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Bankruptcy system takes on the mortgage mess

Aiming to keep overextended borrowers in their homes, judges and trustees in the federal bankruptcy court system have helped set up a service intended to speed the modification of troubled mortgages.
Image: foreclosed home
The “Debtors Counsel Loss Mitigation Web Portal” is intended to keep troubled borrowers out of foreclosure and bankruptcy court, but critics say it will accomplish little, apart from making millions of dollars for its creator. Ethan Miller / Getty Images file

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

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

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

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

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

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

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

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

Image: Joseph C. Smith II
Joseph C. Smith II

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

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

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

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

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

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

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

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

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

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

Intended to gauge lenders' good faith
While Clark, the attorney who first suggested the portal, is also hopeful that it will break logjams in the system and lead to loan modifications, he said that was not his primary motivation. Time after time, he said, he has heard servicers and their attorneys tell judges, reporters and Congress that debtors and their lawyers are to blame for a lack of loan modifications. “I was tired of being the whipping boy for this,” Clark recalled. “I said, ‘Let’s call their bluff!’”

Within a few weeks of hearing the idea, Smith’s eight-person firm, based in Newport, Ky., had a demo site up and was seeking feedback from servicers, judges, trustees and attorneys. In mid-October, the portal had a test run in two bankruptcy court districts in Tennessee and one in California.

By Christmas, Smith was announcing the site would go national on Jan. 1, plans that were disseminated in e-mail from trustees and through links on official court Web sites. Reviewing the product and helping spread the word to his fellow jurists was U.S. Bankruptcy Judge Raymond T. Lyons of Trenton, N.J.

And the portal got a nice boost from consumer bankruptcy expert O. Max Gardner III of North Carolina. Gardner, who schools attorneys on the finer points of bankruptcy practice for $7,750 a head in four-day “boot camps,” sent out e-mail and a press release about it to hundreds of bankruptcy attorneys in December.

As of late last week, Smith said, about 700 debtor lawyers had signed up to use the portal, as had many of the biggest names in  the mortgage business: Bank of America, Countrywide, Wells Fargo, Citi and others that did not want to be publicly named. The service was operating in all 50 states. There is no charge to debtors or their attorneys and just $25 per case to the servicers with discounts for volume.

Saying “I thank my lucky stars” for being in the right place at the right time to score what may be the business opportunity of a lifetime, Smith made no apologies for the help he got from the bankruptcy system. In fact, he said, it was a big gamble. “In six months, we have gone from concept to national rollout with no funding, no commitment to funding, no knowledge that we would ever get funded,” he said. “If the servicers had turned to us and said, ‘We’re not interested,’ my total investment would have been my total loss.”

‘Like manna from heaven’
Instead, Smith said, “The expectation is probably pushing 70,000 to 80,000 (cases) a month … through the system when this is all said and done.” At $25 each, that’s as much as $2 million a month, “sort of like manna from heaven,” he said.

Several Chapter 13 trustees said they didn’t believe the site would generate anywhere near that much traffic. And they, Judge Lyons and some debtor attorneys said they see no problem with helping Smith develop, test and publicize it.

“It seemed like something that would be helpful to homeowners trying to save their homes,” Lyons told “I learned about this and I forwarded it on just to circulate the information. In no way am I touting a particular vendor.”

Miller, the Indiana bankruptcy trustee, agreed. “What I saw was there was something lacking in the system, and there was someone willing to step up and fill that gap at no cost,” she said.

Officials at Department of Justice who appoint and oversee the Chapter 13 trustees declined to comment on the matter.

In an e-mail to, Gardner, the North Carolina bankruptcy expert, said the message he sent publicizing the site was only “for informational purposes,” adding, “I have not used the site so I cannot confirm whether or not it works as advertised.”

A graduate of Gardner’s boot camp, David Baker, a bankruptcy attorney from Boston, told that he is using the site and “I’m certainly going to put as many of my clients through it as I can in hopes that we accomplish something.”

Baker, too, was unconcerned about the help Smith got from trustees and judges in bringing the Web site to life. “Trustees are in private enterprise,” he said. “It doesn’t bother me that the courts would encourage this at the same time, because courts are always looking at ways to reduce their workload. … I don’t see much difference between this and private mediators.”

Can securitization obstacles be overcome?
But Charney, the Florida legal aid attorney, said her work has proven that, because of securitization issues, the true ownership of many currently troubled mortgages cannot be determined, which means that deals with lenders cannot be made.

“Maybe they’re using this data to access a workout, but if you’re in my world you know there’s no workouts to be had,” she said. “I don’t want my client giving out financial information to the other side, and that’s what you’re doing with this portal.”

Clark, who first envisioned the portal, said the idea has exposed a conflict in the debtor bar between “ideological” attorneys like Charney who “believe we are in pursuit of justice” and those like himself who work with “hundreds of actual, living breathing debtors a month” who need practical solutions now.

“I think April quite frankly has misconstrued the purpose of it,” Clark said. “I never said this is going to modify a whole bunch of loans. This is going to shine the light on the real problem because the mortgage industry has no intention of modifying these loans.”

Even with that expectation, Clark said he was surprised by the industry’s response so far. “I thought the servicers would at least pretend to be cooperative,” he said. “They haven’t lived up to the seven days at all.”

But Smith provided statistics to that he said indicate otherwise. In the two-state test, Smith said, 470 loans were submitted for review. Of those, 60 resulted in workouts, a term that can cover a number of solutions, and 30 were rejected. He could not say what happened with the others, though he said some of them also may have resulted in workouts.

The 60 workouts included “short sales, surrenders and repayment plans as well as modifications,” he wrote in an e-mail. “There were a number of straight modifications (re-amortization of delinquent amount) and term modifications. … Both resulted in decreases in payments. There were conversions to fixed rate loans. I did not hear or see anything leading me to believe of significant interest reductions or principal reductions.”

Praise from a lender
Peggy Slattery, director of default specialty servicing with GMAC Residential Capital, had high praise for the portal. “This is basically a low-cost but an effective communication tool,” she told In the pilot program, her firm got 17 requests for loan modifications via the portal, “all successful,” she said. All seven requests received since the system went national also appear to be headed for solutions, she said.

Contrary to fears of debtor attorneys, Slattery added, GMAC can even make deals on securitized loans. “If we need approvals, we’ll go and get the approvals and respond,” she said.

The numbers defy the experience of Miofsky, the Boston attorney who handles hundreds of defaulting mortgages a year. He predicted the portal will change nothing.

“Why don’t you just ask me how many loan modifications I’ve been offered" in 30 years of practice, he said. “To date, I’ve had one.”