Courts Balk at Homeowners' Entitlement Talk: The Substantive Effects of Making Home Affordable

• Author: Edward H. Cahill
• Position: J.D., Capital University Law School, May 2012
• Pages: 1053-1097

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COURTS BALK AT HOMEOWNERS’ ENTITLEMENT TALK: THE SUBSTANTIVE EFFECTS OF MAKING HOME AFFORDABLE

EDWARD H. CAHILL*

I. INTRODUCTION

“Toxie’s dead.”¹After a little more than six months, the residential mortgage-backed security (MBS)²or “toxic asset”³purchased by the producers of National Public Radio’s Planet Money stopped paying dividends.⁴The show’s producers bought Toxie so that listeners could follow the life cycle of a residential MBS.⁵The producers knew from the start that their asset would eventually stop producing dividends, but they believed the cause would be loan defaults on the underlying mortgages, followed by foreclosure.⁶Instead, kindness in the form of loan modifications killed their residential MBS.⁷

Copyright © 2012, Edward H. Cahill.

* Edward Cahill, J.D., Capital University Law School, May 2012. I would like to thank my wife Stephanie and my family for their patience; Brad Leach and Matt Richardson for their encouragement; and Professor Stacey Blasko for her excellent feedback.

¹Chana Joffe-Walt & David Kestenbaum, Toxie’s Dead, NPR (Sept. 24, 2010, 12:00 AM), http://www.npr.org/blogs/money/2010/09/23/130079590/toxie-s-dead.

²See Mortgage-Backed Securities, SEC (July 23, 2010), http://www.sec.gov/answers/ mortgagesecurities.htm. An MBS is a debt obligation “that represent[s] claims to the cash flows from pools of mortgage loans, most commonly on residential property.” Id. The debt obligations may take the form of a participation certificate and may be issued by any one of the government-sponsored enterprises, or “GSEs.” Id. Non-GSE residential MBSs are “known as ‘private-label’ mortgage securities.” Id. Toxie was a private-label MBS. Joffe-Walt & Kestenbaum, supra note 1. This distinction is relevant in the context of the Making Home Affordable Program. See infra Section II.A.1.b for a discussion of the GSEs.

³Joffe-Walt & Kestenbaum, supra note 1.

⁴Id.

⁵See id.

⁶ Id.

⁷ Id.

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A. Loan Modification Basics

In simple economic terms, loan modifications may work to produce an economic gain to the homeowner while also producing a loss to the lender, or in the case of securitized loans, the investor who is entitled to the revenue stream created by the security instrument.⁸However, where the homeowner is also the investor, as is the case for homeowners whose retirement or investment savings are invested in MBSs, loan modification may amount to robbing Peter to pay Peter.⁹Additionally, the securitized nature of the loan itself may disincentivize loan modifications because the agreement between the investors and the party responsible for servicing the loan may contractually limit loan modifications.¹⁰These considerations came to the forefront in the latter half of the last decade.¹¹

B. Legislative Responses to the Financial Crisis

The downturn in economic conditions in late 2007,¹²coupled with an increase in the rate of mortgage defaults, led the 110th Congress to enact several measures related to these conditions.¹³Of this legislation, the Housing and Economic Recovery Act of 2008 explicitly specified encouraging voluntary loan modifications as its purpose and placed authority for a program to do so under the Federal Housing Administration.¹⁴The “HOPE for Homeowners Program,”¹⁵as it was

⁸ Id.

⁹ See Peter L. Cockrell, Comment, Subprime Solutions to the Housing Crisis: Constitutional Problems with the Helping Families Save Their Homes Act of 2009, 17 GEO.

MASON L. REV. 1149, 1154–56 (2010) (describing the potential negative effects of loan modification on owner-investors arising out of large-scale modification regimes).

¹⁰ Id. at 1156.

¹¹See id. at 1159–62.

¹²MARC LABONTE, CONG. RESEARCH SERV., RL 34484, EVALUATING THE POTENTIAL FOR A RECESSION IN 2008 1 (2008).

¹³ See, e.g., Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, 122 Stat 3765 (codified mainly in 12. U.S.C. §§ 5201–5261); Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, 122 Stat. 2654 (codified as amended in various sections of 12 U.S.C.); Mortgage Forgiveness Debt Relief Act of 2007, Pub. L. No. 110–142, 121 Stat. 1803 (codified as amended in various sections of 26 U.S.C.); Economic Stimulus Act of 2008, Pub. L. No. 110–185, 122 Stat. 613 (codified in various sections of 26 U.S.C.).

¹⁴ See 12 U.S.C. § 1715z-23(b)(1)–(7) (Supp. IV 2006).

¹⁵12 U.S.C. § 1715z-23(a) (Supp. IV 2006).

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titled, failed to track its projected goal immediately following enactment,¹⁶

leading then President-elect Barack Obama to consider alternatives, including a ninety-day foreclosure moratorium and changes to the bankruptcy code.¹⁷Ultimately, the chosen solution was to rework the HOPE program under the existing Emergency Economic Stability Act (EESA)¹⁸by placing the program within the newly created “Homeowner Affordability and Stability Plan,”¹⁹and renaming HOPE for Homeowners as the “Making Home Affordable Program” (MHA).²⁰

C. MHA

MHA was introduced to the public primarily as a plan to help “4 to 5 million responsible homeowners” refinance their loans to take advantage of lower interest rates.²¹When announced in early 2009, MHA featured a second, more modest provision aimed at reaching approximately “3 to 4 million at-risk homeowners” who due to the recession, had difficulty paying their mortgage.²²Although these individuals in the past could have taken advantage of rising house prices to refinance²³or sell, declining

¹⁶Kathleen Pender, Obama Wants to Limit Foreclosures-but How?, S.F. CHRON., Nov. 9, 2008, at C–1 (noting that the FHA revised its estimate of 400,000 modified loans over three years to just 13,300 in the first year, a ten-fold reduction in the estimated annual number of modifications over the projected period).

¹⁷ Id. (discussing a ninety-day foreclosure moratorium and reintroduction of changes to the bankruptcy code). See also Cockrell, supra note 9, at 1192–94 (arguing in favor of the latter).

¹⁸ See Press Release, U.S. Dep’t of the Treasury, Secretary Geithner Introduces Financial Stability Plan (Feb. 10, 2009), available at http://www.treasury.gov/press-center/ press-releases/Pages/tg18.aspx.

¹⁹ See Press Release, U.S. Dep’t of the Treasury, Homeowner Affordability and Stability Plan Executive Summary (Feb. 18, 2009), available at http://www.treasury.gov/ press-center/press-releases/Pages/tg33.aspx.

²⁰ See Press Release, U.S. Dep’t of the Treasury, Relief for Responsible Homeowners One Step Closer Under New Treasury Guidelines (Mar. 4, 2009), available at http://www. treasury.gov/press-center/press-releases/Pages/tg48.aspx.

²¹Press Release, supra note 19.

²² See Press Release, U.S. Dep’t of the Treasury, Making Home Affordable, Updated Detailed Program Description (Mar. 4 2009), available at http://www.treasury.gov/press-center/press-releases/Documents/housing_fact_sheet.pdf.

²³ See Samantha M. Shapiro, The Boomtown Mirage, KEY: THE N.Y. TIMES REAL

ESTATE MAGAZINE, Apr. 6, 2008, at 66.

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house values left them with negative equity in their home.²⁴These individuals were “underwater,” in that their home’s value was less than what would be due to the lender upon sale, and selling under such negative equity conditions would leave them with a balance due to the lender.²⁵

The MHA program was intended to fix issues such as low participation rates among the interested parties in previous programs.²⁶Although MHA is a contractually-based program that provides incentives to private entities to modify loan terms,²⁷homeowners have claimed that the program creates substantive rights.²⁸Homeowners have also claimed the ability to bring a cause of action under MHA²⁹and have asserted certain provisions of MHA as a defense during a foreclosure action.³⁰

This comment examines the legal theories advanced by these individuals, the judicial response to these arguments, and the cost of MHA compared to the benefits of the program. The first section of this comment provides a history of the program, its components, and an explanation of how the modification process works. This section also provides the legal foundation for an understanding of recent court decisions concerning homeowners’ claims under MHA.

The next section examines legal arguments raised by homeowners based on MHA and concludes that courts have correctly decided that, due to the voluntary nature of MHA, no independent cause of action nor any defense arises out of or is related to the program.

Finally, this comment places the brief history of MHA and its goals in perspective by comparing the benefits and costs of the two main components of MHA. Based on the available data, the current costs of certain programs within MHA are justified, while for other programs, the costs outweigh the benefits.

Despite this conclusion, current changes to the program are a positive step toward ameliorating criticism and perceived shortcomings of the program. Because the next generation of programs keeps the essential agreements that compose MHA intact, the judicial foundation upon which

²⁴ See Press Release, supra note 22.

²⁵See id.

²⁶ See id.

²⁷See infra Section II.A.2.

²⁸ See infra Section III.

²⁹ See infra Section III.A.

³⁰ See infra Section III.D.

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challenges to the program have been made and rebuffed should also remain intact also.

II. MAKING HOME AFFORDABLE

The MHA program was one of the components of incoming President Barack Obama’s “Comprehensive Financial Stability Plan.”³¹Within one day of U.S. Treasury Secretary Timothy Geithner’s testimony before the Senate Finance Committee concerning the Comprehensive Plan, the U.S. Department of Treasury released details...