Thursday, May 29, 2008

BK Judge Rules Stated Income HELOC Debt Dischargeable

This is a big deal, and will no doubt strike real fear in the hearts of stated-income lenders everywhere. Our own Uncle Festus sent me this decision, in which Judge Leslie Tchaikovsky ruled that a National City HELOC that had been "foreclosed out" would be discharged in the debtors' Chapter 7 bankruptcy. Nat City had argued that the debt should be non-dischargeable because the debtors made material false representations (namely, lying about their income) on which Nat City relied when it made the loan. The court agreed that the debtors had in fact lied to the bank, but it held that the bank did not "reasonably rely" on the misrepresentations.

Sunday, May 25, 2008

Back Door Cram Down on 2nd T.D. Refi [11 U.S.C. 1322 (b)]

A lot has been written by me and others about How To Walk Away From Your Home. My blog has become more of a self-help guide to walking away in California. I get at least 25 calls and emails a week from people who want to get out from their underwater homes, but are scared they will be liable for the unpaid mortgage debt. As I previously explained, California homeowners who used 80/20 loans to purchase their homes and have not refinanced the second mortgage, can walk away without paying anything.Once again it’s the 80/20 loan to the rescue.

This beautiful piece of financial engineering genius (you really need to click on that link, it’s hilarious!) has found yet another way to help distressed home owners. And not just in California, this trick works all over the United States.

The trick is called a “Chapter 13 Lien Strip” but I like to call it the “Back Door Cram Down.” You may have read about the proposed mortgage “Cram Down” legislation that would allow Chapter 13 judges to reduce or “Cram Down” mortgages balances to fair market value in a Chapter 13 case. This legislation has zero chance of passing until a new election and Congress are seated next January.

Instead, we are “Cramming Down” second mortgages using the old Bankruptcy code section 1322 which states:

“Contents of plan

(b) The plan may–

(2) 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, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims.”

What’s not obvious about this code section is a loan is not “secured” by your personal residence if there is no value or equity in your home that would go to the lender if the home was sold. That means the loan can be converted to unsecured or the lien “stripped” from the house by “modifying the rights of holders of secured claims.” This turns it into unsecured debt, like credit card debt, which can be discharged!!!! This is why I call it a “Back Door” cram down because we are cramming down the second mortgage to unsecured status.

Here is an example. You bought your home in 2006 for $500k with 100% financing using an 80/20 loan. So your first mortgage is 80% or $400k and your second mortgage is 20% or $100k. The market is down more than 20% from its peak and your house is now only worth $375k. This means if the house was sold, the first mortgage would take all $375k and the second mortgage would get nothing. In this case the second mortgage is “wholly unsecured” and the second clause of section 1322(b) does not apply, so we can modify the rights of the second mortgage holder and turn it into unsecured debt.

What happens to the now unsecured stripped off second mortgage? It gets paid in your Chapter 13 plan but only after your other secured debts are paid. Secured debts are the first mortgage, your property taxes, and your car payments. And because a Chapter 13 plan lasts only 3-5 years (usually 5) a whole lot of that unsecured debt does not get paid. At the end of 5 years, most unsecured debts (not student loans, back income taxes, or family support payments) are discharged so you don’t have to repay them.

So at the end of 5 years, you are left with just your just mortgage payment on your house. Your cars and your back property taxes are paid off, your student loans and back income taxes are paid down, but your second mortgage and your credit card debt is gone! Beautiful isn’t it? God bless the 80/20! It just keeps on giving

Friday, May 23, 2008

Show Us Your Money - Patriot & Bank Secrecy Act

The Patriot Act authorized broad surveillance of financial transactions, bypassing the Fourth Amendment's normal protections against "unreasonable searches and seizures" by requiring businesses to collect and share information with the government.

After the measure passed and was signed into law, the debate was far from over. The American Civil Liberties Union and other critics continued to rail against the law as an unnecessary breach of privacy.

"Under the act and regulations the reports go forward to the investigative or prosecuting agency...without notice to the customer," one civil libertarian wrote. "Delivery of the records without the requisite hearing of probable cause breaches the Fourth Amendment....I am not yet ready to agree that America is so possessed with evil that we must level all constitutional barriers to give our civil authorities the tools to catch terrorists."

These may sound like the arguments for and against the USA PATRIOT Act, passed immediately after the attacks of September 11, 2001. But they concern another piece of legislation, the Bank Secrecy Act (BSA) of 1970. The only change I made to these decades-old quotes was to substitute the word terrorist for criminal and terrorism for crime.

The congressman was Wright Patman, the populist Texas Democrat who pushed through the bill on the premise that it would help fight drug trafficking, tax evasion, and other crimes, including the then-prohibited ownership of gold as a commodity. The civil libertarian was Supreme Court Justice William O. Douglas. In the 1974 case California Bankers Association v. Shultz, Douglas wrote a dissent, joined by Justices William Brennan and Thurgood Marshall, concluding that the Bank Secrecy Act violated the Fourth Amendment. The final quote is from William Rehnquist, now the Court's chief justice, who wrote the majority opinion upholding the law.

The reason the arguments sound familiar is that the BSA set the precedent for much of the PATRIOT Act, not to mention government fishing expeditions such as the Pentagon's aborted Total Information Awareness program. The law authorized the government to require bank reports of all transactions over a dollar value set by the Treasury Department, even if there is no reason to suspect a criminal connection. For the first time, in the words of the U.S. District Court for the Northern District of California, "the government claim[ed] the legal right to maintain routine surveillance, without summons, subpoena, or warrant, over the details of citizens' financial transactions."

The district court struck down the BSA's reporting requirement, but its decision was reversed by the Supreme Court. In a complicated majority opinion, Rehnquist said that banks, as businesses, don't have the same Fourth Amendment rights as individuals. The opinion relied on the many post-New Deal cases that minimized economic liberties, including one that said "corporations can claim no equality with individuals in the enjoyment of a right to privacy." In this and in a subsequent BSA case, U.S. v. Miller (1976), the Court ruled that a bank's customers generally lack standing to challenge the law.

Law enforcement agencies thus found a convenient end run around the Fourth Amendment. They can access the details of a bank customer's transactions from the Treasury Department's Financial Crimes Enforcement Network (FinCEN) without showing probable cause -- or any evidence at all.

The paperwork is indeed massive. Even before the PATRIOT Act, banks sent more than 12 million transaction reports to the government in 2000 alone.

Despite such concerns, financial surveillance has been massively expanded during the last 30 years, while other intelligence-gathering techniques, such as the use of informants, have been sharply restricted. The Treasury Department's BSA regulations required banks, subject to some exemptions, to file a currency transaction report (CTR) on every cash transfer of $10,000 or more. In the 1990s, the department established FinCEN, which expanded the regulations to require that banks file "suspicious activity reports" (SAR) on all transactions of $5,000 or more if they have "no apparent lawful purpose or are not the sort in which the particular customer would normally be expected to engage." Banks are forbidden to notify customers about the reports. "In effect, bankers have been drafted as spies and snitches," wrote banking industry consultant Bert Ely in a 2002 paper for the conservative Free Congress Foundation.

The PATRIOT Act extended the requirement to many more businesses. FinCEN, pursuant to the act, recently put the "suspicious activity" reporting rules into effect for brokerage houses, and real estate transactions are next on the list. The law also specifically covers casinos, credit card agencies, and life insurers. In the next few months, the Broward Daily Business Review reports, "the Treasury Department will decide whether the act covers travel agents, automobile dealers, mutual funds and dealers in precious metals and stones." And under the law, virtually all businesses, including the "hardware and retail stores" mentioned by Douglas, now have to report to the government any cash purchases over $10,000.