April 30, 2009

Susy’s Short Sale

We are in the process of trying to get a mortgage. Having done a short sale in FL and recieving a Satisfaction of Mortgage are records show fully paid and satisfied. Would it be marked differently on a credit report that would cause us not to Qualify. We have a 760 credit and no non/late payments?

Susy (more…)

WHERE’S THE NOTE, WHO’S THE HOLDER: ENFORCEMENT OF PROMISSORY NOTE SECURED BY REAL ESTATE

Filed under: Foreclosure,Mortgage

INTRODUCTION

In an era where a very large portion of mortgage obligations have been securitized, by assignment to a trust indenture trustee, with the resulting pool of assets being then sold as mortgage backed securities, foreclosure becomes an interesting exercise, particularly where judicial process is involved.  We are all familiar with the securitization process.  The steps, if not the process, is simple.  A borrower goes to a mortgage lender.  The lender finances the purchase of real estate.  The borrower signs a note and mortgage or deed of trust.  The original lender sells the note and assigns the mortgage to an entity that securitizes the note by combining the note with hundreds or thousands of similar obligation to create a package of mortgage backed securities, which are then sold to investors.

Unfortunately, unless you represent borrowers, the vast flow of notes into the maw of the securitization industry meant that a lot of mistakes were made.  When the borrower defaults, the party seeking to enforce the obligation and foreclose on the underlying collateral sometimes cannot find the note.  A lawyer sophisticated in this area has speculated to one of the authors that perhaps a third of the notes “securitized” have been lost or destroyed.  The cases we are going to look at reflect the stark fact that the unnamed source’s speculation may be well-founded.

UCC SECTION 3-309

If the issue were as simple as a missing note, UCC §3-309 would provide a simple solution.  A person entitled to enforce an instrument which has been lost, destroyed or stolen may enforce the instrument.  If the court is concerned that some third party may show up and attempt to enforce the instrument against the payee, it may order adequate protection.  But, and however, a person seeking to enforce a missing instrument must be a person entitled to enforce the instrument, and that person must prove the instrument’s terms and that person’s right to enforce the instrument.  §3-309 (a)(1) & (b).

WHO’S THE HOLDER

Enforcement of a note always requires that the person seeking to collect show that it is the holder.  A holder is an entity that has acquired the note either as the original payor or transfer by endorsement of order paper or physical possession of bearer paper.  These requirements are set out in Article 3 of the Uniform Commercial Code, which has been adopted in every state, including Louisiana, and in the District of Columbia.  Even in bankruptcy proceedings, State substantive law controls the rights of note and lien holders, as the Supreme Court pointed out almost forty (40) years ago in United States v. Butner, 440 U.S. 48, 54-55 (1979). 

However, as Judge Bufford has recently illustrated, in one of the cases discussed below, in the bankruptcy and other federal courts, procedure is governed by the Federal Rules of Bankruptcy and Civil Procedure.  And, procedure may just have an impact on the issue of “who,” because, if the holder is unknown, pleading and standing issues arise.

BRIEF REVIEW OF UCC PROVISIONS

Article 3 governs negotiable instruments – it defines what a negotiable instrument is and defines how ownership of those pieces of paper is transferred.  For the precise definition, see § 3-104(a) (“an unconditional promise or order to pay a fixed amount of money, with or without interest . . . .”)  The instrument may be either payable to order or bearer and payable on demand or at a definite time, with or without interest. 

Ordinary negotiable instruments include notes and drafts (a check is a draft drawn on a bank).  See § 3-104(e). 

Negotiable paper is transferred from the original payor by negotiation.  §3-301.  “Order paper” must be endorsed; bearer paper need only be delivered.  §3-305.  However, in either case, for the note to be enforced, the person who asserts the status of the holder must be in possession of the instrument.  See UCC § 1-201 (20) and comments. 

The original and subsequent transferees are referred to as holders.  Holders who take with no notice of defect or default are called “holders in due course,” and take free of many defenses.  See §§ 3-305(b). 

The UCC says that a payment to a party “entitled to enforce the instrument” is sufficient to extinguish the obligation of the person obligated on the instrument.  Clearly, then, only a holder – a person in possession of a note endorsed to it or a holder of bearer paper – may seek satisfaction or enforce rights in collateral such as real estate. 

NOTE:  Those of us who went through the bank and savings and loan collapse of the 1980’s are familiar with these problems.  The FDIC/FSLIC/RTC sold millions of notes secured and unsecured, in bulk transactions.  Some notes could not be found and enforcement sometimes became a problem.  Of course, sometimes we are forced to repeat history.  For a recent FDIC case, see Liberty Savings Bank v. Redus, 2009 WL 41857 (Ohio App. 8 Dist.), January 8, 2009.

THE RULES

Judge Bufford addressed the rules issue this past year.  See In re Hwang, 396 B.R. 757  (Bankr. C. D. Cal. 2008).  First, there are the pleading problems that arise when the holder of the note is unknown.  Typically, the issue will arise in a motion for relief from stay in a bankruptcy proceeding.

According F.R.Civ. Pro. 17, “[a]n action must be prosecuted in the name of the real party in interest.”  This rule is incorporated into the rules governing bankruptcy procedure in several ways.  As Judge Bufford has pointed out, for example, in a motion for relief from stay, filed under F.R.Bankr.Pro. 4001 is a contested matter, governed by F. R. Bankr. P. 9014, which makes F.R. Bankr. Pro. 7017 applicable to such motions.  F.R. Bankr. P. 7017 is, of course, a restatement of F.R. Civ. P. 17.  In re Hwang, 396 B.R. at 766.  The real party in interest in a federal action to enforce a note, whether in bankruptcy court or federal district court, is the owner of a note.  (In securitization transactions, this would be the trustee for the “certificate holders.”) When the actual holder of the note is unknown, it is impossible – not difficult but impossible – to plead a cause of action in a federal court (unless the movant simply lies about the ownership of the note).  Unless the name of the actual note holder can be stated, the very pleadings are defective.

STANDING

Often, the servicing agent for the loan will appear to enforce the note.   Assume that the servicing agent states that it is the authorized agent of the note holder, which is “Trust Number 99.”   The servicing agent is certainly a party in interest, since a party in interest in a bankruptcy court is a very broad term or concept.  See, e.g., Greer v. O’Dell, 305 F.3d 1297, 1302-03 (11th Cir. 2002).  However, the servicing agent may not have standing: “Federal Courts have only the power authorized by Article III of the Constitutions and the statutes enacted by Congress pursuant thereto. … [A] plaintiff must have Constitutional standing in order for a federal court to have jurisdiction.”  In re Foreclosure Cases, 521 F.Supp. 3d 650, 653 (S.D. Ohio, 2007) (citations omitted).

But, the servicing agent does not have standing, for only a person who is the holder of the note has standing to enforce the note.  See, e.g., In re Hwang, 2008 WL 4899273 at 8.

The servicing agent may have standing if acting as an agent for the holder, assuming that the agent can both show agency status and that the principle is the holder.  See, e.g., In re Vargas, 396 B.R. 511 (Bankr. C.D. Cal. 2008) at 520.

A BRIEF ASIDE:  WHO IS MERS?

For those of you who are not familiar with the entity known as MERS, a frequent participant in these foreclosure proceedings:

MERS is the “Mortgage Electronic Registration System, Inc.  “MERS is a mortgage banking ‘utility’ that registers mortgage loans in a book entry system so that … real estate loans can be bought, sold and securitized, just like Wall Street’s book entry utility for stocks and bonds is the Depository Trust and Clearinghouse.” Bastian, “Foreclosure Forms”, State. Bar of Texas 17th Annual Advanced Real Estate Drafting Course, March 9-10, 2007, Dallas, Texas. MERS is enormous.  It originates thousands of loans daily and is the mortgagee of record for at least 40 million mortgages and other security documents. Id.

MERS acts as agent for the owner of the note.  Its authority to act should be shown by an agency agreement.  Of course, if the owner is unknown, MERS cannot show that it is an authorized agent of  the owner.

RULES OF EVIDENCE – A PRACTICAL PROBLEM

This structure also possesses practical evidentiary problems where the party asserting a right to foreclose must be able to show a default.  Once again, Judge Bufford has addressed this issue.   At In re Vargas, 396 B.R. at 517-19.  Judge Bufford made a finding that the witness called to testify as to debt and default was incompetent.  All the witness could testify was that he had looked at the MERS computerized records.  The witness was unable to satisfy the requirements of the Federal Rules of Evidence, particularly Rule 803, as applied to computerized records in the Ninth Circuit.  See id. at 517-20.  The low level employee could really only testify that the MERS screen shot he reviewed reflected a default.  That really is not much in the way of evidence, and not nearly enough to get around the hearsay rule.

FORECLOSURE OR RELIEF FROM STAY

In a foreclosure proceeding in a judicial foreclosure state, or a request for injunctive relief in a non-judicial foreclosure state, or in a motion for relief proceeding in a bankruptcy court, the courts are dealing with and writing about the problems very frequently.

In many if not almost all cases, the party seeking to exercise the rights of the creditor will be a servicing company.  Servicing companies will be asserting the rights of their alleged principal, the note holder, which is, again, often going to be a trustee for a securitization package.  The mortgage holder or beneficiary under the deed of trust will, again, very often be MERS.

Even before reaching the practical problem of debt and default, mentioned above, the moving party must show that it holds the note or (1) that it is an agent of the holder and that (2) the holder remains the holder.  In addition, the owner of the note, if different from the holder, must join in the motion.

Some states, like Texas, have passed statutes that allow servicing companies to act in foreclosure proceedings as a statutorily recognized agent of the noteholder.  See, e.g., Tex. Prop. Code §51.0001.  However, that statute refers to the servicer as the last entity to whom the debtor has been instructed to make payments.  This status is certainly open to challenge.  The statute certainly provides nothing more than prima facie evidence of the ability of the servicer to act.   If challenged, the servicing agent must show that the last entity to communicate instructions to the debtor is still the holder of the note.  See, e.g., HSBC Bank, N.A. v. Valentin, 2l N.Y.  Misc. 3d 1123(A), 2008 WL 4764816 (Table) (N.Y. Sup.), Nov. 3, 2008.  In addition, such a statute does not control in federal court where Fed. R. Civ. P. 17 and 19 (and Fed. R. Bankr. P. 7017 and 7019) apply.

SOME RECENT CASE LAW

These cases are arranged by state, for no particular reason.

Massachusetts

In re Schwartz, 366 B.R.265 (Bankr. D. Mass. 2007)

Schwartz concerns a Motion for Relief to pursue an eviction. Movant asserted that the property had been foreclosed upon prior to the date of the bankruptcy petition.  The pro se debtor asserted that the Movant was required to show that it had authority to conduct the sale.  Movant, and “the party which appears to be the current mortgagee…” provided documents for the court to review, but did not ask for an evidentiary hearing.  Judge Rosenthal sifted through the documents and found that the Movant and the current mortgagee had failed to prove that the foreclosure was properly conducted.

Specifically, Judge Rosenthal found that there was no evidence of a proper assignment of the mortgage prior to foreclosure.  However, at footnote 5, Id. at 268, the Court also finds that there is no evidence that the note itself was assigned and no evidence as to who the current holder might be. 

Nosek v. Ameriquest Mortgage Company (In re Nosek), 286 Br. 374 (Bankr D Mass. 2008). 

Almost a year to the day after Schwartz was signed, Judge Rosenthal issued a second opinion.  This is an opinion on an order to show cause.  Judge Rosenthal specifically found that, although the note and mortgage involved in the case had been transferred from the originator to another party within five days of closing, during the five years in which the chapter 13 proceeding was pending, the note and mortgage and associated claims had been prosecuted by Ameriquest which has represented itself to be the holder of the note and the mortgage.  Not until September of 2007 did Ameriquest notify the Court that it was merely the servicer.  In fact, only after the chapter 13 bankruptcy had been pending for about three years was there even an assignment of the servicing rights.  Id. at 378. 

Because these misrepresentations were not simple mistakes:  as the Court has noted on more than one occasion, those parties who do not hold the note of mortgage do not service the mortgage do not have standing to pursue motions for leave or other actions arising form the mortgage obligation.  Id at 380. 

As a result, the Court sanctioned the local law firm that had been prosecuting the claim $25,000.  It sanctioned a partner at that firm an additional $25,000.  Then the Court sanctioned the national law firm involved $100,000 and ultimately sanctioned Wells Fargo $250,000.  Id. at 382-386. 

In re Hayes, 393 B.R. 259 (Bankr. D. Mass. 2008). 

Like Judge Rosenthal, Judge Feeney has attacked the problem of standing and authority head on.  She has also held that standing must be established before either a claim can be allowed or a motion for relief be granted. 

Ohio

In re Foreclosure Cases, 521 F.Supp. 2d (S.D. Ohio 2007). 

Perhaps the District Court’s orders in the foreclosure cases in Ohio have received the most press of any of these opinions.  Relying almost exclusively on standing, the Judge Rose has determined that a foreclosing party must show standing.  “[I]n a foreclosure action, the plaintiff must show that it is the holder of the note and the mortgage at the time that the complaint was filed.”  Id. at 653. 

Judge Rose instructed the parties involved that the willful failure of the movants to comply with the general orders of the Court would in the future result in immediate dismissal of foreclosure actions. 

Deutsche Bank Nat’l Trust Co. v. Steele, 2008 WL 111227 (S.D. Ohio) January 8, 2008.

In Steele, Judge Abel followed the lead of Judge Rose and found that Deutsche Bank had filed evidence in support of its motion for default judgment indicating that MERS was the mortgage holder.  There was not sufficient evidence to support the claim that Deutsche Bank was the owner and holder of the note as of that date.  Following In re Foreclosure Cases, 2007 WL 456586, the Court held that summary judgment would be denied “until such time as Deutsche Bank was able to offer evidence showing, by a preponderance of evidence, that it owned the note and mortgage when the complaint was filed.”  2008 WL 111227 at 2.  Deutsche Bank was given twenty-one days to comply.  Id. 

Illinois

U.S. Bank, N.A. v. Cook, 2009 WL 35286 (N.D. Ill. January 6, 2009). 

Not all federal district judges are as concerned with the issues surrounding the transfer of notes and mortgages.  Cook is a very pro lender case and, in an order granting a motion for summary judgment, the Court found that Cook had shown no “countervailing evidence to create a genuine issue of facts.”  Id. at 3.  In fact, a review of the evidence submitted by U.S. Bank showed only that it was the alleged trustee of the securitization pool.  U.S. Bank relied exclusively on the “pooling and serving agreement” to show that it was the holder of the note.  Id.

Under UCC Article 3, the evidence presented in Cook was clearly insufficient. 

New York

HSBC Bank USA, N.A. v. Valentin, 21 Misc. 3D 1124(A), 2008 WL 4764816 (Table) (N.Y. Sup.) November 3, 2008.  In Valentin, the New York court found that, even though given an opportunity to, HSBC did not show the ownership of debt and mortgage.  The complaint was dismissed with prejudice and the “notice of pendency” against the property was cancelled. 

Note that the Valentin case does not involve some sort of ambush. The Court gave every HSBC every opportunity to cure the defects the Court perceived in the pleadings. 

California

In re Vargas, 396 B.R. 511 (Bankr. C.D. Cal. 2008)

and

In re Hwang, 396 B.R. 757 (Bankr. C.D. Cal. 2008)

These two opinions by Judge Bufford have been discussed above.  Judge Bufford carefully explores the related issues of standing and ownership under both federal and California law. 

Texas

In re Parsley, 384 B.R. 138 (Bankr. S.D. Tex. 2008)

and

In re Gilbreath, 395 B.R. 356 (Bankr. S.D. Tex. 2008)

These two recent opinions by Judge Jeff Bohm are not really on point, but illustrate another thread of cases running through the issues of motions for relief from stay in bankruptcy court and the sloppiness of loan servicing agencies.  Both of these cases involve motions for relief that were not based upon fact but upon mistakes by servicing agencies.  Both opinions deal with the issue of sanctions and, put simply, both cases illustrate that Judge Bohm (and perhaps other members of the bankruptcy bench in the Southern District of Texas) are going to be very strict about motions for relief in consumer cases. 

SUMMARY

The cases cited illustrate enormous problems in the loan servicing industry.  These problems arise in the context of securitization and illustrate the difficulty of determining the name of the holder, the assignee of the mortgage, and the parties with both the legal right under Article 3 and the standing under the Constitution to enforce notes, whether in state court or federal court. 

Interestingly, with the exception of Judge Bufford and a few other judges, there has been less than adequate focus upon the UCC title issues.  The next round of cases may and should focus upon the title to debt instrument.  The person seeking to enforce the note must show that:

(1) It is the holder of this note original by transfer, with all necessary rounds;
(2) It had possession of the note before it was lost;
(3) If it can show that title to the note runs to it, but the original is lost or destroyed, the holder must be prepared to post a bond; 
(4) If the person seeking to enforce is an agent, it must show its agency status and that its principal is the holder of the note (and meets the above requirements). 

Then, and only then, do the issues of evidence of debt and default and assignment of mortgage rights become relevant. 

HON. SAMUEL L. BUFFORD
UNITED STATES BANKRUPTCY JUDGE
CENTRAL DISTRICT OF CALIFORNIA
LOS ANGELES, CALIFORNIA

(FORMERLY HON.) R. GLEN AYERS
LANGLEY & BANACK
SAN ANTONIO, TEXAS

AMERICAN BANKRUPTCY INSTUTUTE
APRIL 3, 2009
WASHINGTON, D.C.

April 29, 2009

Lexington Law

April 28, 2009

I’ll Estoppel If You’ll Estoppel

Filed under: Collections,Short Sale

Anyone who closes short sales knows that these second mortgages can be tough to deal with.  When the first forecloses, the second can still go after the borrower for the full balance by suing on the promissory note, so they tend to want to hold out for as much as they feel they can claw back on the short sale and their behavior can potentially kill the transaction.

Readers of the Broken Credit Blog know that I purchase short sales in Florida and throughout the U.S.A.  Call me crazy but I like the challenge of orchestrating a perfect short sale strategy all the way down the finish line.  And along those lines, here’s an example of how to successfully deal with a second mortgage on a short sale.

Bear in mind that the second can offer a full release of liability, a lien release only, or a partial release with signature loan.  The shorting second wants the seller to commit to paying back the deficiency while the seller wants a full release.  Solving this negotiation puzzle takes time and a calculated strategy.  Contrast this with the fact that the normal short sale submission involves a buyer who is extremely anxious and desiring/demanding to close within 30 days of contract.  This is why the short sale and the type of release need to be negotiated in advance of any end buyer.  Here’s a follow up to Estoppel The Insanity:

HSBC Second Mortgage Crummy Short Payoff

Seller Counters By Crossing Off Crummy Terms

HSBC Gives In

I love a happy ending.

This author is not an attorney and this information should not be considered legal advice.  Please consult an attorney for legal advice.

Post Short Sale Cleanup

Hi Paul…I purchased a house in 2006…got behind on a payment and GMAC would not work with me to bring it current….in Aug 2008 I put the house on the market….GMAC sold my note to Midland and Midland sold the house under a quick sale…they have listed it on my credit as paid in full…..however…GMAC has listed on my credit also…as a foreclosure…the house was never foreclosed on although it was in preforeclosure status at one time….how can I get them to delete themselves off my credit report altogether since they sold my note before foreclosure?

Sharon (more…)

April 27, 2009

Palisades v. Graubard

Filed under: Collections,Judgment

Palisades tries to use an article in Wikipedia as evidence that it is entitled to collect a debt against this consumer.  Funny!

Palisades Collection, L.L.C. v. Graubard, No. L-3394-06, 2009 WL 1025176 (N.J. Super. A.D. April 17, 2009)

April 26, 2009

The Legend Joe Lents

Paul-

Just wanted you to know that I think you’re blog provides excellent help and advice.  And, yes my foreclosure is still going….My last mortgage payment was July 2002. 

The plaintiff filed a motion in June 2008, to amend their complaint stating that since they are unable to re-establish the note under FS 673.3091, they want to foreclose under an eqiuitable subrogation claim.  Never been done before in Florida when they didn’t have the note!!

On November 4, 2008, we filed for quite title.  DLJ Mortgage requested an extension of time to respond (until Dec. 12th). As of April 26, 2009, they still haven’t filed an answer that was due within 20 days of Nov. 4, 2008! 

We’re getting ready to file a cross-motion for Final Summary Judgment.

I would strongly encourage your readers to find good legal council when facing a mortgage foreclosure AND by all means fight for their home.  It does work and the only way to guarantee that they will lose is if they do NOTHING!!

Keep up the good work-

Joe Lents

April 24, 2009

Qualified Written Requests & HELOCs

Hello Paul: 

My mortgage is still with the original bank I borrowed from because they do not sell the loans and I have been trying to negotiate with them for 2 years now.

On the HUD website in regards to open ended mortgages, which is what I have, it says: “Both subordinate lien loans and open-end lines of credit (home equity loans) in first lien position are exempted from the loan servicing requirements”.

Does this preclude me from sending a qualified written request to my lender?

Tony (more…)

April 23, 2009

Broken Credit Open Mike

Filed under: Collections,Miscellaneous

I have experienced a company that sells bad debt or (old accounts to consumers) By buying this account and assuming the debt and paying a small amount to settle, this institution reports it clean of lates, you own the account and it’s 7 year history is reported onto your credit. Fast way to rebuild hitting the 35% of your FICO portion of your score.

Passed this through an attorney and he stated it was legal as collection companies buy and sell debt all the time.

I guess Collection companies are tired of chasing debtors and just sell the bad debt to people who need the history. ” Assumable Accounts” is what they are called. Of course removing the lates and reporting it clean is in the settlement contract.

What is your take on this concept? I have tested it and have seen it jump scores 40-75 points. By the way the company is a financial institution.

BAJ

Mortgage Investors Form Battle Lines Over Housing Aid

April 23 (Bloomberg) — The head of Greenwich Financial Services LLC warned bond investors in Washington last month that government efforts to reverse the housing slump are doing more harm than good by undermining debt contracts.

More than 30 money managers with stakes in the $6.7 trillion mortgage bond market that underpins the real-estate industry heard Bill Frey’s March 25 talk, according to a list of the attendees. Since then, a group of investors with home-loan bonds totaling more than $100 billion have hired Patton Boggs LLP, Washington’s biggest lobbying law firm, said Micah Green, a partner and former head of the Bond Market Association.

Bondholders are preparing for a fight over legislation approved last month by the House of Representatives that would shield companies that collect homeowners’ payments from lawsuits over modified mortgages, even if new terms harm investors. The government’s actions may increase borrowing costs because creditors would demand higher returns to compensate for the risk that once-sacrosanct investment terms can be changed, they say.

“Certainly some greater amount of loans should be restructured, but it is a fallacy to think that policymakers can selectively abrogate contracts without affecting future investor behavior,” Frey, chief executive officer of Greenwich Financial, a mortgage-bond broker and investor in Greenwich, Connecticut, said in an e-mail. “We are actively exploring strategies with major investors to protect their rights.”

Four Coalitions

Amherst Securities Group, an Austin, Texas-based firm that specializes in mortgage bonds, said it’s been asked to join four similar coalitions forming to fight the legislation or lobby against the details of President Barack Obama’s plan to cut borrowers’ payments.

Amid money managers’ concern their clients will be hurt as consumers and banks get assistance, Green said lawmakers may protect “predatory lending” and fraud, partly by hindering investor efforts to force repurchases of soured loans.

Frey, 51, made his presentation at a bond investor conference with David Grais, a lawyer at Grais & Ellsworth LLP in New York, and Laurie Goodman, an analyst at Amherst Securities and UBS AG’S former fixed income research chief. Attendees included representatives of Royal Bank of Canada’s Voyageur Asset Management Inc. and Thrivent Financial for Lutherans.

Bonds Plummet

By “allocating losses to some place that’s not expecting it,” including state pension plans, college endowments and life insurers, those investors will demand more return to hold mortgage debt without government backing, if they buy at all, said Amherst CEO Sean Dobson, whose firm trades home-loan bonds and advises clients about the securities. “Capital’s going to cost a lot more for a long time.”

Prices of many mortgage bonds have plummeted in the past two years as delinquency rates on the underlying loans soared. Mounting losses from securities tied to subprime home-loans caused credit markets to seize up in August 2007, triggering a slowdown in the U.S. economy that spread around the world.

In the market for bonds backed by fixed-rate Alt-A loans, a category viewed as less risky than subprime mortgages, the safest securities typically traded at about 52 cents on the dollar last week, down from about 100 cents in mid-2007, according to a Barclays Capital report.

Fixing the mortgage market and stabilizing housing prices would help Obama end the worst U.S. recession since 1982.

Congressional Panel

The U.S. mortgage-finance system depends on bond investors. About 64 percent of the value of America’s home loans is bundled into bonds, a market that is 10 percent bigger than the sum of Treasuries outstanding. Mortgages account for 80 percent of consumer debt, and housing costs represent about 22 percent of the economy, Federal Reserve and Hoover Institution data show.

Jennifer Psaki, a White House spokeswoman, declined to comment on bondholder complaints about the government’s efforts.

An administration official who helped craft Obama’s plan said it only allows loan modifications that are permitted by the terms of the bonds the mortgages back and that are in debt holders’ best interests. The official spoke on the condition of anonymity because he isn’t authorized to discuss the issue publicly.

A congressionally appointed panel overseeing the U.S.’s $700 billion finance-industry bailout said in a March 6 report that government action is needed to encourage loan modifications because soaring foreclosures “injure both the investor and the homeowner.”

Obama’s Plan

Mortgage delinquencies increased to a seasonally adjusted 7.88 percent of all loans in the fourth quarter, the highest in records going back to 1972, the Mortgage Bankers Association in Washington said March 2. Loans in foreclosure rose to 3.3 percent, also a record and up from 2.04 percent a year earlier.

Obama’s $75 billion plan to reduce foreclosures by modifying mortgages targets as many as 4 million homeowners. Foreclosed properties helped drive down home prices in 20 U.S. cities by an average of 19 percent in January from a year earlier, the fastest decline on record, according to an S&P/Case-Shiller index.

The program, announced Feb. 18, is part of Obama’s efforts to shore up companies from General Motors Corp. to Citigroup Inc. and financial markets amid the first global recession since World War II. U.S. gross domestic product shrank 6.3 percent in the fourth quarter. Last month, the World Bank predicted the global economy would contract 1.7 percent this year.

The mortgage initiative offers subsidies to lenders, including bond investors, to help lower borrowers’ housing payments to 31 percent of their income. What troubles bondholders are the incentives for loan servicers, the industry middlemen who decide which loans will be reworked.

Servicer Fees

Servicers can get $1,000 for each modified loan under the plan, an additional $500 for every loan changed before borrowers fall more than two months behind and $1,000 annually for as many as three years of on-time payments.

At least six servicers have signed up to participate, including New York-based JPMorgan Chase & Co. and Wells Fargo & Co. in San Francisco. Government payments to those companies may total $9.9 billion, according Treasury data released April 15.

Guidelines on the Treasury’s Web site tell servicers they can rework a loan only after they verify through financial models that new terms for the homeowner would be better for investors than an immediate foreclosure.

Bondholders still fret that some homeowners who don’t need help will be allowed to rework loans and that calculations to measure the impact will be skewed against bondholders, said Sean Kirk, a trader at New York-based Seaport Group LLC.

‘Financial Incentive’

Part of the concern is that the four largest servicers, including Charlotte, North Carolina-based Bank of America Corp. and JPMorgan, own almost $450 billion in home-equity loans, many tied to the same properties as the mortgages they service, Amherst’s Goodman said.

“They have a large financial incentive through the program to modify, and they’ll also benefit from putting more losses onto the first-lien holders because of their large second-lien positions,” said John Huber, who oversees about $30 billion in Minneapolis as chief investment officer of fixed income at Royal Bank of Canada’s Voyageur unit.

“What’s probably most troubling from a bigger picture perspective is what this means for the sanctity of contract law that has historically differentiated the U.S. as the gold standard of markets,” he added.

‘Respect the Laws’

Responding to complaints that American International Group Inc. was excessive in awarding bonuses and paying off banks after accepting $182.5 billion in bailout funds, National Economic Council Director Lawrence Summers said March 15 on ABC’s “This Week” that “we are a nation of law, where there are contracts” and “the government cannot just abrogate contracts.”

“If we don’t respect the laws on which people reasonably relied, the potential chaos, disruption, lack of credit and resulting unemployment will be that much greater,” Summers said.

A program, announced March 4, under which the government will buy home-equity loans as servicers rework first mortgages remains “of great interest” to the Obama administration, said the official who helped craft the plan. Details of the plan, which are partly based on the feedback it’s received, will be released soon, the official said. The initiative may reduce servicer conflicts.

The legislation opposed by bondholders passed in the House 234-191 on March 6. The measure, which also would allow bankruptcy judges to lower mortgage amounts through so-called cram-downs, is now before the Senate.

Legal Tussle

“I don’t think it’s Congress’s intent to damage the sanctity of contract law and the U.S. capital markets, but there is a risk of that happening,” said Michael Swendsen, a senior money manager in Minneapolis at Thrivent Financial, which oversees $61 billion of assets.

Resistance to loan modifications by Greenwich Financial’s Frey has prompted protesters from the Neighborhood Assistance Corp. of America consumer group to gather outside his Greenwich, Connecticut, home, and has spawned a legal tussle with Bank of America.

In October, the bank reached a settlement with state attorneys general investigating whether Countrywide Financial Corp. tricked homebuyers into mortgages they couldn’t afford before Bank of America acquired the company last year. The deal, which more than 30 states have signed, will save homeowners $8.4 billion, the bank said.

Lobbying Treasury

Greenwich Financial sued Bank of America, alleging that much of the cost will be borne by bondholders. Frey’s firm is seeking class action status for the suit.

Barbara Desoer, Bank of America’s mortgage chief, said in an interview that her company isn’t modifying loans without bondholders’ permission, either in existing bond terms or in newly negotiated agreements.

The bank isn’t “going to do anything to put a contract at risk,” Desoer said. “But, at the same time, we’re thrilled that there’s a standard, and we have a head start because of the AG settlement.”

TCW Group Inc., a Los Angeles-based money manager that oversees more than $100 billion, is lobbying the Treasury for changes to the government’s plan.

Servicer Duties

Obama’s program encourages servicers to “abrogate their duty,” said Chief Investment Officer Jeffrey Gundlach, who oversees $52 billion of mortgage securities, on a conference call with clients March 18. “Servicers’ No. 1 duty is to us, the investor.”

While billed as beneficial to mortgage investors, Obama’s plan will mostly be ineffective in cutting losses because it focuses on lowering payments rather than reducing homeowner debt, said John Geanakoplos, an economics professor at Yale University in New Haven, Connecticut. Many borrowers with “negative equity” will choose to default anyway, he said.

“It’s a lot better situation when contracts are broken in a way that makes everybody better off,” said Geanakoplos, who is also a partner at Michael Vranos’ Ellington Management Group LLC, a hedge-fund firm in Old Greenwich, Connecticut. Geanakoplos has advocated breaking contracts by putting the power to modify loan terms into the hands of independent arbiters.

Program Retool

Scott Simon, Pacific Investment Management Co.’s mortgage bond chief, said retooling the Federal Housing Administration’s Hope for Homeowners program would be best for all parties.

Bond investors sustain losses equal to the amount needed to reduce a loan to 87 percent of a home’s current value under that strategy. In return, the remaining debt is refinanced with government-insured loans, preventing further investor losses. The congressionally approved program was designed to help 400,000 borrowers when it started in October; 51 of the loans have closed, said Lemar Wooley, an FHA spokesman.

“It was a great idea, but there was horse-trading to get the bill passed, creating subtle little things that made it unusable,” said Simon, whose Newport Beach, California-based firm manages the world’s biggest bond fund.

The FHA program “addresses the elephant in the room,” he said, referring to how many borrowers have “negative equity.” Almost one in six U.S. homeowners with mortgages owed more than their homes’ worth after the market lost $3.3 trillion in value last year, according to a Feb. 3 Zillow.com report.

Don Brownstein, CEO of Structured Portfolio Management LLC, said another Obama administration mortgage program announced Feb. 18 also represents the government acting “extra-legally.”

New Program

Under that plan, as many as 5 million additional Fannie Mae and Freddie Mac mortgagees with less than 20 percent in equity will be able to refinance without buying or paying for mortgage insurance. The two government-sponsored companies’ charters typically require insurance for loans with debt-to-value ratios of more than 80 percent.

The new program was created without congressional approval. Federal Housing Finance Agency Director James Lockhart, who oversees the two companies, said it didn’t require legislation because the refinancing is akin to permitted loan modifications, even though some bondholders incur losses if their securities’ underlying loans are paid off faster than expected.

Mistreating “customers, the ones who ultimately lend to the homeowners, is not good a business practice,” said Brownstein, whose hedge-fund firm is based in Stamford, Connecticut.

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