been in business 50 years and was financially stable, making it an attractive candidate.

In addition, the Small Business Administration increased its lending limit on loans for the acquisition of fixed assets in 2011 to $5 million, which helped Mr. Pievac arrange the financing he needed. The total cost of the building with improvements was $7.2 million. The company moved into the new warehouse space in April, and the office space will be ready this week.

Mr. Pievac’s rent used to be $42,000 a month; now, he has more space, owns the building and pays $40,000 a month.

FINDING COMFORTABLE SPACE In early 2010, the employees of M. Studio, a design and branding agency, were spilling out of their northern New Jersey offices. Jenna Zilincar, a founder and creative director, said four people were crammed into 800 square feet that they called “the hamster cage.”

Ms. Zilincar wanted to move closer to her clients and was able to find several affordable options in Asbury Park that had not been available a year earlier. One space was triple the size of M Studio’s previous office. The space needed modifying, Ms. Zilincar said, but she got the landlord to put up walls and take out doors, creating offices and a conference room. Ms. Zilincar was also able to sublease two small offices she did not need, substantially reducing her monthly costs.

Now, M Studio has five people working full-time in an open space. The office has a waiting area, a conference room and a kitchen. Ms. Zilincar also got the landlord to put in hardwood floors, outside lighting, air-conditioning and baseboard heating. She and her broker negotiated a slightly lower rent than the asking price, no increases for a year and a half and a $50 increase for the 18 months after that. If she renews for another three years, the increase will be 5 percent.

Ms. Zilincar believes the new space has helped her close deals. “People’s level of comfort went up because this space is more legitimate,” she said. “We don’t have to meet clients in coffee shops anymore.”

Copyright 2011 The New York Times Company. All rights reserved.

Same-sex marriage, real estate and bankruptcy

Here at Shenwick & Associates, we have been following last month's passage by the New York Legislature and signing into law by Governor Cuomo of the Marriage Equality Act ("the Act"), which became effective on July 24, 2011. This law formally recognizes otherwise-valid marriages without regard to whether the parties to the marriage are of the same or different sex.

Besides simply allowing same-sex couples to marry, we are studying the impact of the Act on our twin practices of real estate and bankruptcy:

1. Under New York law, married couples are allowed to own real property as tenants by the entirety. Tenants by the entirety is a special type of joint tenancy with rights of survivorship (which means that when one owner dies, then the surviving owner or owners will continue to own the asset and the estate and heirs of the deceased owner will receive nothing). Real property owned as tenants by the entirety receives extra protection from creditors. As a leading case describes it:

"[t]he law in New York clearly permits a [spouse]'s interest in a
tenancy by the entirety to be sold under execution upon a judgment against him [or her]. The purchaser at such sale becomes a tenant in common with the debtor's [spouse], subject to [his or] her right of survivorship and is entitled to share in the rents and profits, but not the occupancy." In re Weiss, 4 B.R. 327, 330 (S.D.N.Y. 1980) (citations omitted).

So a creditor can execute a judgment against a debtor spouse's interest in real property, but cannot foreclose on or take occupancy of that debtor spouse's interest.

Presumably same-sex couples who wed in New York (or who have already entered into same-sex marriages in other states that allow it) after the Act becomes effective and take ownership to property will be able to take ownership as tenants by the entirety rather than as tenants in common. Also, same-sex couples who had acquired property as tenants in common could then convey the property to each other as tenants by the entirety after their marriage. Although there is no specific language to this effect, Section 2 of the Act clearly states:

"It is the intent of the legislature that the marriages of same-sex and different-sex couples be treated equally in all respects under the law. The omission from this act of changes to other provisions of law shall not be construed as a legislative intent to preserve any legal distinction between same-sex couples and different-sex couples with respect to marriage."

2. Under federal bankruptcy law and the New York Civil Practice Law and Rules and Debtor and Creditor Law, married debtors can file a joint bankruptcy petition.

Section 302(a) of the Bankruptcy Code provides that "[a} joint case under a chapter of this title is commenced by the filing with the bankruptcy court of a single petition under such chapter by an individual that may be a debtor under such chapter and such individual's spouse." And although New York law does not specifically mention joint debts, all exemptions in personal bankruptcy and from money judgments are "per person."

However, the federal Defense of Marriage Act ("DOMA"), enacted in 1996, defines marriage as a legal union between one man and one woman. Section 3 of DOMA prevents the federal government from recognizing the validity of same-sex marriages.

Although the constitutionality of DOMA is being challenged in federal court and President Obama is supporting a bill to repeal DOMA, for now it is still valid law. But last month, in In re Balas, the Bankruptcy Court for the Central District of California denied the United States Trustee ("UST")'s motion to dismiss the joint Chapter 13 petition of two males who were lawfully married under California law when they filed their joint petition. In denying the UST's motion to dismiss, the Court stated "[i]n this court's judgment, no legally married couple should be entitled to fewer bankruptcy rights than any other legally married couple."

Although this holding is specific to the parties to the case, it's significant that the House Bipartisan Legal Advisory Group, which is leading Congressional efforts to defend DOMA, stated that they would not appeal the ruling to the 9th Circuit Court of Appeals. While it cannot be used as mandatory authority by same-sex couples who are lawfully wed under state law and seeking to file joint bankruptcy petitions, it can certainly be used as persuasive authority to do so.

For more information about the complex intersection of bankruptcy, real estate and same-sex marriage rights, please contact Jim Shenwick.

NYT: Bank's Deal Means More Will Lose Their Homes

By NELSON D. SCHWARTZ

Tens of thousands of Bank of America’s most distressed borrowers could be evicted and lose their homes more quickly as a result of a proposed settlement between the bank, which is the country’s largest mortgage servicer, and investors in its troubled mortgage securities.

For struggling borrowers in better financial shape, the outcome could be more positive: the deal would include incentives for mortgage servicers to help homeowners who have fallen behind on their payments and whose homes are worth less than they borrowed.

“The goal is to reinstate as many borrowers in a modification that performs well,” said Tony Meola, a servicing executive with Bank of America. “It also is likely to lead to faster resolution in those unfortunate situations where foreclosure is inevitable. While not a desirable outcome, the recovery of the housing markets depends on moving through the foreclosure process as quickly and fairly as possible.”

While powerful investors stand to benefit from the $8.5 billion settlement over the bank’s bundling of shoddy mortgages as securities, the fallout for the nearly 275,000 borrowers who took out those loans depends greatly on how deep they are in the foreclosure process and whether they earn enough money to dig themselves out.

While no exact income qualification has been set as part of the agreement, which was announced last month, many servicers use a formula in which borrowers can qualify for a modification as long as the new monthly payment does not exceed 31 percent of their monthly gross income. For borrowers who are unemployed or lack the income to cover even reduced mortgage payments, foreclosure and eviction could be much more immediate.

With 1.3 million borrowers at risk of foreclosure, Bank of America has been overwhelmed by the surge in defaults, and the accord has raised hopes that this logjam will finally begin to ease. But skeptics say that previous arrangements, like another multibillion-dollar settlement by Bank of America in 2008, have barely made a dent in the problem.

“The mortgage servicers have repeatedly promised to do things and then not done them,” said Michael S. Barr, a former assistant Treasury secretary who now teaches law at the University of Michigan. “I think it’s positive in general, but I don’t expect it to be transformative of what we’ve witnessed from the mortgage servicers over the last four years.”

Matthew Weidner, a Florida lawyer who represents borrowers facing foreclosure, said he was skeptical of promises by the deal’s architects that lower monthly payments would be easier to obtain.

“It’s like giving aspirin to someone with cancer,” he said of the proposed assistance. “You had all the big players at the top of the pyramid negotiating but nobody was speaking for the homeowners who have far more at stake at the ground level.”

Still, for some of the homeowners now facing foreclosure who took out loans with Countrywide, the subprime specialist bought by Bank of America in 2008, the deal could bring a few quick improvements.

Under the terms of the agreement, Bank of America must now start transferring these borrowers to 10 smaller outside servicers, even without the deal being approved in court, which is not expected before November. The architects of the settlement say these subservicers will be far more efficient than Bank of America’s giant payment processing operation.

For example, an analysis of data by RBS prepared as part of the settlement found that Bank of America provided fewer modifications as a percentage of unpaid principal than JPMorgan Chase, Wells Fargo, Litton and other servicers. In addition, borrowers defaulted again within six months in nearly one in five cases when modifications were made by Bank of America, a higher rate than other servicers that were studied.

Officials at Bank of America contend the company has made nearly 875,000 modifications since 2008, more than any other servicer.

Under the new proposal, subservicers will have to provide an answer to homeowner modification requests within 60 days of receiving paperwork, and will get up to 1.5 percent of the unpaid principal balance as an incentive fee for each successful permanent modification.

“We wanted smaller, high-touch servicers who would consider every modification option at once, not try this and that,” said Kathy D. Patrick, a Houston lawyer who represented the 22 private investors in the settlement. “Servicers get more in fees for successful modifications than for any other kind of workout, including foreclosure.”

The first homeowners should be transferred out of Bank of America by early fall, with each of the 10 subservicers taking up to 30,000 cases. Borrowers with mortgages 60 days past due who have been delinquent more than once in the last 12 months will receive priority in the switch, followed by homeowners who are 90 days past due but not in foreclosure.

Homeowners already in foreclosure or who have been declared bankrupt will go to the back of the line, although they will also eventually be transferred, Ms. Patrick said. More than 75 percent of the nearly 275,000 delinquent homeowners have not made a payment in more than 120 days or are already in foreclosure.

One unintended consequence of the problems at Bank of America and other large servicers is that many borrowers have managed to remain in their homes despite being in default, and without the income to qualify for a modification. At the time of foreclosure, the typical Bank of America borrower has not made a payment in 18 months.

What is more, according to the analysis of RBS data, it takes 30 months on average for a subprime borrower’s property to move from foreclosure to a final sale with Bank of America, nearly a year longer than Wells Fargo, and 10 months longer than SPS, a smaller subservicer likely to be among the 10 selected to take over the former Countrywide loans.

“Countrywide made a lot of bad loans and borrowers with no money can’t afford a modification,” said Peter Swire, a former special assistant for housing policy in the Obama administration who helped oversee earlier federal efforts to promote modifications. He is now a professor at Ohio State University. “One discouraging problem is that only a small fraction of Countrywide borrowers will likely qualify,” Professor Swire said.

Delores Gosha hopes she will be one of the lucky ones.

It has been more than a year since she last made a mortgage payment to Bank of America, raising the risk that her bungalow in the Cleveland suburbs will end up in foreclosure. The bank, she says, has given varying answers as to whether she qualifies for a modification, telling her she did not at one point last week only to reverse course days later and say it was still under consideration. Ms. Gosha said she had had to deal with a multitude of representatives and submit the same documents over and over.

While a new servicer might not give her the answer she has been praying for, she said, at least she will get an answer.

“I’ve been up and down,” said Ms. Gosha, who is a clerk at a Cleveland hospital. “Can’t somebody tell me something?”

Copyright 2011 The New York Times Company. All rights reserved.

NYT: Fewer Americans File for Bankruptcy as Debt Woes Ease

By TARA SIEGEL BERNARD

After steadily climbing for several years, the number of Americans filing for bankruptcy is on the decline, though that is not necessarily an indicator of an improving economy.

The number of bankruptcy filings in June was 120,623, or an average of 5,483 a day, a drop of 6.2 percent from May, when filings totaled 122,775, or 5,846 a day, according to a report from Epiq Systems, which tracks bankruptcy filings. There was one additional day to file in June compared with May. Average daily filings are down nearly 10 percent from June of last year.

Though economic factors like foreclosures and unemployment play a role in bankruptcy, over the long run, the filing rate tends to be more closely tethered to the amount of outstanding consumer debt.

Access to credit, however, can influence the bankruptcy rate over the shorter term: as lenders tighten their standards, filings tend to rise because struggling consumers can no longer rely on credit cards or other loans to get them through a rough period. But when more new loans are being made, filings tend to fall — at least for a while.

“There is a lot of mythology about what drives bankruptcy rates,” said Robert M. Lawless, a professor at the University of Illinois College of Law who specializes in bankruptcy. “But consumer credit appears to be the most significant indicator.”

Over all, he said he expected filings to decline 5 to 10 percent this year, leveling off at about 1.46 million, largely because consumers have slightly more access to credit now than in recent years. But he also said that consumers had taken on less debt in the past three years, which means there is less debt to discharge and fewer incentives to file bankruptcy.

That estimate compares with about 1.56 million bankruptcy filings in 2010 and nearly 1.45 million in 2009. Filings surpassed two million in 2005, when many people rushed to declare bankruptcy before a new law went into effect that made it more difficult, and significantly more expensive, to file.

There have been 731,237 filings this year. “If they keep going the way they were,” Professor Lawless said, “bankruptcy filings will keep going down a little bit.”

So far this year, the vast majority of the bankruptcy cases — nearly 70 percent — were Chapter 7 filings, which provide individuals with the proverbial “fresh start” because their debts are forgiven. (To qualify, filers need to pass a means test to determine whether they are unable to repay their debts.)

In contrast, a Chapter 13 filing requires individuals to use their disposable income to pay back a portion of their debts through a three- or five-year repayment plan. Some people choose Chapter 13 because it allows them to save their primary homes from foreclosure, though they are required to catch up on their mortgage payments. Slightly more than 27 percent were Chapter 13 filings. (The remainder were mostly commercial filings.) The overall split between Chapter 7 and Chapter 13 filings is consistent with last year’s ratio.

While the overall number of bankruptcy filings was down last month, there were variations from state to state. For instance, filings in Georgia rose 13 percent and were up 33 percent in Delaware, compared with May. But filings in Wyoming fell 30 percent, in South Dakota 21 percent, in West Virginia 18 percent and in Wisconsin 17 percent.

In both New York and New Jersey, the number of bankruptcy cases dropped by 5 percent.

Copyright 2011 The New York Times Company. All rights reserved.

Possible implications of CFTC v. Walsh for divorced couples in bankruptcy

Here at Shenwick & Associates, clients with a variety of marital statuses seek our bankruptcy counsel–single, married, in the process of divorce, filing individually or jointly. Each variation requires the analysis and creativity of sophisticated bankruptcy counsel to avoid potential pitfalls in the process.

On June 23, 2011, in CFTC v. Walsh, the New York State Court of Appeals ruled that a woman could keep proceeds from a divorce agreement, even though those proceeds were the ill-gotten gains of a financial fraud perpetrated by her former husband. In February 2009, federal authorities arrested Stephen Walsh and his business partner Paul Greenwood. According to an article on the case in the New York Times, they were charged with defrauding investors of more than $550 million in a 13 year Ponzi scheme. Although the government did not accuse Ms. Schaberg (the wife of Mr. Walsh) of participating in a crime, they still sought to recover the money she received from her husband in her divorce settlement agreement.

The Court of Appeals ruled that ex-spouses have a reasonable expectation that once their marriage has been dissolved and their property divided, they will be free to move on with their lives. Ms. Schaberg's lawyer argued that once the couple had divided their marital property and signed a divorce settlement agreement, the government could not force her to disgorge what were her rightful proceeds.

Similar principles may also apply in personal bankruptcy and buttress the argument that marital property divided by a divorcing couple, pursuant to a divorce decree in New York State, would not be subject to fraudulent conveyance or other "clawback" actions by a Bankruptcy Trustee if a spouse filed for chapter 7 bankruptcy after the divorce proceeding.

Accordingly, let's assume that a couple with two young children were having marital problems, the husband has substantial debts, cash and stock and the couple owns a house that has appreciated in value. The couple decides that as part of their divorce, the husband will deed the house to his wife and transfer a substantial amount of the stock and cash to his wife pursuant to the divorce decree for support and maintenance. The husband then waits three months and files for Chapter 7 bankruptcy to liquidate his debts and obtain a discharge.

Following the Court of Appeals' holding in CFTC v. Walsh, a Bankruptcy Trustee should not be able to challenge the transfer of the house and assets to his ex-wife, thereby making those assets non-exempt or unreachable by the husband's creditors or the Bankruptcy Trustee. Clients with questions regarding bankruptcy and divorce should contact Jim Shenwick.

Shenwick & Associates Facebook Deal for half off a 1 hour initial consult!

NYT: Court Says Ex-Wife May Retain Ponzi Scheme Money

By PETER LATTMAN

J.B. Nicholas/Bloomberg News

The Ponzi schemes that came to light during the depths of the financial crisis have spawned various lawsuits seeking to claw back money from divorce agreements.

Now, in one case, a court has said: Hands off.

On Thursday, New York’s highest court ruled that a woman could keep proceeds from a divorce agreement, even if those proceeds were the ill-gotten gains of a financial fraud perpetrated by her former husband.

The decision is a blow to the federal government, which is seeking to force the woman to disgorge what it says are millions of dollars in stolen money.

“Ex-spouses have a reasonable expectation that, once their marriage has been dissolved and their property divided, they will be free to move on with their lives,” said Judge Victoria A. Graffeo, writing for the New York State Court of Appeals.

The federal appeals court in Manhattan, which had asked the New York State court for guidance on the case, is now expected to prevent the federal government from seizing the woman’s assets.

Thursday’s ruling could also affect other divorce cases, like some involving victims of Bernard L. Madoff’s huge Ponzi scheme.

The New York State Court of Appeals is hearing a case brought by a man seeking to rescind his divorce settlement with his ex-wife because a large chunk of the marital proceeds were in a Madoff account.

The husband, Steven Simkin, kept much of his money with Mr. Madoff after the divorce; his wife, Laura Blank, received cash. After losing the bulk of his assets in the Madoff fraud, Mr. Simkin now wants to rewrite their divorce agreement.

In Massachusetts, a Madoff victim has also sued his ex-wife to revise their separation pact. A family court judge dismissed the lawsuit this month, and the plaintiff’s lawyer has appealed.

Thursday’s ruling in New York involves Janet Schaberg, 55 years old, the former wife of Stephen Walsh, a former executive at WG Trading, a commodities firm in Greenwich, Conn.

In February 2009, federal authorities arrested Mr. Walsh and his business partner, Paul Greenwood, on charges that they had defrauded investors of more than $550 million in a 13-year Ponzi scheme.

Mr. Greenwood pleaded guilty last year; Mr. Walsh is fighting the case.

Although the government did not accuse Ms. Schaberg of having any knowledge or participation in the scheme, lawyers at the Securities and Exchange Commission and the Commodity Futures Trading Commission went after her money, saying that much of it was ill-gotten proceeds from her former husband’s fraud.

In August 2009, a federal judge agreed with the government, freezing most of Ms. Schaberg’s assets, including $7.6 million in cash.

Ms. Schaberg, who divorced Mr. Walsh in 2007 after 25 years of marriage, appealed the judge’s order.

Her lawyer, Steven Kessler, argued that once she and Mr. Walsh had divided their marital property and signed a divorce settlement agreement, the government could not force her to disgorge what were her rightful proceeds.

In an unusual request, the federal appeals court asked New York state’s highest court for guidance on the divorce-law issues instead of a ruling.

The case, Judge Graffeo wrote, raised “difficult policy questions” that required the court to weigh the competing interests of returning stolen property to its rightful owners against the innocent former spouse of the defrauder.

In ruling for Ms. Schaberg, the court made an analogy between Ms. Schaberg and her divorce settlement proceeds and any person who unknowingly receives tainted money in a business transaction. For instance, the government could not seize stolen money from an architect whom a thief had paid to build his home.

The court said its decision to protect Ms. Schaberg, an innocent recipient of stolen funds, over the victims of the Ponzi scheme, was “rooted in New York’s concern for finality in business transactions.”

The decision emphasized that fraud victims could try to reclaim their stolen money if the former spouse was aware or participated in the crime.

Representatives for the S.E.C. and C.F.T.C. declined to comment.

New York divorce lawyers are divided on the decision. Michael D. Stutman, a divorce lawyer in Manhattan, is uninvolved in the Schaberg case, but along with three other lawyers, he submitted a brief that sided with the government.

“We disagree with the decision because someone in possession of stolen property should not be able to claim an ownership interest superior to the rightful owner,” Mr. Stutman said.

“Here, however, largely because she received ‘title’ to the ill-gotten gains through the divorce, she trumps the claims of people from whom the money was stolen,” he said.

Mr. Stutman also questioned the court’s emphasis on what it called New York’s “strong public policy of ensuring finality in divorce proceedings.”

He said other facets of divorce law — the amount of child and spousal support, as well as child-custody issues — are all subject to change based on newly discovered facts.

“Why is finality all of a sudden so sacred that you’re depriving victims of a fraud from access to their assets?” he asked.

Richard Emery, a lawyer for Ms. Blank, who is battling with her former husband in the New York case involving the Madoff fraud, applauded the ruling, calling it ”the right result for families and society.”

“The appeals court embraced the plight of a spouse who relies on the right to move on with her life after divorce,” Mr. Emery said. “This consideration trumps the interest of even the federal government.”

The Schaberg ruling

Copyright 2011 The New York Times Company. All rights reserved.

A California Bankruptcy Court Rejects U.S. Law Barring Same-Sex Marriage

By JOHN SCHWARTZ

A bankruptcy court in California has declared that the 1996 law barring federal recognition of same-sex marriage is unconstitutional, increasing pressure against the law.

“In this court’s judgment, no legally married couple should be entitled to fewer bankruptcy rights than any other legally married couple,” wrote Judge Thomas B. Donovan of the United States Bankruptcy Court for the Central District of California. In an unusual move, 19 other judges — nearly all of the 24 judges of the central district — also signed the decision.

The impact of the opinion could be limited, since the decision of the court is specific to the bankruptcy of the couple, Gene Douglas Balas and Carlos A. Morales. But the other judges’ signatures suggest that as a matter of policy they would rule similarly.

It is not the first blow to the law known as the Defense of Marriage Act. A federal judge in Boston declared the law unconstitutional last July, and that case is working its way through the legal system. The Department of Justice, however, is not driving that appeals process. In February, Attorney General Eric H. Holder Jr. announced in a letter to members of Congress that while the Obama administration would continue to enforce the law, it would no longer defend it in court and that classifications based on sexual orientation should be subjected to a tough legal test intended to block unfair discrimination.

Speaker John A. Boehner, Republican of Ohio, then announced that Congress would defend the law, and that it had hired former Solicitor General Paul Clement to argue on its behalf.

Mr. Balas and Mr. Morales cited Mr. Holder’s letter in their pleadings, and Judge Donovan quoted it approvingly in his 26-page opinion, and stated, “The Holder Letter demonstrates that DOMA cannot withstand heightened scrutiny.”

Mr. Balas and Mr. Morales were legally married under California law, and wanted to file jointly for bankruptcy. The trustee, the federal officials who oversee the bankruptcy process, moved to dismiss their petition under the Defense of Marriage Act. They then asked Judge Donovan to allow them to file jointly, and Monday’s decision was the result.

Adam Winkler, a professor at the law school at the University of California, Los Angeles, called the decision “a powerful statement about the status of gay rights today.” Professor Winkler said, “it shows the effect of Eric Holder’s letter in shaping legal decisions that came after it, almost as if it’s a precedent in the case.”

Mary Bonauto, the civil rights project director for Gay and Lesbian Advocates and Defenders, the group that brought the Massachusetts case, said she was not surprised to see another judge agree with the earlier decision, because the law “advances a blatant legal double standard.” Ms. Bonauto added, “In our system of justice, it’s the job of courts to call that out.”

One of those who signed Judge Donovan’s opinion, Judge Sheri Bluebond, said that a signing by other judges is “an unusual occurrence, but it is certainly not unprecedented.”

Judge Bluebond said bankruptcy judges signed on to their colleagues’ decisions when “threshold questions” were brought before one judge and the others in that district “so the bar would know where we stand,” and whether they would be able to file in those courts. While 20 judges signed the opinion and there are 24 in the Central District of California, Judge Bluebond said, “the fact that some judges did not sign on to it does not mean one way or another what their views on that issue are.”

“There could have been procedural reasons or just logistical reasons that they did not sign on,” she said.

It is unclear whether an appeal will be filed. Judge Donovan noted that the House Bipartisan Legal Advisory Group, which is leading the Congressional action, requested a brief delay in proceedings while it considered whether to intervene, but that “no further pleadings and no challenge” had ensued.

“The government’s nonresponse to the debtors’ challenges is noteworthy,” Judge Donovan wrote.

A spokesman for Mr. Boehner, Brendan Buck, said the ruling would not be appealed.

“Bankruptcy cases are unlikely to provide the path to the Supreme Court, where we imagine the question of constitutionality will ultimately be decided,” Mr. Buck said. “Obviously, we believe the statute is constitutional in all its applications, including bankruptcy, but effectively defending it does not require the House to intervene in every case, especially when doing so would be prohibitively expensive.”

Copyright 2011 The New York Times Company. All rights reserved.

Banks Amass Glut of Homes

EL MIRAGE, Ariz. — The nation’s biggest banks and mortgage lenders have steadily amassed real estate empires, acquiring a glut of foreclosed homes that threatens to deepen the housing slump and create a further drag on the economic recovery.

All told, they own more than 872,000 homes as a result of the groundswell in foreclosures, almost twice as many as when the financial crisis began in 2007, according to RealtyTrac, a real estate data provider. In addition, they are in the process of foreclosing on an additional one million homes and are poised to take possession of several million more in the years ahead.

Five years after the housing market started teetering, economists now worry that the rise in lender-owned homes could create another vicious circle, in which the growing inventory of distressed property further depresses home values and leads to even more distressed sales. With the spring home-selling season under way, real estate prices have been declining across the country in recent months.

“It remains a heavy weight on the banking system,” said Mark Zandi, the chief economist of Moody’s Analytics. “Housing prices are falling, and they are going to fall some more.”

Over all, economists project that it would take about three years for lenders to sell their backlog of foreclosed homes. As a result, home values nationally could fall 5 percent by the end of 2011, according to Moody’s, and rise only modestly over the following year. Regions that were hardest hit by the housing collapse and recession could take even longer to recover — dealing yet another blow to a still-struggling economy.

Although sales have picked up a bit in the last few weeks, banks and other lenders remain overwhelmed by the wave of foreclosures. In Atlanta, lenders are repossessing eight homes for each distressed home they sell, according to March data from RealtyTrac. In Minneapolis, they are bringing in at least six foreclosed homes for each they sell, and in once-hot markets like Chicago and Miami, the ratio still hovers close to two to one.

Before the housing implosion, the inflow and outflow figures were typically one-to-one.

The reasons for the backlog include inadequate staffs and delays imposed by the lenders because of investigations into foreclosure practices. The pileup could lead to $40 billion in additional losses for banks and other lenders as they sell houses at steep discounts over the next two years, according to Trepp, a real estate research firm.

“These shops are under siege; it’s just a tsunami of stuff coming in,” said Taj Bindra, who oversaw Washington Mutual’s servicing unit from 2004 to 2006 and now advises financial institutions on risk management. “Lenders have a strong incentive to clear out inventory in a controlled and timely manner, but if you had problems on the front end of the foreclosure process, it should be no surprise you are having problems on the back end.”

A drive through the sprawling subdivisions outside Phoenix shows the ravages of the real estate collapse. Here in this working-class neighborhood of El Mirage, northwest of Phoenix, rows of small stucco homes sprouted up during the boom. Now block after block is pockmarked by properties with overgrown shrubs, weeds and foreclosure notices tacked to the doors. About 116 lender-owned homes are on the market or under contract in El Mirage, according to local real estate listings.

But that’s just a small fraction of what is to come. An additional 491 houses are either sitting in the lenders’ inventory or are in the foreclosure process. On average, homes in El Mirage sell for $65,300, down 75 percent from the height of the boom in July 2006, according to the Cromford Report, a Phoenix-area real estate data provider. Real estate agents and market analysts say those ultra-cheap prices have recently started attracting first-time buyers as well as investors looking for several properties at once.

Lenders have also been more willing to let distressed borrowers sidestep foreclosure by selling homes for a loss. That has accelerated the pace of sales in the area and even caused prices to slowly rise in the last two months, but realty agents worry about all the distressed homes that are coming down the pike.

“My biggest fear right now is that the supply has been artificially restricted,” said Jayson Meyerovitz, a local broker. “They can’t just sit there forever. If so many houses hit the market, what is going to happen then?”

The major lenders say they are not deliberately holding back any foreclosed homes. They say that a long sales process can stigmatize a property and ratchet up maintenance and other costs. But they also do not want to unload properties in a fire sale.

“If we are out there undercutting prices, we are contributing to the downward spiral in market values,” said Eric Will, who oversees distressed home sales for Freddie Mac. “We want to make sure we are helping stabilize communities.”

The biggest reason for the backlog is that it takes longer to sell foreclosed homes, currently an average of 176 days — and that’s after the 400 days it takes for lenders to foreclose. After drawing government scrutiny over improper foreclosures practices last fall, many big lenders have slowed their operations in order to check the paperwork, and in two dozen or so states they halted them for months.

Conscious of their image, many lenders have recently started telling real estate agents to be more lenient to renters who happen to live in a foreclosed home and give them extra time to move out before changing the locks.

“Wells Fargo has sent me back knocking on doors two or three times, offering to give renters money if they cooperate with us,” said Claude A. Worrell, a longtime real estate agent from Minneapolis who specializes in selling bank-owned property. “It’s a lot different than it used to be.”

Realty agents and buyers say the lenders are simply overwhelmed. Just as lenders were ill-prepared to handle the flood of foreclosures, they do not have the staff and infrastructure to manage and sell this much property.

Most of the major lenders outsourced almost every part of the process, be it sales or repairs. Some agents complain that lender-owned home listings are routinely out of date, that properties are overpriced by as much as 10 percent, and that lenders take days or longer to accept an offer.

The silver lining for home lenders, however, is that the number of new foreclosures and recent borrowers falling behind on their payments by three months or longer is shrinking.

“If they are able to manage through the next 12 to 18 months,” said Mr. Zandi, the Moody’s Analytics economist, “they will be in really good shape.”