Amicus Curiae Brief — Bank of America, N.A. v. Toledo-Cardona, 135 S. Ct. 677 (2014) (No. 14-163)

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FEB 23 208

FICE OF THE CLERK

No. 13-1421 and No. 14-163 “——

au The

BANK OF AMERICA, N.A.,

Petitioner,

DAVID B. CAULKETT,

Respondent.

BANK OF AMERICA, N.A.,

Petitioner,

Vv.

EDELMIRO TOLEDO-CARDONA,

Respondent.

A 8 REL apersnee

On Writs of Certiorari to the United States

Court of Appeals for the Eleventh Circuit

BRIEF OF AMICUS CURIAE

ADAM J. LEVITIN, PROFESSOR OF LAW

IN SUPPORT OF RESPONDENTS

MICHAEL T. KIRKPATRICK ADAM J. LEVITIN

Counsel of Record Georgetown Univ. Law Center

Institute for Public Representation 600 New Jersey Avenue, NW

Georgetown Univ. Law Center Washington, D.C. 20001

600 New Jersey Avenue, NW (202) 662-9234

Washington, D.C. 20001

(202) 662-9535

michael kirkpatrick@law.georgetown.edu

TABLE OF CONTENTS

aD EE FU BIE OU Shc vobecicacenenedecicecetasacehins iv

ee I Si iin ctetccndet aston cicteionaanescuees 1

SUMMARY OF THE ARGUMENT.......................... 2

NTE: Gavtassnresintersecicanideninshadntdicddchucnsutmaeucbadese 4

I. Legal and Economic Differences Between

First-Lien and Second-Lien Mortgages

Distinguish This Case from Dewsnup. ................ 4

A. The Particular Type of Second-Lien

Mortgages at Issue in This Case Are Almost

Entirely Creatures of the Housing Bubble..... 4

B. Second Liens Routinely Become

Worthless Under Both State and Federal Law,

Re es I, hee 11

1. Foreclosure of a Senior Lien

Discharges All Junior Liens, But

Foreclosure of a Junior Lien Does Not

es ee Ba oe es ee ae 11

2. A Wholly Underwater Second

Lienholder Receives No Distribution from

a “Free and Clear” Sale in Bankruptcy... 15

3. Unhke Second-Lien Mortgages, First-

Lien Mortgages Cannot Be Wholly

III clk J scciiniaithduundicccicssndiscidlibidmeadenic. 17

‘i

C. Underwater Second-lien Lenders Seek to

Recover from dostage Value Rather Than

re co ae Ee ae 18

D. Bankruptcy Law Disfavors Hostage

RN adie CSR Se om eva at eR eh ees ete BLO oe 22

E. Forbidding Lien-Stripping of Wholly

Underwater Second Liens Creates a

Bankruptcy “Windfall” for Second

UN sia ence nada dealin danlbedeatianatlen 23

Ii. Empirical Evidence Demonstrates That

Affirming the Decisions Below Will Not Disrupt

The Settled Expectations of the Mortgage

ERR ce ti eth RUE keane airs WR A. SY RA x to tle 24

A. Chapter 13 Lien-Stripping Had a Minimal

Effect on Mortgage Credit Costs................... 24

B. There Is No Evidence that Lenders

Currently Charge Higher Interest Rates to

Account for Lien-Stripping Risk. .................. 28

C. Lenders Are Unlikely to Charge Higher

Interest Rates to Account for Lien-Stripping

Risk if Bankruptcy Judges’ Valuations Are

Baten na iat herohie Dak aR iPad h edit Tb 30

1. There Is No Reason to Believe Judicial

Valuations Are Lower than Foreclosure

RS TN Re LEE SU ak tle 30

lll

2. Judicial Valuation Is Essential to the

Functioning of the Bankruptcy System. 30

3. Valuations in the Instant Cases Are

RR EE ee Rie es Se 32

D. The Market Will Not Price Adversely to

Judicial Lien-Stripping Because Bankruptcy

Can Create Value for First-Mortgagees. ...... 33

E. Permitting Judicial Lien-Stripping Helps

Overcomes Agency Problems in Mortgage

BN canine 36

F. Petitioner’s Litigation to Protect Utterly

Worthless Liens is Puzzling......................; oe OO

II]. The Second-Lien Mortgage Lending Market

Is Near Dead and Should Not Be Resuscitated 41

AUPE Sic cobs cuasuiensattinigwsmsepenmsabatabreddbasobbo 46

TABLE OF AUTHORITIES

CASES

BFP v. Resols:tion Trust Corp.,

Oe is I aia coiiincpiconndigrenamndanmmanencenenanncn 35

Butner v. United States,

i i ITI sienccscstict dow sasevsmceesciasbuitesiceicaaasianinate 23

Dewsnup v. Timm,

502 U.S. 410 (1992) ......-cccccccceccesesecereees 2, 3,17, 23

In re Bartee,

212 F.3d 277 (5th Cir. 2000) ................. ‘icesiceuacs 29

In re Boston Generating, LLC,

440 B.R. 302 (Bankr. S.D.N.Y. 2010) ................ 16

In re Davis,

716 F.3d 331 (4th Cir. 2013) ........cccccececceceseeeeee: 29

In re Hammond,

ee ee te a PO iicicted cans vsiavsccntascierenconies 29

In re Jolan, Inc.,

403 B.R. 866 (Bankr. W.D. Wash. 2009) ........... 16

In re Lane,

BOO Fe GES Gatis Cat. BOD ovececevcccicccccccessenacsess- 29

In re McDonald,

ee he Re 29

In re Pond,

252 F.3d 122 (2d Cir. 2001) .......cccccccceceseeeseseceees 29

In re Scarborough,

ee Cf: fe RE eee 29

In re Schmidt,

yee fF yye ye | eee 29

In re Tanner,

217 F.3d 1357 (11th Cir. 2000)

In re Thompson,

ch, SO Mee Ce Re 29

In re Woolsey,

696 F.3d 1266 (10th Cir. 2012) .........00....... eee. 29

In re Zimmer,

313 F.3d 1290 Cth Cir. BOOZ) .......006...00....ccccccess 29

Lomas Mortgage, Inc. v. Louis,

Be ee Ce Cie Bi icetitttrncccccccieccesiestsscsscssecs 29

Nobelman v. American Savings Bank,

We OF. UA CEI ois viccccssscsn 25

STATUTES

11 U.S.C. § 1129(b)(2)(A)(i) .esecccescecsesececeeeeeseeseeeee 32

11 U.S.C. § 1129(b)(2)(A)(ii).....ccccccccecccccesesesseeeeeeee 15

11 U.S.C. § 1129(b)(2)(A) (iii) ..cceceecceceeeseeeseeeeeeeeeees 32

OO Oe i i a scsiceaes 15

8 CES, © SI ona osc cscccccecsennses, 32

Ba RE 6 A aes sisssccscdeclaescectcns 32

ee a So 15, 31, 34

ee ae aN, 31

Oe a 34

156c. tte: Ate 31, 34

ee a 15

[Neo Cee a... 15, 31

St. aL a a eee 16

a a talsetelstla bole Balt ae 31

a ee eo 2, 32

OS Ott Oi ico 31

a i re ae SS a 32

55 Ge i eo 32

eee 6A ae ccscccscceecans 6

ee ee ee 6

OOUre BA0em oe 6

ae ra ID treo etiprisvveisccpeiiebedsinnieuniiane 6

BS UE, © Se ceninncosscsishsnenisssacsstseniseniaaee 39

PD ie Lot WEEE Hales Ty, 44

Bile. Caplin © GBB isesccssiisisssccacescevctoa succes 34

Ark. Code Ann. § 18-50-107(b)(3) ...............002..000e 14

By. Beev. Dhak. Aste: 6 GOGO vccesiccnsccsssscseescectaucninn 14

La. Code Civ. Proc. Ann. art. 2335...................206+- 14

La. Code Civ. Proc. Ann. art. 2336.....................6. 14

La. Code Civ. Proc. Ann. art. 2337 .............00sc0s..00 14

ek eo OF ee re 14

Onto Bev. Code Agu. § SEBDBO ...ccccccsssccsssesconseceses 14

eG ewe 14

Tema, Ce © Oe TI oeivissescccccspesccsasseensscdackoaee 34

vii

ADMINISTRATIVE MATERIALS

inca cuhishsdnieivensianoneseciesseveesancese 39

Federal Financial Institutions Examination

Council, Uniform Retail Credit Classification and

Account Managemen? Policy, 65 Fed. Reg. 36903

ak ccetuispnenensansnns 39

OTHER AUTHORITIES

Adam J. Levitin & Susan M. Wachter, Second-

Liens and the Leverage Option 13 (Jan. 28, 2015)

(unpublished article) available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_i

ENS de nea 10

Adam J. Levitin & Tara Twomey, Mortgage

Servicing, 28 Yale J. on Reg. 1 (2012)............... 37

Adam J. Levitin, Resolving the Foreclosure Crisis:

Modification of Mortgages in Bankruptcy, 2009

SEER a 1, 29

Ann M. Burkhart, Freeing Mortgages of Merger, 40

a | ___, S en ae 20

Bank of America, Quarterly Report (Form 10-Q)

a ueesiinnniae 40

Bonnie Sinnock, Second Liens Grow Again as Other

Mortgage Lending Dwindles, Nat’] Mortg. News,

SE” SUE STE 0s Pee ew eee aero ee 42

Christopher Mayer et al., A New Proposal for Loan

Modifications, 26 Yale J. on Reg. 417 (2009) .... 19

Christopher Mayer et al., The Rise in Mortgage

Defaults, 23 J. Econ. Perspectives 27 (2009)....... 7

Collier on Bankruptcy 4 363.06............................. 16

Consent Judgment, United States v. Bank of Am.

Corp., No. 12-cv-00361 (D.D.C. Apr. 4, 2012).... 21

Donghoon Lee et al., A New Look at Second-liens,

569 Fed. Reserve Bank of N.Y. Staff Rep. 7

I iii ican sia aaa ceeaetaanmanaguennniindanne 5, 7,41

Eduardo S. Schwartz & Walter N. Torous,

Mortgage Prepayment and Default Decisions: A

Poisson Regression Approach, 21 R. E. Econ. 431

TI IITIED cendansenidiinigdensbiddeantediaasinenpenbnnnmmbseaienntetieens 7

Fannie Mae & Freddie Mac, Form 3044, Uniform

Security Instrument (2015)..................csseeseeneeees 17

Fannie Mae, 2015 Selling Guide (2015)................ 19

Fannie Mae, Home Affordable Refinance (DU Refi

Plus and Refi Plus) FAQs (2013), available at

https://www.fanniemae.com/content/faq/harp-du-

SI Snccciesncunsinisnnncentenincaiataaniaiats 19

Freddie Mac, Single-Family Seller/Servicer Guide

SITTIN iaiucsi cocedenlcenadereemidmmeesennmupiasiarepdenenneiendieniainle 19

Joshua Goodman & Adam J. Levitin, Bankruptcy

Law & the Cost of Credit: The Impact of

Cramdown on Mortgage Interest Rates, 57 J. L. &

Re 1, 24, 26, 27

Katherine M. Porter, Misbehavior and Mistake in

Bankruptcy Mortgage Claims, 87 Tex. L. Rev.

I I veciisisicossesnaidicieutnibiciiaaianasielaiaasinbmandatadoenaineesi 37

Kathleen Howley & Dankin Campbell, Bank of

America Faces Bad Home Equity Loans:

Mortgages, Bloomberg Business,

I ee rican iicniaiinettiittiieaenenidaarinsiicieiiniarinaaaansiniin 40

Laurie Goodman et al., Where Have Ali the Loans

Gone? The Impact of Credit Availability on

Mortgage Volume, 20 J. Structured Fin. 45

EI ischcasisaabcaidadadived aca inidadsieaniaidaninuiaeniaiaaiinnnitadiaminiéien 41

Michael LaCour-Little et al., The Role of Home

Equity Lending in the Recent Mortgage Crisis, 42

8 |___SCREEN ae ee 9

Min Qi & Xiaolong Yang, Loss Given Default of

High Loan-to- Value Residential Mortgages

(Office of the Comptroller of the Currency, OCC

Economics Working Paper 2007-4, 2007)............ 7

Restatement (Third) of Property: Mortgages § 7.1

(AEN COREE AER Oe ke MA ee ae Ae Re oN 11, 12

Restatement (Third) of Property: Mortgages § 7.4

(SRE IIS 9s: hE EA, 16 5D, 12

Robert B. Avery et al., The 2006 HMDA Data, 93

Fed. Res. Bulletin A73 (2007). .......................2005 41

Vicki Been et al., Sticky Seconds: The Problems

Second-liens Pose to the Resolution of Distressed

Mortgages, 9 N.Y.U. J. L. & Bus. 71, 81

INI soins sceledsaaiitil inland aseanaioments 7, 19, 20, 21, 40

Wenli Li et al., Using Bankruptcy to Reduce

Foreclosures: Does Strip-Down of Mortgages

Affect the Supply of Mortgage Credit? (Fed. Res.

Bank of Phila. Working Paper No. 14-35,

INTEREST OF AMICUS!

Adam J. Levitin is Professor of Law at

Georgetown University Law Center, where he

teaches courses on bankruptcy, commercial law,

and consumer finance, including mortgage lending.

Professor Levitin has previously served as the

Bruce W. Nichols Visiting Professor of Law at

Harvard Law School, as the Robert Zinman Scholar

in Residence at the American Bankruptcy Institute,

and as Special Counsel for Mortgage Affairs to the

Congressional Oversight Panel for the Troubled

Asset Relief Program. In 2013, Professor Levitin

was awarded the American Law Institute’s Young

Scholar’s Medal.

Professor Levitin’s interest in this case is

both as a scholar of bankruptcy law and mortgage

finance and because he has authored or co-

authored two studies that examine the effect of

permitting mortgage lien-stripping on the cost and

availability of credit. See Joshua Goodman & Adam

J. Levitin, Bankruptcy Law & the Cost of Credit:

The Impact of Cramdown on Mortgage Interest

Rates, 57 J. L. & Econ. 139 (2014); Adam J. Levitin,

Resolving the Foreclosure Crisis: Modification of

Mortgages in Bankruptcy, 2009 Wisc. L. Rev. 565.

1 Pursuant to Rule 37.6, Amicus affirms that no

counsel for a party authored this brief in whole or in part, and

that no person other than Amicus and his counsel made a

monetary contribution to its preparation or submission. All

parties have consented to the filing of this brief.

In Dewsnup v. Timm, 502 U.S. 410, 416-17

(1992), the Court recognized the difficulties in a

hypothetical application of section 506(d) of the

Bankruptcy Code, 11 U.S.C. § 506, “to all possible

fact situations” and expressly limited its holding to

the facts of that case. ‘ihe instant cases address a

factual situation distinct from Dewsnup. Professor

Levitin’s explanation of the particular legal and

economic features of second-lien lending, the

structure of the second-lien lending industry, and

the empirical scholarship on the impact of

bankruptcy law on mortgage lending, will aid the

Court’s decisional process in applying section

506(d) to the facts of these cases.

SUMMARY OF THE ARGUMENT

Petitioner and its amici present these cases

as generally being about secured creditors’ rights in

bankruptcy; further, they assert that second liens

are no different from first liens other than in terms

of priority. Accordingly, Petitioner and its amici

argue that the Court’s analysis in Dewsnup should

apply with equal force to the cases before the Court

and that failing to extend Dewsnup to the second-

lien mortgage market will upset the market's

settled expectations.

Dewsnup, however, was expressly limited to

its facts, which involved a partially underwater

first-lien mortgage, meaning that the mortgage had

a loan-to-value ratio (LTV) of over 100%.

Fundamental legal and economic differences

between first-lien and second-lien mortgage lending

distinguish the instant cases from Dewsnup and

suggest that Dewsnup should not be extended.

Applying Dewsnup to cases involving wholly

underwater second-lien mortgages would have the

perverse effect of enabling Petitioner to do better in

bankruptcy than it would at state law. Such an

outcome woulda be inconsistent with Dewsnup,

which was premised on giving the parties only

“what was bargained for by the mortgagor and the

mortgagee.” 502 U.S. at 417. (Parties, of course,

always contract against the backdrop of bankruptcy

law and the risks it creates.)

Petitioner’s arguments about the impact of

affirming the decisions below run contrary to all

empirical evidence about the effect of lien-stripping

in bankruptcy on interest rates. The empirical

evidence shows that mortgage lien-stripping in

bankruptcy has little or no effect on either interest

rates or the availability of mortgage loans. Indeed,

the empirical findings make sense because a

lender's losses from lien-stripping in bankruptcy

are often smaller than a lender’s losses in a state

law foreclosure. The issue is not zero losses versus

losses from lien-stripping, but losses from lien-

stripping versus the losses that would obtain in a

foreclosure outside of bankruptcy. Moreover,

changes in the industrial organization of the

mortgage market mean that lien-stripping may

often be preferable to mortgage investors, even if

not to the banks that service the mortgage loans.

Irrespective of the magnitude of the effect of

permitting lien-stripping on _ interest rates,

reversing Dewsnup or simply declining to extend it

to wholly underwater second-lien mortgage loans is

unlikely to affect mortgage markets for a simple

reason: the market for high cumulative loan-to-

value ratio (CLTV) second-lien mortgages is

virtually dead.? There is a legacy pool of existing

underwater second-lien mortgages, but there is no

significant ongoing market that would be affected

by permitting lien-stripping on these loans. Given

the abuses that oecurred in the second-lien

mortgage market, this Court should not resuscitate

it.

ARGUMENT

I. Legal and Economic Differences

Between First-Lien and Second-Lien

Mortgages Distinguish This Case from

Dewsnup.

A. The Particular Type of Second-Lien

Mortgages at Issue in This Case Are

Almost Entirely Creatures of the

Housing Bubble.

The distinguishing feature of a second-lien

mortgage loan is that it is secured by a lien that is

of second priority. Beyond this basic feature,

however, there is significant variation within the

2 The CLTV ratio is the sum of the LTV ratios of all

mortgages on a property.

second-lien mortgage market. Some second-lien

mortgages secure close-end installment loans, while

others secure open-end revolving lines of credit

known as home equity lines of credit. Some second-

lien mortgages are made to borrowers with very

good credit, while others are made to “asp:. ational”

or “subprime” borrowers.

The issue in this case concerns primarily

close-ena (non-revolving) term loans made to

subprime borrowers. In contrast, second-lien

mortgages made to prime borrowers are often open-

end (revolving) home equity lines of credit.

Donghoon Lee et al., A New Look at Second-liens,

569 Fed. Reserve Bank of N.Y. Staff Rep. 7 at 3

(2012). Prime home equity lines of credit are

typically made well after the first-lien loan has

been originated, and thus partially paid down. /d.

at 6. Accordingly, the CLTVs on properties when

these home equity lines of credit are fully drawn is

typically nowhere close to 100%. Assume, for

example, that a borrower with a first mortgage

currently at 60% LTV wishes to redo her kitchen,

and that interest rates have gone up since the

borrower took out the first mortgage. Instead of

refinancing at a higher rate, the borrower will

simply get an additional mortgage loan, perhaps for

another 10% LTV, to cover the costs of the kitchen

renovation, resulting in a 70% CLTV. This sort of

prime second mortgage is a long-standing product

and is unlikely to ever be wholly underwater lke

the loans in these cases.

During the housing bubble years, a different

type of second-lien mortgage arose, the so-called

“piggyback.” The piggyback second was a loan

designed to evade the statutory leverage

restrictions on the Federal National Mortgage

Association (Fannie Mae) and the Federal Home

Loan Mortgage Company (Freddie Mac). Fannie

Mae and Freddie Mac are prohibited, by statute,

from purchasing mortgage loans with a LTV over

80%, unless there is first-loss private mortgage

insurance covering the loan. 12 U.S.C. § 1717(b)(2);

12 U.S.C. § 1454(a)(2). Private mortgage insurance

premiums add to the cost of borrowing. Therefore,

to expand market share, some lenders sought to

evade the Fannie/Freddie restriction by making

two loans to the borrower: one a first-lien loan for

80% LTV, which could be sold to Fannie Mae or

Freddie Mac, and then a second-lien loan for as

much as 20% LTV These piggyback mortgages

substituted for the borrower’s down payment, and

resulted in a CLTV of 100% on the property,

meaning that the borrower would have no equity in

the property.

Piggyback second-lien mortgages could not

be sold to Fannie Mae or Freddie Mac, 12 U.S.C.

§ 1717(b)(5)(C); 12 U.S.C. § 1454(a)(4)(C), but they

could be securitized in the private-label

securitization market? or, as was often the case,

3 “Private-label” securitization is the issuance of

mortgage-backed securities that are not guaranteed by

they remained on the balance sheet of the lender.

In either case, the lender might still bear the credit

risk on the mortgages, either because the lender

owns the loans or because the lender made

representations and warranties about the loan’s

quality and underwriting in the securitization

process. Piggyback seconds are associated with

higher CLTVs and thus lower down payments. See

Vicki Been et al., Sticky Seconds: The Problems

Second-liens Pose to the Resolution of Distressed

Mortgages, 9 N.Y.U. J. L. & Bus. 71, 81 (2012); Lee

et al., 569 Fed. Reserve Bank of N.Y. Staff Rep. at

6-7, 13-14. Higher CLTVs correlate with an

increased probability of default. See, e.g., Eduardo

S. Schwartz & Walter N. Torous, Mortgage

Prepayment and Default Decisions: A_ Poisson

Regression Approach, 21 R. E. Econ. 431, 445-46

(2003); Christopher Mayer et al., The Rise in

Mortgage Defaults, 23 J. Econ. Perspectives 27, 40-

43 (2009). Higher CLTVs also correlate with

greater loss severities upon default. See, e.g., Min

Qi & Xiaolong Yang, Loss Given Default of High

Loan-to-Value Residential Mortgages (Office of the

Comptroller of the Currency, OCC Economics

Working Paper 2007-4, 2007).

Respondent Caulkett’s second-lien mortgage

was a piggyback mortgage. It was made for 20% of

the property’s value and was made by the same

Fannie Mae, Freddie Mac, or the Government National

Mortgage Association (Ginnie Mae).

lender (Countrywide Financial) on the same date as

the first-lien mortgage made for 80% of the

property's value. Together these mortgages at the

time they were made had a 100% CLTV. Caulkett

Opp. Br. at 5-6. At the time Caulkett filed for

bankruptcy, the LTV on his first mortgage was

187.5% and the CLTV of the first and second

mortgages was 235.8%. Id.

Respondent Toledo-Cardona’s_ second-lien

mortgage was not a piggyback loan made

simultaneously with the first-lien mortgage, but

was made subsequent to the first-lien mortgage.

Toledo-Cardona’s second-lien mortgage was made

when Toledo-Cardona already had a first-lien loan

for more than 100% of the preperty’s value. Toledo-

Cardona Opp. Br. at 5-6. At the time Toledo-

Cardona filed for bankruptcy, the LTV on his first

mortgage was 174.7%, and the CLTV of the first

and second mortgages was 215.9%. Id. Toledo-

Cardona’s second-lien mortgage was apparently an

interest-only loan, id., meaning that the principal

balance of the second-lien mortgage—and hence the

CLTV on the property—was not decreasing with

periodic payments.

Second-lien mortgages, such as piggybacks,

contributed mightily to the increase in mortgage

leverage during the housing bubble. Figure 1

shows that during the housing bubble years of

2003-2007 there was a slight increase in LTVs on

first-lien purchase money mortgages, but that the

real increase in homeowner leverage was in CLTVs.

An increase in CLTVs, but not first-lien LTVs,

indicates that homeowners have increased their

mortgage leverage via second mortgages. Figure 1

also shows that the increase in CLTVs (but not in

first-lien LTVs) closely tracked the increase in

home prices, as increased Joan amounts enabled

housing prices to be bid up. Not surprisingly, then,

homes with junior liens account for over half of the

negative equity in the United States. Michael

LaCour-Little et al., The Role of Home Equity

Lending in the Recent Mortgage Crisis, 42 R.E.

Econ. 153, 155 (2014).

Figure 1. First-Lien Purchase Money LTV

and CLTV Ratios over Time‘

250

S&P Case-Shiller National Housing Price index

(1995100)

“

2010 |

g E E

~ ~ ~

1998 |

—S4." /Case-Shiller National Horne Price index (tv —clTv

Formally, the Bankruptcy Code does not

distinguish among types of second-lien mortgages,

but functionally, the treatment of wholly

underwater second-lien mortgages is almost

entirely a piggyback mottgage problem associated

with the collapse of the housing bubble.

* Adam J. Levitin & Susan M. Wachter, Second-Liens

and the Leverage Option 13 (Jan. 28, 2015) (unpublished

article) available at http://papers.ssrn.com/sol3/

papers.cfm?abstract_id=2556687.

B. Second Liens Routinely Become

Worthless Under Both State and

Federai Law, Unlike First Liens.

1. Foreclosure of a Senior Lien

Discharges All Junior Liens, But

Foreclosure of a Junior Lien Does

Not Affect Senior Liens.

A lien may be released from collateral

property in one of three ways: redemption,

forgiveness, and foreclosure. Relevant to the

instant cases is the release of a lien through

foreclosure.

A foreclosure sale discharges the lien of the

creditor that commences the sale and any junior

liens that have been properly notified or joined

under applicable law. Restatement (Third) of

Property: Mortgages § 7.1 (1997). Therefore, if a

first mortgagee brings a foreclosure sale, the sale

discharges the liens of the second mortgagee, third

mortgagee, etc., irrespective of whether these junior

lienholders have been paid anything from the sale

proceeds,

The junior lienholders are paid only to the

extent that the sale proceeds exceed the costs of the

sale and the first-lien. Restatement (Third) of

Property: Mortgages § 7.4 (1997). The former

junior lienholder may still bring an action on the

debt, but many states have limitations on the

ability to do so, either because the loan was non-

recourse or because of restrictions on foreclosure

deficiency judgments.

In contrast, a foreclosure sale by a junior

lienholder does not affect the liens of any senior

lienholders. Restatement (Third) of Property:

Mortgages § 7.1 (1997). Those liens remain

attached to the property in the hands of the

foreclosure sale purchaser, even though the debt is

still owed by the original borrower. Thus, if the

debt is not paid by the original borrower, the senior

lienholder(s) can foreclose and take the property

away from the purchaser at the junior lienholder’s

foreclosure sale.

Consider, for example, a home worth

$150,000 and secured by a first mortgage for

$100,000 and a second mortgage for $20,000. If the

second mortgagee forecloses, the buyer will receive

a home worth $130,000, but subject to a $100,000

first mortgagee’s lien. The debt, however, is still

owed by the original borrower. Therefore, unless

the buyer pays off the $100,000 first mortgage owed

by the original borrower, the first mortgagee will

foreclose on its mortgage and deprive the buyer of

the property._Therefore, the buyer will rationally

discount its maximum bid by $100,000, the amount

of the first mortgage loan. Thus, the maximum bid

at the second mortgagee’s foreclosure sale would be

$50,000.

This means that the legal rights of a second

mortgagee are fundamentally different from those

of a first mortgagee. The first mortgagee’s lien can

be discharged only if the debt owed to the first

mortgagee is repaid or if the first mortgagee brings

a foreclosure sale itself, which it will only do if it

believes that the sale proceeds will exceed the costs

of the sale. The first mortgagee cannot be deprived

of its lien under non-bankruptcy law absent its

consent.

In contrast, a second mortgagee’s lien can be

discharged as the result of a foreclosure by the first

mortgagee, without the second mortgagee receiving

any of the foreclosure sale proceeds. The second

mortgagee’s lien is thus at the mercy of the first

mortgagee. If the second mortgagee’s lien is wholly

underwater and the first mortgagee forecloses, the

second mortgagee will get nothing.

Furthermore, because a foreclosure by a

junior mortgagee does not discharge senior liens,

junior mortgagees rarely bring foreclosure actions.

This is particularly true for underwater properties.

Consider, for example, a home worth $150,000 and

secured by a first-lien mortgage for $160,000 and a

second-lien mortgage for $40,000. The winning bid

at the second-lien foreclosure sale would receive a

$150,000 home subject to a $160,000 first-lien

mortgage. No rational bidder would bid for such a

property. Accordingly, the second-lienholder would

never bring a foreclosure and incur the sale

expenses for a sale at which it knows no one will

bid.

Indeed, at least one state actually forbids

junior mortgagees from bringing foreclosure sales if

the sale price would be insufficient to satisfy all

obligations secured by senior liens. See La. Code

Civ. Proc. Ann. art. 2335, 2337. Other states

require bidding at a foreclosure sale to start at two-

thirds of the newly appraised value of the property.

See, e.g., Ark. Code Ann. § 18-50-107(b)(3); Ky. Rev.

Stat. Ann. § 426.530 (one-year post-sale right to

redeem at sale price, if sale price less than two-

thirds of appraised value); La. Code Civ. Proc. Ann.

art. 2336 (on first offering property may not be sold

for less than two-thirds of appraised value); N.M.

Stat. Ann. § 39-5-5 (no property to be sold in

foreclosure for less than two-thirds of appraised

value); Ohio Rev. Code Ann. § 2329.20 (no property

to be sold in foreclosure for less than two-thirds of

appraised value); Okla. Stat. tit. 12, § 762 (no

property to be sold in foreclosure for less than two-

thirds of appraised value). In such cases, no bidder

will bid on a sale brought by a junior mortgagee if

the first-lien is for more than two-thirds of the

property's value.

2. A Wholly Underwater Second

Lienholder Receives No

Distribution from a “Free and

Clear” Sale in Bankruptcy.

Irrespective of section 506(d), a completely

underwater second lien can be functionally (if not

formally) wiped out in bankruptcy by a “free and

clear” sale under section 363(f) of the Bankruptcy

Code. Section 363(f) permits the bankruptcy estate

to sell assets “free and clear” of creditor's interests

in the assets, such as liens under certain conditions.

The purchaser in a 363(f) sale takes the assets free

of the creditors’ liens; the liens instead attach to

the proceeds of the 363(f) sale. See 11 U.S.C. §§

363(e), 361, 1129(b)(2)(A)(), 1206. The liens thus

continue to exist, but the lienholders’ recovery will

be limited by the extent of the sale proceeds. If a

lien is wholly underwater, the proceeds from the

sale of the collateral will be insufficient to satisfy a

lien, and the lienholder will get no recovery from

the sale, just as would occur in a foreclosure sale

outside of bankruptcy. Such a wholly underwater

lienholder could still recover from the bankruptcy

estate’s umencumbered assets as a_ general

unsecured creditor.

Two conditions for a “free and clear” sale are

applicable to the instant cases. First, under section

363(f)(3), an asset can be sold free and clear of liens

if the sale price “is greater than the aggregate

value of all liens on such property” 11 U.S.C. §

363(f)(3). Lower courts are split on the

inte: pretation of this provision, but the view that

has “prevailed in practice” is that section 363(f)(3)

requires only that the sale price be greater than the

fair market value of the liens, rather than greater

than the amount of the debt secured by the liens.

See, e.g., In re Boston Generating, LLC, 440 B.R.

302, 333 (Bankr. S.D.N.Y. 2010); Collier on

Bankruptcy § 363.06. Under this reading, a

bankruptcy court could order the sale of a property

encumbered by both a first mortgage and a wholly

underwater second mortgage without the second

mortgagee receiving any distribution on account of

the sale. (The second mortgagee would have a

general unsecured claim in the bankruptcy that

might receive a distribution from the estate’s other

assets.)

Second, under section 363(f)(5), an asset can

be sold free and clear of liens if the lienholder

“could be compelled, in a legal or equitable

proceeding, to accept a money satisfaction of such

interest.” 11 U.S.C. § 363(f(5). A junior lienholder

could be compelled to accept monetary satisfaction

of its interest in a foreclosure by a senior lienholder

see, e.g., In re Jolan, Inc., 403 B.R. 866, 869 (Bankr.

W.D. Wash. 2009), and presumably also in an

eminent domain action. Again, a_ wholly

underwater second mortgagee would lose its lien

without receiving any distribution on account of the

hen.

Thus, a completely underwater second-

lienholder would get nothing if the bankruptcy

estate sold the home in a 363(f) sale under either

section 363(f(3) or 363(f(5). Section 363(f), then,

enables the bankruptcy estate to force through a

“short sale” for less than the amount of the debt

secured by the property. As such, “the pre-Code

rule that liens pass through bankruptcy unaffected,”

Dewsnup, 502 U.S. at 417, has not survived intact,

as least as applied to junior liens. Under the 1978

Bankruptcy Code, the claim that liens necessarily

pass through bankruptcy unaffected is at best an

overstatement and at worst demonstrably false. To

that extent, then, the Court is indeed “writing on a

clean slate.” Jd.

3. Unlike Second-Lien Mortgages,

First-Lien Mortgages Cannot Be

Wholly Underwater.

First-lien mortgages also cannot end up

entirely underwater absent the most unusual

circumstances. For a first-lien mortgage to end up

entirely underwater, not only would any structure

on the property have to be destroyed, but the land

itself would have to have no value. First-lien

lenders virtually always require property insurance

and have the contractual right to force-place

insurance if the borrower lets the insurance lapse.

See, e.g., Fannie Mae & Freddie Mac, Form 3044,

Uniform Security Instrument § 5 (2015).

Thus, typically only in the most unusual

circumstances relating to severe environmental

contamination or complete and permanent flooding

would a first-lien lender find itself wholly

unsecured.

In contrast, a second-lien mortgage could

easily find itself wholly underwater, if property

values shift. A second-lien lender cannot rely on its

loan being partially, much less fully, secured.

In the instant cases, Petitioner's

predecessors in interest made loans that were at

least partially underwater the minute they were

made. The loan made to Respondent Caulkett was

a piggyback loan for 100% CLTV Caulkett Upp.

Br. at 5-6. Given sale and moving costs, the second

mortgage on Caulkett’s property was underwater

from the beginning. Similarly, the second

mortgage on Respondent Toledo-Cardona’s

property was voluntarily re-subordinated to a

refinanced first mortgage that may itself at the

time have been for more than the property’s value.

Toledo-Cardona Opp. Br. at 5-6. In neither case

were Petitioner's predecessors in interest relying on

property value for recovery of their loans. Instead,

they were relying on “hostage” or “hold out” value

to compel repayment.

C. Underwater Second-lien Lenders

Seek to Recover from Hostage Value

Rather Than from Property Value.

A second-lien mortgage lender cannot rely on

being even partially secured, cannot rely on the

ability to foreclose as a means of repayment, and

cannot even count on having a lien because the lien

can be discharged if the first-lien ‘ender forecloses.

This means that second-lien lenders have to

operate on a different economic model than first-

lien lenders. Second-lien lenders aim to be repaid

voluntarily by the borrower, but if the borrower

does not repay, the second-lien lenders seek to be

repaid by being squeaky wheels. See Been et. al., 9

NLY.U. J. L. & Bus. at 82.

Thus, if the borrower wanted to refinance the

first-lien mortgage, the second-lien lender could

block the refinancing by refusing to re-subordinate

its lien to the new lien securing the refinanced loan.

Since 2009, the Federal government’s Home

Affordable Refinance Program (HARP) has

subsidized refinancings of underwater mortgages

owned or guaranteed by Fannie Mae or Freddie

Mac. HARP, however, requires a second-lien

lender to agree to be re-subordinated before the

borrower can receive the government-subsidized

refinancing of the partially underwater first-lien

mortgage. Fannie Mae, Home Affordable Refinance

(DU Refi Plus and Refi Plus) FAQs 3 (2013),

available at https://www.fanniemae.com/content/

faq/harp-du-refi-plus-fags.pdf; Fannie Mae, 2015

Selling Guide, § B5-5.2-01 (2015); Freddie Mac,

Single-Family Seller/Servicer Guide § A24.3 (2014).

Second mortgage lenders often demand payments

for re-subordination. See Been et al., 9 N.Y.U. J. L.

& Bus. at 99; Christopher Mayer et al., A New

Proposal for Loan Modifications, 26 Yale J. on Reg.

417, 419 (2009).

Similarly, second-lien lenders can _ block

“short sales,” in which a borrower sells the house

for less than the full amount of the first-lien

mortgage loan, with the deficiency being forgiven.

The second-lien lender can insist on exercising its

“due on sale” clause in such a situation, thereby

torpedoing the “short sale” unless it is paid off. See

Been et al., 9 N.Y.U. J. L. & Bus. at 84.

Likewise, second-lien lenders can block a

foreclosure alternative known as a “deed in lieu of

foreclosure,” in which the homeowner simply

surrenders the deed to the house to the first-lien

lender in exchange for forgiveness of the first-lien

debt. If there is a second-lien mortgage on the

house, however, the first-lien lender will not want

to do a deed in lieu because under the doctrine of

merger, the first-lien lender’s estates (as owner in

fee simple and as first-lien holder) merge into the

greater estate of fee simple. See Ann M. Burkhart,

Freeing Mortgages of Merger, 40 Vand. L. Rev. 283,

334-35 (1987). Thus, the first-lien lender would own

the property, but subject to the second lien.

Accordingly, without either paying off the

second-lien lender or going through the costs of a

foreclosure, the first-lien lender will not accept a

deed in lieu. Thus, the only potential value in a

wholly underwater second-lien mortgage is hostage

value.

Indeed, because of the problems underwater

second-lien mortgages create for loan restructuring

due to their only value being hostage value, the

federal government pays special bounties to second-

lienholders as part of the Home Affordable

Modification Program (HAMP) for permitting loan

modifications or for extinguishing underwater

second liens. See Been et al., 9 N.Y.U. J. L. & Bus.

at 107-09. HAMP addresses the second len

holdout problem using a carrot of government

payments.

In contrast, the landmark $25 billion

National Mortgage Settlement among 49 states’

attorneys general, the federal government,

Petitioner, and four other large mortgage servicers,

addresses the second lien holdout problem using a

stick. The National Mortgage Settlement requires

Petitioner and the other large mortgage servicers to

reduce the principal balance on second liens

whenever there is a principal reduction on a first

mortgage. See Consent Judgment, United States v.

Bank of Am. Corp., No. 12-cv-00361 (D.D.C. Apr. 4,

2012), at D1-1-D1-3; see also Been et al., 9 N.Y.U.

J. L. & Bus. at 109. The consent judgment also

requires that in the case of a short sale or deed in

lieu of foreclosure the Petitioner must extinguish

any junior lien it holds and forgive the balance

secured by that junior lien. See Consent Judgment,

United States v. Bank of Am. Corp., No. 12-cv-

00361 (D.D.C. Apr. 4, 2012), at D7; see also Been et

al., 9N.Y.U. J. L. & Bus. at 109.

Whether addressed by carrot or stick, the

federal government’s actions relating to second

mortgages illustrate how the holdout problem can

easily frustrate the attempts of courts and

legislators to stabilize the housing market.

D. Bankruptcy Law Disfavors Hostage

Value.

Bankruptcy law disfavors hostage value; the

fundamental structure of bankruptcy law is

designed to reduce holdout value of all sorts.

Outside of bankruptcy, a creditor generally cannot

be forced to compromise its right to payment. This

obviously presents particular difficulties for trying

to address the problem of insolvent debtors, who,

by definition, cannot repay all of their creditors.

While creditors may refuse concessions

outside of bankruptcy, bankruptcy law enables

concessions to be forced upon unwilling creditors.

Most fundamentally, individual crediters can be

bound to a bankruptcy plan irrespective of the

creditor's consent. Chapter 7 liquidations and

Chapter 12 and Chapter 13 plans do not require

any creditor consent whatsoever, while a Chapter

11 plan can be confirmed through majority voting

procedures without the consent of all creditors.

Similarly, section 363(f) of the Bankruptcy

Code—applicable to all types of bankruptcy—

permits assets to be sold “free and clear” of

creditors’ interests in the assets, including liens.

This enables assets to be sold for their market

value and not for their value discounted by the

amount of the lien(s).

E. Forbidding Lien-Stripping of Wholly

Underwater Second Liens Creates a

Bankruptcy “Windfall” for Second

Mortgagees.

For the reasons Respondents articulate, the

Bankruptcy Code’s statutory language is properly

read not to apply Dewsnup to wholly underwater

second-lien mortgages. Rather than repeating

those (lucid) textual arguments, Amicus seeks to

underscore that the lega! and economic differences

between ffirst-lien and second-lien mortgages

differentiate the situation in the instant cases from

this Court’s decision in Dewsnup.

Dewsnup dealt with a partially underwater

first-lien mortgage. The instant cases deal with

wholly underwater second-lien mortgages, which

have substantively different rights under both

applicable non-bankruptcy law and under other

provisions of bankruptcy law. Dewsnup was

concerned with upholding “what was bargained for

by the mortgagor and the mortgagee.” 502 US. at

417. Extending that principle to the facts of the

instant cases requires affirming the decisions below.

In the instant cases, the Petitioner is

requesting that this Court mandate better

treatment for its wholly underwater second-lien

mortgages in bankruptcy than it would receive at

state law. Such superior treatment is inconsistent

with the principle enunciated in Butner v. United

States that bankruptcy law primarily creates

procedural rights. 440 U.S. 48, 54 (1979). <A

bankruptcy should not produce a windfall for an

underwater second mortgagee above what the

mortgagee would receive in a foreclosure. Given

Dewsnup’s explicitly narrow holding, Petitioner did

not bargain with a reasonable expectation that its

liens could not be stripped if they were entirely

underwater. A fortiori, Petitioner did not bargain

for a bankruptcy “windfall” and should not receive

one.

If. Empirical Evidence Demonstrates That

Affirming the Decisions Below Will Not

Disrupt The Settled Expectations of the

Mortgage Market.

A. Chapter 13 Lien-Stripping Had a

Minimal Effect on Mortgage Credit

Costs.

In an empirical study published in a leading

peer-reviewed economics journal, Professor Levitin,

together with Professor Joshua Goodman of the

Harvard Kennedy School of Government,

determined that permitting lhen-stripping in

Chapter 13 bankruptcies resulted in almost no

impact on mortgage credit costs. Joshua Goodman

& Adam J. Levitin, Bankruptcy Law & the Cost of

Credit: The Impact of Cramdown on Mortgage

Interest Rates, 57 J. L. & Econ. 139 (2014). This

study suggests that, contrary to the claims of

Petitioner and its amici, a decision for Respondents

in this case will not disrupt settled expectations.

Between 1978 and the Court’s 1993 decision

in Nobelman v. American Savings Bank, 508 U.S.

324 (1993), there was a split of authority in the

lower courts regarding whether lien-stripping was

permitted in Chapter 13 for first-lien mortgages

solely on real property that was the debtor’s

principal residence. (This is sometimes referred to

as Chapter 13 “cramdown,” not to be confused with

the conceptually distinct Chapter 11 “cramdown,”

which refers to the confirmation of a Chapter 11

plan without the consent of all impaired classes of

claims and interests). In Nobelman, this Court

held unanimously that 11 U.S.C. § 1322(b)

prohibited lien-stripping in Chapter 13 on partially

underwater first-hen mortgages solely on real

property that is the debtor’s principal residence.

508 U.S. at 329.

Professors Levitin and Goodman used both

the prior split of authority in the lower courts and

the subsequent unanimity of authority following

Nobelman to test the impact of permitting or

disallowing lien-stripping on home mortgage

interest rates and lending volumes. The timing of

the splits in lower court authority allowed

Professors Levitin and Goodman to statistically

test how a legal rule on lien-stripping affected

interest rates. They did this through two

“difference-in-differences” analyses, which compare

the change in both a test group and a control group

following an exogenous event.

The first analysis compared interest rates

and lending volumes in judicial districts permitting

hen-stripping with districts that did not during the

1978-1993 period. The second analysis looked at

the differential effect of the Nobelman decision on

interest rates and lending volumes in judicial

districts that had permitted lien-stripping prior to

Nobelman compared with districts that had not. In

both analyses, Professors Levitin and Goodman

statistically controlled for any variation that might

occur because of geographic locale or time.

Professors Levitin and Goodman found only

very small differences in interest rates and lending

volumes based on whether Chapter 13 lien-

stripping was permitted. To ensure the results

were not dependent on any one statistical analysis,

Professors Levitin and Goodman tested their

results across several regression models.

Depending on model specifications, Professors

Levitin and Goodman found an average increase in

the cost of credit of only 0.12%-0.16% (12 to 16

basis points). See Goodman & Levitin, 57 J. L. &

Econ. at 156. This was at a time when average

mortgage interest rates were at 8.2%, so an

additional 12-16 basis points would translate into

around a 1% increase in monthly payments. /d.

Professors Levitin and Goodman observed larger

impacts on borrowers with higher interest rate

loans—presumably riskier borrowers—but the

magnitude of the impact was still small, namely

0.21% - 0.35% (21-35 basis points). Jd. at 154.

Professors Levitin and Goodman attribute

this small magnitude to several factors, including

the rarity of Chapter 13 filings by underwater

homeowners relative to the mortgagor population

in general, the high percentage of Chapter 13 cases

that do not result in completion of a plan and a

discharge, and most importantly, the fact that

losses from cramdown do not necessarily exceed

those in a state law foreclosure. Id. at 156.

A subsequent study by researchers affiliated

with the Federal Reserve Bank of Philadelphia

reached the same conclusions as Levitin and

Goodman. See Wenli Li et al., Using Bankruptcy to

Reduce Foreclosures: Does Strip-Down of

Mortgages Affect the Supply of Mortgage Credit?

(Fed. Res. Bank of Phila. Working Paper No. 14-35,

2014). The Philadelphia Fed study used the same

interest rate data used by Goodman and Levitin

and employed virtually the same methodology as

Goodman and Levitin, but also looked at mortgage

application approval data collected under the Home

Mortgage Disclosure Act. The Philadelphia Fed

study also examined the impact of Chapter 7 lien-

stripping decisions and Dewsnup as well as

Chapter 13 lien-stripping decisions and Nobelman.

The Philadelphia Fed study found that

permitting Chapter 7 lien-stripping resulted in a

1.8% reduction in mortgage approval, but not to

any statistically significant change in interest

rates. Jd. at 14, 20, 29. The Philadelphia Fed

likewise found that permitting Chapter 13 lien-

stripping led to a 0.23% (23 basis point) reduction

in mortgage interest rates and a 1.1% increase in

mortgage approval rates. Jd. at 15, 20, 30. The

Philadelphia Fed study concludes that its results

“suggest that introducing mortgage strip-down

under either bankruptcy chapter would not have a

strong adverse impact on the terms of mortgage

loans and could be a useful new policy tool to

reduce foreclosures.” Jd. at 20.

Two rigorous empirical studies have found

that, historically, permitting lien-stripping has

little discernible impact on mortgage credit costs or

availability. Neither Petitioner nor its amici are

able to cite to any research indicating that

permitting lien-stripping of wholly underwater

second mortgages will have any impact on

mortgage lending or the economy more broadly.

B. There Is No Evidence that Lenders

Currently Charge Higher Interest

Rates to Account for Lien-Stripping

Risk.

The Levitin-Goodman study and _ the

Philadelphia Fed study both examined the 1978-

1993 mortgage market, not the 2015 mortgage

market. Yet, there is reason to believe that these

findings would carry over to the current market.

Other current market indicators show that

the market does not generally price for lien-

stripping risk on properties that can still be lien

stripped in Chapter 13. Three circuit courts of

appeals permit lien-stripping in Chapter 13 of

wholly-or-partially underwater first mortgages that

are not secured solely by the borrower's principal

residence, but also include other collateral, such as

an attached basement apartment or fixtures. See Jn

re Scarborough, 461 F.3d 406 (3d Cir. 2006); Jn re

Thompson, 77 Fed. Appx. 57 (2d Cir. 2003); Lomas

Mortg., Inc. v. Louis, 82 F.3d 1 (1st Cir. 1996); In re

Hammond, 27 F.3d 52 (3d Cir. 1994). And all eight

circuit courts of appeals to address the issue have

permitted lien-stripping in Chapter 13 of wholly

underwater second mortgages. Jn re Pond, 252

F.3d 122, 126 (2d Cir. 2001); In re McDonald, 205

F.3d 606, 611 (3d Cir. 2000); Jn re Davis, 716 F.3d

331, 336 (4th Cir. 2013); In re Bartee, 212 F.3d 277,

288 (5th Cir. 2000); In re Lane, 280 F.3d 663, 667—

69 (6th Cir. 2002); In re Schmidt, 765 F.3d 877,

881-82 (8th Cir. 2014); In re Zimmer, 313 F.3d

1220, 1226 (9th Cir. 2002); In re Tanner, 217 F.3d

1357, 1359-60 (llth Cir. 2000). But cf. In re

Woolsey, 696 F.3d 1266, 1272 (10th Cir. 2012)

(reserving interpretation of § 1322(b)(2) “and its

meaning for another day” because petitioner

refused to argue it).

Despite this difference in lien-stripping risk,

there is no observable difference in pricing of

private mortgage insurance based on whether

properties are potentially subject to len-stripping.

See Adam J. Levitin, Resolving the Foreclosure

Crisis: Modification of Mortgages in Bankruptcy,

2009 Wisc. L. Rev. at 593-596. Similarly, no

pricing difference can be observed based on

property type (and hence Chapter 13 lien-stripping

risk) in either the primary mortgage market, id. at

586-93, or the guarantee fees charged by Fannie

Mae and Freddie Mac in the secondary market. Id.

at 597-98.

C. Lenders Are Unlikely to Charge

Higher Interest Rates to Account for

Lien-Stripping Risk if Bankruptcy

Judges’ Valuations Are Correct.

1. There Is No Reason to Believe

Judicial Valuations Are Lower

than Foreclosure Sale Prices.

There was no evidence of adverse pricing

based on lien-stripping risk in the 2009 mortgage

market for a simple reason: the alternative to lien-

stripping is not payment in full, but the recovery

the lender could get in a state law foreclosure

proceeding or out-of-court loan restructuring.

Unless bankruptcy courts systematically

undervalue properties, there is no reason to think

that lenders would have larger recoveries in state

law foreclosure proceedings. Wholly underwater

mortgages simply get wiped out in state law

foreclosure sales with zero recovery, so lien-

stripping in bankruptcy is no worse of an outcome.

2. Judicial Valuation Is Essential to

the Functioning of the Bankruptcy

System.

There is no _ reason to believe that

bankruptcy courts do a poor job at valuations,

particularly for relatively simple assets such as

single-family residences. Similarly, there is no

reason to think that bankruptcy judges are biased

in one direction or another on valuation issues.

Indeed, the United States bankruptcy system is

generally considered the finest in the world; other

countries seek to emulate the United States

bankruptcy system.

Judicial valuation is the very heart of the

bankruptcy enterprise. Numerous provisions of the

Bankruptcy Code require judicial valuation.

Contrary to Petitioner’s claims, the Bankruptcy

Code does not display an “aversion” to judicial

valuation; neither the Bankruptcy Code nor this

Court have ever required a market test for an

asset’s valuation in lieu of judicial valuation.

For example, the bankruptcy court must

undertake a valuation to determine whether a

creditor is entitled to “adequate protection” of its

interest in the debtor’s property under 11 U.S.C. §

361, pursuant to either 11 U.S.C. §§ 362, 363, or

364(d), and how much the adequate protection

should be. This is never done through a market

test. Likewise, a bankruptcy court must undertake

a valuation to approve a free-and-clear sale under

section 363(f)(3). Again, no market test is invoked.

More generally, bankruptcy courts must

undertake valuations to determine the

reasonableness of any section 363 sale or lease or to

determine if a pre-petition transfer was

constructively fraudulent under 11 U.S.C. §§ 544(b)

and 548. Bankruptcy courts must also undertake

valuations to determine whether and the extent to

which a claim is unsecured under 11 U.S.C. § 506.

Likewise, confirmation of a Chapter 9 or Chapter

11 cramdown plan or a Chapter 12 or 13 plan of

any sort requires the bankruptcy court to value the

payments made to secured creditors to determine if

their present value is equal to the allowed amount

of the secured claim on the effective date of the

plan or is the indubitable equivalent thereof. 11

U.S.C. §§ 901(a), 1129(b)(2)(A)G), 1129(b)(2)(A)(iil),

1225(a)(5)(B), 1325(a)(5)(B). Absent confidence in

the ability of bankruptcy courts to undertake

valuations, the entire bankruptcy system falls

apart.

3. Valuations in the Instant Cases Are

Not in Dispute.

The facts of the instant cases show that

there is no real concern over valuation issues.

Petitioner did not dispute the valuation of either

property. Both of Respondents’ second-lien

mortgages were deeply underwater. Respondent

Caulkett’s home was valued at $98,000 and was

encumbered with a first-lien mortgage for $183,264

and a second-lien mortgage for $47,855. Caulkett

Opp. Br. at 6. Likewise, Respondent Toledo-

Cardona’s home was valued at $77,689, but was

encumbered with a first lien mortgage of $135,703

and a second-lien mortgage of $32,000. Toledo-

Cardona Opp. Br. at 6.

In both cases, the bankruptcy court would

have to have erred in its valuation of Respondents’

properties by fifty percent for Petitioner to have

been “in the money” by as much as a penny. On

these valuations, Respondents’ properties would

have to double in value for Petitioner’s mortgages

to ever be back in the money.

In most situations, like these cases, there

will be no question whether the second-lien

mortgage is wholly underwater; valuations will not

be close to the total amount due under the first-lien

mortgage. In those few close cases, the parties are

likely to settle rather than risk a judicial valuation.

Thus, concerns about inaccurate judicial valuation

are a red herring.

D. The Market Will Not Price Adversely

to Judicial Lien-Stripping Because

Bankruptcy Can Create Value for

First-Mortgagees.

Yet another reason the market is unlikely to

price adversely to the risk of judicial len-stmpping

is that (counter-intuitively) bankruptcy may in fact

create value for first mortgagees. The baseline

against which mortgagees evaluate bankruptcy is

not a world of no losses, but a world of foreclosure

sales and loan _ restructurings. Relative to

foreclosure sales and _ loan __ restructurings,

bankruptcy offers a number of advantages.

First, as long as the debtor is in bankruptcy,

the lender is able to receive adequate protection of

its interest in the property. 11 U.S.C. §§ 361,

362(d)(1).

Second, if the property is sold in bankruptcy

rather than through a state law foreclosure sale, it

is likely to result in a greater recovery for the

lender. Foreclosure sales are done without

marketing aside from judicial notice advertisement.

Foreclosure sales also occur without a showing of

the property to prospective buyers; because the

property remains the borrowers until the

foreclosure sale is closed, prospective buvers lack a

pre-sale nght of entry and inspection. The result is

to depress foreclosure sale prices because of

prospective buyers’ informational disadvantages. A

bankruptcy sale under section 363 can produce a

higher sale price because the property can be

marketed as if it were an arm’s length private sale,

with full inspection rights for potential buyers. 11

U.S.C. § 363.

Likewise, several states allow buyers a

statutory post-sale right of redemption; in some

states this post-sale right of redemption extends for

up to two years. See, e.g., Ala. Code § 6-5-248(b)

(one-year right of reden ption); Tenn. Code § 66-8-

101 (two-year right of redemption). Post-sale

statutory rights of redemption depress foreclosure

sale prices because buyers cannot obtain clean title

until the expiration of the statutory redemption

period. A sale under section 363 of the Bankruptcy

Code would not be subject to state law rights of

redemption that are triggered only by state

foreclosure sales. Cutting off the statutory post-sale

right of redemption increases buyer certainty of

sale finality and thus sale prices.

Not only is judicial valuation central to

bankruptcy, supra, section II.C.2., but it is a far

better valuation methodology than the alternative

of foreclosure sales, which this Court has

recognized have an uncontroverted and

uncontestable downward valuation bias. See BFP

v. Resolution Trust Corp., 511 U.S. 531, 539 (1994).

Third, as discussed in the following section,

bankruptcy enables a circumvention of the

principal-agent problem that can exist between

mortgage lenders and their servicing agents.

Because bankruptcy can actually create value for

lienholders, they might not price adversely to lien-

stripping risk.

E. Permitting Judicial Lien-Stripping

Helps Overcomes Agency Problems

in Mortgage Servicing.

An additional reason why the market may

not price adversely to the risk of lien-stripping is

that lien-stripping solves a principal-agent problem

in the mortgage industry. During the 1978-1994

period, most mortgage loans were financed by

depositories’ balance sheet lending: banks and

thrifts would make loans and hold them. Since

1995, however, most residential mortgage loans are

financed through securitization. This means that

the loans are sold to specially-created trusts that

pay for the loans by issuing debt securities known

as mortgage-backed securities.

Securitized loans still need to be managed on

a day-to-day basis, however. Monthly invoices need

to be mailed, payments collected from mortgagors

and remitted to the holders of the mortgage-backed

securities, payoff statements and escrow balances

generated, and defaults managed. This day-to-day

management of the loans is handled by entities

known as mortgage servicers. 7 The servicers

5 Underlying data sources and _ step-by-step

computations available at: http://instituteforpublic

representation.org/wp-content/uploads/2015/02/Data-sources-

and-computations.pdf.

6 Id.

7 Servicers are often the original lenders. The original

lenders will sell the mortgage loan, but retain the servicing

rights and revenue.

function as agents for mortgage-backed securities

investors, but those investors have little ability to

oversee or discipline the servicers. See Adam J.

Levitin & Tara Twomey, Mortgage Servicing, 28

Yale J. on Reg. 1, 7, 58-63 (2012).

Servicers are paid before the mortgage-

backed securities investors, making’ them

essentially the senior creditors of the trusts that

issue the mortgage-backed securities. See id. at 70.

The result is that servicers’ incentives are

frequently not aligned with those of investors;

servicers are often incentivized to foreclose on loans

when a restructuring, potentially § including

principal reduction, would maximize value for

investors. Jd. at 5, 76; see also Katherine M.

Porter, Misbehavior and Mistake in Bankruptcy

Mortgage Claims, 87 Tex. L. Rev. 121, 126 (2008).

Lien-stripping in bankruptcy accomplishes a

restructuring without consent of the _ servicer.

While servicers may not like this, restructuring is

often in the interest of the mortgage-backed

securities investors, which is why the mortgage

market does not price adversely to the risk of lien-

stripping. Lien-stripping enables value-

maximizing restructuring in the face of a principal-

agent problem in loan servicing.

Beyond the empirical evidence, there are a

multitude of reasons to doubt that there will be any

adverse market reaction to affirming the decisions

below. First, liens have been stripped off of wholly

underwater second mortgages in Chapter 7 for

some time now in the 11th Circuit without there

being an “enormous and unwarranted disruption of

settled expectations” in markets. Pet’r’s Br. at 44.

Second, liens have been stripped off of wholly

underwater second mortgages in Chapter 13 for

some time now in eight circuits, see section II.B,

supra, without there being an “enormous and

unwarranted disruption of settled expectations” in

markets. Pet’r’s Br. at 44.

Third, liens have always been stripped off of

wholly and partially underwater loans of almost all

types in Chapter 11. This has never caused any

sort of market disruption, as markets are capable of

pricing for this risk.

Indeed, neither Petitioner nor its amici are

able to point to any sort of evidence of market

disruption caused by lien-stripping. There is no

reason to think that the U.S. housing finance

market—one of the largest and most liquid markets

in the world—cannot easily adjust to a very

particularized type of bankruptcy risk on wholly

underwater second-lien mortgages, particularly

because the type of loan at issue simply is not made

any more, as discussed in Section III, below.

F. Petitioner’s Litigation to Protect

Utterly Worthless Liens is Puzzling.

Given how deeply underwater the second

mortgages are in the instant cases, it is puzzling

why Petitioner is litigating the issue. Even if

Petitioner were to prevail before this Court, its

lens would still be deeply underwater. Florida real

estate prices would have to double for either of

Petitioner’s mortgages to even “break the

waterline.” If the Respondents’ first mortgage

lenders were to foreclose before such an astonishing

market rebound, Petitioner would have no recovery

from its mortgages. The primary effect of a

favorable ruling for Petitioner would not be the

preservation of the value of these worthless liens;

rather, it might allow Petitioner and similarly

situated banks to delay loss recognition on their

bad loans.

Banks like Petitioner are subject to

minimum regulatory capital requirements based on

the value of the bank’s assets. See 12 U.S.C. §

183lo (requiring minimum capital standards); 12

C.F.R. § 3 (regulatory implementation of capital

standards for national banks). A _ borrower's

bankruptcy filing can trigger regulatory accounting

rules that require a bank to write down the loan on

its books. Federal Financial Institutions

Examination Council, Uniform Retail Credit

Classification and Account Management Policy, 65

Fed. Reg. 36903, 36904 (June 12, 2000). If a bank’s

net asset value falls too low, the bank will have to

raise additional capital to comply with regulatory

capital requirements and thus dilute its existing

shareholders’ equity. To the extent that loss

recognition can be delayed, however, losses can be

offset by retained earnings, thereby avoiding the

need to raise additional capital and dilute existing

shareholders.

Petitioner's financial situation iluminates

the magnitude of this effect. As of the end of the

third quarter of 2014, Petitioner held over $87

billion in junior mortgages.* This is the largest

portfolio of junior mortgages of any financial

institution in the United States,? and accounts for

nearly 6% of Petitioner’s assets. Jd. Seventeen

percent of these junior mortgages were underwater.

See Bank of America, Quarterly Report (Form 10-

Q) 92 & tbl. 37, 171 (Nov. 6, 2014). As of the fourth

quarter of 2014, Petitioner had loss reserves equal

to 3.95% of its junior mortgage portfolio, meaning it

is carrying its junior portfolio at over 96 cents on

the dollar. Jd. at 87. See also Been et al., 9 N.Y.U.

J. L. & Bus. at 95 (observing the same in 2011).

If debtors in all circuits could strip off wholly

underwater junior liens, then Petitioner and

similarly situated banks might have to recognize

losses on much more of their wholly underwater

junior mortgages sooner than they otherwise

would. In other words, this case will not affect the

“settled expectations” of markets, Pet’r’s Br. at 44,

but whether Petitioner and similarly situated

banks will have to dilute their shareholders’ equity.

8 Underlying data sources and _ step-by-step

computations available at: http://instituteforpublic

representation.org/wp-content/uploads/2015/02/Data-sources-

and-computations. pdf.

® Kathleen Howley & Dankin Campbell, Bank of

America Faces Bad Home Equity Loans: Mortgages,

Bloomberg Business, Apr. 18, 2012.

Ill. The Second-Lien Mortgage Lending

Market Is Near Dead and Should Not Be

Resuscitated.

There is further cause to believe that the

economic effect of permitting lien-stripping for

wholly underwater second mortgages is likely to be

minimal: since the implosion of the housing

bubble, second-lien loans with high CLTVs are

rarely (if ever) made. Second-lien mortgages in

general “have now all but disappeared.” Laurie

Goodman et al., Where Have All the Loans Gone?

The Impact of Credit Availability on Mortgage

Volume, 20 J. Structured Fin. 45, 46 (2014); see also

Lee et al., A New Look at Second-liens, 569 Fed.

Reserve Bank of N.Y. Staff Rep. 7 at 28.

There were less than 200,000 second-lien

mortgages of all types originated in 2013.1° In

contrast, during the height of the bubble nearly a

decade ago, there were over 2.8 million second-lien

mortgages made. See Robert B. Avery et al., The

2006 HMDA Data, 93 Fed. Res. Bulletin A73, A82

(Dec. 2007).

computations available at: http-//instituteforpublic

representation.org/wp-content/uploads/2015/02/Data-sources-

and-computations.pdf.

Figure 2. Number of Second-Lien

Mortgages Originated by Year'!

3,000 0007 -

1,000,

;

Number fSecond LienMortgages™iginated?

7 e@es6 «4

20052 20067 20077 20087 20097 20107 20117 20128 20137

Of the second mortgages originated in 2013,

38% were home improvement loans, which

generally have low CLTVs. In contrast only 19% of

the second mortgages originated in 2005 or 2006

were home improvement loans; most were

piggyback purchase money loans. High-CLTV

second-lien lending is a creature of the past. See

Bonnie Sinnock, Second Liens Grow Again as Other

Mortgage Lending Dwindles, Nat’ Mortg. News,

July 31, 2014.

'"! Underlying data sources and _ step-by-step

computations available at: http://instituteforpublic

representation.org/wp-content/uploads/2015/02/Data-sources-

and-computations.pdf.

Figure 3. Number of Second Lien Mortgages

Originated by Year by Loan Purpose!”

1,200,000?

Number®fBecond-LienMorgagesDriginated?

2005S 20067 20077 20087 20097 20108 20117 20127 20137

S Purchase? @ Refi Homeimprovement?

The situation in the instant cases is a

singular product of the 2003-2007 housing bubble.

Subsequent regulatory and market changes mean

that high CLTV second-lien mortgages are rarely

made any more and are unlikely to be in made in

the future.

The high CLTV second-lien mortgage market

has disappeared because of a combination of

regulatory and market conditions. New mortgage

market regulations make it difficult to make high

‘2 Underlying data sources and_ step-by-step

computations available at: http://instituteforpublic

representation.org/wp-content/uploads/2015/02/Data-sources-

and-computations. pdf.

CLTV_ second-lien mortgages. Current law

prohibits the making of mortgage loans without

verification of the borrower’s ability to repay the

loan. See 15 U.S.C. § 1639c. While the regulatory

implementation of the ability to repay requirement

does not have a LTV component, it will effectively

limit most high CLTV lending because high CLTV

lending correlates with other risk characteristics

covered by the implementing regulation, such as

high debt-to-income_ ratios, lack of full

amortization, and prepayment penalties.

Beyond regulation, there is no financing for

making high CLTV second mortgage loans. The

mortgage market’s collapse in 2007 and the

following years severely chastened mortgage

lenders and mortgage investors. There simply is

no financing for high CLTV seconds. Banks do not

want to incur the risk on their balance sheets, and

Fannie Mae and Freddie Mac are prohibited from

purchasing high CLTV seconds.

The other possible financing channel,

private-label securitization, which provided the

high-octane financing for the housing bubble, has

been virtually moribund since 2008. In 2006,

private-label securitization funded 43% of all

residential mortgage originations in the United

States or more than $1.17 trillion of mortgages per

year. 1° In contrast, in 2014, private label

securitization funded a mere $5.58 billion of

mortgage originations.!4 Over 99.5% of the private-

label securitization market has disappeared since

the bubble. Only 7,250 mortgages nationwide were

funded by private-label securitization in 2014.15

The lack of financing for high CLTV second

mortgages is unlikely to change in the foreseeable

future because there is no market appetite for the

credit risk involved in such lending. It is hard to

conceive of super-risky mortgages like the ones the

Petitioner made to Respondents being made in

today’s more sober lending environment. This

Court should not give succor to the revival of such

destructive lending.

13 Underlying data sources and _ step-by-step

computations available at: http://instituteforpublic

representation.org/wp-content/uploads/2015/02/Data-sources-

and-computations. pdf.

14 Td.

16 Td.

CONCLUSION

For the aforementioned reasons, Amicus

Curiae Adam J. Levitin respectfully submits that

the instant cases should not be controlled by

Dewsnup v. Timm and that the 11th Circuit’s

judgments should be affirmed.

Respectfully submitted,

MICHAEL KIRKPATRICK

Counsel of Record

Institute for Public Representation

Georgetown University Law Center

600 New Jersey Ave, NW

Washington, DC 20001

(202) 661-6582

michael. kirkpatrick@law.georgetown.edu

ADAM J. LEVITIN

Georgetown University Law Center

600 New Jersey Ave., NW

Washington, DC 20001

(202) 662-9234

Attorneys for Amicus Curiae

Professor Adam ¢J. Levitin

February 2015

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