Bankruptcy system takes on the mortgage mess

Mike Stuckey Senior news editor • Profile • E-mail

Aiming to keep overextended borrowers in their homes, judges and trustees in the federal bankruptcy court system have helped a small Kentucky firm set up a nationwide service intended to speed the modification of troubled mortgages.

But the court system’s unusual support for the private project, which some supporters believe could also help stem a surge in bankruptcies, has divided debtor attorneys, some of whom believe their colleagues have gotten in bed with the enemy and others who say it is just one potential tool to clean up a giant mess. It could, however, make millions for its creator.

The idea behind the “Debtors Counsel Loss Mitigation Web Portal”  is simple, owner Joseph C. Smith II told msnbc.com in an interview. Attorneys representing troubled borrowers can use a single Web site to communicate with many mortgage servicers and lenders about changing the terms of loans. The servicers and lenders, in turn, can consolidate their work on such requests.

“It’s not rocket science,” said Smith, who has been working in loan modification and loss mitigation since 2003, after quitting the mortgage industry to escape its “corrupt practices.”

As the nation braces for a second straight year in which home foreclosures are expected to reach well above 2 million and bankruptcies over 1 million, one of the toughest problems remains the inability of many troubled borrowers to get viable modifications of mortgages they can no longer afford.

The mortgage industry, eager to avoid legislation allowing bankruptcy judges to rewrite home mortgages and to maintain the flow of taxpayer bailout funds, says it is working hard to modify as many loans as possible.

Bankruptcy and consumer attorneys dispute that, maintaining that servicers are notoriously hard to reach and generally show little interest in negotiating new loan terms. Often that’s because the loans are held in securitized trusts with many different investors and agreements that virtually forbid modifications, they say. Disappointing results from other efforts to modify loans, such as the federally backed Hope Now Alliance, support their claims, they say.

‘What are you going to offer?’
Enter Smith and his portal. “The commitments on both sides are very clear cut,” he said, explaining that debtors’ attorneys enter the information about the borrower and the loan, and the servicers agree to respond in seven days. The system impartially tracks what both sides do.

Joseph C. Smith II

“It’s a very interactive process that’s able to happen out of this very quickly,” said Smith. “That really is what it boils down to. Is there something viable here to work with? What are you going to offer?”

Backers of the portal said that in addition to helping borrowers and servicers, it could lubricate Chapter 13 proceedings, which can be used to halt foreclosure, by letting trustees and judges know what concessions mortgage servicers are willing to make. In best-case scenarios, they said, the portal could help keep some debtors in their homes and out of bankruptcy altogether.

But some debtor lawyers said they shouldn’t have to use a private, for-profit middleman to deal with mortgage servicers. And they questioned how Smith was able to get officials in the court system, along with some well-known debtor lawyers, to help him create, test and then publicize the portal on court Web sites and e-mail lists.

“I really think that is a waste of my time, and I think it’s unnecessary,” said Andy Miofsky, an attorney from Granite City, Ill., who handles hundreds of bankruptcy cases a year. “There is nothing, nothing, nothing in the world that prevents a mortgage servicer from calling me.”

“It reeks to high heaven,” said April Charney, a legal aid lawyer in Jacksonville, Fla., who specializes in foreclosure defense. “Why does this portal have special relationships with all of these servicers, and how did they get that? Why do we have to have a private business connected up in what is supposed to be a public business, the bankruptcy system? … How did they get this nationwide deal?”

Creator says opportunity knocked
Smith, the portal operator, said there was nothing nefarious about it. Members of the National Association of Chapter 13 Trustees approached him in July with the idea, which originally was suggested by Southern California bankruptcy attorney Erik Clark. Clark and Debra Miller, a Chapter 13 trustee from South Bend, Ind., who heads up the trustees’ mortgage committee, confirmed Smith’s account in interviews with msnbc.com.

“Our job as Chapter 13 trustees is to help make the system work better,” said Miller, one of more than 200 Chapter 13 standing trustees across the nation. The trustees are the watchdogs and administrators of the bankruptcy system, collecting payments from debtors and distributing the money to creditors under plans approved by the court. Although appointed by the Department of Justice with salaries set by Congress, the trustees are not federal employees, and their offices are funded via fees, not tax dollars.

The bankruptcy system’s potential role in helping to end the mortgage meltdown is the subject of hot debate in Washington. By law, mortgages on primary residences are the only debts that bankruptcy judges are not allowed to adjust unilaterally in working out repayment plans. A number of lawmakers would like to change that, and legislation to allow such “mortgage cram-downs” could be passed soon.

While “cram-downs” have been adamantly opposed by the mortgage industry, many observers believe they could serve as a huge incentive for servicers to modify loans on their own, rather than taking their chances on what a judge might do in bankruptcy proceedings. Smith and others see great potential for his portal to accommodate these loan workouts too.

“For me, if this thing works, we may have less bankruptcies,” said George Stevenson, a Chapter 13 trustee from Memphis, Tenn. “I live in a community, and I see people coming through my court every day that are poor and struggling” and threatened with losing their homes. He said he’s in favor of “anything to assist these people.”

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