Tuesday, February 24, 2009

Balancing the Equities in Securitized Mortgages

One of the arguments against allowing bankruptcy courts the power to reform mortgages for individuals in Chapter 13 cases similar to those powers available for businesses in Chapter 11 or 15 cases is that the lienholders would be unfairly affected adversely. This is a specious argument, especially given the public whining that mortgagee servicers make about how their hands are tied by the securitization contracts that prevent any modification of the terms of these mortgages. Mortgagors never signed up to be held hostage to derivative financing instruments and never contemplated that such absurd layers of ownership and control would be added to their agreements.

In a traditional two-party contract, if one party seeks a modification of terms, they simply attempt to negotiate with the other party. In the modern, derivative securitization world, the consumer may never be able to locate anyone with even apparent authority to negotiate on behalf of the innumerable interest-holders on the other side.

To those who argue that it should be against public policy to allow a court to harm innocent investors who legitimately helped finance these loans and took no part in the unfortunate events that created the upside-down mortgage, I offer the counterpoint that it should also be against public policy to sit idly by while another family becomes homeless, another house is struck off to the lienholder at auction and yet another straw is removed from the bundle of collateral that theoretically props up someone’s definition of “value.”

When the equities are balanced, a bankruptcy court should have the power to give that asset and that borrower an opportunity to perform rather than fail through an appropriate contract reformation.

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