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S. HRG. 110–511 

THE LOOMING FORECLOSURE CRISIS: HOW TO 

HELP FAMILIES SAVE THEIR HOMES 

HEARING 

BEFORE THE

COMMITTEE ON THE JUDICIARY 

UNITED STATES SENATE 

ONE HUNDRED TENTH CONGRESS 

FIRST SESSION 

DECEMBER 5, 2007 

Serial No. J–110–62 

Printed for the use of the Committee on the Judiciary 

( 

(II) 

COMMITTEE ON THE JUDICIARY 

PATRICK J. LEAHY, Vermont, Chairman 

EDWARD M. KENNEDY, Massachusetts 

JOSEPH R. BIDEN, JR., Delaware 

HERB KOHL, Wisconsin 

DIANNE FEINSTEIN, California 

RUSSELL D. FEINGOLD, Wisconsin 

CHARLES E. SCHUMER, New York 

RICHARD J. DURBIN, Illinois 

BENJAMIN L. CARDIN, Maryland 

SHELDON WHITEHOUSE, Rhode Island 

ARLEN SPECTER, Pennsylvania 

ORRIN G. HATCH, Utah 

CHARLES E. GRASSLEY, Iowa 

JON KYL, Arizona 

JEFF SESSIONS, Alabama 

LINDSEY O. GRAHAM, South Carolina 

JOHN CORNYN, Texas 

SAM BROWNBACK, Kansas 

TOM COBURN, Oklahoma 

BRUCE A. COHEN, Chief Counsel and Staff Director 

MICHAEL O’NEILL, Republican Chief Counsel and Staff Director 

(III) 

C O N T E N T S 

STATEMENTS OF COMMITTEE MEMBERS 

Page 

Durbin, Hon. Richard J., a U.S. Senator from the State of Illinois .................... 1 

Feingold, Hon. Russell D., a U.S. Senator from the State of Wisconsin, prepared statement ................................................................................................... 153 

Sessions, Hon. Jeff, a U.S. Senator from the State of Alabama .......................... 4 

Specter, Hon. Arlen, a U.S. Senator from the State of Pennsylvania ................. 3 

WITNESSES 

Bennett, Thomas, Bankruptcy Judge, U.S. Bankruptcy Court for the Northern, District of Alabama, Birmingham, Alabama .............................................. 17 

Cox, Jacqueline P., Bankruptcy Judge, U.S. Bankruptcy Court for the Northern District of Illinois, Chicago, Illinois ............................................................. 15 

Mason, Joseph, Associate Professor, Drexel University, Philadelphia, Pennsylvania ...................................................................................................................... 10 

McGee, Nettie, Chicago, Illinois ............................................................................. 5 

Scarberry, Mark, Professor of Law, Pepperdine School of Law, and Resident 

Scholar, American Bankruptcy Institute, Washington, DC ............................. 12 

Sommer, Henry J., President, National Association of Consumer Bankruptcy 

Attorneys, Philadelphia, Pennsylvania .............................................................. 20 

Zandi, Mark, Chief Economist, Moody’s Economy.com, Inc., West Chester, 

Pennsylvania ........................................................................................................ 7 

QUESTIONS AND ANSWERS 

Responses of Thomas Bennett to questions submitted by Senators Durbin 

and Sessions ......................................................................................................... 36 

Responses of Jacqueline Cox to questions submitted by Senators Durbin 

and Specter ........................................................................................................... 51 

Responses of Joseph Mason to questions submitted by Senators Brownback, 

Sessions and Durbin ............................................................................................ 56 

Responses of Mark Scarberry to questions submitted by Senators Specter, 

Durbin and Sessions ............................................................................................ 74 

Responses of Henry Sommer to questions submitted by Senators Brownback, 

Durbin and Specter .............................................................................................. 89 

Responses of Mark Zandi to questions submitted by Senators Durbin, 

Brownback and Specter ....................................................................................... 98 

SUBMISSIONS FOR THE RECORD 

American Bankers Association, Washington, D.C., statement ............................ 101 

Bartlett, Steve, on behalf of the Financial Services Roundtable, Washington, 

D.C., statement .................................................................................................... 113 

Bennett, Thomas, Bankruptcy Judge, U.S. Bankruptcy Court for the Northern, District of Alabama, Birmingham, Alabama, statement ........................... 117 

Chemerinsky, Erwin, Alston & Bird Professor of Law, Duke University, 

School of Law, Durham, North Carolina, letter ................................................ 131 

Consumer, civil rights, labor, retiree, housing, lending and community organizations, joint letter ............................................................................................... 135 

Consumer Federation of America, Allen Fishbein, Director, Housing and 

Credit Policy, Washington, D.C., letter .............................................................. 137 

Consumer Mortgage Coalition, Anne C. Canfield, Executive Director, Washington, D.C., letter ............................................................................................... 139 

Page

IV 

Cox, Jacqueline P., Bankruptcy Judge, U.S. Bankruptcy Court for the Northern District of Illinois, Chicago, Illinois, statement .......................................... 145 

Leadership Conference, on Civil Rights, Wade Henderson, President & CEO, 

Nancy Zirkin, Vice President, Director of Public Policy, Washington, D.C., 

letter ...................................................................................................................... 155 

Mason, Joseph, Associate Professor, Drexel University, Philadelphia, Pennsylvania, statement ................................................................................................... 157 

McGee, Nettie, Chicago, Illinois, statement .......................................................... 162 

Mortgage Bankers Association, Washington, D.C., statement ............................ 165 

National Association of Home Builders, Washington, D.C., statement .............. 177 

Scarberry, Mark, Professor of Law, Pepperdine School of Law, and Resident 

Scholar, American Bankruptcy Institute, Washington, DC ............................. 182 

Sommer, Henry J., President, National Association of Consumer Bankruptcy 

Attorneys, Philadelphia, Pennsylvania, statement ........................................... 194 

Stein, Eric, Center for Responsible Lending, Durham, North Caroline, statement and attachments ......................................................................................... 205 

Zandi, Mark, Chief Economist, Moody’s Economy.com, Inc., West Chester, 

Pennsylvania, statement ..................................................................................... 233 

(1) 

THE LOOMING FORECLOSURE CRISIS: HOW 

TO HELP FAMILIES SAVE THEIR HOMES 

WEDNESDAY, DECEMBER 5, 2007 

UNITED STATES SENATE, COMMITTEE ON THE JUDICIARY, Washington, DC 

The Committee met, Pursuant to notice, at 2:29 p.m., in room 

226, Dirksen Senate Office Building, Hon. Richard J. Durbin, presiding. 

Present: Senators Specter and Sessions. 

OPENING STATEMENT OF HON. RICHARD J. DURBIN, A U.S. 

SENATOR FROM THE STATE OF ILLINOIS 

Senator DURBIN. The hearing will come to order. 

Good afternoon, and welcome to this hearing of the Senate Judiciary Committee on ‘‘The Looming Foreclosure Crisis: How to Help 

Families Save Their Homes.’’ 

I want to thank Chairman Patrick Leahy for scheduling this important hearing and permitting me to chair it. I believe I’ll be 

joined by some colleagues during the course of this hearing, and 

they will play an active part in the interrogation, as well as followup questions. 

America’s mortgage crisis is not just your neighbor’s problem, it 

is everyone’s problem. It is putting families out on the streets, driving down home values, and sending our economy into a tailspin. It 

is a crisis that demands an urgent response. 

Home ownership is a pillar of our society and an integral part 

of America’s economy. But the mortgage melt-down means thousands of families are losing their homes. Millions more are at risk 

of foreclosure, and up to a third of all home-owning families in this 

country may see their homes lose value. 

Why is this happening? The reasons are clear. During the heyday 

of the real estate bubble, through a combination of bad information 

and aggressive brokers and bankers, too many families signed up 

for bad mortgages. For a while, many homeowners were able to 

keep up with their mortgage payments because home values were 

on the rise, or because adjustable rate mortgages had not yet reset to higher interest rates. But many of these same homeowners 

are now struggling as housing prices have dropped and the adjustable rate mortgages have begun to re-set. 

Whatever the reason that families may find themselves unable 

to pay their mortgages, the effect of foreclosure is the same: it’s a 

disaster for the family, and for the neighborhood, and for our country. 

2 

The Center for Responsible Lending estimated, a year ago, that 

2.2 million homes might be lost to foreclosure in the coming 

months ahead. That estimates now looks conservative. The impact 

of home foreclosures is not limited to families who are put out on 

the street. Treasury Secretary Paulson said earlier this week, 

‘‘Homes in foreclosure can pose costs for the whole neighborhood, 

as crime goes up and property values decline.’’ 

The Center for Responsible Lending recently released new estimates on the lost home value that the foreclosure wave will cause 

for neighboring families. The Center predicts that, nationwide, 44.5 

million families will experience a loss in home value because of 

foreclosures in their neighborhoods. Forty-four point five million 

homeowners represent one-third of all residential homes in America. These families will see property values decrease by an average 

of $5,000. 

Some metropolitan regions will be particularly hard hit. In Cook 

County, Illinois alone, the Center predicts that around 2 million 

homeowners will lose value in their homes because of neighborhood 

foreclosures. Somewhere between two-thirds and 85 percent of all 

Cook County homeowners will be affected by the 50,000 or 59,000 

foreclosures in that county. These homeowners will lose, collectively, $15.7 billion in home value, an average of $7,000 a home. 

These are astounding numbers. Home foreclosures pose other 

problems as well. The U.S. Conference of Mayors issued a report 

projecting the foreclosure crisis will result in 524,000 fewer jobs 

next year, a drop in consumer spending, a loss of billions of dollars 

in local, State, and Federal tax revenue, and a slower growth rate 

for our U.S. GDP. 

This foreclosure crisis is looming over our entire economy right 

now. It is time to do something. The government, mortgage lending 

industry, and the nonprofits who help homeowners have to work 

together to save as many homes as possible. I am pleased that in 

Congress, we are now talking about how to tighten lending standards so we won’t repeat this type of market melt-down, but there 

is more work to do. In the meantime, many families are already 

in a desperate struggle. 

I have introduced the Helping Families Save Their Homes in 

Bankruptcy Act. This legislation can help save the homes of about 

1 out of every 4 facing foreclosure, about 600,000 families who have 

nowhere else to turn. 

Today, a bankruptcy judge in Chapter 13 can change the structure of any secured debt except for one: the mortgage on a home, 

a principal residence. When this exception was added to the law almost 30 years ago, mortgages were largely 30-year, fixed-rate loans 

that required 20 percent down, and were originated by a local 

banker who personally knew the homeowner. In 1978, when this 

provision was added to the Bankruptcy Code, it was rare, if ever, 

that a mortgage would be the source of financial difficulty that sent 

a family into bankruptcy. 

Well, a lot has changed since 1978. Now, unregulated, out-oftown mortgage brokers sell exotic, ‘‘no-doc’’, interest-only, ‘‘2-28’’, or 

other exotic mortgages to families with few questions asked. The 

mortgages are then securitized by the big banks, sold into secondary markets to investors who have no knowledge of the homeVerDate Aug 31 2005 15:00 Sep 29, 2008 Jkt 044330 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\44330.TXT SJUD1 PsN: CMORC
3 

owner or their financial situation. Risk is dispersed, but so is responsibility. 

In 1978, when a family realized it might begin having trouble 

making a house payment, it could go down to the local bank and 

work out a new plan to keep up. Today, families struggle to even 

get a straight answer from somebody on a telephone about what’s 

happened to their mortgage. We need another solution for families 

who are losing their way in this brave new world of complicated 

mortgages. We need to provide families with more leverage so that 

banks will work harder to come up with reasonable compromises. 

Bankruptcy has to be the last resort. I believe it is. But changing 

how family homes are treated in bankruptcy will help hundreds of 

thousands of families who would otherwise be out on the street. 

Who wins? Who wins in a foreclosure? All of the money that is 

being spent so that someone ends up with a home that can be 

worth no more ultimately than the fair market value? Do bankers 

really want to cut grass and wash windows? I don’t think so. If we 

can keep the family in the home under reasonable terms, that’s the 

best outcome. 

My bill would allow bankruptcy judges to work out mortgage 

payment plans with the homeowners and the banks, and also protect those families from excessive fees. Under my bill, only families 

that desperately need the help will file for bankruptcy, and only 

reasonable mortgages will result. The bill will facilitate dealing 

with each family situation individually, and yet it would provide a 

method for processing the massive volume of needed modifications 

that the banks’ voluntary work-out procedures simply cannot handle. It does not create a new government bureaucracy, and it 

wouldn’t cost the taxpayers a penny. 

This afternoon, I look forward to learning more about the current 

state of the mortgage market and discussing how we might make 

those changes to the Bankruptcy Code. Before I recognize him, I 

want to thank my colleague, Senator Arlen Specter from Pennsylvania. He and I have been talking this over for the last several 

months, and it was his suggestion that we have this hearing. I am 

glad we did. A lot of attention is being paid to this, as it should 

be. This is a national issue of great consequence. I thank Senator 

Specter for his continuing interest, and I give him the floor. 

STATEMENT OF HON. ARLEN SPECTER, A U.S. SENATOR FROM 

THE STATE OF PENNSYLVANIA 

Senator SPECTER. Thank you very much, Mr. Chairman, for that 

excellent background on the problem, and those generous words. 

It is true that Senator Durbin, I, and others have been talking 

about this problem for a long time. We are very close to the same 

approach, with one difference. That is, Senator Durbin’s bill would 

all the bankruptcy courts to cram down, or modify the principal obligation. My bill would deal only with the interest. 

My thinking has been that on the adjustable rate mortgage, people didn’t really know what they were doing and they were getting 

involved in financial transactions which were a surprise to them, 

where they expected to pay a given amount and then suddenly they 

found the adjustable rates are much higher and something they 

could not afford. 

4 

Some of these transactions, I think, border, if not cross the line, 

of fraud and misrepresenting to homeowners what was going to 

happen. With the principal sum, it’s a little different. I think they 

knew what the principal sum was. But it is really anomalous that 

the Bankruptcy Code allows secure transactions to be modified by 

the bankruptcy court, but not first mortgages. 

I noted with interest a notation from a concurring opinion of Justice Stevens in Nobleman v. American Savings. He wrote it this 

way, and he lays it out in very succinct terms: ‘‘At first blush, it 

seems somewhat strange that the Bankruptcy Code should provide 

less protection to an individual’s interest in retaining possession of 

his or her home than of other assets. The anomaly is, however, explained by the legislative history, indicating favorable treatment of 

residential mortgages was intended to encourage the flow of capital 

into the home lending market.’’ 

So the concern that I have had, and candidly expressed to Senator Durbin, is that if we make a modification of the principal 

home, then the lenders will be reluctant to loan money for the principal home for fear that there will be another action by Congress 

to move the goal post. But when he and I talked about this, we 

were of the same mind, that we ought to know what the experts 

thought. We can sit and speculate about it, and our staffs, which 

are more astute than we, could work on it, but that it would be a 

good idea to hear from some of the experts. 

This hearing has been set for the afternoon, which is sort of 

tough on our schedule. We ordinarily have these hearings in the 

morning. This is a major, major problem in this country. The lack 

of attendance of the 19 members of the Judiciary Committee 

doesn’t signify any lack of concern, but only that people are occupied with many other matters. I personally will stay as long as I 

can, but we will be following your testimony very, very closely. 

The President has addressed the subject. Treasury Secretary 

Paulson has. Secretary Jackson has. I believe this is a matter that 

the Congress ought to act on very promptly, so we’re going to move 

the ball ahead with this hearing today. 

Thank you, Mr. Chairman. 

Senator DURBIN. Senator Specter, thank you very much. 

Senator SPECTER. Senator Coleman is a cosponsor of my bill, and 

I would like to thank him for joining. 

Senator DURBIN. Thank you. 

This matter is before the full committee, the Judiciary Committee. It customarily would have been before the Subcommittee on 

Administrative Oversight and the Courts. Senator Sessions of Alabama is the ranking Republican member on that, and I would invite him now if he’d like to make an opening statement. 

STATEMENT OF HON. JEFF SESSIONS, A U.S. SENATOR FROM 

THE STATE OF ALABAMA 

Senator SESSIONS. I thank you for having this hearing. I’m a 

very strong believer that one of the most fantastic things about living in America, is that the average citizen with a decent job can 

borrow $100,000, $150,000, 6, 7 percent interest, pay it off over 30 

years, and move into a nice house, at least in most areas of the 

country. It’s more than that in some, for sure. So, I think it’s a 

5 

great privilege we have. It used to be rather simple. There weren’t 

many different kinds of mortgages and loans that you took out. 

Now we’ve gotten very complicated. 

I think it’s worthy of Congress to consider how we do this. But 

I do know that we’re not going to change the law of supply and demand. If we make too many rules, particularly on the back end in 

court, we’re liable to reduce the amount of money available for the 

average person to borrow to buy a house that he can raise his family in and retire in. So, that would be my concern as we go forward. 

We ask those questions to make sure that we are addressing the 

problems that we now face in the best way possible. 

Thank you, Senator Durbin. 

Senator DURBIN. Thank you, Senator Sessions. 

Before we turn to the witnesses, I want to briefly enter several 

statements into the record. I have a letter in support of my legislation signed by a diverse group of consumer, civil rights, labor, retiree, housing, lending and community organizations. Without objection, they letter will be entered into the record. 

I also have been asked to submit statements for the record from 

the following organizations: the American Bankers Association; National Association of Home Builders; and the Consumer Mortgage 

Coalition. Without objection, they will also be entered into the 

record. 

Now we will turn to our witnesses for their opening statements. 

I am honored to welcome this distinguished panel. Each witness 

will have 5 minutes for an opening statement. You will see the 

timer in front of you turn red when the Capitol Police are about 

to arrive. Since we have a large panel, I ask you to please try to 

stay within 5 minutes if you can. Your complete written statements 

will be made part of the record. 

I’d like to ask the witnesses, with the exception of Ms. McGee, 

who may remain seated, if they would please rise and raise their 

right hands to have the oath. 

[Whereupon, the witnesses were duly sworn.] 

Senator DURBIN. Let the record reflect that the witnesses all answered in the affirmative. 

Our first witness is Ms. Nettie McGee. Ms. McGee is a greatgrandmother who has lived in Chicago for the last 53 years. She 

is now retired after a career of working in a picture frame factory. 

In 1999, at the age of 65, Ms. McGee bought her first home on 

South Aberdeen, on the south side of Chicago. Now she is in danger of losing that home because of an increase in her mortgage interest rates. 

Ms. McGee, I know it was a great sacrifice for you to come out 

here, and I thank you very much. I know it is also hard to talk 

about this situation, but believe me, you are speaking for many, 

many people who can’t be here today. We wanted to hear your 

voice and your story as part of this record. Please proceed with 

your statement. 

STATEMENT OF NETTIE MCGEE, CHICAGO, ILLINOIS 

Ms. MCGEE. Senator Durbin, members of the committee, thank 

you for inviting me to speak before you today. My name is Nettie 

McGee and I’ve lived in Chicago, Illinois for 53 years. I live in a 

6 

home I waited my entire life to own. Now the interest rate on my 

mortgage is going up 3 percent and my payments are $200 more 

each month. I am here to ask you to please help me save my home. 

In 1997, I began renting my current home on South Aberdeen 

Street. I rented it for 2 years with an option to buy. When I finally 

bought my first home in 1999, for $80,000, I was 65 years old. I 

made the payment for 6 years. I had a fixed rate mortgage and I 

knew what to expect each month: it was $735 every month. I was 

able to make my payments and pay my taxes. I could afford all of 

my bills. 

Then in October of 2005, the sheriff came to my door to tell me that my backyard was going to be sold for auction for $5,000 because of an unpaid tax bill. I paid the taxes on my house every 

year. I just didn’t know that I had two tax bills, one for my house 

and one for my backyard. The tax bill for my backyard had been 

sent to an address across town for years, since and before I moved 

in. I was desperate to keep my backyard and my beautiful trees, 

but I had to pay the city $5,000 and I had to do something fast 

because I would lose my yard. I didn’t have $5,000 in the bank. I live on Social Security and 

I get some rent from my daughter. Then I saw a commercial on TV 

about refinancing your home. I thought if I refinanced, I could get 

money to pay the tax bill and keep my yard. I called the number 

and a broker came to visit me the next day. He wrote down my personal information, and a week and a half later he called me and 

asked me to come down to sign the papers. 

After I arrived at the crowded office, I was taken into a small 

room, handed about 40 pages, and told where to sign. The woman 

in charge of the closing stood over me and turned the pages as I 

signed them. The whole process took about 10 minutes. I thought 

I was signing a fixed-rate loan. Then, with no explanation of the 

loan, I was sent out the door. The mortgage company paid the 

taxes to the county. 

Then, to my surprise, they called me a few days later to come 

back and get a check for $9,000. I didn’t know they had me borrowing the extra $9,000. When I asked about it, the mortgage company said that I could use it for bills. I thought it was a good idea, 

so I used the money to pay some bills and fix my plumbing problem. I started paying the loan back. The payments were about the 

same as my original loan. It’s been difficult at times, but I have 

never missed a payment. 

A month and a half ago, in October of this year, I got a letter 

from my mortgage company that said that on December 1, my payment was going up from $706 to $912. I called the mortgage 

broker, but he doesn’t work there anymore. I thought I signed a 

fixed-rate mortgage. I had no idea my payment would jump almost 

25 percent. My interest rate went from 7.8 to 10.87, and eventually 

it will go higher. 

I don’t know how to make my payments now. They are higher 

than my Social Security check. The only reason I can get by now 

is because my daughter pays me a little rent. Right now, my lawyers from the Legal Assistance Foundation in Chicago are trying 

to help me negotiate with my lender, but we don’t know if the bank 

will agree to lower my interest rate back where it was before. 

7 

I know I will lose my home that I waited my entire life to own 

if I can’t get my original rate back. Many people who could originally afford their mortgage payments are losing their homes because they have an adjustable rate mortgage. Please help people 

like me, please, who waited their entire lives to own their homes. 

Please help me. 

Senator DURBIN. Thank you for that great statement, exactly 5 

minutes. You’re a model for the rest of the witnesses. Thank you 

so much, Ms. McGee. 

[The prepared statement of Ms. McGee appears as a submission 

for the record.] 

Our next witness is Mark Zandi. Mr. Zandi is the chief economist 

and co-founder of Moody’s Economy.com, Inc., where he directs the 

company’s research and consulting activities. Moody’s Economy.com 

provides economic research and consulting services to businesses, 

government, and other institutions. Mr. Zandi received his B.S. 

from the Wharton School at the University of Pennsylvania, and 

his Ph.D. at the University of Pennsylvania. 

Thank you very much for joining us today. We look forward to 

your testimony. 

STATEMENT OF MARK ZANDI, CHIEF ECONOMIST, MOODY’S 

ECONOMY.COM, INC., WEST CHESTER, PENNSYLVANIA 

Mr. ZANDI. Thank you for the opportunity to be here today. I am 

the chief economist and co-founder of Moody’s Economy.com. We’re 

an independent subsidiary of the Moody’s Corporation. These are 

my own personal reviews and do not represent those held by, or endorsed by, Moody’s. 

I will make six points in my remarks. First, the Nation’s housing 

and mortgage markets are suffering an unprecedented downturn. 

Housing activity peaked over 2 years ago, and since then home 

sales have fallen by over 30 percent, housing starts by 40 percent, 

and house prices by 7 percent. Over half of the Nation’s housing 

markets are currently experiencing substantial price declines, with 

double-digit price declines occurring throughout Arizona, California, Florida, Nevada, the northeast corridor, and the industrial 

midwest. 

Further, significant declines in housing construction prices are 

likely into 2009 as a record amount of unsold housing inventory 

continues to mount, given the impact of the recent subprime financial shock and its impact on the mortgage securities market and, 

thus, mortgage lenders. There is now a broad consensus that national house prices will fall by between 10 and 15 percent from 

their peak to their eventual trough. Even this disconcerting outlook 

assumes that the broader economy will avoid recession and that 

the Federal Reserve will continue to lower interest rates. 

The second point. Residential mortgage loan defaults and foreclosures are surging, and without significant policy changes, will 

continue to do so through the remainder of the decade. Falling 

housing values, resetting adjustable mortgages for recent subprime 

and all-day borrowers, tighter underwriting standards, and most 

recently a weakening job market, are all conspiring to create the 

current unprecedented mortgage credit problems. Even if mortgage 

loan modification efforts soon measurably increase, I expect apVerDate Aug 31 2005 15:00 Sep 29, 2008 Jkt 044330 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\44330.TXT SJUD1 PsN: CMORC
8 

proximately 2.8 million mortgage loan defaults, the first step in the 

foreclosure process, in 2008 and 2009. 

Of these, 1.9 million homeowners will go through the entire process and ultimately lose their homes. The impact on these households or communities in the broader economy will be substantial. 

Foreclosure sales are very costly after accounting for substantial 

transaction costs and can serve to significantly depress already 

reeling housing markets are foreclosed properties are generally sold 

at deep discounts to prevailing market prices. In much less stressful times, these discounts are estimated to be between 20 and 30 

percent. 

Point three. There’s a substantial risk that the housing downturn 

and the surging foreclosures will result in a national economic recession. The stunning decline in housing activity and prices will 

combine with rising gasoline prices, crimping consumer spending, 

and the job market appears increasingly weak as it struggles with 

layoffs in housing-related industries. Regional economies, such as 

California, Florida, Nevada, and much of the industrial midwest, 

together, accounting for well over one-fourth of the Nation’s GDP, 

are, in my judgment, already in recession. 

The turmoil in the housing and mortgage markets also threaten 

to further up-end the fragile global financial system, with very 

clear negative implications for the U.S. economy. Estimates of the 

mortgage losses global investors will eventually have to bear range 

as high as $500 billion. The losses recognized so far to date are 

now more than $75 billion. If the U.S. economy does slide into recession, then of course house prices will decline. Foreclosures will 

rise to an even more serious degree. 

Point No. 4. Without a quick policy response, mortgage loan 

modification efforts are unlikely to increase enough to forestall a 

surge in foreclosure. A recent Moody survey of loan servicers found 

that very little modification had been done, at least through this 

past summer. This highlights the substantial impediments to modification efforts. Some tax, accounting, and legal hurdles appear to 

have been overcome, but large differences in the incentives of first 

and second mortgage lienholders and the various investors in mortgage securities are proving very daunting. 

Given the overwhelming number of foreclosures, loan servicers 

are also having difficulty appropriately staffing the modification efforts. While the total economic benefit of forestalling foreclosure is 

significant, these benefits do not accrue to all parties involved in 

determining whether to proceed with the loan modification. 

A recent initiative by the Treasury Department in the Nation’s 

lenders to freeze interest rates on re-setting subprime ARM loans 

is a good step, but should not forestall passage of your legislation, 

the Helping Families Save Their Homes in Bankruptcy Act. If the 

Treasury plan is successful in helping many borrowers, then these 

borrowers will not avail themselves of the opportunity to avoid 

foreclosure and Chapter 13 provided by this legislation. If, however, Treasury’s efforts are unsuccessful, which may very well be 

the case, then this legislation will prove invaluable. 

The fifth point. Senator Durbin’s legislation, which would give 

bankruptcy judges the authority in Chapter 13 to modify mortgages 

by treating them as secured only up to the market value of the 

9 

property, would significantly reduce the number of foreclosures. An 

estimated over one-fourth of homeowners likely to lose their homes 

between now and the end of the decade, equal to an estimated 

570,000 homeowners, would benefit from this legislation. 

This calculation is based on the number of homeowners who face 

a first payment re-set through the end of the decade that would 

meet the means test required in the 13 that are still current on 

their mortgage loans. This would be very helpful in reducing the 

pressure on the housing and mortgage markets and will measurably reduce the odds of recession in the coming year. 

Note that in order to limit any potential abuses in the Chapter 

13 modification process, Congress should provide firm guidelines to 

bankruptcy courts, such as providing a formula for determining the 

term to maturity and the rate of a property’s market value. 

Finally, this legislation will not significantly raise the cost of 

mortgage credit, disrupt secondary markets, or lead to substantial 

abuses by borrowers. Given that the total cost of foreclosure to 

lenders is much greater than that associated with a 13, there’s no 

reason to believe that the cost of mortgage credit across all mortgage loan products should rise. 

Simply consider the substantial costs involved with navigating 

through 50 different State foreclosure processes in contrast to one 

well-defined bankruptcy proceeding. Indeed, the cost of mortgage 

credit to prime borrowers may decline. The cost of second mortgage 

loans, such as piggy-back seconds, could rise as they are likely to 

suffer most from bankruptcy. Such lending has played a clear contributing role in the current credit problems. 

There is also no evidence that the secondary mortgage markets 

will be materially impacted as other consumer loans already have 

similar protection in 13 and have well-functioning secondary markets. However, the non-conforming residential mortgage market 

has already effectively been shut down in the wake of the financial 

shock and will only revive after there are major changes to the 

process. The changes proposed in this legislation are immaterial by 

comparison. 

It is also unlikely that the abuses by borrowers will increase as 

a result of the legislation, given that a work-out in a 13 is a very 

financially painful process. Indeed, the number of filings has remained surprisingly low since the late 2005 bankruptcy reform, 

likely reflecting the now much higher cost to borrowers in a 13 proceeding. Short-term investors, or flippers, those who have borrowed 

heavily, looking to make a quick profit in the boom, would certainly 

not consider 13 a viable solution to their problem. 

The housing downturn is intensify, foreclosures are surging. A 

self-reinforcing negative dynamic of mortgage foreclosures begetting house price declines, begetting more foreclosures, is under way 

in many neighborhoods across the country. The odds of a full-blown 

recession are very high. There is no more efficacious way to shortcircuit this developing cycle and forestall a recession than passing 

this legislation. Thank you. 

Senator DURBIN. Thank you, Mr. Zandi. 

[The prepared statement of Mr. Zandi appears as a submission 

for the record.] 

10 

Senator DURBIN. Professor Joseph Mason is an Associate Professor of Finance at Drexel University’s LeBow College of Business 

in Philadelphia, and a senior fellow at the Wharton School. Before 

joining Drexel, Professor Mason spent 3 years at the Office of the 

Comptroller of the Currency. Professor Mason has an M.S. and a 

Ph.D. from the University of Illinois, and a B.S. from Arizona State 

University. 

Professor Mason, you may proceed. 

STATEMENT OF JOSEPH MASON, ASSOCIATE PROFESSOR, 

DREXEL UNIVERSITY, PHILADELPHIA, PENNSYLVANIA 

Mr. MASON. Thank you, Mr. Chairman, Ranking Senator Specter, and members of the committee, for the opportunity to be here 

today. I am pleased to appear before you to talk about this foreclosure crisis and the legislative options for addressing the economic and social concerns arising from that crisis. 

People only file for bankruptcy if they are, first, vulnerable—i.e., 

they have debt greater than their assets—and second, only if some 

financial shock occurs that prevents them from keeping debt service payments current. The typical shocks that cause bankruptcy— 

divorce, illness, accident, and addiction—have all increased over 

the last several decades and are particularly prevalent among individuals in their 30’s, in a time when they have the highest debt 

load of their lives. With the advent of subprime mortgages, we 

must now add adjustable rate mortgage payment shocks to the list 

of classic influences. 

The question today, therefore, is to what extent legislative intervention can, and should, insulate individuals from the payment 

shocks in their mortgage contracts. I offer you three main conclusions from an economic perspective. 

First, mortgages and other real assets are poor candidates for bifurcation in bankruptcy because they can be fully expected to regain value later on in the life of the contract. Hence, bifurcation of 

a debt secured by real estate may be considered a taking, in a 

sense, not applicable to fully depreciable assets. 

The reason a bifurcation makes sense for a fully depreciable collateral, is that the value of that collateral is decreasing throughout 

the life of the loan. If a court bifurcates a claim on an automobile 

loan, the automobile is not expected to ever be worth more than the 

market value established by the courts at that time. 

For real estate, even in today’s market conditions, the value of 

the collateral can be expected to grow in the future, so that bifurcating the claim is akin to taking away real value from the lender 

and giving that value to the borrower. The concept is especially 

egregious in real estate markets that are highly sensitive to economic or market conditions. High-flying real estate markets of 

1980’s returned handsome profits for investors after the relatively 

brief market disruptions of the late 1980’s and the recession of 

1991. 

The Case-Schiller Mortgage Price Index, which begins in January 

1987, shows that Boston home prices hit a high of 75.53 on the 

index in July 1988, and retreated thereafter, only to reach and exceed that level again in May, 1997. Boston now stands at an indexed level of 170.73, providing 127 percent total return for a 

11 

buyer who bought at that January 1987 peak, or 4.2 percent annual return since 1987. 

Los Angeles, similarly, peaked at an index level of 100 in June, 

1990, and after a similar hiatus reached that level again in January of 2000. Los Angeles now stands at an indexed level of 254.79, 

which provided a buyer at that previous peak, 155 percent total return, or 5.7 percent annually since 1990. 

It’s important to point out, these are worst-case returns obtained 

from buying at the top of the market and holding. The cases do not 

account for the fact that the investment made by a home buyer is 

leveraged so that an investment of 20 percent down, along with 

periodic payments, is enough to obtain the full gain of the property 

value. 

Second, legislative changes to enable bifurcation of mortgage contracts will increase the cost of credit to mortgage borrowers to 

cover the expected aggregate value of judiciary settlements. The 

cost of mortgage credit can be expected to rise to levels on par with 

other secured non-mortgage credit, like automobile loans, and unsecured credit, like credit cards. 

The problem, however, will also extend to secondary markets for 

securitized loans that have been devastated by uncertainty over the 

last year. Since the ability to bifurcate mortgages will extend to 

contracts already written and sold in securitized pools, existing 

loans will decline in value by the risk difference employed in the 

spread between non-real estate and real estate secured credit. That 

means that the value of residential mortgage-backed securities will 

decline further as well. 

In the event that markets will not be able to adequately ascertain the impact of judicial intervention, they will impose an additional ‘‘Lemons’’ discount above and beyond that already imposed 

on the market for fundamental opacity and ratings agency malfeasance to account for the maximum possible effect a priori. Knockon effects will reverberate through resecuritization markets like 

those for CDOs and SIVs. 

The point is that judicial adjustment will add further information 

difficulties to an already uncertain market environment. The effect 

will not be limited to changes in bankruptcy law. Loan modifications will have a similar influence. For additional background on 

that, you can see Marty Feldstein’s op-ed in today’s Wall Street 

Journal. 

In addition, changing the nature of mortgage priority in bankruptcy further incentivizes the shift away from building equity in 

one’s own home by paying down the mortgage. If mortgage debt is 

tax-exempt and can be discharged in bankruptcy, it becomes even 

more advantageous for consumers to maximize their mortgage debt 

relative to the value of the home. 

Addressing Senator Session’s opening remarks, as a result of 

similar incentives we face a generation that stands to enter their 

retirement years without the historically largest retirement asset, 

their home equity, intact. Poorly funded 401(k)s, pension funds 

that will eventually have to face up to subprime mortgage losses 

in their own portfolios, and Social Security will not make up for 

that shortcoming, which will therefore create a tremendous drag on 

economic growth and social well-being. 

12 

Last, the act of bifurcating mortgage credit will increase the cost 

of bankruptcy to cover appraisal and other transactions costs needed to establish the fair market value of the underlying real estate, 

imposing yet another cost on filers above and beyond those imposed 

in the Bankruptcy Abuse, Prevention, and Consumer Protection 

Act that went into effect on October of 2005. 

In the case of bifurcating the automobile loan mentioned previously, the judge need only look at a Kelly Blue Book to establish 

a reasonable market value for the collateral asset. In the case of 

a mortgage, however, getting the fair market value is not so simple. The judge will have to order an appraisal of the property to 

assess a fair market value. That will cost approximately $300 to 

$500, and the cost would be expected to be paid by the debtor. 

In addition to the cost, however, the accuracy of appraisals also 

has to be considered. The fact is, appraisals have not been very accurate in recent past. Appraisals skewed to the high end fueled recent over-borrowing and home price inflation, causing much of the 

present-day mortgage market difficulties. An industry experiencing 

such difficulties, which has contributed so much to the recent mortgage crisis, is hardly a reliable basis for a substantial component 

of bankruptcy law. 

In conclusion, the U.S. economy continues to experience very real 

problems stemming from the mortgage crisis. The problems originate in a variety of unsafe and unsound practices in the mortgage 

industry, ranging from predation to speculation. It is easy to see 

the need to address predation in the mortgage industry. It makes 

sense to seek judicial remedies that have the power to nullify contractual terms that violate terms of the Real Estate Settlement 

Procedures Act, the Truth in Lending Act, the Homeowner Equity 

Protection Act, and/or other laws and regulations relating to the 

mortgage industry. 

Giving the judiciary the power to fully bifurcate mortgage contracts, however, sets the stage for potential abuse of the bankruptcy system to further speculative purposes and further 

incentivizes cashing out home equity rather than sustainable home 

ownership. 

Senator DURBIN. Thank you very much, Professor Mason. 

[The prepared statement of Professor Mason appears as a submission for the record.] 

Senator DURBIN. Our next witness is Professor Mark Scarberry. 

Professor Scarberry is a Professor of Law at Pepperdine University 

College of Law in Malibu, California, currently the Robert Zinman 

Resident Scholar at the American Bankruptcy Institute in Alexandria, Virginia. He graduated from Occidental College in Los Angeles, and the UCLA School of Law. 

Thank you for joining us today. Please proceed. 

STATEMENT OF MARK SCARBERRY, PROFESSOR OF LAW, 

PEPPERDINE SCHOOL OF LAW, AND RESIDENT SCHOLAR, 

AMERICAN BANKRUPTCY INSTITUTE, WASHINGTON, DC 

Mr. SCARBERRY. Chairman Durbin, Ranking Member Specter, 

and members of the committee, I am Mark Scarberry, Professor of 

Law at Pepperdine University and Resident Scholar at the American Bankruptcy Institute, or ABI. I teach and write primarily on 

13 

bankruptcy law and am pleased to appear today to speak on the 

bankruptcy bills dealing with the mortgage crisis. 

ABI is a nonpartisan, nonprofit association of over 11,000 professionals who represent both debtors and creditors in consumer and 

businesses cases. ABI is not an advocacy group and does not lobby. 

It is a neutral source for bankruptcy information and a resource for 

Members of Congress and their staff. As a professor and ABI resident scholar, I can give my views, but they should not be taken as 

the ABI’s views. 

You have a chart I prepared comparing the four pending bills. A 

key difference between the two Senate bills is that Senator Durbin’s, S. 2136, allows a Chapter 13 plan in some cases to reduce 

the amount of an under-secured mortgage to the value of the home 

without the consent of the mortgage holder, a result that is called 

‘‘strip-down’’ or sometimes ‘‘cram-down’’. Senator Specter’s S. 2133 

would require consent of the mortgage holder before a strip-down 

could take place. The Code currently does not permit home mortgage strip-down under Chapters 7, 11, or 13. 

Now, a side point. Bankruptcy courts may not be able to handle 

the needed volume of cases on a one-case-at-a-time retail basis. 

Congress, instead, could use its bankruptcy power to help Secretary 

Paulson as he seeks a wholesale solution that could help hundreds 

of thousands of homeowners like Ms. McGee. 

Mortgage servicers may lack authority to modify mortgages on 

such a wholesale basis as is sought by the Secretary. Legislation 

under Congress’s bankruptcy power may be particularly appropriate to validate such agreements if made per Treasury guidelines 

and to immunize servicers from liability for making such agreements. 

Now, no Circuit Court had permitted home mortgage strip-down 

in Chapter 13 until 1989. By 1993, strip-down was becoming so 

widely used that it threatened to further damage the already weak 

home lending industry. But that year, the Supreme Court, in 

Nobelman, held that Section 1322(b)(2) prohibited home mortgage 

strip-down in Chapter 13. The next year, Congress gave home 

mortgages in Chapter 11 cases the same protection. S. 2136 would 

remove that protection in some Chapter 13 cases. 

Allowing home mortgage strip-down in Chapter 13 would, in fact, 

treat holders of home mortgages worse than other secured creditors. If a secured credit’s lien is stripped down under current law, 

the stripped-down amount must be paid off, with interest, during 

the Chapter 13 case over no more than 5 years. As a practical matter, a debtor cannot strip down a first mortgage on a substantial 

vacation home because the payments needed to pay off the 

stripped-down amount over 5 years would be too large. 

S. 2136 would let a debtor pay off a stripped-down home mortgage over a period that could be nearly 30 years. Strip-down, thus, 

would become feasible, but primarily only for home mortgages, 

with the lender forced to accept a court-determined interest rate for 

that very long period. 

Indeed, after the 2005 amendments, the other major kind of secured consumer debt, purchase-money auto loans, may be stripped 

down only if the loan was made more than two and a half years 

before the petition filing date, which is at least half the life of a 

14 

typical auto loan. Home mortgages, thus, would be treated worse 

than car loans. 

Home mortgage strip-down would substantially change the risk 

characteristics of home mortgages. Permitting strip-down would 

likely cause difficulties in the secondary market that is so important to the availability and affordability of home mortgages, and it 

would cause unjustified harm to holders of home mortgages and 

mortgage-related securities, including investors of modest means, 

through their retirement plans. 

Under the approach in S. 2136, home mortgage holders would receive little benefit from the upturn in the real estate market that 

ordinarily follows a downturn. Under current law, in many cases 

the mortgage holder benefits from appreciation. Some financially 

distressed debtors can tighten their belts, make their current mortgage payments, and use Chapter 13 over 5 years to make up any 

missed payments. When the market recovers, the mortgage holder 

benefits from the increased value backing the full amount of its 

mortgage and may suffer no loss at all. 

Under S. 2136, such debtors typically could, in fact, qualify to 

strip down their mortgages, despite provisions designed to prevent 

them from doing so, and I think they would opt to do it. The later 

upturn then will provide equity for the debtor rather than a restoration of value to the mortgage. Home mortgage strip-down thus 

eliminates the up-side potential and dramatically changes the risk 

characteristics of the mortgage. And note that under current law, 

even after a foreclosure, the mortgage holder can hold the property 

and wait for it to appreciate. 

Compounding the problem, losses from strip-down probably are 

not covered under private mortgage insurance if there is no foreclosure. Strip-down would deprive home mortgage holders, likely, of 

the benefit of insurance protection that they bargained for. 

Changing the risk characteristics of home mortgages retroactively likely would depress further the value of existing home 

mortgages. Increased risk would mean increased interest rates on 

new mortgages to compensate for the risk, and denial of mortgage 

credit to some who presently qualify. There would be a further 

shadow cast on the trustworthiness of American mortgage-backed 

securities with implications that would be disturbing, given that 

such securities are held worldwide by investors who count on the 

protection of vested property and contract rights under American 

law. 

My written statement includes specific substantive and technical 

recommendations for the legislation, should Congress choose to 

move forward. I’d be happy to discuss those in response to questions. 

The final point. Let me add that many Chapter 13 plans fail. 

Under section 1325(a)(5)(b)(2) of the current law added in 2005, 

any modification of the mortgage holder’s lien would be reversed if 

the plan were 

not successfully completed, even if the failure involved a debt 

other than the home mortgage, such as a priority tax claim. 

Thank you again for the opportunity to appear today. I’d be very 

happy to answer any questions. 

Senator DURBIN. Thank you, Professor Scarberry. 

15 

[The prepared statement of Professor Scarberry appears as a 

submission for the record.] 

Senator DURBIN. Our next witness is Judge Jacqueline Cox at 

the U.S. Bankruptcy Court for the Northern District of Illinois, 

based in Chicago. Judge Cox has served as a Federal Bankruptcy 

Judge since 2003. From 1988 to 2003, she served as Judge of the 

Circuit Court of Cook County. Judge Cox has also worked in government service in the office of the Cook County State’s Attorney, 

the City of Chicago Law Department, and the Chicago Housing Authority Law Department. She received her undergraduate degree 

from Cornell and her law degree from Boston University. 

Judge Cox, thank you for joining us. We look forward to your testimony. 

STATEMENT OF JACQUELINE P. COX, BANKRUPTCY JUDGE, 

U.S. BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF 

ILLINOIS, CHICAGO, ILLINOIS 

Judge COX. Thank you, Senator Durbin, Senator Specter, and 

Senator Sessions. I genuinely appreciate the opportunity to address 

the Senate on protecting home ownership and helping families deal 

with burdensome home mortgages. I speak for myself, however. I 

do not represent the Judicial Conference of the United States or 

the Administrative Office of the Courts. 

Because home ownership represents economic inclusion in the 

American dream, and because of the disparate impact of the mortgage crisis on African-Americans and Latinos, passage of the Durbin bill is critical. The Bankruptcy Code generally allows reorganizing debtors in Chapters 11, 12, and 13 to bifurcate secured debt. 

The plan strips down claims to the value of the collateral. The 

balance, the amount of the claim that exceeds that value, gets 

treated as an unsecured claim. In the Chapter 13 context, the unsecured amount would be paid under the plan by a percentage generally based on the debtor’s income. 

Section 1 of the Helping Families Save Their Homes in Bankruptcy Act will, for the first time since 1978, allow a debtor to modify mortgage debt if the debtor’s income is insufficient to pay the 

mortgage. This income limitation is important. It limits this extraordinary relief to those homeowners who need it. Homeowners 

who can afford their payments will not receive a windfall. Allowing 

the strip-down of mortgage debt to the collateral’s fair market 

value reflects the economic realities of the lender’s situation. The 

lender who forecloses a loan will recover the value of the home and 

may receive a deficiency claim when the debt exceeds the value of 

the home. 

When Americans purchase homes, the most important consideration is affordability. Most of us anticipate modest future increases 

in income but cannot afford mortgage interest debt that increases 

up to 40 percent. The Durbin bill interest rate section allows the 

debtor to pay the strip-down amount at an interest rate equal to 

the rate published by the Board of Governors of the Federal Reserve system regarding the annual yield on conventional mortgages 

with a reasonable premium for risk. 

Under the U.S. Supreme Court decision in Till v. SCS Credit, 

Chapter 13 debtors now follow a similar standard when adjusting 

16 

interest rates on non-residence secured debt. I will quote from the 

Supreme Court: ‘‘Taking its cue from ordinary lending practices, 

the approach begins by looking to the national prime rate, reported 

daily in the press, which reflects the financial market’s estimate of 

the amount a commercial bank should charge a credit-worthy commercial borrower to compensate for the opportunity costs of the 

loan, the risk of inflation, and the relatively slight risk of default. 

Because bankruptcy debtors typically pose a greater risk of nonpayment than solvent commercial borrowers, the approach then requires a bankruptcy court to adjust the prime rate accordingly.’’ 

I quote the Supreme Court to emphasize that interest rates are 

adjusted in our proceedings routinely. In fact, since the 2004 Till 

decision I have heard only two or three hearings involving disputes 

over interest rate adjustments. The Bar and the financial services 

community have very little trouble in this regard. 

The Durbin bill also waives the pre-petition credit counseling requirement which was added to the Bankruptcy Code by the Bankruptcy Abuse, Prevention, and Consumer Protection Act. Because 

most debtors facing foreclosure, probably because of fear or denial, 

wait until the week of a foreclosure sale to seek bankruptcy relief, 

credit counseling offers them no help. The briefing that debtors are 

required to receive outline the opportunities—I paraphrase the 

statute—outline the opportunities for available credit counseling 

and assist them in performing a budget analysis. Once a foreclosure is pending, it’s too late for those kinds of relief. 

I am particularly supportive of the bill’s section 201, which combats excessive fees. It allows fees, costs, and other charges to be 

added to the secured debt only if notice of such additional charges 

is filed with the court within a year of when they are incurred, or 

60 days before the conclusion of the plan. This policy reflects the 

practice of our bankruptcy court. We have a very similar provision 

in our model Chapter 13 plan. 

The bill allows a plan to waive prepayment penalties. This assists those debtors who can arrange to refinance their obligations 

under more favorable terms, and we see a lot of that in Chapter 

13. Such penalties do not compensate lenders for costs, they only 

serve to punish debtors. 

I agree with the position of the National Bankruptcy Conference 

in remarks presented to the House of Representatives in October. 

On behalf of that organization, Attorney Richard Levin compared 

the plight of homeowners today to the plight of family farmers in 

the 1980s. There is clear precedent for Congress to solve this mortgage crisis by allowing debtors to bifurcate or strip down mortgage 

debt. That was done for the family farmers and it enabled lenders 

to renegotiate farm debt to reflect falling land prices. The good 

work of Senator Charles Grassley and Representative Mike Synar 

created Chapter 12. I ask that Chapter 12-style adjustments that 

include home mortgages be applied to Chapter 13 for the same reasons. 

In conclusion, I support passage of Senator Durbin’s Helping 

Families Save Their Homes in Bankruptcy Act. A lot of the provisions are things we do routinely. They are not new. We just don’t 

do them for home mortgages. I agree that there would be a lot of 

them, but I think we can do them. As in the family farmer case, 

17 

once the bankruptcy community sets a model of how to do these 

things, more of the modifications will be made in out-of-court situations. I believe this bill provides a sensible and much-needed modification to the Bankruptcy Code. Thank you very much. 

Senator DURBIN. Thanks, Judge Cox. 

[The prepared statement of Judge Cox appears as a submission 

for the record.] 

Senator DURBIN. Our next witness is Judge Thomas Bennett. 

Judge Bennett has served as a Federal Bankruptcy Judge for the 

Northern District of Alabama since 1995. He is currently presidentelect of the National Conference of Bankruptcy Judges. From 1980 

until his appointment, he was a partner with the law firm of 

Bowles, Rice, McDavid, Graff & Love in Charleston, West Virginia. 

He holds undergraduate, graduate, and law degrees from West Virginia University. Following his graduation from law school in 1976, 

he served as law clerk for the Honorable John R. Brown of the 

Fifth Circuit Court of Appeals. 

Judge Bennett, thank you for being here. We look forward to 

your testimony. 

STATEMENT OF THOMAS BENNETT, BANKRUPTCY JUDGE, U.S. 

BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF 

ALABAMA, BIRMINGHAM, ALABAMA 

Judge BENNETT. Thank you, Senator Durbin. I want to thank 

you and Senator Specter and Senator Sessions for inviting me. 

I’m not going to repeat what I’ve already submitted in my written comments. What I would like to do, is maybe expand on some 

things that I think may be misperceived and make some comments. 

Feel free to interrupt me if you want to. 

One of the things that I want to follow up on, was a statement 

by one of our prior witnesses. It’s something that I have written 

down: why is bankruptcy the ticket to get this relief? There really 

is a bigger picture here, in my opinion. In order to get this relief, 

you have to file bankruptcy. I would suggest to you that there are 

a group of people that otherwise would not have to file bankruptcy 

that will be forced to file bankruptcy to get this relief. It’s a fact 

that should be looked at. 

Senator SESSIONS. When you say ‘‘forced’’, you mean a lawyer 

would advise them that it only makes common sense that they file 

bankruptcy? Is that what you mean? 

Judge BENNETT. If you faced the prospect of losing your property 

because you cannot afford the increase and you only have the ability to forestall that by filing bankruptcy, you’d have to file the 

bankruptcy if you wanted to preserve that property. This particular 

type of relief could be made available to a broader segment, is my 

point, potentially, that otherwise would not have to file bankruptcy. 

I point this out, because in the context of bankruptcy there are certain dynamics. Those people that are filing bankruptcy because 

they have overall financial difficulties that go beyond just mortgages will file bankruptcy anyway. They will have to. 

Those that only have to deal with the increase in the mortgage 

cost and don’t have other financial problems would not otherwise 

necessarily have to file bankruptcy if the bill were structured in a 

fashion that gave a broader scope than simply looking at bankVerDate Aug 31 2005 15:00 Sep 29, 2008 Jkt 044330 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\44330.TXT SJUD1 PsN: CMORC
18 

ruptcy. That’s why it’s a fact that you ought to look at—I would 

suggest you look at. 

There are two principal areas in the other comments that I want 

to expand on that have been made by others. One, rises out of my 

comments, my written comments. There are really two stages of 

losses in a bill that writes down mortgages. The first stage is the 

stage that exists today with respect to any mortgage. If there is a 

loss on the market, it’s there. The testimony of the others is correct. If you have to foreclose the mortgage today, you will suffer a 

loss. If that loss is in bankruptcy on a write-down, you will suffer 

that loss. A significant difference is the second loss. 

The second loss that occurs under a restructuring of principal, 

particularly over an attenuated time frame, is with respect to what 

would be the fully secured portion of the debt. When you restructure a debt over an up to 30-year period that is currently not a 30- 

year obligation, that fully secured debt, if the interest rate is below 

the market rate, will be significantly impaired. That is on somebody that just holds all payment streams. The current mortgage 

structure is such that there are multiple payment streams. 

When you take a payment stream on what will be a writtendown mortgage to its fully secured value and you bust those 

streams up, as they have done, into interest and principal, and 

some of those interest streams can be broken down and some of 

those principal streams can be broken down, and then you drag out 

the payment for 30 years, on some of those—particularly interest— 

streams it is very possible that they become worthless, despite the 

fact that the debt may be fully secured. It’s because of the interest 

rate discount factors. This is a very, very complex problem. It is not 

simply just writing down the principal up front. There is a second 

tier of write-downs that really has to be given serious consideration. 

The pooling factor, when you pool these mortgages, the pooling 

is designed to take care of some of the risk that I’ve told you about. 

In fairness to you, you should look at the mitigation that is caused 

on those losses by pooling or packaging of these streams of income. 

But it is a very serious issue. That’s one. 

The next is—and there is testimony that you’ve received—there 

really is no evidence that the interest rate and cost of interest and 

supply of credit has changed. There are examples in prior periods. 

But I would tell you, it’s really like comparing apples and oranges. 

The reason is this: the discussion should always be on what would 

have otherwise been there. When you know the cost of something 

goes up or the supply decreases, you will not, in the future, be able 

to say, look, I told you so, because in the dynamics of what is going 

on here you could have two impacts. You could actually have lower 

interest rates. 

But what you need to know is, how much lower would they have 

otherwise gone but for legislation that may go awry? You could 

have higher interest rates. The question, though, becomes: how 

much lower would they have been had the legislation not been 

passed? 

Likewise, the supply of credit could generally increase. The real 

question is, how much more would it have increased but for the 

legislation? The supply could have decreased. The question may be 

19 

how much less it would have decreased but for the legislation, and 

giving historical examples will not demonstrate that. That is another issue that is of serious consequence. 

What I would like to also address, is that I think there is merit 

in something. Where I’m coming from, if I were you, I would ask 

me what would I do. What I think, is there needs to be a pause 

for a while. As much as I may hate to admit this, it may be somebody that is from a different political background than I that has 

suggested something. 

I think it is maybe wise to pause for a short time frame. It might 

be 60, 90 days, something, to try to stop what’s going on, leave everything where it is at this point in time. Maybe stop foreclosures 

on an interim basis. But a short enough time frame to get it better 

fixed so you develop a broader picture. It may entail fixing of interest rates or not allowing changes in interest rates for a short time. 

But my main thrust is, what you are getting ready to do may 

have much more serious, much broader implications than what 

people may contemplate. We as lawyers and judges are very bad 

when we deal with words and understanding what are really multivariant dynamics. That’s the main thrust of what I want to do, not 

to tell you not to do something, because these are difficult times 

for many people. 

The difficult times sometimes require we do things we may not 

otherwise do, but we need to do them in a context and a framework, I think, that addresses the overall picture, not a segment of 

the picture. We need to do it in a way that does the least amount 

of harm, and hopefully a lot more good, than the greater amount 

of harm. 

I would like to say that there is another category of people here 

that we will never know exists without some very quantitative 

analysis, and that is if what is done by the legislation forces writedowns and converts over to a fixed interest rate and causes the cost 

of credit to increase incrementally enough, there will be people who 

would never have had to have gone to bankruptcy or elsewhere to 

restructure mortgages. 

The numbers? I can’t tell you. But what will happen is, they may 

have otherwise potentially been able to pay their mortgages without having legislation. The incremental cost adjustment could be 

such that they now face the same problem of people that you wanted to help, but because of what’s occurred they now are pushed into 

that group you want to help. So, it’s a really complex problem that 

I don’t think, in fairness to what people may perceive is my side 

or the other side, that a rush to judgment on these benefits—those 

are my principal points. I mean, I don’t want to belabor what I’ve 

already said. 

Senator DURBIN. Thank you very much, Judge Bennett. 

[The prepared statement of Judge Bennett appears as a submission for the record.] 

Senator DURBIN. Our final witness is Henry Sommer, supervising 

attorney at the Pro Bono Consumer Bankruptcy Assistance Project 

in Philadelphia; president of the National Association of Consumer 

Bankruptcy Attorneys; former head of the Consumer Law Project 

of the Community Legal Services in Philadelphia, where he worked 

for 21 years; Editor-in-Chief of Collier on Bankruptcy. He served as 

20 

lecturer at University of Pennsylvania Law School received his undergraduate degree from Harvard, and his law degree from Harvard as well. 

Mr. Sommer, thank you. 

STATEMENT OF HENRY J. SOMMER, PRESIDENT, NATIONAL 

ASSOCIATION OF CONSUMER BANKRUPTCY ATTORNEYS, 

PHILADELPHIA, PENNSYLVANIA 

Mr. SOMMER. Thank you, Mr. Chairman, Senator Specter, Senators Sessions. Thank you for inviting me to testify today. 

It is now quite clear that our country is facing approximately 2 

million mortgage foreclosures over the next few years. These foreclosures are already having widespread effects in neighborhoods 

across America, as well as in financial markets, and those effects 

will get much worse in the months to come. Not only will millions 

of people lose their homes, but other homes in the vicinity will decline in value as a result of nearby foreclosures, causing an enormous loss of wealth to most American homeowners. 

It is also clear that it is within the power of Congress to prevent 

hundreds of thousands of these foreclosures and the ripple effect 

they’ll cause throughout the economy. 

Senator Durbin’s proposed legislation, S. 2136, which would 

make modest changes in the Bankruptcy Code, could save as many 

as 600,000 families from losing their homes. Allowing families to 

modify their mortgage debts and reduce their payments would utilize an existing, efficient, well-established, and predictable template to prevent foreclosures and it would not require the use of 

government funds to bail out homeowners or lenders. No other legislative proposal has the potential to save nearly as many homes. 

The basic principle underlying the bill, that liens are reduced to 

the extent they exceed the value of the collateral and the payment 

terms modified to reflect a fair rate of interest, is popularly known 

as ‘‘cram-down’’. The concept is one of longstanding importance in 

bankruptcy law. Essentially, it simply permits the debtor to buy 

back an asset from a creditor’s lien at the current market value 

that anyone else would pay for it. The principle is fundamental to 

the way the bankruptcy laws reflect economic reality. 

The basic underlying fact in these cases is that bankruptcy does 

not cause the loss to the creditor. The debtor’s inability to pay has 

already caused the loss. The loss already exists as a matter of economic reality, whether or not the creditor has recognized it on its 

books. If cram-down is not permitted for debtors who cannot pay 

their mortgages, debtors and creditors have several other alternatives: there could be foreclosure; there could be a short sale of 

the property; there could be a deed in lieu of foreclosure; or there 

could be a voluntary modification to terms similar to cram-down. 

In each of these scenarios, the creditor will take a loss equal to, or 

greater than, what would occur with the cram-down. 

I understand that industry lobbyists have been arguing that such 

legislation is unnecessary because: 1) lenders will solve the problem through voluntary modifications; and 2) the legislation would 

cause interest rates to increase dramatically. Neither of these arguments has merit. 

21 

First, voluntary modifications are not being made in any significant numbers. When I testified in the House 8 months ago, an industry witness testified that such efforts were well under way to 

solve the problem. But now even the Secretary of Treasury has recognized the inadequacy of the industry’s response. That inadequacy 

was predictable for the same reasons that the current administration effort and any voluntary modification program would be inadequate, reasons I have detailed in my written testimony. 

With respect to the claim that interest rates would increase by 

1 to 2 percent on all mortgages, the fact is that legislation such as 

this has no measurable impact because, again, ability to pay, not 

the bankruptcy law, is what is causing the losses. In the current 

mortgage situation, as I discussed previously, the lenders will suffer the losses, perhaps greater losses, even if this bankruptcy legislation is never enacted. You have to remember that the alternative 

to cram-down is not the debtor paying the loan according to its 

terms. The alternative is foreclosure. 

Industry lobbyists have also argued that enactment of S. 2136 

would bring uncertainty to the financial markets. Just like the 

losses that they claim would be brought about by the legislation, 

that uncertainty already exists. It would be hard to imagine how 

this bill could bring even a small fraction of the uncertainty that 

the lenders themselves have already caused. If anything, allowing 

modification in Chapter 13 will foster more certainty and stability 

because it will create a predictable template for dealing with defaulted mortgages. 

I also hope you will remember that those who are making those 

projections are the same people who not long ago told this Congress 

that there were no problems with abuses or excesses in subprime 

mortgage lending that needed regulatory or statutory action. The 

people who now say they are so concerned about risk are the same 

people who saw no problems when it was repeatedly pointed out 

that they were giving loans without even determining 

whether borrowers could pay those loans. In other words, these 

are the people who created this mess and are now suffering billions 

of dollars of losses, not because of any bankruptcy laws, but rather 

because of their poor ability to predict what would happen in the 

mortgage market. 

The mortgage modification remedy in S. 2136 is narrowly tailored. It will not be used where it is not needed because there are 

strict eligibility requirements based on the stringent means test enacted in the 2005 bankruptcy bill. A family that cannot afford a 

feasible plan to repay a modified mortgage will not be eligible to 

have its plan confirmed. 

S. 2136 will help the many families who refinanced their homes 

with predatory mortgages, often because they were deceived into 

refinancing an affordable mortgage into one they could not afford, 

and especially the many families who in fact qualified for better 

terms all along. It will help their neighbors, whose homes will not 

lose value because of foreclosures on their block, as well as their 

local governments who will not suffer a precipitous loss in their 

property tax base. 

In conclusion, Congress has an opportunity to prevent hundreds 

of thousands of families from losing their homes if it acts soon. ProVerDate Aug 31 2005 15:00 Sep 29, 2008 Jkt 044330 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\44330.TXT SJUD1 PsN: CMORC
22 

viding resolution in such cases is more likely to rationalize and stabilize the market rather than destabilize it. 

Thank you. 

Senator DURBIN. Thank you, Mr. Sommer. 

[The prepared statement of Mr. Sommer appears as a submission 

for the record.] 

Senator DURBIN. Senator Specter has another meeting to go to, 

and I’m going to allow him to ask first if he’d like to, and I will 

follow him. 

Senator SPECTER. Thank you very much, Mr. Chairman. We 

started off by saying this was a very complex issue. As we’ve listened to seven witnesses, it’s become even more complex. 

Professor Scarberry, you suggest that the bankruptcy courts can’t 

handle this on a case-by-case basis. If one of our bills is adopted 

and the bankruptcy courts are faced with the gigantic flood, will 

they be unable to adjudicate these issues? 

Mr. SCARBERRY. I don’t know for sure. I think it would mean a 

very substantial increase in caseload, and depending— 

Senator SPECTER. Judge Cox, Judge Bennett, you’re bankruptcy 

judges. Can you handle it? 

Judge COX. I would definitely put my arms around it. As I indicated in my remarks, by the lawyers and the financial services industry, testing us for a few cases, finding out exactly what we do, 

how the U.S. trustee would set up guidelines on how mortgages— 

Senator SPECTER. So you think, after you ruled in a few cases, 

they’d know better and could handle it themselves? 

Judge COX. They would know better and they would be guided 

by those out of court. 

Senator SPECTER. Judge Bennett, what do you think? 

Judge BENNETT. I think, on the volume, in the short term it 

would be difficult, in the long term it’s handleable. Yes. 

Judge COX. Yes. 

Senator SPECTER. Short term? 

Judge BENNETT. Short term. 

Judge COX. Our U.S. Trustee’s Office is excellent in getting these 

sorts of things organized. They’re excellent. 

Senator SPECTER. Professor Scarberry, you have your hand up. 

Mr. SCARBERRY. One of the difficulties is that S. 2136 refers back 

to the Chapter 7 means test, which includes a good number of ambiguities and has given rise to a great deal of litigation. I think the 

bankruptcy judges here might agree that they have not been the 

easiest provisions to apply, and in fact have in some cases been 

counter to what was intended. 

Senator SPECTER. Wouldn’t it be wise to, at least at this moment, 

freeze interest rates so that people like Ms. McGee are not facing 

this variable adjustment which comes as such a shock before we 

adjourn for Christmas and come back and we’re in gridlock on 

some other matters and nothing happens? That at a minimum, if 

some administrative action can be taken to freeze the interest 

rates, that that would provide some relief right now? What do you 

think, Ms. McGee? Would you like that? 

Ms. MCGEE. Sure. [Laughter]. 

Senator SPECTER. I thought I’d get a direct answer from you. 

Judge BENNETT. Senator, may I say this? 

23 

Senator SPECTER. Go ahead, Judge Bennett. 

Judge BENNETT. I mean, in fairness to everybody, I think that 

a short-term potential freeze on foreclosures so that they don’t impend at this time frame, it gives a breathing spell to analyze and 

to get a game plan that really encompasses everybody— 

Senator SPECTER. So you’re for a freeze? 

Judge BENNETT. For very short term, yes. 

Senator SPECTER. How long? 

Judge BENNETT. Well, 60, 90 days. With people working, potentially, it could—I can’t tell you off the top of my head. Also, an interest rate holding for short term, I think, would give everybody a 

chance to analyze a lot of things that may not have been looked 

at fully. 

Senator SPECTER. What I’m trying to get a handle on, and perhaps it’s not handleable, as to the real question as to whether this 

cram-down will affect the future markets, as Justice Stevens said 

in the Supreme Court decision, that in the long term effect it will 

increase costs. 

Professor Mason, you say in your testimony that investors are 

likely to impose a lemons discount, so that it will have an effect. 

Mr. Sommer, you think that it will be fine to have the cram-down 

and the market will adjust to it. Is there anything you can really 

grab ahold of, any empirical evidence which would give us some 

sense of, if not certainty, reasonable likelihood, aside from just the 

opinions? You are experts and we value your opinions, but opinions 

are not as valuable when we seek to legislate on something harder. 

What can you say, Mr. Sommer, that’s more definitive? 

Mr. SOMMER. Well, obviously there’s no certainty to these predictions. But I will point out that cram-down on cars did not exist 

before 1978, and no one has ever suggested that car interest rates 

went up after it was adopted in 1978. Cram-down was limited 

somewhat on cars in 2005. No one has suggested that interest rates 

went down as a result. In 1986, Congress passed the Family Farmer Bankruptcy law, which permitted cram-down on farm loans and 

farm mortgages, and no one has suggested that farm interest rates 

changed. So we have those examples. 

I think the real issue is, we’re talking about a very—even though 

it’s a large number of foreclosures, in total we’re talking about a 

very small part of the total market. We’re not talking about wiping 

them out completely. What we’re talking about is— 

Senator SPECTER. Mr. Sommer, aren’t cars, as a depreciable 

asset, very, very different from homes? 

Mr. SOMMER. Cars are different from homes. But I think that— 

Senator SPECTER. So different that the analogy is inapt? 

Mr. SOMMER. Well, I don’t think it is because the fundamental 

principle of bankruptcy is all based around liquidation of assets. 

Remember here, the alternative is foreclosure. There’s going to be 

a liquidation. It’s not like the homeowner is going to keep making 

payments while the property increases in value. It’s not like the 

mortgage company, if it forecloses, is going to hold onto the property— 

Senator SPECTER. Excuse me. My time is almost up. I want to 

give Professor Mason a chance to answer that question. 

24 

Mr. MASON. I wanted to address your points about the lemons 

discounts, and in particular the evidence that we have for that lies 

in George Ackerloff’s Nobel Prize-winning work in the economics of 

asymmetric information discounts and premiums that are invoked 

in markets. There is a very clear understanding: you add more uncertainty to a market, the price is going to react. Right now, you’re 

getting ready to enter the earnings season where banks report 

their earnings, in particular, the year-end earning season where 

we’re looking for annual reports to give us some notion of the losses 

on bank balance sheets. 

Senator SPECTER. What does all that mean? 

Mr. MASON. If you freeze interest rates on adjustable rate mortgages right now you’re going to add further uncertainty to the 

value of those holdings on bank balance sheets and fuel this crisis 

even further. 

Senator SPECTER. So you are against the freezing? 

Mr. MASON. Right now is, in fact, a low point in the adjustment 

cycle for adjustable rate mortgages. Next spring, that will accelerate. 

Senator SPECTER. Before my red light goes on I want to start a 

question to Mr. Zandi. You testified that cram-downs will significantly decrease the number of foreclosures. Why do you think that? 

People won’t foreclose when they go into a bankruptcy court, they 

have their principal sum go down? 

Mr. ZANDI. I think borrowers, given the choice of a Chapter 13 

bankruptcy or a foreclosure and losing their home, will take the 

Chapter 13 bankruptcy. The number of folks that would benefit, 

that would apply under the means test, would be about 500,000 to 

600,000 people. Yes. 

Senator SPECTER. I have great sympathy for the Chairman. I like 

to help the Chairman, when my light goes on, to stop. 

Senator DURBIN. Well, spoken like a former Chairman. 

Senator SPECTER. One who aspires to be a Chairman again. 

[Laughter]. 

Judge COX. We understand. 

Senator DURBIN. We hope that God will answer your prayers, but 

not too soon. 

[Laughter]. 

If I might, I’m trying to put this in context. We’re talking about 

500,000 or 600,000 people who may be affected by this bill. We’re 

talking, I think, roughly about 130 million mortgage owners in 

America. We are talking, as I see it, less than one-half of 1 percent. 

I’ve heard speculation here that this is going to warp the market. 

It’s going to have this dramatic dislocation in trying to figure out 

the credit future. But that ignores the obvious. Doing nothing has 

an impact on the market, too. It has an impact on Mrs. McGee and 

a lot of other people. 

I’d like to go back to your point, Mr. Zandi. If I heard you correctly, you said that a foreclosure sale—and I’ll let you correct me 

if I’m wrong—will result in a price that is 20 to 30 percent below 

fair market value. Is that what you said? 

Mr. ZANDI. That is correct. The literature on this subject, some 

of it coming from the Federal Reserve, suggests, in normal times, 

25 

not stressful times like the one we’re in today, the discount is 20 

to 30 percent. 

Senator DURBIN. And there is also a cost associated with foreclosure itself. 

Mr. ZANDI. Quite significant. The cost of maintenance, the realtors involved in selling the home. Many, many other costs. 

Senator DURBIN. And like a banker from one of the biggest financial institutions in America recently told me over dinner, bankers 

don’t like to cut grass. 

Mr. ZANDI. They don’t. 

Judge COX. They don’t. 

Senator DURBIN. Well, they’re stuck with a situation cutting 

grass on a property in foreclosure until they get it sold. 

Mr. ZANDI. Exactly. Right. 

Senator DURBIN. They have to hire somebody to do that, as one 

example. So the point I’m trying to get to is, all the arguments that 

have been made by some, that this is creating a real hardship on 

financial institutions, ignore the obvious. Foreclosure is a real 

hardship on financial institutions. They’re going to lose money. Our 

outcome is based on a crammed down/stripped down discount, 

whatever you want to call it, no lower than fair market value. That 

is the bottom line here. It seems to me like it is a reasonable bottom line. 

Judge Cox, a point was raised earlier, and I think it was by Mr. 

Scarberry, about how difficult it would be to come up with fair 

market value of property. Do you have to cope with that challenge? 

Judge COX. We don’t have that much of a problem. Sometimes 

people bring in expensive appraisals. Sometimes they just put a 

real estate broker on the stand and talk about prices in the area. 

It can be done cheaper than that. 

Senator DURBIN. And if it’s disputed, I mean, you can take more 

than one appraisal. 

Judge COX. We hear those matters all the time. 

Senator DURBIN. So that is not an issue. 

Judge COX. That is not a big problem. 

Senator DURBIN. You mentioned coming up with an interest rate, 

you said earlier, was something you could calculate. 

Judge COX. By the Board of Governors of the Federal Reserve 

Board. The interest rate published for today is 6.1. We add premiums for cars. We could add a premium for loans. These issues 

are never disputed in our court. We never have hearings on these. 

That is not difficult for the financial services market and the debtors and the debtor’s bar to do. 

Senator DURBIN. If God would smile down and decide that this 

bill should become law, would it be an incentive or a disincentive 

for financial institutions to renegotiate the terms of a mortgage before foreclosure and bankruptcy? Anybody have an opinion? 

Judge COX. I’m not sure that will happen without some sort of 

immunity for a suit from their shareholders and bondholders, but 

I think that by having debtors come into bankruptcy, certainly 

shields the lenders from those sorts of civil actions. 

Senator DURBIN. Any other thoughts on that? 

Mr. SCARBERRY. It would certainly encourage that sort of thing. 

I tell my students all the time that one of the key functions of 

26 

bankruptcy law is to provide a backstop for consensual negotiations. Certainly in Chapter 11, that’s the case. 

But to go back to a point, Mr. Chairman, that you made earlier, 

that this is a small percentage of loans, I might analogize that to 

saying that it only snows 1 percent of the time, but when it snows 

you really want to have your warm weather gear. So, these are the 

mortgages on which the need to look to the protections of the real 

property secured transactions laws is important. If that protection 

is taken away when it’s needed, that has a substantial effect, especially when what is taken away is the up-side, and the possibility 

occurs that during a severe market downturn, the up-side is removed. 

Senator DURBIN. But that’s the point I want to get to. You are 

arguing that real estate, unlike the car, is an appreciable asset. It 

can appreciate in value. Historically, that is what has happened 

and we hope it will continue to happen. But ultimately in a foreclosure, you are making a sale at that moment in time. You are 

selling at that moment in time at fair market value, knowing that 

if history serves you, 10 years from now that property is going to 

be worth more. That doesn’t mean you’re going to get that much 

more when you sell it. 

Mr. SCARBERRY. Mr. Chairman, that depends. That depends, first 

of all, on whether there is a foreclosure. And to the extent that this 

bill creates moral hazard and people end up using it to strip down 

mortgages, where they could—but for the bill, and they would but 

for the bill, in some cases—tighten their belts and use existing provisions of Chapter 13 to keep their homes, there wouldn’t be a foreclosure. 

It also assumes that there would not, under these circumstances, 

be further developments. Typically the bank is going to buy at the 

foreclosure sale, so there’s no actual money, in many of these cases, 

that changes hands. If they decide that they want to set up a subsidiary to handle rental property and wait out a couple of years 

until the market recovers, they have that option now. 

Mr. MASON. No, they don’t have that option. Even under GrammLeach-Bliley, banks don’t have a real estate option. 

Mr. SCARBERRY. Well, most of these aren’t held by banks at this 

point. 

Senator DURBIN. But I really struggle with this notion that when 

it comes to immoral conduct, it’s always the consumer. 

Mr. SCARBERRY. Oh, no, no. No. 

Senator DURBIN. In this circumstance here, I’d like to ask Mr. 

Sommer, do you think these people would race into bankruptcy 

court because the Chapter 13 work-out under Durbin might be 

available? 

Mr. SOMMER. We find people who, even when we advise them to 

file bankruptcy, don’t want to do it. It’s really the converse. 

Senator DURBIN. And it’s harder to do it today than it was before 

we changed the law. 

Mr. SOMMER. It’s harder. And for this particular remedy they 

would have to pass the—they would have to live under the expenses set by the means test, 2005 means test. Only then, if they 

didn’t have enough money to pay their mortgage, could they use 

this remedy. 

27 

Senator DURBIN. Well, I think that if the prospect on the horizon 

that we’ve heard about the economy going into a tailspin, I’ve 

heard the word ‘‘recession’’ from several different witnesses here, 

how many financial institutions out there are looking at that and 

viewing it as a sanguine result? That has to be something that is 

painful to anticipate. If we can slow down, as Senator Specter has 

suggested, what is coming and stabilize the situation, it’s got to be 

in the interests not only of homeowners, but also of financial institutions. 

Judge BENNETT. Senator, may I say something? I think if it can 

be done properly, yes. My concern is, it’s not being done properly. 

What’s happening—let me give you an example. If you strip down 

the mortgage to its principal balance, you are then going to refinance, theoretically, under your proposal, up to another 30 years. 

The interest rate that you use on that could actually be negative, 

be bad for the borrower in certain instances. It already occurs in 

cars right now, that car dealers are coming in that sold cars at zero 

percent interest. 

Under our current statutory framework, they asked for the increase to the market rate. The bill, the way it’s structured, for instance, does not apply to these teaser rate loans only. It applies to 

the broad market. But my bigger point here is that when you then 

subdivide all of the ownership, who owns what makes a big difference. Second, the whole structure of what’s going on for a 30- 

year period is far more dramatic—up to a 30-year, I should say— 

than what are short-term loans. Third, we need to bear in mind 

that, unfortunately, in all bankruptcies the failure rate is astoundingly high. We can disagree on what failure or success is, because 

sometimes success is restructuring, being able to hold onto the 

property and dismissing the case. So, dismissal numbers are not 

that great. 

Senator DURBIN. Judge, I’m sorry to interrupt you. My time is 

up. 

Judge BENNETT. I’m sorry. 

Senator DURBIN. I would note that Senator Sessions has another 

meeting to go to, and I’d like to yield to him at this point. We can 

return to this after Senator Sessions. 

Senator SESSIONS. Thank you, Mr. Chairman. It certainly is 

highlighting the complexity of the problem we’re dealing with, the 

amount of money that has been brought forth to allow borrowers 

to buy houses. I mean, lenders are out to make a profit. They write 

the contracts that help make themselves a profit and protect their 

interests in every way they can, but the lender puts the money out. 

They give $100,000, $200,000, $500,000 and they can’t do that if 

we have a problem and make it too difficult to get the repayment. 

That’s why I will offer three letters here for the record. One is 

from Mr. Clark, former Comptroller of the Currency, and Mr. Isaac, 

a former FDIC Board Chairman, and Mr. Powell, FDIC Chairman, 

and the Mortgage Bankers Association, and from the Securities Association. 

I’d just point out that these pieces of legislation have the tendency to increase interest rates. I think Judge Bennett said, I don’t 

know exactly what the interest rate will be, but if you put a burden 

28 

on it, Mr. Mason, an uncertainty, you say whatever it will be, it 

will be a little bit higher. Is that right? 

Mr. MASON. Yes. 

Senator SESSIONS. One of the letters said it could be 2 percent. 

Do you think that is excessive? Would you give an opinion on that? 

Mr. MASON. I don’t think that would be excessive at all. The 

problem is, with the amount of uncertainty markets can’t accurately price, so they throw up worst-case scenario— 

Senator SESSIONS. Well, Ms. McGee indicated, what, a 3 percent increase in your interest rate, resulting in a $200 a month increase 

in payment? One percent can easily be $100 a month for the average borrower. So half a percent, even if it went up only a half a 

percent, could be $50 a month for the average borrower. So we’ve 

got to be careful about this, is all I’m saying. 

Now, with regard to the question of 600,000 foreclosures perhaps 

being avoided, does that contemplate 600,000 more bankruptcies 

being filed to avoid the foreclosures? If I could get an affirmative 

answer there. 

Mr. MASON. Yes. 

Senator SESSIONS. So we’re talking about really moving foreclosures into Chapter 13 bankruptcies. But you can file Chapter 13 

now, right, without this legislation? Professor Scarberry, maybe 

you could tell me. Put it down here where the horses can eat it, 

I guess. What does this mean? I mean, what are the forces at work 

here? You talk about moving. Who is it going to help? What is the 

overall economic impact? 

Mr. SCARBERRY. That’s a big question, Senator Sessions. I’ll try 

to answer it. Who is it going to help? It will help the homeowner 

who is able to make payments at a court-determined interest rate 

on a mortgage on the value of the property, but not able to make 

the mortgage payment that is called for under the contract, or even 

a mortgage payment at an appropriate interest rate on the full 

amount of the debt. So, it would help that person. 

Senator SESSIONS. Now, you indicated earlier, did you not, that 

this could cause them to lose their appreciation? 

Mr. SCARBERRY. No. It could cause—and the Chairman and I 

were having a discussing a moment ago— 

Senator SESSIONS. I’m sorry I missed it. 

Mr. SCARBERRY.—as to whether the holder of the mortgage is 

harmed by not having the possibility of benefitting from appreciation in the future. So if we catch the value of the property when 

it’s at a low point and fix the amount of the mortgage there, then 

if the property appreciates the debtor gets the equity from the appreciation and the mortgage holder is still stuck with the loss. One 

conceivable possibility would be to have some sort of revaluation 

several years down the road in which the value of the property is 

considered to get— 

Senator SESSIONS. There’s no free lunch there. If you cram down 

the value of the property, somebody loses. 

Mr. SCARBERRY. Somebody loses, yes. 

Senator SESSIONS. And if it goes to the lender, more lenders in 

the future are going to charge higher interest rates. 

Mr. SCARBERRY. I don’t see any other way, Senator Sessions. If 

risks are increased and costs are increased, then interest rates will 

29 

be higher than they otherwise would have been. I think that simply 

follows. 

Senator SESSIONS. Now, I supported cram-down for automobiles. 

I think it makes sense. I think we came pretty close. Senator Durbin was articulate on that issue, I know, when we discussed it, and 

Senator Feingold. I think we came close to the right amount there. 

But it does appear to me that since homes tend to be generally upward and you can have periods of decline, that it is less appropriate. 

Judge Bennett, you’ve been at this a while. Would you agree, 

whether you should or not, it’s less appropriate than in an automobile? 

Judge BENNETT. I’m going to leave the policy decisions to those 

that make those. I will tell you what I think from an economic 

point of view. The answer is, the risk and the uncertainty is far 

greater than on what are shorter term and smaller dollar amounts. 

So, from that point of view I think I would tell you that by pushing 

these out at longer terms with bigger dollar volumes and with interest rates, that really—and I could tell you the experience of interest rates on cars is, it’s prime plus 1, 2 or 3. Realistically, in the 

real market, the credit quality of the people who get prime or 

prime plus 1, 2, or 3 are not bankrupts. So, the idea that the interest rate on the cram-down really reflects the market rate misses 

the point in the real world. 

Senator SESSIONS. You mentioned in your written statement, 

Judge Bennett, and discussed—you suggested, I’ll just say it that 

way—that we’re putting a lot of police pressures on bankruptcy 

judges to make decisions that that’s not their training or their normal requirement. Did you say that? Would you discuss what you 

said in that regard? 

Judge BENNETT. Well, let me tell you my framework. The framework of what I did, was to set forth, here are some over-arching 

issues that are of more economic significance. Here’s a comparison 

of the two bills. If you look at what I did, I really laid you a blueprint out on each bill as to where I think there are interpretation 

and other problems. So if you want to take those into consideration, 

you can structure around those. I did that in more of a bipartisan 

sense to tell you where I think there are interpretation problems. 

What I think, and have always thought and used to tell my clients, you can always file bankruptcy but you cannot unfile. In that 

sense, I think right now—I don’t think the economists of this 

world—and I’ll take the fall for being one of those in a prior life— 

really know where we are headed, necessarily, and really know 

whether the mortgage issue is the cause or the symptom, or whether it’s both. I really urge caution until we get a better picture, and 

we do the whole picture. I think that something will ultimately 

have to be done. That’s where I come from. 

Lawyers and judges are not professionals in these areas. What 

we are, are professionals at arguing positions for our clients and 

resolving positions. The function of the legal system is not necessarily solely to get it right—hopefully we do most of the time— 

but is to bring finality to an issue. From that point of view, our 

training is not in other things. I would suggest that if you look at 

the car issues and the real market rates that would be paid out on 

30 

these, that the cram-downs on cars are effectively well below market rates of comparable credit risk. That same thing will happen 

in the context of mortgages, which means that the risk of loss for 

those that hold a residual portion of the cram-down mortgage will 

be under-paid and will be a further diminution of the value, if that 

answers your question. 

Senator SESSIONS. Professor Scarberry? 

Mr. SCARBERRY. Senator Sessions, you asked a moment ago 

about the 600,000 cases. I would suggest caution in assuming that 

the litigation in those cases will be similar to the litigation over car 

loan strip-downs or cram-downs. In a car situation, you may be arguing about $1,000 in difference. In a home mortgage situation, 

you may be arguing about $50,000 or $100,000 or more. With the 

incentive to litigate, and the greater uncertainties in valuation for 

real property, especially when so few properties are being sold, it 

seems to me we have a potential for a very large amount of litigation in a very large number of cases. 

That’s why I suggested that it might be useful for Congress to 

think about using the bankruptcy power to assist in resolving this 

problem, not in bankruptcy cases, but through the process that Secretary Paulson has attempted. So, perhaps in a sense I’m reflecting 

on what Judge Bennett said. To do this in a Chapter 13 creates all 

sorts of problems and it may not be the best way to do it. In particular, as I pointed out, unless the Congress changes the provision 

that was added in 2005, if the Chapter 13 fails for any reason before the end of, typically, 5 years, the modification of the mortgage 

will disappear. 

So, failing to pay priority tax claims or other sorts of things— 

perhaps that’s a technical aspect of the bill. But to tie this to a 5- 

year payment plan, which tends to be how you deal with other 

kinds of debts, may not be the best way for Congress to use the 

bankruptcy power here, to help in a situation where I think there 

needs to be something done. 

Senator SESSIONS. Go ahead. 

Mr. MASON. If I can jump in for just a moment. I’m not sure that 

addressing this in bankruptcy is really the most effective way, but 

as I’ve said before, I’m not sure that modifying the terms of all existing mortgages is appropriate either. I think that Senator Durbin 

raised an extremely important point that I want to come back to, 

which is the foreclosure system in the United States. 

It’s not clear, when we’re working on a bankruptcy, that the 

property will be foreclosed upon. From an economic point of view, 

if it was economical for the lender to restructure the loan on behalf 

of the borrower, that would be carried out. I wrote an article on 

this that was picked up in The Economist and cited very widely. 

Senator SESSIONS. In other words, they would do it on their own 

because it’s in their own self interest. They don’t want to have another house in the inventory. If they can’t get a price for it, they 

have an incentive themselves, or selfish interest, to refinance. 

Mr. MASON. Precisely. Precisely. And given that the matter is in 

bankruptcy should be a flag to the lender that we’re getting pretty 

close to a foreclosure point here, and if it’s economical we can still 

negotiate in a bankruptcy court, notwithstanding anything that 

31 

this committee might do. So it strikes me that the market should 

be working and there shouldn’t really be an issue. 

I think the bigger issue that is sometimes lost in what we’ve 

been talking about with the mortgage crisis, is the foreclosure system, because in the U.S. we’re going to put this house on the market and auction it off for cash on the barrel head to an individual 

buyer. Oftentimes, even if that individual who was just foreclosed 

upon might have some amount of cash, let’s say it’s 70 percent of 

the market value, they would even be locked out of the bidding 

process. We don’t have a chance for banks to buy the home back 

because banks can’t own real estate. 

As a banking specialist, that was one power that was left out of 

Gramm-Leach-Bliley. They can’t own real estate and couldn’t lease 

it back. But it strikes me that there is a tremendous opportunity 

here, a tremendous market opportunity for the market to purchase 

real estate and, in fact, lease it back to the existing occupant to 

fight the urban blight problem. 

Now, I’m not saying, give that power to the banks. But I am saying that there could be a role in fixing this foreclosure system to 

allow greater efficiencies in bidding, similar to structures that we 

do see in Europe where properties are placed on the market, and, 

say, 100 properties at a time, a corporation will buy them, will 

maintain the homes, and will lease them to occupants so that they 

do not go idle. 

Senator SESSIONS. Thank you. 

Mr. Chairman, this is an able panel on an important issue. 

Thank you very much. 

Senator DURBIN. Thank you, Senator Sessions, for being part of 

this. I have a few more questions. 

Ms. McGee, what is going to happen to you if you lose your 

home? 

Ms. MCGEE. Well, I really don’t know. 

Senator DURBIN. You’re living on Social Security, right? 

Ms. MCGEE. Yes. That’s my source of income. But I was hoping 

that somebody would come up with an idea or something today, not 

only for me, but to help people who—I got in this situation on my 

own, you know. But now they’re talking about bankruptcy. I don’t 

think I could afford bankruptcy. You know, I couldn’t afford bankruptcy. So then that means that if I can’t pay the mortgage, I lose 

my home. Then I go where? 

Senator DURBIN. Have you seen any homes in your neighborhood 

or where you live that have gone through this? 

Ms. MCGEE. Well, not right where I live, but where my granddaughter lives at 69th and Hermitage, there are five foreclosed 

houses in one block. One block. It’s all over, you know. But mine 

will be next, I guess. 

Senator DURBIN. I hope not. 

Ms. MCGEE. I don’t know. I don’t know what to say or what to 

do. 

Senator DURBIN. Professor Scarberry, who wins in a foreclosure? 

Mr. SCARBERRY. I don’t think anyone wins. I don’t think anyone 

wins in a foreclosure. 

32 

Senator DURBIN. But you raised a point that somebody raised to 

me, which I want to try to bring out on the record here, about some 

insurance. 

Mr. SCARBERRY. Yes. Well, my understanding—I’m not an expert 

on this. I have spoken to people who are involved in it, and the 

committee should look more closely, and perhaps others here know 

more about private mortgage insurance, which often is required on 

loans where not very much money is put down, often less than 20 

percent. 

Private mortgage insurance ordinarily, as I understand it, only 

pays to the mortgage holder if there is a foreclosure. So to the extent that the lien is stripped down in a Chapter 13, and that there 

is no foreclosure, the mortgage holder suffers a loss, but does not 

get the benefit of the insurance that they bargained to receive and 

that went into the pricing of the whole mortgage. 

Now, that, it seems to me, is a problem. Now, perhaps there 

could be some sort of—on the other hand, if too much is asked of 

the private mortgage insurers, their ability to handle the load— 

again, it’s not my area. One would question, if we have 2 million 

foreclosures, how a private mortgage insurance system is going to 

work. 

Senator DURBIN. It’s a legitimate policy question, probably beyond the Judiciary Committee, and something that we shouldn’t ignore. 

Mr. SCARBERRY. And so it does seem to me that if the process 

of securitization of mortgages, with the dividing up of the rights to 

the various income streams and to so many different forms of securities, if that has resulted in there being no one who can really negotiate the loan modification with the homeowner because the 

servicer says, ‘‘oh, well, I can’t do that. I would do it if I owned the 

mortgage, because it makes sense, but it would hurt this security 

holder who has the right to the first bit of the interest.’’ 

It seems to me it would make sense for Congress to say there 

will be someone who can act, it will be the servicer, and the 

servicer will act, perhaps, to try to get the best value overall, and 

if that hurts some of the securities, it hurts them. But that seems 

to me to be something that might be very useful. 

Senator DURBIN. One of the goals here was to hope that passing 

this would encourage work-outs so that people wouldn’t have their 

homes lost, that Ms. McGee and others might find some terms or 

interest rates that they can live with. But as you just described the 

situation, as the paper moves further and further away from the 

original transaction and the only protection for the ultimate paper 

holder is insurance that depends on foreclosure, it strikes me that 

you’ve just created a disincentive for a work-out in the negotiation. 

Mr. SCARBERRY. Well, yes. Yes, you have. So in that sense I understand your initial question: who wins in a foreclosure. In a 

sense, the beneficiary of the private mortgage insurance may gain 

from a foreclosure. 

It is true that mortgage originators—and others, perhaps Professor Mason will know a lot more about this than I do—have 

taken back some of the risk by way of reinsurance. So, I think it’s 

very complex. But initially, at least, it would seem that, absent a 

foreclosure, the loss will be borne by the mortgage holder, not by 

33 

the insurance company. The insurance coverage, essentially, has 

been rendered worthless. 

Mr. ZANDI. Senator Durbin, can I pipe in for just a second? 

Senator DURBIN. Sure. Go ahead, Mr. Zandi. 

Mr. ZANDI. There are certain investor groups that do benefit in 

a foreclosure, and that’s why the modification efforts are not working. There’s a market failure because of the way the securities are 

structured. Certain investor groups want the process to go through 

foreclosure and the losses to be realized because they won’t suffer 

the losses, the folks who took on the most risk in the securities 

will. So they have no interest whatsoever to see these things modified, and that’s why they’re not happening, and that’s why there’s 

a failure in the marketplace. That’s why the Treasury Secretary 

has put forward his proposal, because he realizes it’s not going to 

happen in a significant way. 

Senator DURBIN. I think that’s the point Mr. Sommer made. 

Mr. ZANDI. Yes. That’s exactly the point. Yes. So there is a market failure here and you can’t let the market do it by itself because 

it’s not going to happen. It’s not going to work. 

Senator DURBIN. Anyone like to comment on that before summation? 

Mr. MASON. I’d like to address that a little bit more accurately. 

There aren’t security holders that will benefit from foreclosure. In 

fact, the problem is really more accurately characterized by Professor Scarberry: nobody really wins here. But the problem is that 

nobody wins in a modification in the sense that the servicing structures are built so that the serving contracts that pay the servicer 

to send out the bills and make the phone calls aren’t written to 

handle any of the activities that we see in modification. 

So let’s say a servicer goes ahead and, let’s say I’m late on my 

loan, the servicer calls me, we have some talks, we work some 

things out, they freeze my interest rate for a couple of years, or 

maybe permanently, who knows. But we work some things out and 

I keep paying the mortgage. Well, they’ve just incurred some additional expenditures in that activity. The problem is, nowhere in 

their contract do they get to recover those expenditures because I 

didn’t go into foreclosure. 

Senator DURBIN. Do you acknowledge and concede the earlier 

point, that the sale and foreclosure is going to be at a loss to fair 

market value; that the foreclosure proceeding itself is an expensive 

undertaking; that a financial institution is not in the business of 

cutting grass and selling property? 

Mr. MASON. I do. I completely concede. 

Senator DURBIN. Conceding all those points, doing nothing is expensive to someone in this process who is the ultimate mortgage 

owner, right? 

Mr. ZANDI. There’s obvious winners in modification. Obvious winner. The borrower is the obvious winner. The community in which 

the borrower lives is an obvious winner. The economy is an obvious 

winner because house prices aren’t going to fall quite as much. The 

costs of foreclosure are substantively greater, by anyone’s measure, 

to modification. Those benefits have to go to somebody. They’re 

going to go to the borrower, they’re going to go to the lender, 

they’re going to go to the servicer, and they’re going to go to the 

34 

investor. So, there are significant benefits to modification of a foreclosure. 

Mr. MASON. Now, that being said, that borrower is a winner and 

it’s not clear that every borrower out there deserves that status. 

There are certain borrowers that— 

Mr. ZANDI. Now, that’s a different argument in a different story, 

in a different point. 

Mr. MASON. There are certainly borrowers like the one sitting at 

this table that has been truly harmed by the mortgage system, by 

abuses and by predatory practices. Those borrowers certainly need 

redress. But we have also had a tremendous amount of speculation. 

Senator DURBIN. Well, I might just add, though I have my differences, and have had many with the administration, I talked to 

Secretary Paulson yesterday. What they are proposing is certainly 

not paying homage to the sanctity of the contract. They know that 

we cannot continue these contracts. We’ve got to either not allow 

a re-set or come to some sort of—eliminating pre-payment penalty, 

whatever it takes, that is going to step into this situation and say 

it has to stop. This is not good for this Nation for this to continue. 

Mr. MASON. I also want to point out another thing that Ms. 

McGee mentioned in her testimony. There are these fundamental 

problems with the mortgage closing practices under RESPA, where 

she was put in a room for 10 minutes with 40 pages of paper. 

There was no way possible she could read, much less digest the 

terms of the contract. Giving her that contract, a firm contract 2 

weeks beforehand might have given her a fighting chance where 

she could show that to her daughter, or her friend, or her friend’s 

friend, or an attorney. 

Senator DURBIN. Oh, no. Having been an attorney at closings, I 

can just tell you, I’m sure Ms. McGee’s daughter is a very smart 

young lady, but give me a week with it and I might be able to 

make some sense out of it. 

I’ll just say this. Let me close by saying this. I had a meeting 

today with the realtors. We talked about a lot of things, including 

this issue, obviously. I am hopeful, at the end of the day, that we 

not only deal with this crisis, but look prospectively. There ought 

to be a simple, simple sheet that you put in front of a borrower 

which says this is how much you’re borrowing, this is the interest 

rate, it is either permanent or it’s going to change, here is your prepayment penalty if there’s going to be one. 

Now, this debate was started a long time ago by the first man 

I ever worked for, Paul Douglas, who initiated Truth in Lending. 

I am sure Senator Douglas, if he saw that stack of papers pushed 

in front of Ms. McGee, or Senator Proxmire, who ultimately passed 

the bill, would consider this a great victory for consumers. We’ve 

got to get to the point where consumers have some basic information so that they know what they’re getting into. The moral hazard 

argument, I think, is applicable if in fact people are informed and 

make a bad decision. In most cases, people are not informed. 

Mr. MASON. Let me just say, that’s very true, but I’ve seen the 

development of the Schumer-Box for credit card contracts and I’ve 

seen the terms in credit card contracts move beyond the Schumer 

Box, so that what you’ve legislated to be presented no longer contains—accurately—represents accurately the important terms of 

35 

the contract. So I am worried about prospectively is the industry 

moving beyond these requirements. 

Senator DURBIN. Being a legislator means being hopeful, so we’re 

hoping that we can do better. 

Mr. SCARBERRY. Mr. Chairman, the idea of a single sheet very 

clearly setting forth terms, it seems to me, is crucial. One of the 

problems with mandating disclosure is, the more disclosure you 

mandate, the harder it is to read and the less is actually conveyed. 

So that seems to me to be an extremely valuable approach. 

Senator DURBIN. My thanks to the entire panel. To Ms. McGee, 

for your sacrifice in coming here. We hope that we can help you 

work this out. To the judges, for coming and giving us an important perspective, and to all the members of the panel. Thank you 

very much. 

This meeting of the subcommittee, or the full committee, will 

stand adjourned. There may be some written questions sent your 

way. I hope you can respond to them in a timely way for the 

record. Other members who wish to make statements and put them 

in the record will be given that chance. 

We stand adjourned. 

[Whereupon, at 4:18 p.m. the hearing was adjourned.] 

[Questions and answers and submissions for the record follow.] 

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