Consumer Law & Policy Blog

Supreme Court Term Begins Soon - Sign Up For Supreme Court Watch List Now

by Brian Wolfman

Today, Monday, September 29, the Supreme Court Justices held their annual "long conference" at which they considered hundreds of petitions for writs of certiorari that had piled up over the Court's 3-month summer recess. If the Court's recent pattern is followed this year, expect the Court to issue orders tomorrow, September 30, granting review in a handful of cases. Then, expect the Court to issue a massive order next Monday, October 6, denying review in hundreds of cases. Next Monday is also the first day of oral argument for the Court's 2008-2009 Term.

Approximately every 2 weeks during the Court's Term, the Justices hold conferences to decide which cases to hear from among the petitions that have accumulated. Prior to each conference, Public Citizen Litigation Group's Supreme Court Assistance Project (SCAP) publishes a "watch list" of public interest cases on the conference. The watch list for today's long conference, along with a cover email highlighting the critical cases, are available here.

It's easy to sign up to receive our email and watch list before each of the Justices' conferences. Just go here.

Stabilize Home Mortgage Borrowers with Eminent Domain

By Lauren E. Willis [reprinted here with permission]

Edward Leamer’s “trickle up” economic plan is a good start, but if a downward spiral is a serious possibility in the economy right now, we need not a trickle but a flood. We need to quick-take homes by eminent domain, prepay mortgage balances that are not extinguished (mortgage debt beyond the market value of the home would be extinguished), and sell the homes back to the homeowners using fixed-rate mortgages with affordable monthly payments. This would eliminate today’s mortgage debt overhang, staunch foreclosures, and restore liquidity and stability in our financial markets.

To halt the Great Depression, the federal government nullified all clauses in contracts that pegged debt to the price of gold. By taking these contracts off the gold standard, debts were reduced by roughly 40 percent. Economist Randall Kroszner, now a governor on the Federal Reserve Board, examined the effects of this sweeping debt reduction and found that both stocks and bonds responded favorably. Investors and creditors decided that the elimination of debt overhang and the avoidance of threatened corporate bankruptcies more than offset the cost to creditors of receiving 60 cents on the dollar. And the taxpayer did not pay a penny.

This trick could only be performed once, now that gold clauses are out. But we still have a potent weapon against the crisis: eminent domain.

Query About the Bailout Mechanism

Now that the House has rejected the bailout proposal in its present incarnation (see here), perhaps those who know more about this subject than I do can help me understand something: if the problem is with the freezing of credit, why doesn't Congress simply create a mechanism to lend money to credit-worthy borrowers (perhaps by providing money to lenders for that specific purpose, or by paying lenders a service fee to provide the necessary services to choose credit-worthy lenders, service loans, etc.), rather than by buying assets of uncertain value?

Homeowners and the Bailout

By Alan White

For homeowners as well as for banks, the bailout deal announced today could be a turning point, or it could be more of the same, depending on what Treasury actually does with its enormous new powers. Treasury could buy mortgage securities at deep discounts, causing banks and investors to absorb losses (much of which they have already reserved for), and then aggressively restructure the underlying mortgage debt, passing on writedowns to homeowners in distress. Or Treasury could pay high prices for the securities to bail out financial institutions and then continue the senseless foreclosure policy servicers are currently following, losing billions by foreclosing and reselling homes.

The bill (download here, but be warned there is a lot of server traffic now) requires Federal contractors (who will now be hired in droves) to develop foreclosure prevention plans, and submit monthly reports to Congress on the number of foreclosures and the number and type of modifications. This is all still precatory, in a sense, but has the potential to change the paradigm in mortgage servicing and start a process of genuine mortgage restructuring. Treasury can imitate the FDIC in its takeover of IndyMac, or it could continue accepting the bland assurances of HOPE NOW.

The foreclosure provisions are in sections 109 and 110. The Treasury Secretary is directed to implement a plan to maximize assistance for homeowners, and to consent (as owner or investor) to reasonable requests for loan restructuring, including interest and principal write-downs.

On the other hand, it is unfortunate that the bankruptcy modification tool was not incorporated in the legislation. Giving bankruptcy courts the ability to rework the subprime mortgages of 2005-2007 when servicers refuse to do so voluntarily would add real impetus to the restructuring effort, and as Adam Levitin has demonstrated, would not impair the future supply or price of mortgage credit.

It may also become quickly apparent that Congress needs to tinker with some tax law provisions that drive the limitations in pooling and servicing contracts that in turn govern securitized mortgages. Servicers are prevented from doing anything that endangers the special tax status of mortgage trusts they administer. This may mean that Treasury cannot effectively tell servicers what to do, or buy mortgages out of securitized pools, without some adjustments to the REMIC tax provisions. In my view, if there is a will to restructure mortgages, a way will be found.

On a related note, Ruth Simon reports in today's Wall Street Journal that the kind of modifications offered to homeowners in foreclosure matters a great deal in how well these homeowners do making their new payments. Not surprisingly, modifications that reduce interest, principal and monthly payments have much higher success rates than the other kind (where payments and principal are increased to recoup interest arrears.)

Times Article on Impact of Bailout on Distressed Homeowners

Amid the welter of articles on the bailout proposal is this one in today's Times on the impact of the bill on homeowners: "A Bill Encouraging to Distressed Homeowners, but Its Reach is Unclear."  An excerpt:

The legislation does take steps to help some troubled borrowers modify their mortgages. As part of the package, the Treasury Department would purchase problematic mortgage-related assets. The bill would also set up a program to assist homeowners by encouraging the companies that service the mortgage-related assets the Treasury owns to take advantage of the Hope for Homeowners program.

The article also notes that the bill does not give bankruptcy courts the power to alter the terms of mortgages on primary residences.  It also quotes our own Alan White.  A copy of the bill is available here.

Another idea

By Alan White

Instead of buying mortgage-backed securities from banks, Treasury could buy the mortgages themselves from the servicers of mortgage-backed securities at a discount via a reverse auction. As written, I believe the Paulson plan would actually permit this modern version of the Homeowners Loan Corporation. Here's how it would work.

A typical pool of say $500 million in subprime loans now has a third or so of its mortgages delinquent or in foreclosure. If the servicer forecloses, it will likely recover only about 60% of principal on a given mortgage. The servicer might agree to accept 80% of the balance due in a sale to Treasury. A competing servicer might accept 75%, and the lowest bidder would be able to unload its loans at a higher-than-currently-expected return. Once the servicer sells the mortgage, it is treated as prepaid, the loss is realized, and all the mystery about the value of the securities related to that mortgage pool is resolved. All the financial institutions wondering how to value that security will be paid, and can fix the value and stop writing it down. If the servicer loses 25% on one-third of its mortgages, and the other two-thirds are repaid, the pool will lose about 8%. (At 75% or more recovery on the underlying mortgages, the AAA securities will be paid in full, typically, while junior tranches will absorb losses.)

Once Treasury buys a mortgage, it can be restructured, as FDIC is doing with IndyMac mortgages now, and in some cases the homeowner could repay the Treasury the discounted purchase price, or even the original loan amount, while in other cases there would likely be a loss.

How much would this cost? There are about 5 million mortgages now delinquent or in foreclosure, with perhaps another 2 million in danger. Let's assume half of those mortgages (3.5 million) would meet whatever standards the Treasury might set (occupied by a homeowner with a pulse, house is still standing, etc.) Let's further assume that the average balance is $250,000 and the average purchase price @ 80% is $200,000. Let's see, $200,000 times 3.5 million equals . . . $700 billion. Recoveries would depend on the reliability of Main Street in meeting its obligations, not the reliability of Wall Street.

Moral Hazard and the Bailout: A One-Minute Play

Time: Five years or so in the future.  Setting: Exterior of a dilapidated home. DRACO rings the home's doorbell.

Jorkins: Hello?

Draco: Good morning. I couldn't help but notice that the siding on your home looks, well, it looks as if it needs a bit of work.

Jorkins: It does, yes, but who can afford it? Social Security goes only so far, you know.

Draco: Have you thought about taking out a loan? You could fix up the rest of your place too. I represent Malfoy Lending and we have some very affordable loans. We could also find you someone to replace that siding. Anyway, let me just give you these forms to read and fill out.

Jorkins: Oh dear, I'm not very good with forms.

Draco: I can help you with that.

Jorkins: How affordable is this loan? I don't have a lot of money to pay it back.

Draco: Not to worry. We have loans that start with a low rate and when the rates go up in a few years, your home will be worth so much more that you'll be able to refinance, so that won't be a problem.

Jorkins: And you'll help me refinance then?

Draco: Well, I probably won't be in the company then. I'm shifting fields. But if it's not me, someone else can help you.

Jorkins: But what if prices don't go up in time?

Draco: No problem. If worse comes to worst, we can always get another bailout.

Postscript: Of course, this is completely unfair because changes in the law will prevent the making of loans that cannot be repaid.  Or will they?

Fannie and Freddie too big?

By Alan White

Die-hard free market advocates are responding to the nationalization of Fannie Mae and Freddie Mac by calling for them to be gradually shrunk out of existence, to unleash the private market to meet our housing finance needs. This appalling proposal completely ignores the clear lessons of the crisis unfolding all around us.

Fannie and Freddie have provided American homeowners with low-interest, safe, fixed-rate long-term mortgages for the past seventy years. In the last decade their share of the mortgage market did not grow too big, indeed it shrank. Why? Because the private securitization market grew dramatically, offering high-interest subprime and alt-A loans. The advocates of eliminating the public role in mortgage finance are thus advocating that we rely solely on a private mortgage finance system that lately brought us 2/28’s, NINJA loans (no income no job no assets) and Payment-Option ARMs.

Jones Day Opposes Trademark Amicus Brief -- What Is It Afraid Of?

by Paul Alan Levy

Twelve days ago, I posted comments here about a Jones Day lawsuit claiming that its trademark is infringed and diluted by mention of its name in headlines of articles on the BlockShopper web site, www.blockshopper.com, and by links to the Jones Day web site. Last week, we joined with EFF and other groups to file an amicus brief discussing Jones Day’s claims in light of both trademark law and the First Amendment, and posted word of that brief here.   

There are, apparently, some arguments in that brief that Jones Day is desperate to keep away from the judge – or, at least, to avoid having to answer – because it has taken the remarkable step of filing a  five-page brief opposing the motion for leave to file the brief.  It argues that the brief should not be accepted on the one hand because it duplicates arguments made by BlockShopper, and on the other because it makes an argument that BlockShopper does not make, and because the amicus brief is “partisan” in that it takes one side in the case instead of being neutral.  At bottom, Jones Day’s view rests on the notion that amicus briefs should rarely be allowed, relying in turn on a handful of opinions from Judge Richard Posner who feels that amicus briefs rarely say anything that he doesn’t already know.  Both Jones Day’s opposition and our response, as well as the original amicus brief, can be found  here. 

There is one statement in Jones Day’s opposition brief that requires a correction of a statement that I made in  my first blog post.  I expressed concern about a statement by Judge Darrah, leaning on the defendants to give up their free speech rights as follows:  “Do you know, young man, how much money it’s going to cost you to defend yourselves against Jones Day?”  I then said that it was understandable that, after learning the judge’s position, BlockShopper had stipulated to a TRO lasting six weeks.  Jones Day claims that this statement was not made until a court session on August 26, but the TRO was stipulated on August 19, and hence defendants’ decision to stipulate the temporary TRO could not have been influenced by what the judge said.  Following up with my original source, I have satisfied myself that Jones Day’s claim about the date is correct, and hence both my statement that it was made at the initial TRO hearing, and my causal statement, were in error.

Construction Arbitration Services’ Arbitrator Allegedly Destroys Evidence, Faces Motion for Contempt

By Matt Melamed and Paul Bland

Among consumer advocates, advocates for home buyers and home owners, and lawyers who represent consumers, Construction Arbitration Services ("CAS") is notorious for being cozy with the home construction industry and for often ruling for builders and against home buyers and home owners. In 2004, consumer advocates Public Citizen issued a report raising a number of concerns about CAS. [<a href="http://www.citizen.org/pressroom/release.cfm?ID=1775">Read the report here</a>.] While we at Public Justice don’t know of any broad study of outcomes in CAS arbitration cases, we have been contacted over the years by many home owners and home buyers who strongly believed that CAS had ignored the evidence in their cases and ruled against them inappropriately. (We have never taken a case for one of these consumers, in large part because the legal standards for challenging an arbitrator’s ruling are generally almost impossibly high – arbitrators’ decisions are frequently not overturned even when arbitrators get the law or the facts wrong.)

In a recent case in Louisiana, though, court filings suggest that CAS has clearly crossed the line into inappropriate behavior. According to court documents, the arbitrator provided by CAS, Ben DeVries, destroyed all evidence submitted during an arbitration hearing within days of issuing the arbitration award. Worse, the pleadings in the case set out that DeVries destroyed the evidence AFTER the plaintiffs had told him in writing that they planned to appeal the award and AFTER DeVries had promised to safeguard the evidence. CAS and DeVries now face a motion for contempt in the 26^th Judicial District Court, Bosser County, Louisiana – a motion supported by an affidavit in which opposing counsel, the builder’s attorney, states that he also heard DeVries promise to safeguard the evidence. In response, CAS has graciously offered . . . a free arbitration proceeding.

The underlying matter, Gilbert v. Robert Angel Builder, Inc., was initiated by a husband and wife seeking completion of their new custom-built home and repair of damages resulting from alleged deficiencies in the construction that had been completed. The deficiencies and damages specified include, but are not limited to:

A leak in the master shower led to massive structural damage in the home’s walls and floor. The seat was not placed in the shower pan, causing the leak. Angel’s own subcontractor testified that he was instructed by Angel to build the shower improperly because Angel did not have enough money built into the contract to build the shower properly.

The front doors leaked and water intrusion damaged the interior flooring and door frames. The front doors lacked sill pans and were not properly designed, composed, or installed.

Replacement of the hardwood floor (required due to the above-described water damage) was complicated because the floor was improperly installed. The Angel glued the floor, contrary to national guidelines for hardwood floor installation.

Water intrusion through the bedroom doors, which Angel suggested curing by sealing the doors shut. Angel invited the Gilberts to avoid local code violations and minimize potential resale value by re-labeling the room as a study.

The finish on the front door and windows failed to last six months. Protective stain was only applied after significant moisture intrusion that resulted from Angel leaving the doors and windows exposed to the elements prior to finishing.

The Gilberts’ expert witness – George "Geep" Moore, President of the Louisiana Home Builders Association – examined the house and testified in detail about the substandard workmanship and materials that led to the defects. The Gilberts contracted to spend more than $550,000 for construction of a new, custom-built home. They spent nearly $200,000 in addition on repairs and completion of construction (a sum that does not include legal fees and arbitration costs).

The Gilberts filed suit in Louisiana state court. Angel countersued for the last remaining construction payment, which the Gilberts had placed in escrow to be released when construction was complete as agreed by the parties in the construction contract. The Louisiana Court of Appeal consolidated the claims and sent them to CAS.

The Gilberts’ attorney – David Szwak, Chairman of the Consumer Protection Section of the Louisiana State Bar Association – hired a court reporter to create a transcript of the arbitration hearing. After the hearing, arbitrator DeVries took the entire body of original evidence submitted during the arbitration hearing with him to Texas, where he lives, including the original copy of the transcript from the first day of the two-day arbitration hearing (Szwak maintains a duplicate copy) and the original plans for the Gilberts’ house. DeVries allegedly told attorneys for both the Gilberts and Angel that he’d "safeguard" the evidence.

While the arbitration award ultimately ordered Angel to pay the Gilberts some of the damages they sustained, it appears from court documents to be deficient. In a ruling that Szwak argues is contrary to the Louisiana Home Warranty Act ("NHWA") (La. Rev. Stat. Ann. § 9:3141, et seq.), DeVries ruled that the Gilberts were in default for not paying the final $20,000 under the construction contract, $20,000 that the parties had contracted would be held in escrow until construction was completed and all defects were cured. Angel admitted during the arbitration hearing that he never completed construction nor repaired all defects.

Further, DeVries awarded a mere $9,000 to the Gilberts for the shower repair, relying on an estimate by Angel’s expert – who had never seen the damage, was unaware that the Gilberts had submitted numerous punch lists, did not know of or account for the structural damage to the walls resulting from the leak, and was shocked at the facts established at trial that Angel had not previously disclosed – over testimony from plaintiffs’ expert witness Moore and Angel’s own subcontractor that more than 80 hours of labor plus new materials were required. DeVries did not award anything to address the damage to the doors and windows and awarded only a portion of the attorney’s fee which the Gilberts said they had incurred. Even when DeVries was right, he was wrong: while he properly awarded $48,580.74 for replacement of the hardwood floor, he decided – over testimony by both the Gilberts’ and Angel’s expert witnesses – that gluing the floor down was not improper. Thus, DeVries failed to award damages for the increased labor to remove the damaged floor.

In sum, the evidence set forth in the pleadings indicates that arbitrator DeVries awarded the Gilberts $114,000 to fix nearly $200,000 of what the Gilberts argued were clearly established damages.

Under Louisiana law, the Gilberts had three months to challenge DeVries’ award, and on June 28, 2008, 78 days after the award, the Gilberts filed a motion to vacate or modify and correct the award. Szwak, the Gilberts’ attorney, also took the unusual step, within days after the award was entered, of asking the court to order the arbitrators not to destroy the evidence. On July 1, 2008, in response to a discovery motion filed by Szwak, the Louisiana District Court issued an order that defendants CAS and DeVries deliver all evidence submitted during arbitration to the court. In response, DeVries sent a letter to the clerk saying he’d destroyed all the evidence "after 20 days" from the date of the award.

Not only had Szwak given clear notice to DeVries during the arbitration hearing that the Gilberts intended to file a motion to vacate or modify and correct the award, and not only had DeVries promised to safeguard the evidence (a promise opposing counsel has attested to), but Szwak had sent a letter by fax and email to CAS directing them to file the arbitration evidence with the district court 18 days after the award was entered. Accordingly, the documents demonstrate that DeVries destroyed the evidence after CAS received the fax asking for the evidence to be delivered to the district court.

In response to the contempt motion [<a href="http://www.myfaircredit.com/forum/viewtopic.php?p=14691&sid=f6a95cb07e14bdda804a1e38aed293c0">read the motion here</a>] CAS has offered to pay for the time and cost it takes the Gilberts to reconstruct the evidence and for the cost of the original house plans destroyed by DeVries. In addition, CAS has tentatively agreed to a no deference referral for the appeal and a refund to the Gilberts for all costs of the arbitration. Mysteriously, CAS has also offered help in trying to "locate" the destroyed evidence, which begs the question whether something even stranger than DeVries’ destruction of evidence is going on. And finally, CAS has offered a free arbitration proceeding. (Thank you sir, may I have another.)

The contempt proceeding, originally scheduled for September 15, was continued due to inclement weather and will likely be heard in November. The matter is Gilbert, et al. v. Robert Angel Builder, Inc., No. 126,995-B, 26^th Judicial District Court, Bossier Parish, Louisiana.