Many clients, lawyers and accountants have called us regarding the discharge of taxes in bankruptcy filings. In these difficult economic times, the IRS and New York State have stepped up their auditing of individuals and businesses.
Many kinds of “old” state and federal income taxes are dischargeable in bankruptcy. In the case of income taxes, they are dischargeable in Chapter 7 if all of the following criteria are met:
1. The tax is for a year for which a tax return is due more than 3 years prior to the filing of the bankruptcy petition;
2. A tax return was filed more than two years prior to the filing of the bankruptcy petition;
3. The tax was assessed more than 240 days prior to filing of the bankruptcy petition;
4. The tax was not due to a fraudulent tax return, nor did the taxpayer attempt to evade or defeat the tax;
5. The tax was not assessable at the time of the filing of the bankruptcy petition; and
6. The tax was unsecured.
Section 507(a)(8) of the Bankruptcy Code provides that:
Income taxes: (i) for tax years ending on or before the date of filing the bankruptcy petition, for which a return is due (including extensions) within 3 years of the filing of the bankruptcy petition; (ii) assessed within 240 days before the date of filing the petition; (iii) not assessed before the petition date, but were assessable as of the petition date, unless these taxes were still assessable solely because no return, a late return (within 2 years of the filing of the bankruptcy petition), or a fraudulent return was filed, withholding taxes for which a person is liable in any capacity, an employer's share of employment taxes on wages, salaries, or commissions (including vacation, severance, and sick leave pay) and excise taxes on transactions occurring before the date of filing the bankruptcy petition are all not dischargeable in bankruptcy.
As part of our bankruptcy intake process, we analyze a client’s state and federal tax transcripts to determine whether or not their tax debts (if any) are dischargeable or not.
However, some of the taxes that would ordinarily be dischargeable because of their age may not be, if the Bankruptcy Court determines that the debtor has acted in “bad faith” with respect to their non-payment of taxes. Section 523 of the Bankruptcy Code (which governs exemptions to discharge) provides in Section 523(a)(1)(C) that:
“A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”
However, Section 523 does not define what constitutes a “willful attempt to evade or defeat” a tax. To interpret this language, the Bankruptcy Court adopted the three-part test applicable under Section 6672 of the Internal Revenue Code, which imposes civil penalties on any taxpayer “who willfully attempts in any manner to evade or defeat any . . . tax or the payment thereof.” Under that test, a willful attempt to evade or defeat a tax is established if the debtor (1) had a duty to pay the tax, (2) knew of that duty, and (3) voluntarily and intentionally violated the duty. Numerous courts have adopted this test as the standard for willful evasion under Section 523.
With respect to the attempt to avoid or evade taxes, the IRS takes the position that if a well-to-do individual (doctor, investment banker, or attorney) pays creditors other than the IRS, when they have available assets, this is “an attempt to avoid or evade taxes.”
In Lynch v. United States, 299 B.R. 62 (Bankr. S.D.N.Y. 2003), the debtor, Christine Carter Lynch, brought an adversary proceeding under chapter 7 of the Bankruptcy Code seeking a discharge of the claims of the Internal Revenue Service, totaling approximately $600,000 as of the time of trial, with respect to her tax liability for two groups of tax years -- for tax years 1980, 1981 and 1982, totaling approximately $542,000 (the “1980s Taxes”), and for tax years 1993, 1994 and 1995, totaling approximately $55,000 (the “1990s Taxes”). The IRS opposed her request for relief, with respect to both groups of tax years, contending that she is subject to the statutory exception to discharge of §523(a)(1)(C).
The Court noted that the caselaw applying §523(a)(1)(C) has consistently held that its requirements are satisfied in situations where the debtor -- even without
fraud or evil motive -- has prioritized his or her spending by choosing to satisfy other obligations and/or pay for other things (at least for non-essentials) (emphasis added) before the payment of taxes, and taxes knowingly are not paid.
Here, with respect to each of the 1980s Taxes and 1990s Taxes, the Court had to determine whether that latter principle applies under the facts here. Assuming it did, the Court had to also determine, with respect to the 1980s Taxes, to what extent it applies when if the Debtor not acted in that manner, she could not have paid all of the tax debt anyway.
After hearing the evidence, the Court found that Ms. Lynch - among other things, spending money on a Central Park West Apartment at a cost of more than $6,000 per month; eating dinner in restaurants four days a week; traveling considerably, to California, China and Paris; running up credit card bills; and making huge gratuitous transfers to her church, all ahead of payment of the back taxes due -- of the same type that has been held to constitute a willful attempt to evade the payment of taxes in earlier cases. And the Court further found that, but for her spending priorities, Ms. Lynch could have paid the majority of the 1980s Taxes -- even after payment of the 1990s Taxes, which plainly could have been and should have been paid in full.
The Court held that Ms. Lynch’s extravagant lifestyle was a factor in her failure to pay both the 1980s Taxes and the 1990s Taxes, stating:
“By electing to make discretionary expenditures on the incremental cost of a Central Park West apartment, the restaurant dining, the credit card purchases and payments, the travel, the tuition and the ‘tithing,’ Ms. Lynch evidenced exactly the kind of conduct that resulted in nondischargeability in Wright, Haesloop, Angel, and the other discretionary spending cases.” Lynch at 65.
Because Ms. Lynch elected to spend her money elsewhere and not to satisfy her tax obligations -- especially when she had the ability to easily pay them in full -- the Court held that she willfully evaded her 1990s Taxes.
At the same time, the Court conceded that the IRS was unrealistic in expecting Ms. Lynch to be able to pay the entirety of her 1980s Taxes without a reduction, and criticized the government’s conduct in the case. However, the Court found that Ms. Lynch could have easily paid her 1990s Taxes without a drastic adjustment in her lifestyle.
Anyone who has questions concerning the discharge of taxes should contact Jim Shenwick.
Tuesday, January 27, 2009
Monday, January 26, 2009
Bankruptcy as a Step to Solvency
By M. P. DUNLEAVEY
Published: January 23, 2009
The idea of declaring bankruptcy may be unpleasant, even abhorrent, but for many people right now it could be the best option.
The question is: How do you make that choice? How bad do things need to get before you throw in the towel, and most of your debts, and petition the courts for a fresh start?
More than a million people filed for personal bankruptcy in the 12 months that ended last September, a staggering 30 percent increase over the period a year earlier, according to the Administrative Office of the U.S. Courts. And thousands more “are unofficially bankrupt” and reluctant to file, said Justin Harelik, a lawyer with Price Law Group in Los Angeles.
“I’m aware that the word itself carries so much shame and stigma,” said Mr. Harelik. “But it’s right for so many people.”
The sting of failure and the dread of ruined credit are, understandably, deterrents to a bankruptcy filing. But those fears can prevent people from taking advantage of the financial protection offered by bankruptcy, which may allow you to erase most of your consumer debt while preserving assets like your retirement accounts and sometimes even your home and car. Instead, many people delay filling until they are truly desperate.
“When we surveyed people about how long they seriously struggled, over 40 percent said more than two years,” said Katherine M. Porter, associate professor at the University of Iowa law school and a researcher with the Consumer Bankruptcy Project, a continuing study of consumer bankruptcy filings. “A lot of attorneys say they wish people would come earlier, before they emptied their retirement accounts or lost their car to repossession,” she said.
Because bankruptcy is so complex, and because bankruptcy laws underwent a major overhaul in 2005, many people are not only wary of filing, but also confused about their options and what the possible outcomes are.
One common misunderstanding is that declaring bankruptcy will ruin your credit. If you’re at the point of even considering bankruptcy, it’s likely that your credit is in tatters anyway, notes Ms. Porter.
“You may not end up that much worse off,” she said. In some cases, your credit could emerge in better shape once you’ve dealt with your debts.
Another myth is that you must be at the frayed end of your financial rope before you file. You won’t lose everything in a bankruptcy because some assets are protected, and you will need those to move forward, says Elizabeth Warren, a professor at Harvard Law School and one of the lead researchers on the Consumer Bankruptcy Project. Waiting until your resources are entirely depleted defeats an important purpose of bankruptcy, “which is to help people rebuild their lives on a sounder footing,” Ms. Warren said.
It was the desire to move forward with her life, not just shrug off her debts, that finally pushed Claire Morgan, who lives in Chicago, to begin the bankruptcy process in December. In addition to lingering student loans of about $12,000, Ms. Morgan had been struggling to pay $40,000 in credit card debt — a sum slightly higher than her annual income, she said. But she couldn’t make any headway.
In part, it was the sense of futility that finally pushed Ms. Morgan over the edge. But she also happened to hear a cautionary tale about a friend, also deeply in debt, who had decided not to declare bankruptcy — and ended up living in constant strain, unable to move forward with life.
“That really made me think twice,” she said. “Bankruptcy was the last thing I wanted. But it’s better to be able to say ‘I’m in the clear’ than to be still be struggling in five years to pay $40,000 in debt on a $35,000 salary.”
Knowing whether to file, when to file and whether to do so under Chapter 7 or Chapter 13 of the bankruptcy code is a decision best made with the help of a lawyer. Most bankruptcy lawyers offer a free initial consultation, Ms. Porter said. The National Association of Consumer Bankruptcy Attorneys has a Web site where you can search for a lawyer by location.
Copyright 2009 The New York Times Company. All rights reserved.
Published: January 23, 2009
The idea of declaring bankruptcy may be unpleasant, even abhorrent, but for many people right now it could be the best option.
The question is: How do you make that choice? How bad do things need to get before you throw in the towel, and most of your debts, and petition the courts for a fresh start?
More than a million people filed for personal bankruptcy in the 12 months that ended last September, a staggering 30 percent increase over the period a year earlier, according to the Administrative Office of the U.S. Courts. And thousands more “are unofficially bankrupt” and reluctant to file, said Justin Harelik, a lawyer with Price Law Group in Los Angeles.
“I’m aware that the word itself carries so much shame and stigma,” said Mr. Harelik. “But it’s right for so many people.”
The sting of failure and the dread of ruined credit are, understandably, deterrents to a bankruptcy filing. But those fears can prevent people from taking advantage of the financial protection offered by bankruptcy, which may allow you to erase most of your consumer debt while preserving assets like your retirement accounts and sometimes even your home and car. Instead, many people delay filling until they are truly desperate.
“When we surveyed people about how long they seriously struggled, over 40 percent said more than two years,” said Katherine M. Porter, associate professor at the University of Iowa law school and a researcher with the Consumer Bankruptcy Project, a continuing study of consumer bankruptcy filings. “A lot of attorneys say they wish people would come earlier, before they emptied their retirement accounts or lost their car to repossession,” she said.
Because bankruptcy is so complex, and because bankruptcy laws underwent a major overhaul in 2005, many people are not only wary of filing, but also confused about their options and what the possible outcomes are.
One common misunderstanding is that declaring bankruptcy will ruin your credit. If you’re at the point of even considering bankruptcy, it’s likely that your credit is in tatters anyway, notes Ms. Porter.
“You may not end up that much worse off,” she said. In some cases, your credit could emerge in better shape once you’ve dealt with your debts.
Another myth is that you must be at the frayed end of your financial rope before you file. You won’t lose everything in a bankruptcy because some assets are protected, and you will need those to move forward, says Elizabeth Warren, a professor at Harvard Law School and one of the lead researchers on the Consumer Bankruptcy Project. Waiting until your resources are entirely depleted defeats an important purpose of bankruptcy, “which is to help people rebuild their lives on a sounder footing,” Ms. Warren said.
It was the desire to move forward with her life, not just shrug off her debts, that finally pushed Claire Morgan, who lives in Chicago, to begin the bankruptcy process in December. In addition to lingering student loans of about $12,000, Ms. Morgan had been struggling to pay $40,000 in credit card debt — a sum slightly higher than her annual income, she said. But she couldn’t make any headway.
In part, it was the sense of futility that finally pushed Ms. Morgan over the edge. But she also happened to hear a cautionary tale about a friend, also deeply in debt, who had decided not to declare bankruptcy — and ended up living in constant strain, unable to move forward with life.
“That really made me think twice,” she said. “Bankruptcy was the last thing I wanted. But it’s better to be able to say ‘I’m in the clear’ than to be still be struggling in five years to pay $40,000 in debt on a $35,000 salary.”
Knowing whether to file, when to file and whether to do so under Chapter 7 or Chapter 13 of the bankruptcy code is a decision best made with the help of a lawyer. Most bankruptcy lawyers offer a free initial consultation, Ms. Porter said. The National Association of Consumer Bankruptcy Attorneys has a Web site where you can search for a lawyer by location.
Copyright 2009 The New York Times Company. All rights reserved.
Tuesday, January 20, 2009
More Headaches on the Way for Madoff Investors
The Bernard Madoff Ponzi scheme was announced on December 11, 2008, and already, much has transpired. The U.S. Justice Department has a criminal action pending against Madoff, the U.S. Securities Exchange Commission has an enforcement action against him and his brokerage firm, and numerous suits have been filed against various parties. Bernard L. Madoff Securities, LLC is now in bankruptcy and a Trustee has been appointed. The Trustee recently sent claim forms to customers of Madoff Securities in order to provide them with information on how to take advantage of insurance protection that is available from the Securities Investment Protection Corporation.
What lies ahead for investors? Investors are likely to be faced with a lawsuit by the Trustee seeking the return of some or all of the proceeds they received from Madoff Securities. As an example, in another recent Ponzi scheme, the trustee brought suit against more than 10,000 investors for the return of proceeds received from the Ponzi scheme operator.
On the basis of fraudulent transfer laws, the Trustee can pursue investors to recover money paid to them. Under Section 548 of the Bankruptcy Code, the Trustee may avoid any transfer of monies from the Ponzi scheme operator made within two (2) years prior to the date of filing of a petition in Bankruptcy. Under similar state statutes, the Trustee to go back even longer, up to six (6) years in some cases. Other actions can also be initiated. Under fraudulent conveyance law, as long as the transfer of payment was made with the intent to hinder, delay, or defraud a bankrupt entity, the Trustee can seek to recover funds.
Unfortunately, for the investors, the courts have determined that actual fraud always exists in a Ponzi scheme. Based on this theory, the Trustee can seek to recover all the amounts that have been paid to the investor, both principal and any return on the investment. Other theories of recovery also exist. In any event, lawsuits are on their way.
The investor must then defend the suit or be subject to entry of default judgment. The investor can try to avail himself of certain defenses, including one based on "good faith." In such instance, if the investor can prove that payments were received in good faith, the Trustee will only be able to recover profits, not any principal that was returned to the investor. A good faith defense will be judged by an objective standard, that is, the investor must prove that he did not know and should not have known of the debtors Ponzi scheme. One of the factors that determines whether the investor should have known that a Ponzi scheme was in place will be an analysis of the profits promised in contrast to returns that can be obtained under actual market conditions.
If the investor successfully proves a good faith defense, the Trustee's recovery will be limited to the amount of profits received and the investor will be able to retain any principal repayments.
The Trustee can also proceed based on the theory of "constructive fraud" under the fraudulent transfer laws. However, under this theory, the Trustee can only recover profits paid to the investor, not the principal.
The Trustee also has another option in attempting to recover money from investors. Under the bankruptcy law provisions, the Trustee can seek recover, as a preference payment, any payment to the investor made within ninety (90) days of filing the petition in the bankruptcy case. This period can be extended to one (1) year for "insiders." Depending on the facts, the investor may have defenses available to this action.
Where will all this "recaptured" money go? To the Bankruptcy Estates.
Eventually, after the expenses of the bankruptcy case and litigations are paid, the money will go back to claimants and investors. The leftover funds will to be distributed pro rata, on the basis of valid claims against the Bankruptcy Estate, and in order of priority established under the Bankruptcy Code.
It is clear that another headache awaits the investors in this Ponzi scheme... defending themselves from lawsuits brought by the Trustee.
Copyright 2009 LeClairRyan. All rights reserved.
What lies ahead for investors? Investors are likely to be faced with a lawsuit by the Trustee seeking the return of some or all of the proceeds they received from Madoff Securities. As an example, in another recent Ponzi scheme, the trustee brought suit against more than 10,000 investors for the return of proceeds received from the Ponzi scheme operator.
On the basis of fraudulent transfer laws, the Trustee can pursue investors to recover money paid to them. Under Section 548 of the Bankruptcy Code, the Trustee may avoid any transfer of monies from the Ponzi scheme operator made within two (2) years prior to the date of filing of a petition in Bankruptcy. Under similar state statutes, the Trustee to go back even longer, up to six (6) years in some cases. Other actions can also be initiated. Under fraudulent conveyance law, as long as the transfer of payment was made with the intent to hinder, delay, or defraud a bankrupt entity, the Trustee can seek to recover funds.
Unfortunately, for the investors, the courts have determined that actual fraud always exists in a Ponzi scheme. Based on this theory, the Trustee can seek to recover all the amounts that have been paid to the investor, both principal and any return on the investment. Other theories of recovery also exist. In any event, lawsuits are on their way.
The investor must then defend the suit or be subject to entry of default judgment. The investor can try to avail himself of certain defenses, including one based on "good faith." In such instance, if the investor can prove that payments were received in good faith, the Trustee will only be able to recover profits, not any principal that was returned to the investor. A good faith defense will be judged by an objective standard, that is, the investor must prove that he did not know and should not have known of the debtors Ponzi scheme. One of the factors that determines whether the investor should have known that a Ponzi scheme was in place will be an analysis of the profits promised in contrast to returns that can be obtained under actual market conditions.
If the investor successfully proves a good faith defense, the Trustee's recovery will be limited to the amount of profits received and the investor will be able to retain any principal repayments.
The Trustee can also proceed based on the theory of "constructive fraud" under the fraudulent transfer laws. However, under this theory, the Trustee can only recover profits paid to the investor, not the principal.
The Trustee also has another option in attempting to recover money from investors. Under the bankruptcy law provisions, the Trustee can seek recover, as a preference payment, any payment to the investor made within ninety (90) days of filing the petition in the bankruptcy case. This period can be extended to one (1) year for "insiders." Depending on the facts, the investor may have defenses available to this action.
Where will all this "recaptured" money go? To the Bankruptcy Estates.
Eventually, after the expenses of the bankruptcy case and litigations are paid, the money will go back to claimants and investors. The leftover funds will to be distributed pro rata, on the basis of valid claims against the Bankruptcy Estate, and in order of priority established under the Bankruptcy Code.
It is clear that another headache awaits the investors in this Ponzi scheme... defending themselves from lawsuits brought by the Trustee.
Copyright 2009 LeClairRyan. All rights reserved.
Monday, January 12, 2009
Business Week: The Madoff Case Could Reel in Former Investors
By Matthew Goldstein
The managers of the Fort Worth Employees' Retirement Fund thought they had dodged a bullet when Bernard L. Madoff was arrested on Dec. 11 for alleged fraud. Just a few months earlier the $1.7 billion public pension plan had pulled $10 million out of a hedge fund that invested exclusively with Madoff. But now the managers face the possibility of having to give back the money—a sum that includes all of the pension's purported gains over the years plus its initial investment.
The Fort Worth plan and other Madoff investors who got out before the operation imploded may yet be snared by the bankruptcy proceedings. Under federal law, the trustee in the case can sue former investors to force them to return their profits and principal, a process known as a clawback. The legal theory is that investors who stick around to the bitter end shouldn't bear all the pain. With the multibillion-dollar tally of losses rising daily, the Madoff case could take years to unravel in court, leaving hundreds of pensions, endowments, and other former investors in the lurch as they await a ruling on their financial liability. "It depends on what the trustee wants to do," says Michael Missal, a lawyer at K&L Gates. Irving Picard, the trustee named on Dec. 15 to oversee the liquidation of Madoff's business, declined to comment.
Picard may take his cues from the recent bankruptcy case of Bayou Group, the $450 million hedge fund whose managers were convicted of conspiracy and fraud in 2005. The trustee in those proceedings, Jeff Marwil, filed more than 130 suits against investors who had pulled money from the fund within the prior six years. Marwil argued that former clients, even those who barely knew Bayou manager Samuel Israel, should have to take a hit as well, since Bayou was nothing more than a Ponzi scheme. The judge ruled in his favor.
The clawbacks in the Madoff case could prove more controversial. In most hedge fund scandals, including Bayou, the majority of clients invested directly with the dubious money management firm. But most of Madoff's customers came through a half-dozen or so "feeder" funds. Those affiliated vehicles operated under their own brand name but handed much of the money over to Madoff.
"financial death sentence"
Some investors may not have known what they were buying. The Fort Worth pension fund, for example, owned the Rye Select Broad Market, a hedge fund managed by the Tremont Group. The Rye marketing literature rarely, if ever, mentioned Madoff by name, even though his fund was the only investment. Says Steven Caruso, a lawyer for a number of Tremont investors: "Some investors may be facing the prospect of a financial death sentence if they're forced to return funds." In a letter to investors, Tremont's managers say they "exercised appropriate due diligence."
Managers of the Fort Worth pension fund, who first invested with Rye five years ago, started to rethink their investment in early 2008 after hiring Albourne Partners, a London due diligence firm, to assess their hedge fund portfolio. The Rye fund raised red flags almost immediately. Albourne's managing director, Simon Ruddick, says the firm, which had long-standing concerns about Madoff's trading strategy and consistent returns, had urged clients for nearly a decade to avoid affiliated funds such as Rye. In July the pension's board voted unanimously to dump its Rye stake. "If you are person who has nothing left, naturally you want everyone to share in the pain," says Robert Klausner, a lawyer for the Fort Worth pension. "But if you are someone with no inside knowledge of fraud who redeems an investment in the ordinary course of business, you shouldn't be punished."
Copyright 2000-2009 by The McGraw-Hill Companies Inc. All rights reserved.
The managers of the Fort Worth Employees' Retirement Fund thought they had dodged a bullet when Bernard L. Madoff was arrested on Dec. 11 for alleged fraud. Just a few months earlier the $1.7 billion public pension plan had pulled $10 million out of a hedge fund that invested exclusively with Madoff. But now the managers face the possibility of having to give back the money—a sum that includes all of the pension's purported gains over the years plus its initial investment.
The Fort Worth plan and other Madoff investors who got out before the operation imploded may yet be snared by the bankruptcy proceedings. Under federal law, the trustee in the case can sue former investors to force them to return their profits and principal, a process known as a clawback. The legal theory is that investors who stick around to the bitter end shouldn't bear all the pain. With the multibillion-dollar tally of losses rising daily, the Madoff case could take years to unravel in court, leaving hundreds of pensions, endowments, and other former investors in the lurch as they await a ruling on their financial liability. "It depends on what the trustee wants to do," says Michael Missal, a lawyer at K&L Gates. Irving Picard, the trustee named on Dec. 15 to oversee the liquidation of Madoff's business, declined to comment.
Picard may take his cues from the recent bankruptcy case of Bayou Group, the $450 million hedge fund whose managers were convicted of conspiracy and fraud in 2005. The trustee in those proceedings, Jeff Marwil, filed more than 130 suits against investors who had pulled money from the fund within the prior six years. Marwil argued that former clients, even those who barely knew Bayou manager Samuel Israel, should have to take a hit as well, since Bayou was nothing more than a Ponzi scheme. The judge ruled in his favor.
The clawbacks in the Madoff case could prove more controversial. In most hedge fund scandals, including Bayou, the majority of clients invested directly with the dubious money management firm. But most of Madoff's customers came through a half-dozen or so "feeder" funds. Those affiliated vehicles operated under their own brand name but handed much of the money over to Madoff.
"financial death sentence"
Some investors may not have known what they were buying. The Fort Worth pension fund, for example, owned the Rye Select Broad Market, a hedge fund managed by the Tremont Group. The Rye marketing literature rarely, if ever, mentioned Madoff by name, even though his fund was the only investment. Says Steven Caruso, a lawyer for a number of Tremont investors: "Some investors may be facing the prospect of a financial death sentence if they're forced to return funds." In a letter to investors, Tremont's managers say they "exercised appropriate due diligence."
Managers of the Fort Worth pension fund, who first invested with Rye five years ago, started to rethink their investment in early 2008 after hiring Albourne Partners, a London due diligence firm, to assess their hedge fund portfolio. The Rye fund raised red flags almost immediately. Albourne's managing director, Simon Ruddick, says the firm, which had long-standing concerns about Madoff's trading strategy and consistent returns, had urged clients for nearly a decade to avoid affiliated funds such as Rye. In July the pension's board voted unanimously to dump its Rye stake. "If you are person who has nothing left, naturally you want everyone to share in the pain," says Robert Klausner, a lawyer for the Fort Worth pension. "But if you are someone with no inside knowledge of fraud who redeems an investment in the ordinary course of business, you shouldn't be punished."
Copyright 2000-2009 by The McGraw-Hill Companies Inc. All rights reserved.
Friday, January 09, 2009
NYT: Citi Reaches Deal with Lawmakers on Home Loans
By CARL HULSE
Published: January 8, 2009
WASHINGTON — In a move that would help troubled homeowners, Citigroup agreed to support legislation that would let bankruptcy judges adjust mortgages for at-risk borrowers, leading Congressional Democrats said on Thursday.
Financial industry lobbyists, however, said the plan was flawed and vowed to fight legislation aimed at easing up on homeowners facing foreclosure.
Members of the House and Senate said Citigroup had agreed to drop its opposition, providing no future mortgages are covered by the law.
Citigroup, which is receiving more than $300 billion in bailout assistance, says that it is open to measures that would help homeowners.
“Citi shares this legislation’s goal to help distressed borrowers stay in their homes, and believes it will serve as an additional tool to the extensive home retention programs currently in place to help at-risk borrowers,” Vikram S. Pandit, the chief executive of Citigroup, wrote in a letter released Thursday night.
The revised bill that Citigroup endorsed would allow bankruptcy judges to adjust the principal payments or interest rates on existing loans.
Judges could also extend the terms on mortgage loans, according to the language of the bill, which would force lenders to take losses without a say in bankruptcy court proceedings.
Senator Richard J. Durbin of Illinois, the No. 2 Senate Democrat, said he and fellow backers of the plan see it as a way to create more voluntary negotiations between struggling homeowners and financial institutions. So far, voluntary programs have proved ineffective, Democrats said.
Citigroup had been part of the Bankruptcy Coalition of the Financial Services Roundtable, an industry group, since it aggressively lobbied for changes to the bankruptcy code in 2005.
The coalition — a group of major trade associations and lenders like Bank of America, JPMorgan Chase and Wells Fargo — also fought to block the so-called cramdown legislation last year.
No other bank has broken ranks with the industry on the proposed bill. Mr. Durbin said he hoped the move by Citigroup, should other banks and financial trade associations take the same stance, would lead to backing by enough Democrats and moderate Republicans to push the bill through.
Senator Charles E. Schumer, Democrat of New York, said he had been contacting officials of top financial institutions for months, trying to persuade them that it would be to their advantage to back the plan since it could help stabilize a housing market that has severely hurt the economy.
Three changes were made to the legislation sponsored by Mr. Durbin and Representative John Conyers Jr., Democrat of Michigan and chairman of the House Judiciary Committee: only existing mortgages will be eligible; homeowners will have to certify they tried to contact their mortgage holder lenders regarding loan modifications before filing for bankruptcy; and only major violations of the Truth in Lending Act will cause lenders to forfeit their claims in a bankruptcy.
Backed by bankers and other financial groups, many Congressional Republicans and some Democrats have balked at the plan to let bankruptcy judges alter mortgage terms on primary residences, saying that would drive up mortgage costs.
But officials said financial institutions were coming to the conclusion that it might be better to get a reduced loan payment through a bankruptcy or voluntary negotiations than to get no money at all.
Aides to Senator Richard C. Shelby of Alabama, the senior Republican on the Senate banking committee, said he would have no immediate response to the plan.
Scott E. Talbott, senior vice president for government affairs at the Financial Services Roundtable, said the group opposed cramdown legislation because it “creates huge risks” for the mortgage market.
He suggested the bill would force banks to further restrict lending and absorb huge losses as the economy worsens. He also suggested the bill would create perverse incentives that might encourage more homeowners to seek bankruptcy protection.
Citigroup recently began negotiating with lawmakers, in a move that some observers suggest reflects its desire to win favor on Capitol Hill after receiving billions in funds from the bailout program.
The government has invested $45 billion in Citigroup and agreed to guarantee about $269 billion in highly illiquid mortgage investments.
“If you’re looking at a way to get to the bottom of the economic problems in our country, this is the cause of our economic problems,” said Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the banking committee. “It is the housing foreclosure problem. We’ve got to address that.”
The plan has been backed by members of Congress who see it as a way to help distressed homeowners and balance federal relief efforts that have been aimed at Wall Street and the automobile industry.
Mr. Schumer said he had been in contact with other large banks and he expected they would soon announce their support or at least drop their opposition to the plan.
“Citigroup’s action has broken the dam,” he said.
Eric Dash in New York contributed reporting.
Copyright 2008 The New York Times Company. All rights reserved.
Published: January 8, 2009
WASHINGTON — In a move that would help troubled homeowners, Citigroup agreed to support legislation that would let bankruptcy judges adjust mortgages for at-risk borrowers, leading Congressional Democrats said on Thursday.
Financial industry lobbyists, however, said the plan was flawed and vowed to fight legislation aimed at easing up on homeowners facing foreclosure.
Members of the House and Senate said Citigroup had agreed to drop its opposition, providing no future mortgages are covered by the law.
Citigroup, which is receiving more than $300 billion in bailout assistance, says that it is open to measures that would help homeowners.
“Citi shares this legislation’s goal to help distressed borrowers stay in their homes, and believes it will serve as an additional tool to the extensive home retention programs currently in place to help at-risk borrowers,” Vikram S. Pandit, the chief executive of Citigroup, wrote in a letter released Thursday night.
The revised bill that Citigroup endorsed would allow bankruptcy judges to adjust the principal payments or interest rates on existing loans.
Judges could also extend the terms on mortgage loans, according to the language of the bill, which would force lenders to take losses without a say in bankruptcy court proceedings.
Senator Richard J. Durbin of Illinois, the No. 2 Senate Democrat, said he and fellow backers of the plan see it as a way to create more voluntary negotiations between struggling homeowners and financial institutions. So far, voluntary programs have proved ineffective, Democrats said.
Citigroup had been part of the Bankruptcy Coalition of the Financial Services Roundtable, an industry group, since it aggressively lobbied for changes to the bankruptcy code in 2005.
The coalition — a group of major trade associations and lenders like Bank of America, JPMorgan Chase and Wells Fargo — also fought to block the so-called cramdown legislation last year.
No other bank has broken ranks with the industry on the proposed bill. Mr. Durbin said he hoped the move by Citigroup, should other banks and financial trade associations take the same stance, would lead to backing by enough Democrats and moderate Republicans to push the bill through.
Senator Charles E. Schumer, Democrat of New York, said he had been contacting officials of top financial institutions for months, trying to persuade them that it would be to their advantage to back the plan since it could help stabilize a housing market that has severely hurt the economy.
Three changes were made to the legislation sponsored by Mr. Durbin and Representative John Conyers Jr., Democrat of Michigan and chairman of the House Judiciary Committee: only existing mortgages will be eligible; homeowners will have to certify they tried to contact their mortgage holder lenders regarding loan modifications before filing for bankruptcy; and only major violations of the Truth in Lending Act will cause lenders to forfeit their claims in a bankruptcy.
Backed by bankers and other financial groups, many Congressional Republicans and some Democrats have balked at the plan to let bankruptcy judges alter mortgage terms on primary residences, saying that would drive up mortgage costs.
But officials said financial institutions were coming to the conclusion that it might be better to get a reduced loan payment through a bankruptcy or voluntary negotiations than to get no money at all.
Aides to Senator Richard C. Shelby of Alabama, the senior Republican on the Senate banking committee, said he would have no immediate response to the plan.
Scott E. Talbott, senior vice president for government affairs at the Financial Services Roundtable, said the group opposed cramdown legislation because it “creates huge risks” for the mortgage market.
He suggested the bill would force banks to further restrict lending and absorb huge losses as the economy worsens. He also suggested the bill would create perverse incentives that might encourage more homeowners to seek bankruptcy protection.
Citigroup recently began negotiating with lawmakers, in a move that some observers suggest reflects its desire to win favor on Capitol Hill after receiving billions in funds from the bailout program.
The government has invested $45 billion in Citigroup and agreed to guarantee about $269 billion in highly illiquid mortgage investments.
“If you’re looking at a way to get to the bottom of the economic problems in our country, this is the cause of our economic problems,” said Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the banking committee. “It is the housing foreclosure problem. We’ve got to address that.”
The plan has been backed by members of Congress who see it as a way to help distressed homeowners and balance federal relief efforts that have been aimed at Wall Street and the automobile industry.
Mr. Schumer said he had been in contact with other large banks and he expected they would soon announce their support or at least drop their opposition to the plan.
“Citigroup’s action has broken the dam,” he said.
Eric Dash in New York contributed reporting.
Copyright 2008 The New York Times Company. All rights reserved.
Thursday, January 08, 2009
NYT: Gentler Tax Laws Urged on Debt Default
By LYNNLEY BROWNING
Published: January 7, 2009
Congress should ease certain tax laws governing defaults on mortgages, credit cards and other consumer debt to help Americans who are struggling in the economic downturn, the watchdog agency of the Internal Revenue Service said Wednesday.
In its annual written report, the agency, the National Taxpayer Advocate, said that without the changes hundreds of thousands of Americans could mistakenly pay taxes this year on their canceled debts, adding to their financial malaise.
The I.R.S. generally treats canceled debts as subject to federal income tax unless the taxpayer is insolvent or in bankruptcy proceedings.
But Nina E. Olson, who leads the watchdog agency, wrote that most taxpayers eligible to exclude canceled debts from their overall taxable income were unaware that they must file an obscure, complex form with the I.R.S.
She called on Congress to change the law to exempt taxpayers with what she termed “modest” amounts of canceled debt from having to submit the form. She did not put a dollar limit on the amounts and instead asked Congress to establish a threshold.
Congress has already provided some debt relief to homeowners through the Mortgage Forgiveness Debt Relief Act of 2007, which exempts from taxes any debts reduced or canceled during foreclosure or mortgage restructuring. But the exemption applies only if proceeds are used to acquire or improve a principal residence — something home buyers do not always do.
“It appears that most subprime borrowers use a portion of their loans for other purposes (e.g., to pay off car loans, credit card balances, student loans or medical bills),” Ms. Olson wrote.
She issued her report amid a flurry of unusual activity by the I.R.S. to award tax breaks to banks and financial corporations. The breaks, which give banks more leeway to use tax losses from banks they acquire, are estimated by leading tax specialists to be worth at least $110 billion.
Ms. Olson, referring to the economic downturn, also called on the I.R.S. to ease harsh collection practices. Levies, liens and asset seizures — all increasingly used tools of the I.R.S. — should give way to installment agreements with taxpayers and deals known as “offers in compromise,” in which taxpayers offer to pay part of their tax debts.
While I.R.S. staff members are required by law and internal procedures to consider whether collection efforts impose an economic hardship on taxpayers, they often do not do so, Ms. Olson wrote.
She urged the I.R.S. to protect low-income Social Security recipients from automated tax levies, which typically total 15 percent of the federal payments they receive.
In 2008, the I.R.S. issued levies against 1.8 million payments made to Social Security recipients. More than a fourth of those taxpayers had incomes below the poverty level, and more than a third probably would be classified as unable to pay by the I.R.S. if their cases were subject to human review.
Ms. Olson also called on Congress to simplify the tax code radically, an issue she identified as the leading challenge to taxpayers, and one that has appeared frequently in her annual reports.
Copyright 2008 The New York Times Company. All rights reserved.
Published: January 7, 2009
Congress should ease certain tax laws governing defaults on mortgages, credit cards and other consumer debt to help Americans who are struggling in the economic downturn, the watchdog agency of the Internal Revenue Service said Wednesday.
In its annual written report, the agency, the National Taxpayer Advocate, said that without the changes hundreds of thousands of Americans could mistakenly pay taxes this year on their canceled debts, adding to their financial malaise.
The I.R.S. generally treats canceled debts as subject to federal income tax unless the taxpayer is insolvent or in bankruptcy proceedings.
But Nina E. Olson, who leads the watchdog agency, wrote that most taxpayers eligible to exclude canceled debts from their overall taxable income were unaware that they must file an obscure, complex form with the I.R.S.
She called on Congress to change the law to exempt taxpayers with what she termed “modest” amounts of canceled debt from having to submit the form. She did not put a dollar limit on the amounts and instead asked Congress to establish a threshold.
Congress has already provided some debt relief to homeowners through the Mortgage Forgiveness Debt Relief Act of 2007, which exempts from taxes any debts reduced or canceled during foreclosure or mortgage restructuring. But the exemption applies only if proceeds are used to acquire or improve a principal residence — something home buyers do not always do.
“It appears that most subprime borrowers use a portion of their loans for other purposes (e.g., to pay off car loans, credit card balances, student loans or medical bills),” Ms. Olson wrote.
She issued her report amid a flurry of unusual activity by the I.R.S. to award tax breaks to banks and financial corporations. The breaks, which give banks more leeway to use tax losses from banks they acquire, are estimated by leading tax specialists to be worth at least $110 billion.
Ms. Olson, referring to the economic downturn, also called on the I.R.S. to ease harsh collection practices. Levies, liens and asset seizures — all increasingly used tools of the I.R.S. — should give way to installment agreements with taxpayers and deals known as “offers in compromise,” in which taxpayers offer to pay part of their tax debts.
While I.R.S. staff members are required by law and internal procedures to consider whether collection efforts impose an economic hardship on taxpayers, they often do not do so, Ms. Olson wrote.
She urged the I.R.S. to protect low-income Social Security recipients from automated tax levies, which typically total 15 percent of the federal payments they receive.
In 2008, the I.R.S. issued levies against 1.8 million payments made to Social Security recipients. More than a fourth of those taxpayers had incomes below the poverty level, and more than a third probably would be classified as unable to pay by the I.R.S. if their cases were subject to human review.
Ms. Olson also called on Congress to simplify the tax code radically, an issue she identified as the leading challenge to taxpayers, and one that has appeared frequently in her annual reports.
Copyright 2008 The New York Times Company. All rights reserved.
Monday, January 05, 2009
NYT: Credit Card Companies Willing to Deal Over Debt
By ERIC DASH
Published: January 2, 2009
Hard times are usually good times for debt collectors, who make their money morning and night with the incessant ring of a phone.
But in this recession, perhaps the deepest in decades, the unthinkable is happening: collectors, who usually do the squeezing, are getting squeezed a bit themselves.
After helping to foster the explosive growth of consumer debt in recent years, credit card companies are realizing that some hard-pressed Americans will not be able to pay their bills as the economy deteriorates.
So lenders and their collectors are rushing to round up what money they can before things get worse, even if that means forgiving part of some borrowers’ debts. Increasingly, they are stretching out payments and accepting dimes, if not pennies, on the dollar as payment in full.
“You can’t squeeze blood out of a turnip,” said Don Siler, the chief marketing officer at MRS Associates, a big collection company that works with seven of the 10 largest credit card companies. “The big settlements just aren’t there anymore.”
Lenders are not being charitable. They are simply trying to protect themselves.
Banks and card companies are bracing for a wave of defaults on credit card debt in early 2009, and they are vying with each other to get paid first. Besides, the sooner people get their financial houses in order, the sooner they can start borrowing again.
So even as many banks cut consumers’ credit lines, raise card fees and generally pull back on lending, some lenders are trying to give customers a little wiggle room. Bank of America, for instance, says it has waived late fees, lowered interest charges and, in some cases, reduced loan balances for more than 700,000 credit card holders in 2008.
American Express and Chase Card Services say they are taking similar actions as more customers fall behind on their bills. Every major credit card lender is giving its collection agents more leeway to make adjustments for consumers in financial distress.
Debt collectors, who are typically paid based on the amount of money they recover, report that the number of troubled borrowers getting payment extensions has at least doubled in the last six months. In other cases, borrowers who appear to be pushed to the brink are being offered deals that forgive 20 to 70 percent of credit card debt.
“Consumers have never been in a better position to negotiate a partial payment,” said Robert D. Manning, the author of “Credit Card Nation” and a longtime critic of the credit card industry. “It’s like that old movie ‘Rosalie Goes Shopping.’ When it’s $100,000 of debt, it’s your problem. When it’s a million dollars of debt, it’s the bank’s problem.”
The recent wave of debt concessions is a reversal from only a few years ago, when consumers usually lost battles with their credit card companies. Now, as bad debts soar, it is the lenders who are crying mercy.
Credit card lenders expect to write off an unprecedented $395 billion of soured loans over the next five years, according to projections from The Nilson Report, an industry newsletter. That compares with a total of about $275 billion in the last five years.
All that bad debt is getting harder to collect. In the past, troubled borrowers might have been able to pay down card loans by tapping the equity in their homes, drawing on retirement savings, taking out a debt consolidation loan, or even calling a relative for help. But with credit tight, consumers are maxed out.
“Knowing that the sources of funding have dried up, having someone pay the balance in full isn’t a viable strategy,” said Tim Smith, a senior executive at Firstsource, one of the biggest debt collection companies.
Lenders are reluctant to admit they will accept less than full payment, lest they encourage good customers to stop paying what they can. Industrywide data is scarce.
Unlike the huge mortgage loan modification programs that are taking place, which address thousands of mortgages at once, workouts for credit card customers are still being handled on a case-by-case basis.
In addition to debt forgiveness, debt collectors are allowing many delinquent borrowers to pay down their debt over the course of a year rather than the standard six months.
Paul Hunziker, the chairman of Capital Management Services, said that before this downturn, his firm put only about a quarter of all borrowers into longer-term repayment plans. Now, it puts about half on such plans.
Some lenders are also reaching out to borrowers shortly after they fall behind on their payments to try to avoid having to write off the account. Others are reaching out to customers who seem likely to fall behind. Just as lenders competed for years to be the first card to be taken out of the wallet, they are now competing to be the first ones paid back.
And realizing that millions more consumers are likely to default on their credit card bills in the coming months, the banking industry has started lobbying regulators to make it more advantageous to lenders to extend payment terms or forgive debt.
In an unusual alliance, the Financial Services Roundtable, one of the industry’s biggest lobbyists, and the Consumer Federation of America recently proposed a credit card loan modification program, which was rejected by regulators.
Under the plan, lenders would have forgiven about 40 percent of what was owed by individual borrowers over five years. Lenders could report the loss once whatever part of the debt was repaid, instead of shortly after default, as current accounting rules require. That would allow them to write off less later. Borrowers would have been allowed to defer any tax payments owed on the forgiven debt.
Landmark changes to bankruptcy legislation passed in 2005, for which the industry aggressively lobbied, seem to have hurt card debt collections. Credit card industry data indicate the average debt discharged in Chapter 7 bankruptcy has nearly tripled since 2004. And in Chapter 13 bankruptcies, secured lenders like auto finance companies routinely elbow out unsecured lenders like card companies, trends that have contributed to the card lenders’ willingness to settle.
Borrowers should not expect sweetheart deals. Card companies will offer loan modifications only to people who meet certain criteria. Most customers must be delinquent for 90 days or longer. Other considerations include the borrower’s income, existing bank relationships and a credit record that suggests missing a payment is an exception rather than the rule.
While a deal may help avoid credit card cancellation or bankruptcy, it will also lead to a sharp drop in the borrower’s credit score for as long as seven years, making it far more difficult and expensive to obtain new loans. The average consumer’s score will fall 70 to 130 points, on a scale where the strongest borrowers register 700 or more.
For the moment, it may be easier for troubled borrowers to start negotiating a modification by contacting the card company or collection agency directly. Credit counselors can help borrowers consolidate their debts and get card companies to lower their interest payments and other fees, but they currently cannot get the loan principal reduced.
Another option is for a borrower to sign up a debt settlement company to negotiate on her behalf. But regulation of this business is loose, and consumer advocacy groups warn that some firms prey on troubled borrowers with aggressive marketing tactics and exorbitant upfront fees.
Copyright 2009 The New York Times Company. All rights reserved.
Published: January 2, 2009
Hard times are usually good times for debt collectors, who make their money morning and night with the incessant ring of a phone.
But in this recession, perhaps the deepest in decades, the unthinkable is happening: collectors, who usually do the squeezing, are getting squeezed a bit themselves.
After helping to foster the explosive growth of consumer debt in recent years, credit card companies are realizing that some hard-pressed Americans will not be able to pay their bills as the economy deteriorates.
So lenders and their collectors are rushing to round up what money they can before things get worse, even if that means forgiving part of some borrowers’ debts. Increasingly, they are stretching out payments and accepting dimes, if not pennies, on the dollar as payment in full.
“You can’t squeeze blood out of a turnip,” said Don Siler, the chief marketing officer at MRS Associates, a big collection company that works with seven of the 10 largest credit card companies. “The big settlements just aren’t there anymore.”
Lenders are not being charitable. They are simply trying to protect themselves.
Banks and card companies are bracing for a wave of defaults on credit card debt in early 2009, and they are vying with each other to get paid first. Besides, the sooner people get their financial houses in order, the sooner they can start borrowing again.
So even as many banks cut consumers’ credit lines, raise card fees and generally pull back on lending, some lenders are trying to give customers a little wiggle room. Bank of America, for instance, says it has waived late fees, lowered interest charges and, in some cases, reduced loan balances for more than 700,000 credit card holders in 2008.
American Express and Chase Card Services say they are taking similar actions as more customers fall behind on their bills. Every major credit card lender is giving its collection agents more leeway to make adjustments for consumers in financial distress.
Debt collectors, who are typically paid based on the amount of money they recover, report that the number of troubled borrowers getting payment extensions has at least doubled in the last six months. In other cases, borrowers who appear to be pushed to the brink are being offered deals that forgive 20 to 70 percent of credit card debt.
“Consumers have never been in a better position to negotiate a partial payment,” said Robert D. Manning, the author of “Credit Card Nation” and a longtime critic of the credit card industry. “It’s like that old movie ‘Rosalie Goes Shopping.’ When it’s $100,000 of debt, it’s your problem. When it’s a million dollars of debt, it’s the bank’s problem.”
The recent wave of debt concessions is a reversal from only a few years ago, when consumers usually lost battles with their credit card companies. Now, as bad debts soar, it is the lenders who are crying mercy.
Credit card lenders expect to write off an unprecedented $395 billion of soured loans over the next five years, according to projections from The Nilson Report, an industry newsletter. That compares with a total of about $275 billion in the last five years.
All that bad debt is getting harder to collect. In the past, troubled borrowers might have been able to pay down card loans by tapping the equity in their homes, drawing on retirement savings, taking out a debt consolidation loan, or even calling a relative for help. But with credit tight, consumers are maxed out.
“Knowing that the sources of funding have dried up, having someone pay the balance in full isn’t a viable strategy,” said Tim Smith, a senior executive at Firstsource, one of the biggest debt collection companies.
Lenders are reluctant to admit they will accept less than full payment, lest they encourage good customers to stop paying what they can. Industrywide data is scarce.
Unlike the huge mortgage loan modification programs that are taking place, which address thousands of mortgages at once, workouts for credit card customers are still being handled on a case-by-case basis.
In addition to debt forgiveness, debt collectors are allowing many delinquent borrowers to pay down their debt over the course of a year rather than the standard six months.
Paul Hunziker, the chairman of Capital Management Services, said that before this downturn, his firm put only about a quarter of all borrowers into longer-term repayment plans. Now, it puts about half on such plans.
Some lenders are also reaching out to borrowers shortly after they fall behind on their payments to try to avoid having to write off the account. Others are reaching out to customers who seem likely to fall behind. Just as lenders competed for years to be the first card to be taken out of the wallet, they are now competing to be the first ones paid back.
And realizing that millions more consumers are likely to default on their credit card bills in the coming months, the banking industry has started lobbying regulators to make it more advantageous to lenders to extend payment terms or forgive debt.
In an unusual alliance, the Financial Services Roundtable, one of the industry’s biggest lobbyists, and the Consumer Federation of America recently proposed a credit card loan modification program, which was rejected by regulators.
Under the plan, lenders would have forgiven about 40 percent of what was owed by individual borrowers over five years. Lenders could report the loss once whatever part of the debt was repaid, instead of shortly after default, as current accounting rules require. That would allow them to write off less later. Borrowers would have been allowed to defer any tax payments owed on the forgiven debt.
Landmark changes to bankruptcy legislation passed in 2005, for which the industry aggressively lobbied, seem to have hurt card debt collections. Credit card industry data indicate the average debt discharged in Chapter 7 bankruptcy has nearly tripled since 2004. And in Chapter 13 bankruptcies, secured lenders like auto finance companies routinely elbow out unsecured lenders like card companies, trends that have contributed to the card lenders’ willingness to settle.
Borrowers should not expect sweetheart deals. Card companies will offer loan modifications only to people who meet certain criteria. Most customers must be delinquent for 90 days or longer. Other considerations include the borrower’s income, existing bank relationships and a credit record that suggests missing a payment is an exception rather than the rule.
While a deal may help avoid credit card cancellation or bankruptcy, it will also lead to a sharp drop in the borrower’s credit score for as long as seven years, making it far more difficult and expensive to obtain new loans. The average consumer’s score will fall 70 to 130 points, on a scale where the strongest borrowers register 700 or more.
For the moment, it may be easier for troubled borrowers to start negotiating a modification by contacting the card company or collection agency directly. Credit counselors can help borrowers consolidate their debts and get card companies to lower their interest payments and other fees, but they currently cannot get the loan principal reduced.
Another option is for a borrower to sign up a debt settlement company to negotiate on her behalf. But regulation of this business is loose, and consumer advocacy groups warn that some firms prey on troubled borrowers with aggressive marketing tactics and exorbitant upfront fees.
Copyright 2009 The New York Times Company. All rights reserved.
NYT: As Vacant Office Space Grows, So Does the Crisis for Lenders
By CHARLES V. BAGLI
Published: January 4, 2009
Vacancy rates in office buildings exceed 10 percent in virtually every major city in the country and are rising rapidly, a sign of economic distress that could lead to yet another wave of problems for troubled lenders.
With job cuts rampant and businesses retrenching, more empty space is expected from New York to Chicago to Los Angeles in the coming year. Rental income would then decline and property values would slide further. The Urban Land Institute predicts 2009 will be the worst year for the commercial real estate market “since the wrenching 1991-1992 industry depression.”
Banks and other financial companies have not had the problems with commercial properties in this recession that they have had with residential properties. But many building owners, while struggling with more vacancies and less rental income, will need to refinance commercial mortgages this year.
The persistent chill in lending from banks to the credit markets will make that difficult — even for borrowers who are current on their payments — setting the stage for loan defaults.
The prospect bodes ill for banks, along with pension funds, insurance companies, hedge funds and others holding the loans or pieces of them that were packaged and sold as securities.
Jeffrey DeBoer, chief executive of the Real Estate Roundtable, a lobbying group in Washington, is asking for government assistance for his industry and warns of the potential impact of defaults. “Each one by itself is not significant,” he said, “but the cumulative effect will put tremendous stress on the financial sector.”
Stock analysts say commercial real estate is the next ticking time bomb for banks, which have already received hundreds of billions of dollars in capital and other assistance from the federal government. Big banks — like Bank of America, JPMorgan Chase and Morgan Stanley — each hold tens of billions of dollars in commercial real estate securities. The banks also invested directly in properties.
Regional banks may be an even bigger concern. In the last decade, they barreled their way into commercial real estate lending after being elbowed out of the credit card and consumer mortgage business by national players. The proportion of their lending that is in commercial real estate has nearly doubled in the last six years, according to government data.
Just as home loans were pooled, then carved up and sold to investors as securities over the last two decades, commercial property loans were repackaged for the financial markets. In 2006 and 2007, nearly 60 percent of commercial property loans were turned into securities, according to Trepp, a research firm that tracks mortgage-backed securities.
Now that the market for those securities has dried up, borrowers cannot easily roll over the loans that are coming due.
Many commercial property owners will face a dilemma similar to that of today’s homeowners who cannot easily get mortgage relief because their loans were sliced and sold to many different parties. There often is not a single entity with whom to negotiate, because investors have different interests.
By many accounts, building owners have been caught off guard by how quickly the market has deteriorated in recent weeks.
Rising vacancy rates were expected in Orange County, Calif., a center of the subprime mortgage crisis, and New York, where the now shrinking financial industry dominates office space. But vacancies are also suddenly climbing in Houston and Dallas, which had been shielded from the economic downturn until recently by skyrocketing oil prices and expanding energy businesses. In Chicago, brokers say demand has dried up just as new office towers are nearing completion.
“The economic recession is so widespread that we believe virtually every market in the country will see a rise in vacancy rates of between 2 and 5 percentage points by mid-2009,” said Bill Goade, chief executive of CresaPartners, which advises corporations on leasing and buying office space.
There is no relief in sight for Orange County, where subprime lenders and title companies once dominated the market but are now shedding space because their business has dried up, and big banks are now shrinking because of a wave of mergers. The vacancy rate has soared from 7 percent at the end of 2006 to 18 percent, a rate that the Tampa area should match this month, local real estate brokers say.
In New York, where rents had risen the highest as financial companies gobbled up office space, vacancy rates are floating above 10 percent for the first time in years.
What looked like the worst possible case a few weeks ago for Chicago now appears to be the most likely outcome, said Bill Rogers, a managing director at Jones Lang LaSalle, a real estate broker. The vacancy rate, which was fairly stable at 10 percent, is now rising quickly and could hit 17 percent in 2009, he said. “A lot of companies are trying to shed excess space ahead of what is expected to be a worse market in 2009,” Mr. Rogers said.
Newmark Knight Frank, a real estate broker, expects the vacancy rate in Dallas to rise to 19 percent this year, from 16.3 percent.
Houston, like Dallas, held up while many other cities were showing the strains of an economic slowdown. But job growth and the brisk business of oil and gas exploration have come to an abrupt halt.
Vacant or unfinished shopping centers dot the highways. Among the 8.4 million square feet of office space under construction or recently completed in the metropolitan area, 80 percent has not been leased. As a result, the vacancy rate is 11 percent and rising.
“I see a wave of troubled assets coming out of Texas in the near future,” said Dan Fasulo, managing director of Real Capital Analytics, a real estate research firm.
Effective rents, after free rent and other landlord concessions, have already started to fall and are expected to decline 30 percent or more across the country from the euphoric days of the real estate boom, according to real estate brokers and analysts.
That is making it all the more difficult for owners, who projected ever-rising rents when they financed their office buildings, hotels, shopping centers and other commercial property. Owners typically pay only the interest on loans of 5, 7 or 10 years and refinance the big principal payments necessary when the loans come due.
Without new financing, owners will have few options other than to try to negotiate terms with their lenders or hand over the keys to banks and bondholders.
Among commercial properties, the most troubled have been hotels and shopping centers, where anemic sales and bankruptcies by retailers are leading to more vacancies and where heavily leveraged mall operators, like General Growth Properties and Centro, are under intense pressure to sell assets. But analysts are increasingly worried about the office market.
The Real Estate Roundtable sees a rising risk of default and foreclosure on an estimated $400 billion in commercial mortgages that come due this year. In recent weeks, a group led by the New York developer William Rudin has pleaded with Treasury Secretary Henry M. Paulson Jr., Senator Charles E. Schumer, Democrat of New York, and others to have the government include commercial real estate in a new $200 billion program intended to spur lending.
Mr. DeBoer, the roundtable’s leader, said building owners are by and large making their loan payments. It is the refinancing that is worrisome.
Most loans, he said, were made at 50 percent to 70 percent of property values. At the top of the market in 2006 and 2007, though, some owners took advantage of available credit and borrowed 90 percent or more of the value of a property, a strategy that works only in a rising market. Since then, property values have dropped 20 percent, Mr. DeBoer said.
Where possible, owners are trying to extend loans. A lender might agree to extend the term on a 10-year commercial mortgage, for example, if the borrower remains current on payments and can make an equity payment to compensate for the decline in the building’s value.
Already, $107 billion worth of office towers, shopping centers and hotels are in some form of distress, ranging from mortgage delinquency to foreclosure, according to a report by Real Capital Analytics.
New York, the biggest market by far, leads the pack with 268 troubled properties valued at $12 billion. But there are 19 more cities, including Atlanta, Denver and Seattle, with more than $1 billion worth of distressed commercial properties.
Analysts are especially concerned about buildings like 666 Fifth Avenue, One Park Avenue and the Riverton complex in New York, the Pacifica Tower in San Diego and the Sears Tower in Chicago, which were acquired in 2006 and 2007 with mortgage-backed financing based on future rents rather than existing income.
“Many of those buildings are basically underwater,” said Mr. Goade of CresaPartners. “The price they paid was too high to begin with. There’s no way anyone would lend that kind of money today.”
Copyright 2009 The New York Times Company. All rights reserved.
Published: January 4, 2009
Vacancy rates in office buildings exceed 10 percent in virtually every major city in the country and are rising rapidly, a sign of economic distress that could lead to yet another wave of problems for troubled lenders.
With job cuts rampant and businesses retrenching, more empty space is expected from New York to Chicago to Los Angeles in the coming year. Rental income would then decline and property values would slide further. The Urban Land Institute predicts 2009 will be the worst year for the commercial real estate market “since the wrenching 1991-1992 industry depression.”
Banks and other financial companies have not had the problems with commercial properties in this recession that they have had with residential properties. But many building owners, while struggling with more vacancies and less rental income, will need to refinance commercial mortgages this year.
The persistent chill in lending from banks to the credit markets will make that difficult — even for borrowers who are current on their payments — setting the stage for loan defaults.
The prospect bodes ill for banks, along with pension funds, insurance companies, hedge funds and others holding the loans or pieces of them that were packaged and sold as securities.
Jeffrey DeBoer, chief executive of the Real Estate Roundtable, a lobbying group in Washington, is asking for government assistance for his industry and warns of the potential impact of defaults. “Each one by itself is not significant,” he said, “but the cumulative effect will put tremendous stress on the financial sector.”
Stock analysts say commercial real estate is the next ticking time bomb for banks, which have already received hundreds of billions of dollars in capital and other assistance from the federal government. Big banks — like Bank of America, JPMorgan Chase and Morgan Stanley — each hold tens of billions of dollars in commercial real estate securities. The banks also invested directly in properties.
Regional banks may be an even bigger concern. In the last decade, they barreled their way into commercial real estate lending after being elbowed out of the credit card and consumer mortgage business by national players. The proportion of their lending that is in commercial real estate has nearly doubled in the last six years, according to government data.
Just as home loans were pooled, then carved up and sold to investors as securities over the last two decades, commercial property loans were repackaged for the financial markets. In 2006 and 2007, nearly 60 percent of commercial property loans were turned into securities, according to Trepp, a research firm that tracks mortgage-backed securities.
Now that the market for those securities has dried up, borrowers cannot easily roll over the loans that are coming due.
Many commercial property owners will face a dilemma similar to that of today’s homeowners who cannot easily get mortgage relief because their loans were sliced and sold to many different parties. There often is not a single entity with whom to negotiate, because investors have different interests.
By many accounts, building owners have been caught off guard by how quickly the market has deteriorated in recent weeks.
Rising vacancy rates were expected in Orange County, Calif., a center of the subprime mortgage crisis, and New York, where the now shrinking financial industry dominates office space. But vacancies are also suddenly climbing in Houston and Dallas, which had been shielded from the economic downturn until recently by skyrocketing oil prices and expanding energy businesses. In Chicago, brokers say demand has dried up just as new office towers are nearing completion.
“The economic recession is so widespread that we believe virtually every market in the country will see a rise in vacancy rates of between 2 and 5 percentage points by mid-2009,” said Bill Goade, chief executive of CresaPartners, which advises corporations on leasing and buying office space.
There is no relief in sight for Orange County, where subprime lenders and title companies once dominated the market but are now shedding space because their business has dried up, and big banks are now shrinking because of a wave of mergers. The vacancy rate has soared from 7 percent at the end of 2006 to 18 percent, a rate that the Tampa area should match this month, local real estate brokers say.
In New York, where rents had risen the highest as financial companies gobbled up office space, vacancy rates are floating above 10 percent for the first time in years.
What looked like the worst possible case a few weeks ago for Chicago now appears to be the most likely outcome, said Bill Rogers, a managing director at Jones Lang LaSalle, a real estate broker. The vacancy rate, which was fairly stable at 10 percent, is now rising quickly and could hit 17 percent in 2009, he said. “A lot of companies are trying to shed excess space ahead of what is expected to be a worse market in 2009,” Mr. Rogers said.
Newmark Knight Frank, a real estate broker, expects the vacancy rate in Dallas to rise to 19 percent this year, from 16.3 percent.
Houston, like Dallas, held up while many other cities were showing the strains of an economic slowdown. But job growth and the brisk business of oil and gas exploration have come to an abrupt halt.
Vacant or unfinished shopping centers dot the highways. Among the 8.4 million square feet of office space under construction or recently completed in the metropolitan area, 80 percent has not been leased. As a result, the vacancy rate is 11 percent and rising.
“I see a wave of troubled assets coming out of Texas in the near future,” said Dan Fasulo, managing director of Real Capital Analytics, a real estate research firm.
Effective rents, after free rent and other landlord concessions, have already started to fall and are expected to decline 30 percent or more across the country from the euphoric days of the real estate boom, according to real estate brokers and analysts.
That is making it all the more difficult for owners, who projected ever-rising rents when they financed their office buildings, hotels, shopping centers and other commercial property. Owners typically pay only the interest on loans of 5, 7 or 10 years and refinance the big principal payments necessary when the loans come due.
Without new financing, owners will have few options other than to try to negotiate terms with their lenders or hand over the keys to banks and bondholders.
Among commercial properties, the most troubled have been hotels and shopping centers, where anemic sales and bankruptcies by retailers are leading to more vacancies and where heavily leveraged mall operators, like General Growth Properties and Centro, are under intense pressure to sell assets. But analysts are increasingly worried about the office market.
The Real Estate Roundtable sees a rising risk of default and foreclosure on an estimated $400 billion in commercial mortgages that come due this year. In recent weeks, a group led by the New York developer William Rudin has pleaded with Treasury Secretary Henry M. Paulson Jr., Senator Charles E. Schumer, Democrat of New York, and others to have the government include commercial real estate in a new $200 billion program intended to spur lending.
Mr. DeBoer, the roundtable’s leader, said building owners are by and large making their loan payments. It is the refinancing that is worrisome.
Most loans, he said, were made at 50 percent to 70 percent of property values. At the top of the market in 2006 and 2007, though, some owners took advantage of available credit and borrowed 90 percent or more of the value of a property, a strategy that works only in a rising market. Since then, property values have dropped 20 percent, Mr. DeBoer said.
Where possible, owners are trying to extend loans. A lender might agree to extend the term on a 10-year commercial mortgage, for example, if the borrower remains current on payments and can make an equity payment to compensate for the decline in the building’s value.
Already, $107 billion worth of office towers, shopping centers and hotels are in some form of distress, ranging from mortgage delinquency to foreclosure, according to a report by Real Capital Analytics.
New York, the biggest market by far, leads the pack with 268 troubled properties valued at $12 billion. But there are 19 more cities, including Atlanta, Denver and Seattle, with more than $1 billion worth of distressed commercial properties.
Analysts are especially concerned about buildings like 666 Fifth Avenue, One Park Avenue and the Riverton complex in New York, the Pacifica Tower in San Diego and the Sears Tower in Chicago, which were acquired in 2006 and 2007 with mortgage-backed financing based on future rents rather than existing income.
“Many of those buildings are basically underwater,” said Mr. Goade of CresaPartners. “The price they paid was too high to begin with. There’s no way anyone would lend that kind of money today.”
Copyright 2009 The New York Times Company. All rights reserved.
Friday, January 02, 2009
WSJ: Mortgage 'Cram-Downs' Loom as Foreclosures Mount
By MICHAEL CORKERY
Mortgage lenders who wake up Thursday with a New Year's hangover are likely to face another headache soon: The effort to give bankruptcy judges the power to rewrite mortgages is gaining steam.
The banking industry hoped the mortgage "cram-down" measure died when Congress removed it from the $700 billion bailout bill that passed in October. But it has been gathering momentum in Democrat-controlled Washington, as evidence emerges that current voluntary foreclosure-prevention programs are falling short.
In a cram-down, a judge modifies a loan, often reducing principal so a borrower can afford it. Lenders hate it because they have to absorb the loss. Bankruptcy judges currently have the ability to modify certain personal loans and even mortgages on vacation homes, but they can not cram-down mortgages on primary residences.
Even staunch opponents acknowledge that mortgage cram-downs for primary residences are likely to be as part of Congress's economic-stimulus package in early 2009. The National Association of Home Builders used to reject any bill with a cram-down provision outright. Now it is saying the measure is worth a look.
President-elect Barack Obama and his incoming administration aren't disclosing details of the much-awaited foreclosure-prevention plans, but during the campaign Mr. Obama called for closing the loophole that prevents bankruptcy judges from restructuring mortgages on primary residences. Lawrence Summers, a top economic adviser of Mr. Obama, publicly voiced support for bankruptcy reform before his appointment.
"To the extent that nothing else is working, bankruptcy cram-downs are becoming more likely," says Rod Dubitsky, head of asset-backed-securities research at Credit Suisse.
The latest embattled foreclosure-prevention program is Hope for Homeowners, which was approved by Congress last summer and supposed to help 400,000 homeowners. Only 357 people have signed up so far for the voluntary program. The Department of Housing and Urban Development, which is administering the program, acknowledges that it has been encumbered by high fees and narrow eligibility requirements.
[With efforts to stem home foreclosures stagnating, mortgage 'cram-down' efforts seem destined to re-emerge under the new Congress. Here, a foreclosed home for sale in Lakewood, Colo., in September.] Associated Press
With efforts to stem home foreclosures stagnating, mortgage 'cram-down' efforts seem destined to re-emerge under the new Congress. Here, a foreclosed home for sale in Lakewood, Colo., in September.
Another government program, FHASecure, was intended to help 80,000 homeowners who had fallen behind on their payments after their adjustable interest rates reset. It has helped only 4,100 delinquent borrowers refinance since September 2007 and will stop taking new loan applications as of Wednesday.
Mortgage lenders also are modifying tens of thousands of loans without government help. But often this hasn't solved the problem. A report last week by the Office of the Comptroller of the Currency and the Office of Thrift Supervision found that nearly 37% of mortgages modified in the first quarter of 2008 were 60 days or more delinquent after six months.
"It is absolutely clear that voluntary modification is just not working," says Rep. Brad Miller, a North Carolina Democrat. "Every plan that Congress has passed, we do it and nothing happens."
Mr. Miller intends to introduce a mortgage bankruptcy-reform bill Monday, the first day of the new session. Illinois Democrat Richard Durbin plans to introduce a similar bill in the Senate.
Lenders warn that mortgage cram-downs will lead to higher interest rates and down payments, as banks seek to mitigate future losses from judicially imposed write-downs. They also are concerned that the reform measure would add to the losses they have already sustained from the housing crisis.
"Our members have modified 2.8 million loans," says Francis Creighton, chief lobbyist of the Mortgage Bankers Association, which opposes cram-downs. "Could we do better? We are trying to do better."
Proponents of bankruptcy reform say that previous modification efforts are falling short because they have focused on spreading out payment terms and forestalling delinquent payments. But that hasn't cured a big part of the problem: that one in six houses is now worth less than its mortgage. Only programs that reduce principal amounts are likely to restore equity to millions of homeowners, they say.
"You have to deal with the systematic problem of underwater mortgages or you are not going to stop foreclosures," says Harvard University economist Martin Feldstein, who has proposed his own plan to help homeowners with negative equity in their homes, which involves mortgage principal write-downs and replacing part of the original mortgage with a new, lower cost loan.
Proponents of bankruptcy reform also note that millions of troubled loans aren't being addressed by current modification programs because they were carved up and sold to investors as securities. Mortgage servicers have been reluctant to aggressively modify these loans because they have been unsure of their legal rights.
The mere threat of mortgage cram-downs could break the standoff between mortgage servicers and mortgage investors, which has slowed aggressive loan modifications. Investors may be more willing to go along with industry-driven modifications when facing the threat that a judge could ultimately order the amounts of loan principals reduced, forcing them to eat bigger losses.
"The servicers can argue we have to give this to the borrower otherwise they will get it in bankruptcy court," Mr. Dubitsky says.
Lenders argue that loans modified by bankruptcy judges often have high rates of default on the new payment plans. "We should be working on keeping people out of bankruptcy not pushing people into it,'' says Mr. Creighton of the Mortgage Bankers trade group
Bankruptcy reform is likely to be one of many proposals that Congress considers as part of comprehensive foreclosure-prevention effort. Another element is likely to be one that FDIC Chairman Sheila Bair has been proposing. Under her plan, the government and lenders would split the losses on modified loans that go into default.
Some economists are urging the new administration to go even further. Mark Zandi, chief economist at Moody's Economy.com, proposes that the government subsidize the bulk of principal write-downs to the tune of $100 billion, about four times as much as Ms. Bair's program.
—Nick Timiraos contributed to this article.
Write to Michael Corkery at michael.corkery@wsj.com
Copyright 2008 News Corp. All rights reserved.
Mortgage lenders who wake up Thursday with a New Year's hangover are likely to face another headache soon: The effort to give bankruptcy judges the power to rewrite mortgages is gaining steam.
The banking industry hoped the mortgage "cram-down" measure died when Congress removed it from the $700 billion bailout bill that passed in October. But it has been gathering momentum in Democrat-controlled Washington, as evidence emerges that current voluntary foreclosure-prevention programs are falling short.
In a cram-down, a judge modifies a loan, often reducing principal so a borrower can afford it. Lenders hate it because they have to absorb the loss. Bankruptcy judges currently have the ability to modify certain personal loans and even mortgages on vacation homes, but they can not cram-down mortgages on primary residences.
Even staunch opponents acknowledge that mortgage cram-downs for primary residences are likely to be as part of Congress's economic-stimulus package in early 2009. The National Association of Home Builders used to reject any bill with a cram-down provision outright. Now it is saying the measure is worth a look.
President-elect Barack Obama and his incoming administration aren't disclosing details of the much-awaited foreclosure-prevention plans, but during the campaign Mr. Obama called for closing the loophole that prevents bankruptcy judges from restructuring mortgages on primary residences. Lawrence Summers, a top economic adviser of Mr. Obama, publicly voiced support for bankruptcy reform before his appointment.
"To the extent that nothing else is working, bankruptcy cram-downs are becoming more likely," says Rod Dubitsky, head of asset-backed-securities research at Credit Suisse.
The latest embattled foreclosure-prevention program is Hope for Homeowners, which was approved by Congress last summer and supposed to help 400,000 homeowners. Only 357 people have signed up so far for the voluntary program. The Department of Housing and Urban Development, which is administering the program, acknowledges that it has been encumbered by high fees and narrow eligibility requirements.
[With efforts to stem home foreclosures stagnating, mortgage 'cram-down' efforts seem destined to re-emerge under the new Congress. Here, a foreclosed home for sale in Lakewood, Colo., in September.] Associated Press
With efforts to stem home foreclosures stagnating, mortgage 'cram-down' efforts seem destined to re-emerge under the new Congress. Here, a foreclosed home for sale in Lakewood, Colo., in September.
Another government program, FHASecure, was intended to help 80,000 homeowners who had fallen behind on their payments after their adjustable interest rates reset. It has helped only 4,100 delinquent borrowers refinance since September 2007 and will stop taking new loan applications as of Wednesday.
Mortgage lenders also are modifying tens of thousands of loans without government help. But often this hasn't solved the problem. A report last week by the Office of the Comptroller of the Currency and the Office of Thrift Supervision found that nearly 37% of mortgages modified in the first quarter of 2008 were 60 days or more delinquent after six months.
"It is absolutely clear that voluntary modification is just not working," says Rep. Brad Miller, a North Carolina Democrat. "Every plan that Congress has passed, we do it and nothing happens."
Mr. Miller intends to introduce a mortgage bankruptcy-reform bill Monday, the first day of the new session. Illinois Democrat Richard Durbin plans to introduce a similar bill in the Senate.
Lenders warn that mortgage cram-downs will lead to higher interest rates and down payments, as banks seek to mitigate future losses from judicially imposed write-downs. They also are concerned that the reform measure would add to the losses they have already sustained from the housing crisis.
"Our members have modified 2.8 million loans," says Francis Creighton, chief lobbyist of the Mortgage Bankers Association, which opposes cram-downs. "Could we do better? We are trying to do better."
Proponents of bankruptcy reform say that previous modification efforts are falling short because they have focused on spreading out payment terms and forestalling delinquent payments. But that hasn't cured a big part of the problem: that one in six houses is now worth less than its mortgage. Only programs that reduce principal amounts are likely to restore equity to millions of homeowners, they say.
"You have to deal with the systematic problem of underwater mortgages or you are not going to stop foreclosures," says Harvard University economist Martin Feldstein, who has proposed his own plan to help homeowners with negative equity in their homes, which involves mortgage principal write-downs and replacing part of the original mortgage with a new, lower cost loan.
Proponents of bankruptcy reform also note that millions of troubled loans aren't being addressed by current modification programs because they were carved up and sold to investors as securities. Mortgage servicers have been reluctant to aggressively modify these loans because they have been unsure of their legal rights.
The mere threat of mortgage cram-downs could break the standoff between mortgage servicers and mortgage investors, which has slowed aggressive loan modifications. Investors may be more willing to go along with industry-driven modifications when facing the threat that a judge could ultimately order the amounts of loan principals reduced, forcing them to eat bigger losses.
"The servicers can argue we have to give this to the borrower otherwise they will get it in bankruptcy court," Mr. Dubitsky says.
Lenders argue that loans modified by bankruptcy judges often have high rates of default on the new payment plans. "We should be working on keeping people out of bankruptcy not pushing people into it,'' says Mr. Creighton of the Mortgage Bankers trade group
Bankruptcy reform is likely to be one of many proposals that Congress considers as part of comprehensive foreclosure-prevention effort. Another element is likely to be one that FDIC Chairman Sheila Bair has been proposing. Under her plan, the government and lenders would split the losses on modified loans that go into default.
Some economists are urging the new administration to go even further. Mark Zandi, chief economist at Moody's Economy.com, proposes that the government subsidize the bulk of principal write-downs to the tune of $100 billion, about four times as much as Ms. Bair's program.
—Nick Timiraos contributed to this article.
Write to Michael Corkery at michael.corkery@wsj.com
Copyright 2008 News Corp. All rights reserved.
Wednesday, December 24, 2008
NYT: Loans on Distressed Properties Become a Burden and an Opportunity
By JULIE SATOW
Published: December 23, 2008
When the New York developer Harry B. Macklowe acquired the Drake Hotel almost three years ago and began buying up surrounding properties, market specialists expected him to include the site in a mammoth luxury office development.
Robert L. Freedman’s firm in Manhattan is forming a group to handle loan sales. “We are expecting a flurry of deals,” he said.
After the downturn in credit markets, however, Mr. Macklowe defaulted on his loans, and bidders are now vying for the Park Avenue site at fire-sale prices.
But the Drake site is not for sale directly. What is available is a $200 million mortgage for the swath of land, which covers a third of a city block between Park and Madison Avenues and 56th and 57th Streets. The buyer of this note will own a majority of the most senior piece of the debt, and so will most likely be paid back first should Mr. Macklowe have enough funds. If he defaults, the owner of the note will be in the best position to take ownership of the underlying property through a foreclosure.
This deal highlights a shift in the commercial real estate market, away from brick-and-mortar properties and toward the buying and selling of debt. “We are expecting a flurry of deals like the Drake Hotel site, where it is the loan that is for sale, not the actual real estate,” said Robert L. Freedman, the executive chairman of Williams Real Estate, a New York firm. The company is now creating a distressed-property group to handle such transactions.
During the real estate boom of recent years, developers increasingly used debt to finance their acquisitions. Now, with the market cooling, some of these borrowers are beginning to default. This is leaving lenders — including banks, private equity firms and hedge funds — in the position of owning the real estate.
Many lenders are looking to offload these loans because they need to cash out quickly, or because they are not in the business of selling real estate and lack the necessary resources and expertise. This means that commercial brokers, who regularly negotiated the acquisition and sale of properties, are now marketing mortgages and other loans.
“I am being inundated with calls from banks who want to sell their loans,” said David Schechtman, a senior director at the commercial brokerage firm Eastern Consolidated. “In just the last few weeks, I have also collected a list of about 30 clients — primarily high-net-worth individuals, long-established real estate families and small opportunity funds — who want to buy up these loans.”
As the market tumbles, the delinquency rate for bonds backed by commercial properties has surged. It measured 0.71 percent as of Dec. 5, compared with 0.26 percent a year earlier, according to the research firm Trepp L.L.C. While the actual number of defaults is still quite low, it is expected to increase.
“Loans don’t typically go into default immediately when there is a downturn in the market,” said Robert Knakal, the chairman of the brokerage firm Massey Knakal. “In the beginning, owners continue to make payments on their loans, hoping things will turn around, or if the loan is relatively new, it may have a significant interest reserve that is still carrying the note. So defaults on mortgages are a lagging indicator of market conditions.”
Despite this delay, there are early indications of an increase in loan sales. “Clearly, there has been a pickup in sales volume,” said David F. Dorros, a managing director at CB Richard Ellis.
To handle this uptick, brokerage firms like Eastern Consolidated are expanding their distressed-debt teams. Some firms are also requiring that their real estate brokers get broker-dealer licenses, which allows them to sell financial instruments.
Cash-rich developers and wealthy individuals are maneuvering to take advantage of the shift. Some are buying performing loans, where the borrower is continuing to pay interest on the debt. In this case, the buyer acquires the loan at a discount, but continues to receive interest payments. Then, when the loan comes due, the buyer is paid back the full face value.
Others are snatching up nonperforming loans, where the borrower has defaulted on the payments. In this case, patient buyers, including developers and private equity firms, may acquire the debt at a discount and eventually take ownership of the underlying real estate — usually after court action.
This is the strategy that the New York developer Time Equities Inc. is pursuing. “Rather than buying properties from conventional owners, we are looking to buy discounted debt on nonperforming properties,” said Francis J. Greenburger, the founder of the firm.
Time Equities is establishing a joint venture with the KOR Companies of Jersey City to buy nonperforming loans on land in the New York area, with an emphasis on New Jersey. It hopes to take ownership of the vacant sites at a discount, and develop them.
While there is a noticeable increase in this type of vulture investing, the buying and selling of commercial real estate loans is not a new strategy. CB Richard Ellis, for example, began a national loan sale advisory group five years ago.
“The business has become more visible now, but lenders have always understood it as a viable option to proactively manage their loan portfolios,” Mr. Dorros said.
In the current environment, however, the volume and complexity of deals are expected to be much greater than in the past because so many of the loans were grouped together and converted into bonds.
“The cash bind that many lenders are in is much more acute today than in the early 1990s,” when the previous major downturn in commercial real estate occurred, Mr. Knakal said.
As the market grows accustomed to the sale of loans, many eyes will be trained on the Drake Hotel site.
“It will set a floor price, establishing new benchmark metrics for the new economic realities,” Mr. Freedman said. “The Drake is just the tip of the iceberg; stay tuned, there is more to come.”
Copyright 2008 The New York Times Company. All rights reserved.
Published: December 23, 2008
When the New York developer Harry B. Macklowe acquired the Drake Hotel almost three years ago and began buying up surrounding properties, market specialists expected him to include the site in a mammoth luxury office development.
Robert L. Freedman’s firm in Manhattan is forming a group to handle loan sales. “We are expecting a flurry of deals,” he said.
After the downturn in credit markets, however, Mr. Macklowe defaulted on his loans, and bidders are now vying for the Park Avenue site at fire-sale prices.
But the Drake site is not for sale directly. What is available is a $200 million mortgage for the swath of land, which covers a third of a city block between Park and Madison Avenues and 56th and 57th Streets. The buyer of this note will own a majority of the most senior piece of the debt, and so will most likely be paid back first should Mr. Macklowe have enough funds. If he defaults, the owner of the note will be in the best position to take ownership of the underlying property through a foreclosure.
This deal highlights a shift in the commercial real estate market, away from brick-and-mortar properties and toward the buying and selling of debt. “We are expecting a flurry of deals like the Drake Hotel site, where it is the loan that is for sale, not the actual real estate,” said Robert L. Freedman, the executive chairman of Williams Real Estate, a New York firm. The company is now creating a distressed-property group to handle such transactions.
During the real estate boom of recent years, developers increasingly used debt to finance their acquisitions. Now, with the market cooling, some of these borrowers are beginning to default. This is leaving lenders — including banks, private equity firms and hedge funds — in the position of owning the real estate.
Many lenders are looking to offload these loans because they need to cash out quickly, or because they are not in the business of selling real estate and lack the necessary resources and expertise. This means that commercial brokers, who regularly negotiated the acquisition and sale of properties, are now marketing mortgages and other loans.
“I am being inundated with calls from banks who want to sell their loans,” said David Schechtman, a senior director at the commercial brokerage firm Eastern Consolidated. “In just the last few weeks, I have also collected a list of about 30 clients — primarily high-net-worth individuals, long-established real estate families and small opportunity funds — who want to buy up these loans.”
As the market tumbles, the delinquency rate for bonds backed by commercial properties has surged. It measured 0.71 percent as of Dec. 5, compared with 0.26 percent a year earlier, according to the research firm Trepp L.L.C. While the actual number of defaults is still quite low, it is expected to increase.
“Loans don’t typically go into default immediately when there is a downturn in the market,” said Robert Knakal, the chairman of the brokerage firm Massey Knakal. “In the beginning, owners continue to make payments on their loans, hoping things will turn around, or if the loan is relatively new, it may have a significant interest reserve that is still carrying the note. So defaults on mortgages are a lagging indicator of market conditions.”
Despite this delay, there are early indications of an increase in loan sales. “Clearly, there has been a pickup in sales volume,” said David F. Dorros, a managing director at CB Richard Ellis.
To handle this uptick, brokerage firms like Eastern Consolidated are expanding their distressed-debt teams. Some firms are also requiring that their real estate brokers get broker-dealer licenses, which allows them to sell financial instruments.
Cash-rich developers and wealthy individuals are maneuvering to take advantage of the shift. Some are buying performing loans, where the borrower is continuing to pay interest on the debt. In this case, the buyer acquires the loan at a discount, but continues to receive interest payments. Then, when the loan comes due, the buyer is paid back the full face value.
Others are snatching up nonperforming loans, where the borrower has defaulted on the payments. In this case, patient buyers, including developers and private equity firms, may acquire the debt at a discount and eventually take ownership of the underlying real estate — usually after court action.
This is the strategy that the New York developer Time Equities Inc. is pursuing. “Rather than buying properties from conventional owners, we are looking to buy discounted debt on nonperforming properties,” said Francis J. Greenburger, the founder of the firm.
Time Equities is establishing a joint venture with the KOR Companies of Jersey City to buy nonperforming loans on land in the New York area, with an emphasis on New Jersey. It hopes to take ownership of the vacant sites at a discount, and develop them.
While there is a noticeable increase in this type of vulture investing, the buying and selling of commercial real estate loans is not a new strategy. CB Richard Ellis, for example, began a national loan sale advisory group five years ago.
“The business has become more visible now, but lenders have always understood it as a viable option to proactively manage their loan portfolios,” Mr. Dorros said.
In the current environment, however, the volume and complexity of deals are expected to be much greater than in the past because so many of the loans were grouped together and converted into bonds.
“The cash bind that many lenders are in is much more acute today than in the early 1990s,” when the previous major downturn in commercial real estate occurred, Mr. Knakal said.
As the market grows accustomed to the sale of loans, many eyes will be trained on the Drake Hotel site.
“It will set a floor price, establishing new benchmark metrics for the new economic realities,” Mr. Freedman said. “The Drake is just the tip of the iceberg; stay tuned, there is more to come.”
Copyright 2008 The New York Times Company. All rights reserved.
Monday, December 22, 2008
WSJ: Burned Investors Won't Find Strong Safety Net
By JANE J. KIM
Investors who lost money with Bernard Madoff shouldn't count on the Securities Investor Protection Corp. riding to their rescue.
The federally mandated SIPC has a narrow requirement as to what it covers -- generally theft in brokerage accounts.
Furthermore, securities attorneys say the nonprofit organization, which is supported by brokerages' membership fees, has a miserly track record of paying out claims and its current reserves may not be nearly big enough to handle potential losses from the Madoff case.
On Monday, SIPC started the process of liquidating Bernard L. Madoff Investment Securities LLC. The case is by far, the biggest one that SIPC has ever handled. Madoff reported that it held more than $17 billion at the start of this year.
Indeed, since its creation by Congress in 1970, SIPC has had to spend only $508 million to reimburse investors after recovering assets. The Madoff case alone is likely to dwarf that.
Ceiling on Coverage
SIPC covers losses up to $500,000 per customer, which includes $100,000 on claims for cash.
Virtually all broker dealers registered with the Securities and Exchange Commission are required to have SIPC coverage, and most brokerage firms carry excess coverage for losses above this amount.
When a brokerage firm files for bankruptcy, SIPC will typically step in to help transfer investors' holdings to another firm. With Madoff's firm, however, it's not likely that SIPC and the trustee will be able to transfer the customers accounts to a solvent brokerage firm. That means that it could be months, even years, before SIPC starts paying out claims, experts say.
"We don't have any faith or reliability in the firm's statements," says SIPC's president and chief executive Steve Harbeck.
"The individual victims will have to file claims asserting and proving what they gave to Madoff securities, and we'll have to compare that to records that we have on hand," Mr. Harbeck says. "We don't know how much people gave to this organization, and we don't know how much realistically they think they're owed."
Losses from theft and proven unauthorized trading are generally covered. Losses from fraud, churning or manipulation of stock prices are usually not. SIPC also doesn't cover investment losses or some holdings, such as currencies, hedge funds and limited partnerships not registered with the SEC.
"Our job is really elegantly simple: It's to return the contents of your account," says Mr. Harbeck.
Securities attorneys say SIPC often takes a narrow definition of what is covered by its statute, the Securities Investor Protection Act. "Literally, you have to prove that someone reached into your brokerage account and wrote a check to themselves," said Robert Uhl, a securities attorney in Beverly Hills, Calif.
Mark Maddox, an Indianapolis attorney, has represented about 300 investors from 1997 to 2001 who struggled to get SIPC to pay their claims after they lost money when the Stratton Oakmont brokerage firm filed for bankruptcy in 1997. Of those clients, he says that SIPC initially denied about 90% of his claims, forcing him to file appeals. In most cases, SIPC took the position that it would be responsible only for losses up to its $100,000 cash limit.
"SIPC doesn't like to pay claims and when they do pay a claim, they try to pay as little as possible," he says.
SIPC says only 349 customers through 2007 have failed to get their entire portfolios back.
Some industry watchers question whether SIPC has enough in reserves to cover potential claims in the Madoff liquidation. Currently, the SIPC Fund has about $1.6 billion to cover potential claims and SIPC can borrow up to $1 billion from an international consortium of banks and another $1 billion from the Securities and Exchange Commission.
"There are so many different things that we don't know that it's impossible to determine what the SIPC exposure is," says Mr. Harbeck.
Annual Fee: $150
SIPC's reserve is funded by its member brokerage firms, which all pay a flat fee of $150 a year. SIPC used to charge an assessment fee based on the firm's net operating revenues but moved to a flat annual fee of $150 in 1996 after its fund hit $1 billion.
SIPC's reserves are tiny compared to what's held by the Federal Deposit Insurance Corp., which covers bank deposits up to $250,000. The FDIC's reserves totaled $34.6 billion as of the third quarter. But SIPC says its coffers don't need to be big because brokerage firms are supposed to keep investors' stocks and bonds segregated from the firms' assets.
Banks, by contrast, lend out customers' money to other customers, who might default on those loans.
Now that SIPC has started the liquidation process, the court-appointed trustee will compile a mailing list of the company's customers. After the court has approved the claim forms and authorized the publication of notice, the trustee will mail out the claim forms to customers.
Investors will typically have six months to file their claims, which must be sent by certified mail, from the time the notice is published. Eventually, the trustee will set up a Web site with more information.
For now, any investors with brokerage accounts at Mr. Madoff's firm should save any documentation, such as monthly statements and investor reports going back as far as possible, says Steven Caruso, a securities attorney in New York.
"Those statements show what was supposed to be in your account or what the value was," says Mr. Caruso, who worked with about 500 investors to file claims with SIPC in the Stratton Oakmont case.
In many of those cases, his clients had to provide detailed paper trails -- such as documentation proving that they complained to the firm about unauthorized trades at the time of the trade -- in order to show that their trades were unauthorized.
Copyright 2008 News Corp. All rights reserved.
Investors who lost money with Bernard Madoff shouldn't count on the Securities Investor Protection Corp. riding to their rescue.
The federally mandated SIPC has a narrow requirement as to what it covers -- generally theft in brokerage accounts.
Furthermore, securities attorneys say the nonprofit organization, which is supported by brokerages' membership fees, has a miserly track record of paying out claims and its current reserves may not be nearly big enough to handle potential losses from the Madoff case.
On Monday, SIPC started the process of liquidating Bernard L. Madoff Investment Securities LLC. The case is by far, the biggest one that SIPC has ever handled. Madoff reported that it held more than $17 billion at the start of this year.
Indeed, since its creation by Congress in 1970, SIPC has had to spend only $508 million to reimburse investors after recovering assets. The Madoff case alone is likely to dwarf that.
Ceiling on Coverage
SIPC covers losses up to $500,000 per customer, which includes $100,000 on claims for cash.
Virtually all broker dealers registered with the Securities and Exchange Commission are required to have SIPC coverage, and most brokerage firms carry excess coverage for losses above this amount.
When a brokerage firm files for bankruptcy, SIPC will typically step in to help transfer investors' holdings to another firm. With Madoff's firm, however, it's not likely that SIPC and the trustee will be able to transfer the customers accounts to a solvent brokerage firm. That means that it could be months, even years, before SIPC starts paying out claims, experts say.
"We don't have any faith or reliability in the firm's statements," says SIPC's president and chief executive Steve Harbeck.
"The individual victims will have to file claims asserting and proving what they gave to Madoff securities, and we'll have to compare that to records that we have on hand," Mr. Harbeck says. "We don't know how much people gave to this organization, and we don't know how much realistically they think they're owed."
Losses from theft and proven unauthorized trading are generally covered. Losses from fraud, churning or manipulation of stock prices are usually not. SIPC also doesn't cover investment losses or some holdings, such as currencies, hedge funds and limited partnerships not registered with the SEC.
"Our job is really elegantly simple: It's to return the contents of your account," says Mr. Harbeck.
Securities attorneys say SIPC often takes a narrow definition of what is covered by its statute, the Securities Investor Protection Act. "Literally, you have to prove that someone reached into your brokerage account and wrote a check to themselves," said Robert Uhl, a securities attorney in Beverly Hills, Calif.
Mark Maddox, an Indianapolis attorney, has represented about 300 investors from 1997 to 2001 who struggled to get SIPC to pay their claims after they lost money when the Stratton Oakmont brokerage firm filed for bankruptcy in 1997. Of those clients, he says that SIPC initially denied about 90% of his claims, forcing him to file appeals. In most cases, SIPC took the position that it would be responsible only for losses up to its $100,000 cash limit.
"SIPC doesn't like to pay claims and when they do pay a claim, they try to pay as little as possible," he says.
SIPC says only 349 customers through 2007 have failed to get their entire portfolios back.
Some industry watchers question whether SIPC has enough in reserves to cover potential claims in the Madoff liquidation. Currently, the SIPC Fund has about $1.6 billion to cover potential claims and SIPC can borrow up to $1 billion from an international consortium of banks and another $1 billion from the Securities and Exchange Commission.
"There are so many different things that we don't know that it's impossible to determine what the SIPC exposure is," says Mr. Harbeck.
Annual Fee: $150
SIPC's reserve is funded by its member brokerage firms, which all pay a flat fee of $150 a year. SIPC used to charge an assessment fee based on the firm's net operating revenues but moved to a flat annual fee of $150 in 1996 after its fund hit $1 billion.
SIPC's reserves are tiny compared to what's held by the Federal Deposit Insurance Corp., which covers bank deposits up to $250,000. The FDIC's reserves totaled $34.6 billion as of the third quarter. But SIPC says its coffers don't need to be big because brokerage firms are supposed to keep investors' stocks and bonds segregated from the firms' assets.
Banks, by contrast, lend out customers' money to other customers, who might default on those loans.
Now that SIPC has started the liquidation process, the court-appointed trustee will compile a mailing list of the company's customers. After the court has approved the claim forms and authorized the publication of notice, the trustee will mail out the claim forms to customers.
Investors will typically have six months to file their claims, which must be sent by certified mail, from the time the notice is published. Eventually, the trustee will set up a Web site with more information.
For now, any investors with brokerage accounts at Mr. Madoff's firm should save any documentation, such as monthly statements and investor reports going back as far as possible, says Steven Caruso, a securities attorney in New York.
"Those statements show what was supposed to be in your account or what the value was," says Mr. Caruso, who worked with about 500 investors to file claims with SIPC in the Stratton Oakmont case.
In many of those cases, his clients had to provide detailed paper trails -- such as documentation proving that they complained to the firm about unauthorized trades at the time of the trade -- in order to show that their trades were unauthorized.
Copyright 2008 News Corp. All rights reserved.
Friday, December 19, 2008
New York Times: Tax Rules for Theft Losses Could Help Some Investors
By LYNNLEY BROWNING
Published: December 18, 2008
For the legions of investors who appear to have been swindled by Bernard L. Madoff, there could be some relief.
Tax rules allow investors who fall prey to criminal theft perpetrated by their investment advisers or brokers to claim a tax deduction stemming from their losses.
The rules, which are intended to aid investors cheated through embezzlement, pyramid schemes, extortion or robbery, could potentially put hundreds of millions or even billions of dollars back into the pockets of Mr. Madoff’s stunned investors. They include the publishing magnate Mort Zuckerman; the owner of the New York Mets, Fred Wilpon; a foundation run by the filmmaker Steven Spielberg; and wealthy clients and banks from Palm Beach to Switzerland.
But it is unclear whether the Internal Revenue Service will see things that way. “We are aware of the situation, but beyond that, we have no comment,” Bruce Friedland, an I.R.S. spokesman, said on Thursday.
Gary A. Zwick, a tax lawyer at Walter & Haverfield in Cleveland, said, “It’s fair to say that many people will take the position that the theft loss rules will apply, but the government may not take that approach.”
Investors who can prove they were cheated may also be able to claim a refund for federal taxes paid over the last two years on “phantom” interest income from their investments with Mr. Madoff. But they cannot claim a refund for taxes paid on any capital paid back to them. Mr. Madoff, who was arrested last Thursday, ran what prosecutors contend is history’s largest Ponzi scheme.
On the tax front, a formal declaration that Mr. Madoff’s investment funds are bankrupt would help investors. “Embezzlement followed by bankruptcy is a pretty good indication that you’re not going to get your money back and will have a theft-loss claim,” said D. Matthew Richardson, a tax lawyer at Sheppard Mullin Richter & Hampton in Los Angeles. Mr. Madoff’s firm, Bernard L. Madoff Investment Securities, is currently being liquidated by a court-appointed trustee.
But before investors can claim the deduction, they have to clear a tall hurdle: they have to be reasonably certain that they will not recover their money. Proving that could take years, as investigators and regulators pore over Mr. Madoff’s books and a wave of lawsuits emerges.
It is unknown whether Mr. Madoff used investors’ money not just to pay early investors but also to stash in his personal bank accounts overseas or to underwrite a lavish lifestyle. Any such assets, as well as insurance, could be a source of recovery for investors — and could dilute any tax write-offs. The charities that fell victim to Mr. Madoff would not be eligible for any relief because they are exempt from taxes.
“I think it’s 100 percent certain that investors will get the theft-loss deduction, but nobody’s going to get it right away, and it may take five years,” said Alvin Brown, a tax lawyer and former manager in the I.R.S.’s chief of legal department.
Under theft-loss rules, investors can generally deduct 90 percent of their losses against their adjusted gross income, according to Robert Willens, a tax and accounting authority. Investors who argue that the loss arose from a for-profit transaction — the point of investing — may be able to deduct 100 percent. “Investors in programs sponsored by Mr. Bernard Madoff may find that their losses will be mitigated by certain ameliorative provisions of the tax code,” Mr. Willens said.
The rules permit losses stemming from theft to be deducted in the year in which the loss is discovered by the investor, even if it took place earlier. They also allow investors to carry back theft-losses for three years — one more year than under the rules for capital losses — and to carry losses forward for 20 years. Investors compute losses according to the adjusted basis in their investment, not the current fair-market value.
The theft-loss deduction is not the same as the more commonly used capital loss deduction, which applies to securities that decline in value.
In 2006, the I.R.S. processed more than 206,000 claims for theft-loss and casualty deductions — the I.R.S. groups the two — worth more than $5.1 billion. Claims filed under the Madoff scheme would most likely dwarf that dollar figure.
Copyright 2008 The New York Times Company. All rights reserved.
Published: December 18, 2008
For the legions of investors who appear to have been swindled by Bernard L. Madoff, there could be some relief.
Tax rules allow investors who fall prey to criminal theft perpetrated by their investment advisers or brokers to claim a tax deduction stemming from their losses.
The rules, which are intended to aid investors cheated through embezzlement, pyramid schemes, extortion or robbery, could potentially put hundreds of millions or even billions of dollars back into the pockets of Mr. Madoff’s stunned investors. They include the publishing magnate Mort Zuckerman; the owner of the New York Mets, Fred Wilpon; a foundation run by the filmmaker Steven Spielberg; and wealthy clients and banks from Palm Beach to Switzerland.
But it is unclear whether the Internal Revenue Service will see things that way. “We are aware of the situation, but beyond that, we have no comment,” Bruce Friedland, an I.R.S. spokesman, said on Thursday.
Gary A. Zwick, a tax lawyer at Walter & Haverfield in Cleveland, said, “It’s fair to say that many people will take the position that the theft loss rules will apply, but the government may not take that approach.”
Investors who can prove they were cheated may also be able to claim a refund for federal taxes paid over the last two years on “phantom” interest income from their investments with Mr. Madoff. But they cannot claim a refund for taxes paid on any capital paid back to them. Mr. Madoff, who was arrested last Thursday, ran what prosecutors contend is history’s largest Ponzi scheme.
On the tax front, a formal declaration that Mr. Madoff’s investment funds are bankrupt would help investors. “Embezzlement followed by bankruptcy is a pretty good indication that you’re not going to get your money back and will have a theft-loss claim,” said D. Matthew Richardson, a tax lawyer at Sheppard Mullin Richter & Hampton in Los Angeles. Mr. Madoff’s firm, Bernard L. Madoff Investment Securities, is currently being liquidated by a court-appointed trustee.
But before investors can claim the deduction, they have to clear a tall hurdle: they have to be reasonably certain that they will not recover their money. Proving that could take years, as investigators and regulators pore over Mr. Madoff’s books and a wave of lawsuits emerges.
It is unknown whether Mr. Madoff used investors’ money not just to pay early investors but also to stash in his personal bank accounts overseas or to underwrite a lavish lifestyle. Any such assets, as well as insurance, could be a source of recovery for investors — and could dilute any tax write-offs. The charities that fell victim to Mr. Madoff would not be eligible for any relief because they are exempt from taxes.
“I think it’s 100 percent certain that investors will get the theft-loss deduction, but nobody’s going to get it right away, and it may take five years,” said Alvin Brown, a tax lawyer and former manager in the I.R.S.’s chief of legal department.
Under theft-loss rules, investors can generally deduct 90 percent of their losses against their adjusted gross income, according to Robert Willens, a tax and accounting authority. Investors who argue that the loss arose from a for-profit transaction — the point of investing — may be able to deduct 100 percent. “Investors in programs sponsored by Mr. Bernard Madoff may find that their losses will be mitigated by certain ameliorative provisions of the tax code,” Mr. Willens said.
The rules permit losses stemming from theft to be deducted in the year in which the loss is discovered by the investor, even if it took place earlier. They also allow investors to carry back theft-losses for three years — one more year than under the rules for capital losses — and to carry losses forward for 20 years. Investors compute losses according to the adjusted basis in their investment, not the current fair-market value.
The theft-loss deduction is not the same as the more commonly used capital loss deduction, which applies to securities that decline in value.
In 2006, the I.R.S. processed more than 206,000 claims for theft-loss and casualty deductions — the I.R.S. groups the two — worth more than $5.1 billion. Claims filed under the Madoff scheme would most likely dwarf that dollar figure.
Copyright 2008 The New York Times Company. All rights reserved.
New York Times: In Madoff, Winners May Still Lose Out
By ALEX BERENSON
Published: December 18, 2008
Amid the thousands of people caught up in the apparent multibillion-dollar fraud of Bernard L. Madoff, some investors stand out.
They made money.
One client said he invested more than $1 million with Mr. Madoff over a decade ago. As his portfolio rose in value, he took out several million dollars. While his statements showed several million dollars in his Madoff account when the fund collapsed last week, the client still ended up ahead.
How many clients of Bernard L. Madoff Investment Securities profited unwittingly on what Mr. Madoff described as a big Ponzi scheme isn’t known. But given the structure of Ponzi schemes, which use money from later investors to pay early investors, many longtime clients may actually have wound up ahead.
“In a Ponzi scheme, not all investors lose,” said Tamar Frankel, a law professor at Boston University who has written on Ponzi schemes. “Those who manage to get out in time retain their investments and some of their gains.”
But previous court rulings regarding financial frauds suggest the winners could be forced to give up some of their gains to losers.
One of the unanswered questions so far is precisely how much investors lost over all.
When Mr. Madoff confessed and was arrested last week, he told F.B.I. agents that the losses might be $50 billion, according to court filings. Various institutions and individuals so far have reported losses totaling more than $20 billion, but it is unclear how much of that is cash they actually invested and how much represents paper profits based on the falsified returns Mr. Madoff said investors were earning.
Mr. Madoff regularly delivered returns of 10 to 17 percent to investors, a very good year-in, year-out return but on the low end of the 10 to 100 percent a year typically dangled by promoters of Ponzi schemes.
But assets that can guarantee those returns year after year without risk simply do not exist. Instead of profitable investments, Ponzi schemes repay initial investors by raising more money from new investors. The schemes typically collapse when the promoter cannot bring in enough money to pay existing investors seeking redemptions.
Joel M. Cohen, the deputy head of litigation for the Clifford Chance law firm and a former federal prosecutor who specialized in business and securities fraud, said that payments to early investors were an integral part of any Ponzi scheme.
“You need to deliver returns in the range that you promised to attract investors,” Mr. Cohen said.
Yet even Mr. Madoff’s most fortunate clients may wind up having to give back some of their gains, as investors might have to do in another recent financial fraud, the collapse of the hedge fund Bayou Group in 2005.
In the Bayou case, in which investors lost $400 million, a bankruptcy judge ruled that investors who withdrew money even before Bayou collapsed might have to return their profits, and possibly some of the initial investments, to the bankruptcy trustee overseeing the unwinding of Bayou.
The returned money is to be distributed among all investors, who are expected to receive only about 20 to 40 percent of their original investments.
Mr. Madoff’s winning clients are likely to face similar legal challenges. In fact, the Madoff client who profited from his investment spoke on the condition that he not be identified, out of concern that he might be sought out to repay some of his gains to the receiver or bankruptcy trustee for Mr. Madoff.
Jay B. Gould, a former lawyer at the Securities and Exchange Commission who now runs the hedge funds practice at Pillsbury Winthrop Shaw Pittman, said the client was correct to be concerned. New York State law may allow the receiver or bankruptcy trustee to demand that Mr. Madoff’s investors return money they received from the scheme any time in the last six years, Mr. Gould said.
Such so-called clawbacks may occur even if the client had no idea that the gains were fraudulent, he said.
“The idea is that the whole thing was a fraudulent undertaking, so nobody should profit from it, and everybody should be put on equitable footing,” Mr. Gould said.
But in a sign of the complexity of securities law, Mr. Cohen said he did not agree with Mr. Gould’s interpretation.
“I don’t think it’s that easy to claw back money from something that happened six years ago,” Mr. Cohen said. “There’s no level of fiduciary duty between investors. If someone put in a million dollars five years ago, and made 11 percent, and took their money out after one year, are they required to give back the 11 percent? I think that’s inaccurate.”
Even determining which investors made money will be enormously complicated.
Mr. Madoff’s practices appear to have gone on for many years and entangled thousands, perhaps tens of thousands, of clients, who invested both directly with him and through third-party hedge funds. Some of those investors never took out a cent, while others took out only a fraction of what they invested and a few took out more than they put in.
Jesse Gottlieb, a life insurance broker in New York, said his account statements show that he had about $17 million at the Madoff firm when it collapsed.
Mr. Gottlieb declined to say how much cash he had invested, but he said he had taken out only a small amount of money from his investments with Mr. Madoff, which were held in trusts for his sons.
Mr. Gottlieb said he knew of other investors who regularly cashed out portions of their accounts. In most cases, they were retirees who left their principal with Mr. Madoff, but lived off the annual 10 to 17 percent returns he provided, Mr. Gottlieb said.
The complexity of situations like the one that Mr. Gottlieb described means that investors may wind up suing each other, as well as the hedge funds and banks that brought them into Mr. Madoff’s funds and the auditors who worked for those hedge funds.
“This is so big, and there are so many people situated differently,” Mr. Gould said. “Everybody is potentially averse to everybody else.”
Copyright 2008 The New York Times Company. All rights reserved.
Published: December 18, 2008
Amid the thousands of people caught up in the apparent multibillion-dollar fraud of Bernard L. Madoff, some investors stand out.
They made money.
One client said he invested more than $1 million with Mr. Madoff over a decade ago. As his portfolio rose in value, he took out several million dollars. While his statements showed several million dollars in his Madoff account when the fund collapsed last week, the client still ended up ahead.
How many clients of Bernard L. Madoff Investment Securities profited unwittingly on what Mr. Madoff described as a big Ponzi scheme isn’t known. But given the structure of Ponzi schemes, which use money from later investors to pay early investors, many longtime clients may actually have wound up ahead.
“In a Ponzi scheme, not all investors lose,” said Tamar Frankel, a law professor at Boston University who has written on Ponzi schemes. “Those who manage to get out in time retain their investments and some of their gains.”
But previous court rulings regarding financial frauds suggest the winners could be forced to give up some of their gains to losers.
One of the unanswered questions so far is precisely how much investors lost over all.
When Mr. Madoff confessed and was arrested last week, he told F.B.I. agents that the losses might be $50 billion, according to court filings. Various institutions and individuals so far have reported losses totaling more than $20 billion, but it is unclear how much of that is cash they actually invested and how much represents paper profits based on the falsified returns Mr. Madoff said investors were earning.
Mr. Madoff regularly delivered returns of 10 to 17 percent to investors, a very good year-in, year-out return but on the low end of the 10 to 100 percent a year typically dangled by promoters of Ponzi schemes.
But assets that can guarantee those returns year after year without risk simply do not exist. Instead of profitable investments, Ponzi schemes repay initial investors by raising more money from new investors. The schemes typically collapse when the promoter cannot bring in enough money to pay existing investors seeking redemptions.
Joel M. Cohen, the deputy head of litigation for the Clifford Chance law firm and a former federal prosecutor who specialized in business and securities fraud, said that payments to early investors were an integral part of any Ponzi scheme.
“You need to deliver returns in the range that you promised to attract investors,” Mr. Cohen said.
Yet even Mr. Madoff’s most fortunate clients may wind up having to give back some of their gains, as investors might have to do in another recent financial fraud, the collapse of the hedge fund Bayou Group in 2005.
In the Bayou case, in which investors lost $400 million, a bankruptcy judge ruled that investors who withdrew money even before Bayou collapsed might have to return their profits, and possibly some of the initial investments, to the bankruptcy trustee overseeing the unwinding of Bayou.
The returned money is to be distributed among all investors, who are expected to receive only about 20 to 40 percent of their original investments.
Mr. Madoff’s winning clients are likely to face similar legal challenges. In fact, the Madoff client who profited from his investment spoke on the condition that he not be identified, out of concern that he might be sought out to repay some of his gains to the receiver or bankruptcy trustee for Mr. Madoff.
Jay B. Gould, a former lawyer at the Securities and Exchange Commission who now runs the hedge funds practice at Pillsbury Winthrop Shaw Pittman, said the client was correct to be concerned. New York State law may allow the receiver or bankruptcy trustee to demand that Mr. Madoff’s investors return money they received from the scheme any time in the last six years, Mr. Gould said.
Such so-called clawbacks may occur even if the client had no idea that the gains were fraudulent, he said.
“The idea is that the whole thing was a fraudulent undertaking, so nobody should profit from it, and everybody should be put on equitable footing,” Mr. Gould said.
But in a sign of the complexity of securities law, Mr. Cohen said he did not agree with Mr. Gould’s interpretation.
“I don’t think it’s that easy to claw back money from something that happened six years ago,” Mr. Cohen said. “There’s no level of fiduciary duty between investors. If someone put in a million dollars five years ago, and made 11 percent, and took their money out after one year, are they required to give back the 11 percent? I think that’s inaccurate.”
Even determining which investors made money will be enormously complicated.
Mr. Madoff’s practices appear to have gone on for many years and entangled thousands, perhaps tens of thousands, of clients, who invested both directly with him and through third-party hedge funds. Some of those investors never took out a cent, while others took out only a fraction of what they invested and a few took out more than they put in.
Jesse Gottlieb, a life insurance broker in New York, said his account statements show that he had about $17 million at the Madoff firm when it collapsed.
Mr. Gottlieb declined to say how much cash he had invested, but he said he had taken out only a small amount of money from his investments with Mr. Madoff, which were held in trusts for his sons.
Mr. Gottlieb said he knew of other investors who regularly cashed out portions of their accounts. In most cases, they were retirees who left their principal with Mr. Madoff, but lived off the annual 10 to 17 percent returns he provided, Mr. Gottlieb said.
The complexity of situations like the one that Mr. Gottlieb described means that investors may wind up suing each other, as well as the hedge funds and banks that brought them into Mr. Madoff’s funds and the auditors who worked for those hedge funds.
“This is so big, and there are so many people situated differently,” Mr. Gould said. “Everybody is potentially averse to everybody else.”
Copyright 2008 The New York Times Company. All rights reserved.
Wednesday, December 17, 2008
Season's Greetings
President John F. Kennedy said “Change is the law of life.” And 2008 has been a year full of change-in the markets, in politics and in all of our lives.
In these uncertain and changing times, everyone at Shenwick & Associates wishes you and your family happy holidays. Wherever the changes of life take you, we will be there to help guide you through.
We hope you enjoy the warm spirit of this season with much joy in the coming year.
Wishing you the very best during the holidays and throughout the New Year.
Jim & Staff
In these uncertain and changing times, everyone at Shenwick & Associates wishes you and your family happy holidays. Wherever the changes of life take you, we will be there to help guide you through.
We hope you enjoy the warm spirit of this season with much joy in the coming year.
Wishing you the very best during the holidays and throughout the New Year.
Jim & Staff
Wednesday, December 03, 2008
New York Times: Manhattan Awash in Open Office Space
Square Feet
By J. ALEX TARQUINIO
Last year, when the New York real estate market was still frothy, large blocks of office space were hard to come by. Not anymore.
Almost 16 million square feet is currently listed as available in large blocks in 68 office buildings in Manhattan, according to Colliers ABR, a commercial brokerage firm. That is nearly double the space available a year ago, both in terms of the number of large office blocks — which in New York usually means 100,000 square feet or more — and in terms of total square feet.
Those figures are widely expected to go much higher, said Robert L. Sammons, the managing director of research for Colliers ABR. He said it was difficult to get a handle on exactly how much space financial companies alone might put back onto the Manhattan office market over the next year or so.
“Honestly, I don’t think any of these financial firms know how this is going to play out,” he said. “They are trying to figure out how many people they will need on staff, and in some cases how they are going to stay in business.”
Pending layoffs in the financial industry certainly account for some of the space on the market. But there are other factors. Some companies are moving into new headquarters — which were first planned years ago — while others are disposing of real estate that they came into through acquisitions.
By far the biggest increase in availability has been in the sublease market. Currently, at least 16 large office blocks are being marketed for sublease in Manhattan, up from just 3 listed at this time last year, according to Colliers ABR.
Michael Colacino, the president of Studley, a real estate brokerage firm that specializes in representing office tenants, said the sublet space that had come onto the market recently was attractively priced.
He said some tenants might do better by shopping the sublet market rather than trying to renegotiate a better rent with their current landlords. “A lot of landlords are still in denial,” Mr. Colacino said, “but the sublease space is priced realistically for the actual market conditions.”
Mr. Colacino estimates that the actual rents on deals signed in the last three months are down by as much as 20 to 30 percent from the going rents at the end of the summer — to around $75 to $80 a square foot annually in Midtown and around $45 a square foot downtown.
Among current offerings — including both subleases and direct leases from owners — roughly a quarter of the space in the Midtown and downtown office markets became available because a financial company either did not renew its lease or decided to market the space for sublet.
But the picture could become much starker next year. Among large office blocks that brokers expect to hit the market, Mr. Sammons estimates that the financial industry will account for roughly one-third of the new space coming on the market in Midtown and more than half of the new space downtown.
Lehman Brothers, Merrill Lynch and Deutsche Bank all have leases that Mr. Sammons counted among the potential new listings of large office blocks. And that list does not include Citigroup — although the banking giant has announced that it will lay off more than 50,000 employees worldwide — because Mr. Sammons said it was too soon to know if Citigroup would give up any large office blocks in Manhattan.
So far this year, brokers say, the main event in Midtown has been the completion of One Bryant Park, a 54-story office tower that recently opened at the corner of 42nd Street and the Avenue of the Americas.
As the main tenant, Bank of America, which is based in Charlotte, N.C., moves employees into this new building, it is giving up earlier leases for hundreds of thousands of square feet in other prominent Midtown office buildings, like 9 West 57th Street. Brokers also widely expect the bank to offer for sublet more than 300,000 square feet that it currently leases in 50 Rockefeller Plaza.
JPMorgan Chase has already put some large blocks of space on the sublet market near its world headquarters, at 270 Park Avenue, between 47th and 48th Streets. Chase is marketing sublets for 140,000 square feet at 320 Park Avenue, and 195,000 square feet at 237 Park Avenue. The bank acquired the lease at 237 Park Avenue when it bought Bear Stearns in March.
Chase plans to keep the former Bear Stearns headquarters, though, which is at 383 Madison Avenue, between 46th and 47th Streets. Chase plans to move its investment banking unit into that building, which is just one block from its own headquarters.
“We are looking to make the most economical use of the space that we have for our employees, businesses and shareholders,” said Darlene Taylor, a spokeswoman for JPMorgan Chase.
Downtown, some large blocks of space are expected to become available late next year, when Goldman Sachs completes its new 2.1-million-square-foot 43-story world headquarters at 200 West Street in Battery Park City. When Goldman starts moving into its new building, it plans to allow earlier leases for more than 1.5 million square feet in Lower Manhattan to expire. The bank is also marketing for sublet 600,000 square feet of space that it leases at 77 Water Street.
There is also a great deal of speculation swirling around the ultimate destination of Merrill Lynch, which is to be acquired by Bank of America. The merger could close this month or early next year.
Some brokers suggest that Bank of America might decide to move Merrill Lynch from its headquarters at 4 World Financial Center, where Merrill leases 2.1 million square feet, to be closer to the bank’s new Bryant Park headquarters. If that happens, it would shift even more of the financial industry from Wall Street to Midtown, following what has been a long-term trend.
Copyright 2008 The New York Times Company. All rights reserved.
By J. ALEX TARQUINIO
Last year, when the New York real estate market was still frothy, large blocks of office space were hard to come by. Not anymore.
Almost 16 million square feet is currently listed as available in large blocks in 68 office buildings in Manhattan, according to Colliers ABR, a commercial brokerage firm. That is nearly double the space available a year ago, both in terms of the number of large office blocks — which in New York usually means 100,000 square feet or more — and in terms of total square feet.
Those figures are widely expected to go much higher, said Robert L. Sammons, the managing director of research for Colliers ABR. He said it was difficult to get a handle on exactly how much space financial companies alone might put back onto the Manhattan office market over the next year or so.
“Honestly, I don’t think any of these financial firms know how this is going to play out,” he said. “They are trying to figure out how many people they will need on staff, and in some cases how they are going to stay in business.”
Pending layoffs in the financial industry certainly account for some of the space on the market. But there are other factors. Some companies are moving into new headquarters — which were first planned years ago — while others are disposing of real estate that they came into through acquisitions.
By far the biggest increase in availability has been in the sublease market. Currently, at least 16 large office blocks are being marketed for sublease in Manhattan, up from just 3 listed at this time last year, according to Colliers ABR.
Michael Colacino, the president of Studley, a real estate brokerage firm that specializes in representing office tenants, said the sublet space that had come onto the market recently was attractively priced.
He said some tenants might do better by shopping the sublet market rather than trying to renegotiate a better rent with their current landlords. “A lot of landlords are still in denial,” Mr. Colacino said, “but the sublease space is priced realistically for the actual market conditions.”
Mr. Colacino estimates that the actual rents on deals signed in the last three months are down by as much as 20 to 30 percent from the going rents at the end of the summer — to around $75 to $80 a square foot annually in Midtown and around $45 a square foot downtown.
Among current offerings — including both subleases and direct leases from owners — roughly a quarter of the space in the Midtown and downtown office markets became available because a financial company either did not renew its lease or decided to market the space for sublet.
But the picture could become much starker next year. Among large office blocks that brokers expect to hit the market, Mr. Sammons estimates that the financial industry will account for roughly one-third of the new space coming on the market in Midtown and more than half of the new space downtown.
Lehman Brothers, Merrill Lynch and Deutsche Bank all have leases that Mr. Sammons counted among the potential new listings of large office blocks. And that list does not include Citigroup — although the banking giant has announced that it will lay off more than 50,000 employees worldwide — because Mr. Sammons said it was too soon to know if Citigroup would give up any large office blocks in Manhattan.
So far this year, brokers say, the main event in Midtown has been the completion of One Bryant Park, a 54-story office tower that recently opened at the corner of 42nd Street and the Avenue of the Americas.
As the main tenant, Bank of America, which is based in Charlotte, N.C., moves employees into this new building, it is giving up earlier leases for hundreds of thousands of square feet in other prominent Midtown office buildings, like 9 West 57th Street. Brokers also widely expect the bank to offer for sublet more than 300,000 square feet that it currently leases in 50 Rockefeller Plaza.
JPMorgan Chase has already put some large blocks of space on the sublet market near its world headquarters, at 270 Park Avenue, between 47th and 48th Streets. Chase is marketing sublets for 140,000 square feet at 320 Park Avenue, and 195,000 square feet at 237 Park Avenue. The bank acquired the lease at 237 Park Avenue when it bought Bear Stearns in March.
Chase plans to keep the former Bear Stearns headquarters, though, which is at 383 Madison Avenue, between 46th and 47th Streets. Chase plans to move its investment banking unit into that building, which is just one block from its own headquarters.
“We are looking to make the most economical use of the space that we have for our employees, businesses and shareholders,” said Darlene Taylor, a spokeswoman for JPMorgan Chase.
Downtown, some large blocks of space are expected to become available late next year, when Goldman Sachs completes its new 2.1-million-square-foot 43-story world headquarters at 200 West Street in Battery Park City. When Goldman starts moving into its new building, it plans to allow earlier leases for more than 1.5 million square feet in Lower Manhattan to expire. The bank is also marketing for sublet 600,000 square feet of space that it leases at 77 Water Street.
There is also a great deal of speculation swirling around the ultimate destination of Merrill Lynch, which is to be acquired by Bank of America. The merger could close this month or early next year.
Some brokers suggest that Bank of America might decide to move Merrill Lynch from its headquarters at 4 World Financial Center, where Merrill leases 2.1 million square feet, to be closer to the bank’s new Bryant Park headquarters. If that happens, it would shift even more of the financial industry from Wall Street to Midtown, following what has been a long-term trend.
Copyright 2008 The New York Times Company. All rights reserved.
Tuesday, December 02, 2008
Unsecured Mortgages in Chapter 13 bankruptcy
In our current falling real estate market, Shenwick & Associates has been receiving many calls regarding saving homes from foreclosure. One possible solution may be Chapter 13 bankruptcy. In a Chapter 13 bankruptcy, an individual with regular income can retain their property and make installment payments to their creditors over a period of three to five years, if they have unsecured debt of less than $336,900 and secured debt of less than $1,010,650.
Due to declining real estate values, many homeowners (over 7.5 million, according to a recent CNN Money report) are “underwater”-in other words, the value of their property (the collateral) is less than the balance due on their mortgages. In 2001, the Second Circuit Court of Appeals held in Pond v. Farm Specialist Realty et al. (In re Pond), 252 F. 3d 122 (2d Cir. 2001), that an unsecured mortgagee’s interest in a Chapter 13 debtor’s principal residence is voidable where there is insufficient equity in the property to cover any portion of their lien.
The debtors, Richard and Lorrie Pond, filed for bankruptcy under Chapter 13 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of New York. The Court held a hearing and determined that the debtors’ residential property was valued at $69,000. The Court also determined that there were four liens on the property, which had to be discharged in the following order of priority: (1) $1,505.18 for real property taxes; (2) $48,995.63 for the mortgage of the Farmers Home Administration; (3) $20,000 for the mortgage of the New York State Affordable Housing Corporation; and (4) $10,630.58 for the mortgage of Farm Specialist Realty and Charles Livingston, Jr. (the Defendants). The first three liens amounted to an encumbrance of $70,500.81, so the Ponds’ property had insufficient equity to cover any portion of the Defendants’ lien.
The Ponds then commenced an adversary proceeding to dissolve the Defendants’ lien under Section 1322(b)(2) of the Bankruptcy Code, which provides:
“A Chapter 13 plan may modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence . . . .” (emphasis added)
The Ponds argued that the Defendants' lien was wholly unsecured under Section 506 of the Bankruptcy Code, which provides:
“An allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property, . . . and is an unsecured claim to the extent that the value of such creditor's interest . . . is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest.”
The Bankruptcy Court held that defendants' lien could not be modified because, even though there was insufficient equity to cover any portion of the lien, the underlying security interest was the Debtors’ principal residential property, and, therefore, the lien was protected from modification under Section 1322(b)(2).
The U.S. District Court for the Northern District of New York reversed, holding that the statutory prohibition against modification does not apply to a holder of a wholly unsecured lien under Section 506, because such a lien is not "secured" by a residential property within the meaning of Section 1322 (b)(2). According to the District Court, the Defendants' lien was wholly "unsecured" under Section 506(a) because there was no equity in the Ponds’ property to cover the lien; therefore, the lien was not protected under the antimodification exception of Section 1322(b)(2) and could be voided.
The Defendants challenged this holding on appeal, and the 2nd Circuit Court of Appeals affirmed the District Court.
In its discussion of its holding, the Court reviewed the Supreme Court’s holding in Nobelman v. American Savings Bank, 508 U.S. 324 (1993), in which a Chapter 13 debtor sought to split a creditor's undersecured residential mortgage lien into a secured lien and an unsecured lien, so that only the secured portion of the mortgage was protected under the antimodification exception of Section 1322(b)(2).
The Supreme Court rejected that proposal, holding that, as long as some portion of the lien was secured by the residence, the creditor was a holder of "a claim secured only by . . . the debtor's principal residence," and its rights in the entire lien were protected under the antimodification exception. Accordingly, the debtors' Chapter 13 plan could not void the unsecured component of the creditor's mortgage lien.
However, the Nobelman opinion left open the issue presented in this case- namely, whether its holding extended to a holder of a wholly unsecured homestead lien. The issue has sharply divided Bankruptcy and District Courts, but the majority view (which the District Court adopted in this case, and the Second Circuit Court of Appeals affirmed) is that the antimodification exception of Section 1322(b)(22) applies only where a creditor's claim is at least partially secured under Section 506(a).
For more information about how Chapter 13 bankruptcy can protect your home, please contact Jim Shenwick.
Due to declining real estate values, many homeowners (over 7.5 million, according to a recent CNN Money report) are “underwater”-in other words, the value of their property (the collateral) is less than the balance due on their mortgages. In 2001, the Second Circuit Court of Appeals held in Pond v. Farm Specialist Realty et al. (In re Pond), 252 F. 3d 122 (2d Cir. 2001), that an unsecured mortgagee’s interest in a Chapter 13 debtor’s principal residence is voidable where there is insufficient equity in the property to cover any portion of their lien.
The debtors, Richard and Lorrie Pond, filed for bankruptcy under Chapter 13 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of New York. The Court held a hearing and determined that the debtors’ residential property was valued at $69,000. The Court also determined that there were four liens on the property, which had to be discharged in the following order of priority: (1) $1,505.18 for real property taxes; (2) $48,995.63 for the mortgage of the Farmers Home Administration; (3) $20,000 for the mortgage of the New York State Affordable Housing Corporation; and (4) $10,630.58 for the mortgage of Farm Specialist Realty and Charles Livingston, Jr. (the Defendants). The first three liens amounted to an encumbrance of $70,500.81, so the Ponds’ property had insufficient equity to cover any portion of the Defendants’ lien.
The Ponds then commenced an adversary proceeding to dissolve the Defendants’ lien under Section 1322(b)(2) of the Bankruptcy Code, which provides:
“A Chapter 13 plan may modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence . . . .” (emphasis added)
The Ponds argued that the Defendants' lien was wholly unsecured under Section 506 of the Bankruptcy Code, which provides:
“An allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property, . . . and is an unsecured claim to the extent that the value of such creditor's interest . . . is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest.”
The Bankruptcy Court held that defendants' lien could not be modified because, even though there was insufficient equity to cover any portion of the lien, the underlying security interest was the Debtors’ principal residential property, and, therefore, the lien was protected from modification under Section 1322(b)(2).
The U.S. District Court for the Northern District of New York reversed, holding that the statutory prohibition against modification does not apply to a holder of a wholly unsecured lien under Section 506, because such a lien is not "secured" by a residential property within the meaning of Section 1322 (b)(2). According to the District Court, the Defendants' lien was wholly "unsecured" under Section 506(a) because there was no equity in the Ponds’ property to cover the lien; therefore, the lien was not protected under the antimodification exception of Section 1322(b)(2) and could be voided.
The Defendants challenged this holding on appeal, and the 2nd Circuit Court of Appeals affirmed the District Court.
In its discussion of its holding, the Court reviewed the Supreme Court’s holding in Nobelman v. American Savings Bank, 508 U.S. 324 (1993), in which a Chapter 13 debtor sought to split a creditor's undersecured residential mortgage lien into a secured lien and an unsecured lien, so that only the secured portion of the mortgage was protected under the antimodification exception of Section 1322(b)(2).
The Supreme Court rejected that proposal, holding that, as long as some portion of the lien was secured by the residence, the creditor was a holder of "a claim secured only by . . . the debtor's principal residence," and its rights in the entire lien were protected under the antimodification exception. Accordingly, the debtors' Chapter 13 plan could not void the unsecured component of the creditor's mortgage lien.
However, the Nobelman opinion left open the issue presented in this case- namely, whether its holding extended to a holder of a wholly unsecured homestead lien. The issue has sharply divided Bankruptcy and District Courts, but the majority view (which the District Court adopted in this case, and the Second Circuit Court of Appeals affirmed) is that the antimodification exception of Section 1322(b)(22) applies only where a creditor's claim is at least partially secured under Section 506(a).
For more information about how Chapter 13 bankruptcy can protect your home, please contact Jim Shenwick.
Monday, December 01, 2008
New York Times: An End Run Around Realogy's Lenders
By FLOYD NORRIS
It was as badly timed a takeover as there was during the private equity boom.
At the end of 2006, Apollo Management, the private equity firm headed by Leon Black, agreed to buy Realogy, a conglomerate with a number of franchised real estate businesses, among them Century 21 and Coldwell Banker, for $7 billion in cash.
That was a few months after house prices peaked. By the next spring, when the deal closed, subprime mortgage lenders were starting to go broke. The great housing bubble was bursting, and that was very bad news for a company whose revenue was based on how many homes it could sell and how high the prices were.
Now a struggle is emerging over how the unfortunate lenders should be treated. Realogy, under the direction of Apollo, is using a classic divide-and-conquer strategy. Bondholders are screaming that the tactics are illegal.
The strategy is simple: Just tell one group of bondholders that they can move up in the capital structure (and thus be more likely to be paid if the company goes broke). But first, they have to agree to forget about collecting most of the money they are owed. They are being asked to trade in old bonds for new loans with much smaller face values.
Overindebted consumers can only look on with envy, wishing they could pull off something similar, perhaps by telling one credit card company that they will pay another card company first unless the first company agrees to forgive most of what it is owed.
No owner of Realogy bonds has to make the exchange, of course. But if a bondholder turns it down, and others do make the exchange, that bondholder may find that he is much farther back in line, with even less probability of being paid anything.
Part of what makes the tactic irritating is that it is being planned by the people who are supposed to be at the rear of the line in case of bankruptcy — the people who own the equity. In theory, they should not get anything unless all the creditors are first paid in full. In reality, they often can get away with changing the rules.
Realogy wants to make up to $650 million in debt disappear, trading $500 million of new loans for $1.15 billion of old bonds.
The new loans have no guarantee of being paid off, either, but they are not only senior to the old ones, they also mature a few months earlier. There is a possibility that the bondholders who refuse the deal will receive nothing in the end.
All this is possible because companies, in most cases, do not owe fiduciary duties to their bondholders, as they do to their creditors. This transaction is a contractual one, and if a tactic is allowed by the contract, the courts generally will not stop it.
Realogy claims it has the approval of senior creditors to issue more debt, and says that is all that is needed. Of course, those creditors have no reason to care. Their claims will remain senior to everyone else’s. It is sort of like getting Jimmy’s permission to hit Bobby. Bobby may not think Jimmy was the right person to ask.
Realogy has yet to violate the covenants on its bonds, but its business is suffering and it is reasonable to think that covenant violations are possible. Revenue so far this year is down 21 percent, and the company has not been able to cut costs that fast. Losses are rising.
One part of Realogy’s business is faring well. Revenue is soaring at a subsidiary that sells foreclosed homes. It reports that in the third quarter business was up 91 percent compared with a year earlier in the Sacramento area. But that is not enough to offset the growing problems in other operations.
The bonds are trading as if disaster is all but certain, all at prices under 20 cents on the dollar. Some of them are going for prices that assure a profit if the bond simply pays interest for the next 18 months before becoming totally worthless.
Realogy disclosed this week that a lawyer claiming to represent owners of a majority of one class of bonds had threatened to sue, arguing the offering violated bond indentures. The company did not identify the lawyer, but one person involved in the case said Carl C. Icahn, the financier, owned the bonds. Mr. Icahn declined to comment.
Realogy became an independent company in July 2006, just a few months before Apollo swooped in to buy it. It began trading when Cendant, a franchising conglomerate that had fought back from what was, before Enron, the largest accounting fraud in American history, split into four pieces.
Realogy was the only one of the four that worked out for shareholders, selling to Apollo for 19 percent more than the shares were worth just after the split-up. The other three — PHH, a mortgage services company; Wyndham Worldwide, which franchises hotel brands like Days Inn and Ramada; and Avis Budget, the car rental company — have all plunged in the recession. PHH, with a 72 percent decline, is the best performer of the three. Avis Budget, down 97 percent, is the worst.
As it turned out, Cendant split up not long before bad times arrived at virtually all of its businesses. Apollo, which did not see what was coming, now wants those who lent it money to share the pain.
Copyright 2008 The New York Times Company. All rights reserved.
It was as badly timed a takeover as there was during the private equity boom.
At the end of 2006, Apollo Management, the private equity firm headed by Leon Black, agreed to buy Realogy, a conglomerate with a number of franchised real estate businesses, among them Century 21 and Coldwell Banker, for $7 billion in cash.
That was a few months after house prices peaked. By the next spring, when the deal closed, subprime mortgage lenders were starting to go broke. The great housing bubble was bursting, and that was very bad news for a company whose revenue was based on how many homes it could sell and how high the prices were.
Now a struggle is emerging over how the unfortunate lenders should be treated. Realogy, under the direction of Apollo, is using a classic divide-and-conquer strategy. Bondholders are screaming that the tactics are illegal.
The strategy is simple: Just tell one group of bondholders that they can move up in the capital structure (and thus be more likely to be paid if the company goes broke). But first, they have to agree to forget about collecting most of the money they are owed. They are being asked to trade in old bonds for new loans with much smaller face values.
Overindebted consumers can only look on with envy, wishing they could pull off something similar, perhaps by telling one credit card company that they will pay another card company first unless the first company agrees to forgive most of what it is owed.
No owner of Realogy bonds has to make the exchange, of course. But if a bondholder turns it down, and others do make the exchange, that bondholder may find that he is much farther back in line, with even less probability of being paid anything.
Part of what makes the tactic irritating is that it is being planned by the people who are supposed to be at the rear of the line in case of bankruptcy — the people who own the equity. In theory, they should not get anything unless all the creditors are first paid in full. In reality, they often can get away with changing the rules.
Realogy wants to make up to $650 million in debt disappear, trading $500 million of new loans for $1.15 billion of old bonds.
The new loans have no guarantee of being paid off, either, but they are not only senior to the old ones, they also mature a few months earlier. There is a possibility that the bondholders who refuse the deal will receive nothing in the end.
All this is possible because companies, in most cases, do not owe fiduciary duties to their bondholders, as they do to their creditors. This transaction is a contractual one, and if a tactic is allowed by the contract, the courts generally will not stop it.
Realogy claims it has the approval of senior creditors to issue more debt, and says that is all that is needed. Of course, those creditors have no reason to care. Their claims will remain senior to everyone else’s. It is sort of like getting Jimmy’s permission to hit Bobby. Bobby may not think Jimmy was the right person to ask.
Realogy has yet to violate the covenants on its bonds, but its business is suffering and it is reasonable to think that covenant violations are possible. Revenue so far this year is down 21 percent, and the company has not been able to cut costs that fast. Losses are rising.
One part of Realogy’s business is faring well. Revenue is soaring at a subsidiary that sells foreclosed homes. It reports that in the third quarter business was up 91 percent compared with a year earlier in the Sacramento area. But that is not enough to offset the growing problems in other operations.
The bonds are trading as if disaster is all but certain, all at prices under 20 cents on the dollar. Some of them are going for prices that assure a profit if the bond simply pays interest for the next 18 months before becoming totally worthless.
Realogy disclosed this week that a lawyer claiming to represent owners of a majority of one class of bonds had threatened to sue, arguing the offering violated bond indentures. The company did not identify the lawyer, but one person involved in the case said Carl C. Icahn, the financier, owned the bonds. Mr. Icahn declined to comment.
Realogy became an independent company in July 2006, just a few months before Apollo swooped in to buy it. It began trading when Cendant, a franchising conglomerate that had fought back from what was, before Enron, the largest accounting fraud in American history, split into four pieces.
Realogy was the only one of the four that worked out for shareholders, selling to Apollo for 19 percent more than the shares were worth just after the split-up. The other three — PHH, a mortgage services company; Wyndham Worldwide, which franchises hotel brands like Days Inn and Ramada; and Avis Budget, the car rental company — have all plunged in the recession. PHH, with a 72 percent decline, is the best performer of the three. Avis Budget, down 97 percent, is the worst.
As it turned out, Cendant split up not long before bad times arrived at virtually all of its businesses. Apollo, which did not see what was coming, now wants those who lent it money to share the pain.
Copyright 2008 The New York Times Company. All rights reserved.
Monday, November 24, 2008
New York Times: Downturn Drags More Consumers Into Bankruptcy
By TARA SIEGEL BERNARD and JENNY ANDERSON
Published: November 15, 2008
The economy’s deep troubles are pushing a growing number of already struggling consumers into bankruptcy, often with far more debt than those who filed in previous downturns.
Plummeting home values, dwindling incomes and the near disappearance of credit have proved a potent mixture. While all the usual reasons that distressed borrowers seek bankruptcy — job loss, medical bills, divorce — play significant roles, new economic forces are changing the calculus of who can ride out the tough times and who cannot.
The number of personal bankruptcy filings jumped nearly 8 percent in October from September, after marching steadily upward for the last two years, said Mike Bickford, president of Automated Access to Court Electronic Records, a bankruptcy data and management company.
Filings totaled 108,595, surpassing 100,000 for the first time since a law that made it more difficult — and often twice as expensive — to file for bankruptcy took effect in 2005. That translated to an average of 4,936 bankruptcies filed each business day last month, up nearly 34 percent from October 2007.
Robert M. Lawless, a professor at the University of Illinois College of Law, pointed to the tightening of credit by banks as a significant factor in the increase in October. As banks have pulled back on lending, he said, consumers have been finding it more difficult, and in many cases impossible, to use credit cards, refinance their home mortgages or fall back on their home equity lines to get them through a rough period.
“A credit crunch can drive people into bankruptcy today rather than later as sources of lending dry up,” Professor Lawless said. “With the consumer credit tightening and the economy in a nosedive, this pop could just be the beginning of a long-term rise in the bankruptcy filing rate to levels that are even higher than we had before the 2005 bankruptcy law.”
Not only are filings up, but recent filers have had much more credit card debt, often run up in an attempt to keep current on a mortgage that now exceeds the value of their home, bankruptcy lawyers said in interviews.
A recent study found that the typical family who filed for bankruptcy in 2007 was carrying about 21 percent more in secured debts, like mortgages and car loans, and about 44 percent more in unsecured debts, like credit cards and medical and utility bills, than filers in 2001.
Their incomes, meanwhile, remained static over those six years, according to the study, which used data from the 2007 Consumer Bankruptcy Project, a joint effort of law professors, sociologists and physicians. Researchers surveyed 2,500 households nationwide that filed for bankruptcy in February and March 2007.
“Earlier downturns followed strong booms, so families went into recessions with higher incomes and lower debt loads,” said Elizabeth Warren, a professor at Harvard Law School and, along with Professor Lawless, part of the Bankruptcy Project team. “But the fundamentals are off for families even before we hit the recession this time, so bankruptcy filings are likely to rise faster.”
Not surprisingly, filings are increasing most rapidly in states where real estate values skyrocketed and then crashed, including Nevada, California and Florida. In Nevada, bankruptcy filings in October were up 70 percent compared with last year. In California, bankruptcies jumped 80 percent in the same period, while Florida’s filings rose 62 percent.
In those regions, some people are trying to rescue their homes through bankruptcy proceedings, but many are just as relieved to walk away, shedding layers of debt that otherwise would have taken decades to pay off.
Tony and Carrie Forsyth, both 30, chose not to walk away from their house in Florida. The couple said they thought their financial situation would improve in 2006, when Mr. Forsyth accepted a promotion from his employer, a Michigan food distributor, that required them to move to Florida. But they could not sell their home in Ypsilanti, Mich., so they decided to rent it out.
In June 2006, the couple headed south and bought a house for $220,000 in Tamarac, Fla., with no money down. Five months later, their tenants in Michigan stopped paying, and the family had to carry two mortgage payments, just as the adjustable-rate mortgage on their Michigan home reset to a higher interest rate. They lost the Michigan home to foreclosure in February 2007.
By that time, however, the couple, who have two young daughters, were using credit cards to pay for food, utilities and clothes. After accumulating about $20,000 in debt, they said, they realized that bankruptcy was the only way they could remain in their Florida home, whose value, meanwhile, had plunged 25 percent. They filed for Chapter 13 bankruptcy protection this year, which permitted them to keep the house, and they agreed to repay a portion of their debts over the next three years.
A Chapter 7 bankruptcy, by contrast, provides filers with what is known as a “fresh start” because debts are forgiven. In this case, assets are liquidated, though the states allow for various exemptions. To qualify for a Chapter 7, filers need to pass a means test to determine whether they are unable to repay their debts.
Filers who are deemed able to repay a portion of their debts must file for Chapter 13 bankruptcy. Some debtors choose Chapter 13 because it permits them to save their primary homes from foreclosure, though they are required to catch up on their mortgage payments.
Mr. Forsyth said declaring bankruptcy was a difficult step. “Because of our Christian background, it didn’t feel right,” he said. “But there was no other way for us to live and support our family unless we went that route.”
Mrs. Forsyth added: “We are just rolling with life. You have to eat. You have to have diapers.”
The Forsyths are emblematic of the new forces that have led to the sharp rise in bankruptcy filings. “Historically, a person would get behind in his mortgage because of a temporarily catastrophic financial event, such as job loss, divorce, illness,” said Chip Parker, a bankruptcy lawyer in Jacksonville, Fla. “However, when these adjustable-rate mortgages started resetting from their teaser rate and clients couldn’t refinance their way out of trouble, they were getting behind even though there was no catastrophic event.”
Bankruptcy lawyers report that they have been having more consultations with middle-class families with six-figure incomes — including many who either bought a home during the boom or pulled out most or all of their available home equity just keep to up with the cost of living. Also caught up in the bankruptcies are real estate investors, who hoped to flip properties they had bought near the height of the market.
“There are a lot of foreclosures that haven’t taken place yet because people still have available credit,” said Jeffrey H. Tromberg, a bankruptcy lawyer in Fort Lauderdale, Fla. “We don’t see them until they’ve maxed out their credit cards.”
A similar pattern has emerged in Las Vegas, where more people are filing for Chapter 7 bankruptcy protection because it makes more financial sense to walk away from their homes. Real estate values have plummeted, and now the local economy is also suffering. Car salesmen and casino dealers are being laid off. Valet parking attendants and masseuses are collecting less in tips.
“My clients are basically good people that got into a home the best way they could and can no longer meet their obligations because their income has gone down,” said Roger P. Croteau, a lawyer in Las Vegas who concentrates on bankruptcy. “There is no equity to pay off their credit cards, and they are maxed out. They haven’t saved enough because of housing costs.”
Ellen Stoebling, a bankruptcy lawyer in Las Vegas, added: “People are using their cards to try and hold onto their property for as long as possible in hopes they can somehow talk some sense into their lender and stay in the property.”
The problems are not limited to people with adjustable-rate mortgages and homes that are now worth less than they owe. Job losses are also playing a role. Bankruptcies are also up sharply in Delaware, Rhode Island and Indiana, where the unemployment rates have been climbing.
And, of course, some people continue to seek bankruptcy for the usual reasons.
Lisa Marquis, a 35-year-old mother of five in Indiana, has no medical insurance but has undergone 21 operations in the last nine years, some related to emphysema and other respiratory diseases, and others related to accidents and several miscarriages.
Mrs. Marquis cannot work, but her husband earns $13.50 an hour as a truck driver — a salary that makes them ineligible for Medicaid but unable to pay their medical bills. Earlier this year, the family had to leave the mobile home they owned because the mold there was making it hard for her to breathe; they moved into a house where they paid more than $600 a month in rent. Mr. Marquis was spending three days a week in court fending off angry creditors, cutting down on the number of hours he could work.
In April, facing more than $114,000 in medical bills and less available overtime work, the Marquises filed for Chapter 13 bankruptcy — the third time in less than 10 years that Mrs. Marquis had to file for protection because of medical bills. Because the latest filing is a Chapter 13, they have agreed to pay some of their debts.
“We could have waited to do a 7,” Mrs. Marquis said. “I want to pay my debts. I didn’t want to cheat people who helped to save my life.”
Despite the rise in bankruptcies, academics and lawyers say they believe that many others have been discouraged from filing because of the 2005 bankruptcy law.
Ms. Warren, the Harvard law professor, said many borrowers had been left with the mistaken impression that they could no longer file. And, she argued, “the widespread perception that bankruptcy is not available to help families makes this economic crisis worse.”
Published: November 15, 2008
The economy’s deep troubles are pushing a growing number of already struggling consumers into bankruptcy, often with far more debt than those who filed in previous downturns.
Plummeting home values, dwindling incomes and the near disappearance of credit have proved a potent mixture. While all the usual reasons that distressed borrowers seek bankruptcy — job loss, medical bills, divorce — play significant roles, new economic forces are changing the calculus of who can ride out the tough times and who cannot.
The number of personal bankruptcy filings jumped nearly 8 percent in October from September, after marching steadily upward for the last two years, said Mike Bickford, president of Automated Access to Court Electronic Records, a bankruptcy data and management company.
Filings totaled 108,595, surpassing 100,000 for the first time since a law that made it more difficult — and often twice as expensive — to file for bankruptcy took effect in 2005. That translated to an average of 4,936 bankruptcies filed each business day last month, up nearly 34 percent from October 2007.
Robert M. Lawless, a professor at the University of Illinois College of Law, pointed to the tightening of credit by banks as a significant factor in the increase in October. As banks have pulled back on lending, he said, consumers have been finding it more difficult, and in many cases impossible, to use credit cards, refinance their home mortgages or fall back on their home equity lines to get them through a rough period.
“A credit crunch can drive people into bankruptcy today rather than later as sources of lending dry up,” Professor Lawless said. “With the consumer credit tightening and the economy in a nosedive, this pop could just be the beginning of a long-term rise in the bankruptcy filing rate to levels that are even higher than we had before the 2005 bankruptcy law.”
Not only are filings up, but recent filers have had much more credit card debt, often run up in an attempt to keep current on a mortgage that now exceeds the value of their home, bankruptcy lawyers said in interviews.
A recent study found that the typical family who filed for bankruptcy in 2007 was carrying about 21 percent more in secured debts, like mortgages and car loans, and about 44 percent more in unsecured debts, like credit cards and medical and utility bills, than filers in 2001.
Their incomes, meanwhile, remained static over those six years, according to the study, which used data from the 2007 Consumer Bankruptcy Project, a joint effort of law professors, sociologists and physicians. Researchers surveyed 2,500 households nationwide that filed for bankruptcy in February and March 2007.
“Earlier downturns followed strong booms, so families went into recessions with higher incomes and lower debt loads,” said Elizabeth Warren, a professor at Harvard Law School and, along with Professor Lawless, part of the Bankruptcy Project team. “But the fundamentals are off for families even before we hit the recession this time, so bankruptcy filings are likely to rise faster.”
Not surprisingly, filings are increasing most rapidly in states where real estate values skyrocketed and then crashed, including Nevada, California and Florida. In Nevada, bankruptcy filings in October were up 70 percent compared with last year. In California, bankruptcies jumped 80 percent in the same period, while Florida’s filings rose 62 percent.
In those regions, some people are trying to rescue their homes through bankruptcy proceedings, but many are just as relieved to walk away, shedding layers of debt that otherwise would have taken decades to pay off.
Tony and Carrie Forsyth, both 30, chose not to walk away from their house in Florida. The couple said they thought their financial situation would improve in 2006, when Mr. Forsyth accepted a promotion from his employer, a Michigan food distributor, that required them to move to Florida. But they could not sell their home in Ypsilanti, Mich., so they decided to rent it out.
In June 2006, the couple headed south and bought a house for $220,000 in Tamarac, Fla., with no money down. Five months later, their tenants in Michigan stopped paying, and the family had to carry two mortgage payments, just as the adjustable-rate mortgage on their Michigan home reset to a higher interest rate. They lost the Michigan home to foreclosure in February 2007.
By that time, however, the couple, who have two young daughters, were using credit cards to pay for food, utilities and clothes. After accumulating about $20,000 in debt, they said, they realized that bankruptcy was the only way they could remain in their Florida home, whose value, meanwhile, had plunged 25 percent. They filed for Chapter 13 bankruptcy protection this year, which permitted them to keep the house, and they agreed to repay a portion of their debts over the next three years.
A Chapter 7 bankruptcy, by contrast, provides filers with what is known as a “fresh start” because debts are forgiven. In this case, assets are liquidated, though the states allow for various exemptions. To qualify for a Chapter 7, filers need to pass a means test to determine whether they are unable to repay their debts.
Filers who are deemed able to repay a portion of their debts must file for Chapter 13 bankruptcy. Some debtors choose Chapter 13 because it permits them to save their primary homes from foreclosure, though they are required to catch up on their mortgage payments.
Mr. Forsyth said declaring bankruptcy was a difficult step. “Because of our Christian background, it didn’t feel right,” he said. “But there was no other way for us to live and support our family unless we went that route.”
Mrs. Forsyth added: “We are just rolling with life. You have to eat. You have to have diapers.”
The Forsyths are emblematic of the new forces that have led to the sharp rise in bankruptcy filings. “Historically, a person would get behind in his mortgage because of a temporarily catastrophic financial event, such as job loss, divorce, illness,” said Chip Parker, a bankruptcy lawyer in Jacksonville, Fla. “However, when these adjustable-rate mortgages started resetting from their teaser rate and clients couldn’t refinance their way out of trouble, they were getting behind even though there was no catastrophic event.”
Bankruptcy lawyers report that they have been having more consultations with middle-class families with six-figure incomes — including many who either bought a home during the boom or pulled out most or all of their available home equity just keep to up with the cost of living. Also caught up in the bankruptcies are real estate investors, who hoped to flip properties they had bought near the height of the market.
“There are a lot of foreclosures that haven’t taken place yet because people still have available credit,” said Jeffrey H. Tromberg, a bankruptcy lawyer in Fort Lauderdale, Fla. “We don’t see them until they’ve maxed out their credit cards.”
A similar pattern has emerged in Las Vegas, where more people are filing for Chapter 7 bankruptcy protection because it makes more financial sense to walk away from their homes. Real estate values have plummeted, and now the local economy is also suffering. Car salesmen and casino dealers are being laid off. Valet parking attendants and masseuses are collecting less in tips.
“My clients are basically good people that got into a home the best way they could and can no longer meet their obligations because their income has gone down,” said Roger P. Croteau, a lawyer in Las Vegas who concentrates on bankruptcy. “There is no equity to pay off their credit cards, and they are maxed out. They haven’t saved enough because of housing costs.”
Ellen Stoebling, a bankruptcy lawyer in Las Vegas, added: “People are using their cards to try and hold onto their property for as long as possible in hopes they can somehow talk some sense into their lender and stay in the property.”
The problems are not limited to people with adjustable-rate mortgages and homes that are now worth less than they owe. Job losses are also playing a role. Bankruptcies are also up sharply in Delaware, Rhode Island and Indiana, where the unemployment rates have been climbing.
And, of course, some people continue to seek bankruptcy for the usual reasons.
Lisa Marquis, a 35-year-old mother of five in Indiana, has no medical insurance but has undergone 21 operations in the last nine years, some related to emphysema and other respiratory diseases, and others related to accidents and several miscarriages.
Mrs. Marquis cannot work, but her husband earns $13.50 an hour as a truck driver — a salary that makes them ineligible for Medicaid but unable to pay their medical bills. Earlier this year, the family had to leave the mobile home they owned because the mold there was making it hard for her to breathe; they moved into a house where they paid more than $600 a month in rent. Mr. Marquis was spending three days a week in court fending off angry creditors, cutting down on the number of hours he could work.
In April, facing more than $114,000 in medical bills and less available overtime work, the Marquises filed for Chapter 13 bankruptcy — the third time in less than 10 years that Mrs. Marquis had to file for protection because of medical bills. Because the latest filing is a Chapter 13, they have agreed to pay some of their debts.
“We could have waited to do a 7,” Mrs. Marquis said. “I want to pay my debts. I didn’t want to cheat people who helped to save my life.”
Despite the rise in bankruptcies, academics and lawyers say they believe that many others have been discouraged from filing because of the 2005 bankruptcy law.
Ms. Warren, the Harvard law professor, said many borrowers had been left with the mistaken impression that they could no longer file. And, she argued, “the widespread perception that bankruptcy is not available to help families makes this economic crisis worse.”
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