Wells Fargo Bank, National Association et al v. City of Richmond, California et al

Filing 35

Declaration of Robert Hockett in Support of 32 Opposition/Response to Motion filed byCity of Richmond, California, Mortgage Resolution Partners LLC. (Related document(s) 32 ) (Kronland, Scott) (Filed on 8/22/2013)

1 SCOTT A. KRONLAND (SBN 171693)
JONATHAN WEISSGLASS (SBN 185008)
2 ERIC P. BROWN (SBN 284245)
Altshuler Berzon LLP
3
177 Post Street, Suite 300
4 San Francisco, CA 94108
Tel: [phone]
5 Fax: [phone]
E-mail: [e-mail]
6
[e-mail]
[e-mail]
7
8 Attorneys for Defendants City of Richmond and
Mortgage Resolution Partners LLC
9
BRUCE REED GOODMILLER (SBN 121491)
WILLIAM A. FALIK (SBN 53499)
10 City Attorney
100 Tunnel Rd
CARLOS A. PRIVAT (SBN 197534)
Berkeley, CA 94705
11
Assistant City Attorney
Tel: [phone]
CITY OF RICHMOND
Fax: [phone]
12
450 Civic Center Plaza
E-mail: [e-mail]
13 Richmond, CA 94804
Telephone: [phone]
Attorney for Defendant
14 Facsimile: [phone]
Mortgage Resolution Partners LLC
E-mail: [e-mail]
15
[e-mail]
16
Attorneys for Defendant City of Richmond
17
UNITED STATES DISTRICT COURT
18
19

NORTHERN DISTRICT OF CALIFORNIA

20

SAN FRANCISCO DIVISION

21 WELLS FARGO BANK, NATIONAL
ASSOCIATION, as Trustee, et al.,
22
Plaintiffs,

23
24

Case No. CV-13-3663-CRB
DECLARATION OF ROBERT HOCKETT
IN SUPPORT OF OPPOSITION TO
PRELIMINARY INJUNCTION

v.

25 CITY OF RICHMOND, CALIFORNIA, a
municipality, and MORTGAGE
26
RESOLUTION PARTNERS LLC,
27
Defendants.
28

Date: September 13, 2013
Time: 10:00 a.m.
Judge: Honorable Charles R. Breyer

Declaration of Robert Hockett, Case No. CV-13-3663-CRB

1

DECLARATION OF ROBERT HOCKETT

2

Robert Hockett does hereby declare:

3

1.

I am a Professor of Law at Cornell Law School in Ithaca, New York, where

4 since 2004 I have taught courses on finance and financial regulation. Over the past several years I
5 have also served as a consultant for the Federal Reserve Bank of New York (FRBNY), the
6 International Monetary Fund (IMF), Americans for Financial Reform, and a number of members of
7 the U.S. Senate and House of Representatives as well as state and city officials. I am a member of
8 the New York City Bar and its Committee on Banking Law, and am the incoming Chair of the
9 Association of American Law Schools’ Section on Financial Institutions and Consumer Financial
10 Services. I am also a Fellow of The Century Foundation and a commissioned author for the New
11 America Foundation.
12

2.

Much of my research and writing since 2007 has focused on the causes and

13 consequences of the recent bubble and bust in housing prices, as well as on how best (a) to clean up
14 the mess that has been left in their aftermath, while (b) preventing a recurrence. In connection with
15 (a), I have developed and long advocated “lease swap” and eminent domain plans for underwater
16 Private Label Securitization (“PLS”) mortgage loans whose contract arrangements render
17 voluntary, economically sensible modifications of those mortgage loans impossible. In connection
18 with (b), I have long worked on a variety of “macroprudential” finance-regulatory and home
19 finance reform projects, including the drafting of a mortgage bridge loan statute recently
20 introduced in the Senate of the State of New York.1
21

3.

One development that I and many others have concluded must occur if U.S.

22 cities are ever fully to emerge from the aftermath of the bubble and bust is the writing-down of
23 post-bubble private debt overhang. The overwhelmingly greater part of that overage is mortgage
24 debt overhang. I firmly believe that debt-writedowns can and must be done in a manner that is not
25 only fair, but also efficient, by which I mean beneficial to debtors and creditors alike. I believe this
26 possible owing to (a) the extraordinary degree of default risk that attends deeply underwater
27 ___________________________________
1

See NY S5035-2013, available at http://open.nysenate.gov/legislation/bill/S5035-2013.

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Declaration of Robert Hockett, Case No. CV-13-3663-CRB

1 mortgage loan obligations, and (b) the high cost of foreclosure, when default occurs, to creditor and
2 debtor alike. Because fair and efficient writedowns of the mentioned sort are possible, the success
3 of a debt-reduction plan does not depend upon under-compensating investors; indeed if done
4 properly, it will render investors better off even as it leaves homeowners and cities better off. I
5 elaborate in more detail below.
6

4.

In early 2012, I received a small fee to assist Mortgage Resolution Partners, but

7 I have no ongoing business relationship with the firm and no investment interest in Mortgage
8 Resolution Partners, Gordian Sword, or the outcome of this case. The opinions in this declaration
9 are based on my research and study of the issues here discussed over the years leading up to and
10 following the mortgage price bubble and bust. Citations to some of my prior writings on these
11 issues, as well as to Congressional testimony provided one year ago, will be found at the end of this
12 declaration.
13

5.

In many American cities like the City of Richmond, California, where large

14 percentages of homeowners are deeply underwater on their mortgages, creditors, debtors, and their
15 communities alike continue to suffer the aftereffects of the housing price bubble and bust. The
16 underwater mortgage loan problem continues to place – as it has done for six years and counting –
17 enormous pressure on investors (themselves homeowners), homeowners (themselves investors),
18 and their communities alike. It also continues to operate as by far the principal ongoing drag upon
19 post-crash local and national economic recovery.2
20

6.

Underwater mortgagors struggle to stay current on their loans. In consequence,

21 more go delinquent each month. Today’s delinquent loans were once current, and many –
22 astonishingly many – of today’s current loans will go delinquent and default. The suffering
23 wrought by this ongoing struggle befalls not only mortgagors, but also their ultimate creditors – the
24 holders of mortgage-backed securities issued by pools of now underwater loans. It also spills over
25 ___________________________________
2

26
27
28

Academic studies show that negative equity reduces consumption expenditures and economic activity, even
absent a default, and that the effect is disproportionately greater in areas with high concentrations of underwater
mortgages. See, e.g., Mian, Rao and Sufi, "Household Balance Sheets, Consumption, and the Economic Slump,"
Chicago Booth Working Paper No. 13-42 (June 7, 2013), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1961211. The Federal Reserve Board and Federal Reserve Bank
of New York, as cited in some of my own work referenced at the end of this declaration, have found likewise.
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Declaration of Robert Hockett, Case No. CV-13-3663-CRB

1 to neighbors, in multiple ways, as study after study has shown. Foreclosure on one home depresses
2 the value of neighboring homes. That in turn cuts into municipal revenues as property values – the
3 basis on which municipal tax revenues are determined – decline. This happens, ironically, just as
4 municipal abatement costs wrought by foreclosures – costs of boarding and maintaining abandoned
5 properties, policing neighborhoods in which empty homes become magnets for crime, etc. – begin
6 mounting. City services – police, sanitation, fire protection, etc. – accordingly come to be cut,
7 people of means who are able to leave find it more tempting to do so, property values and revenues
8 accordingly fall even lower, and so on.
9

7.

Self-worsening “downward spirals” of this sort account for the high correlation

10 we find between high average loan to value (LTV) ratios on the one hand, and the incidence of
11 municipal insolvencies on the other. High rates of negative equity, mass foreclosure, blight and
12 municipal bankruptcy go hand in hand. That is why so many American cities are now in crisis.
13

8.

The loss and the suffering described above are needless. They constitute waste,

14 sheer deadweight loss. I say this because in ordinary credit transactions, creditors and debtors
15 commonly write down underwater debt in a manner that renders the debt more payable and
16 accordingly renders both debtor and creditor better off. There is an established market for
17 mortgage loans that are not locked in trusts, and that market reflects that the writedown of principal
18 of many underwater mortgage loans would increase the market values of the loans as financial
19 assets. Simply refinancing these underwater loans to reduce interest payments or extend payment
20 durations is not a solution because it still leaves the homeowners in negative-equity situations with
21 high risk of default and eventual costly foreclosure. The market for saleable mortgage loans
22 reflects this reality. For this very reason, some states and community groups already are
23 purchasing available underwater loans to reduce principal and keep homeowners in their homes.
24 The Mortgage Resolution Fund has adopted this model in Illinois and Ohio, for example, and The
25 Resurrection Project is now taking similar steps in Chicago.3
26 ___________________________________
3

27

For more information see: http://mortgageresolutionfund.org/ and http://resurrectionproject.org/theresurrection-project-and-self-help-federal-credit-union-joint-venture-acquires-1100-loans-to-prevent-massiveforeclosures/.

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Declaration of Robert Hockett, Case No. CV-13-3663-CRB

1

9.

A very large class of securitized mortgage loans, however, are presently not

2 saleable or modifiable. Unlike portfolio loans, they have not thus far been sold or modified in
3 adequate numbers because they are locked up in PLS trusts.4 They are now at the core of the local
4 and national mortgage problem because the securitization arrangements pursuant to which they are
5 pooled operate as obstacles to economically sensible transactions that would bring simultaneously
6 creditor- and debtor-friendly principal reductions. That is why the problem may be repairable only
7 through use of some government’s or governments’ eminent domain authority.
8

10.

During the bubble, buyers had to pay inflated market prices to purchase their

9 homes; they were price-takers, not -makers. Buyers accordingly had to incur large debt obligations
10 to pay for their homes. This did not present any obstacle so long as housing prices were rising, for
11 credit flowed freely and inexpensively for as long as those prices continued to rise. Once prices
12 began dropping, however, matters were turned upside-down. The variable prices of mortgagors’
13 homes dropped, but the fixed debt obligations they had had to incur in order to pay for the houses
14 did not. That meant that literally millions – at present, still 11 to 13 millions – of American
15 families owed more on the debts they had had to incur than their homes were now worth.
16

11.

When people fall below water as dramatically as so many millions of American

17 homeowners did in the wake of the crash, they find it increasingly difficult to stay current on their
18 payments, no matter how hard they try. Fannie Mae and Freddie Mac’s 10-K and 10-Q filings
19 afford a telling illustration, anticipating a 71% default rate among the Government-Sponsored
20 Enterprises’ (GSEs’) underwater subprime loans, a 67% rate among the alt-As, and a remarkable
21 40% even among the 30-year fixed-rates. With default rates like that, and with foreclosure costs as
22 high as they are, it is easy to understand why so many portfolio loan holders – that is, banking
23 institutions that own and have power to modify whole loans – write down the underwater loans of
24
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4

26
27

The term “Residential Mortgage-Backed Securities” (“RMBS”) refers to securities issued by securitization
trusts that hold residential real estate mortgage loans as distinguished from commercial real estate mortgage loans or
other assets. The term “Private Label Securitization” (“PLS”) applies to RMBS trusts whose assets receive no
backing from any government agency such as Ginnie Mae. Some, but not all RMBS trusts are PLS trusts, and these
are the trusts to which I refer in this declaration.

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Declaration of Robert Hockett, Case No. CV-13-3663-CRB

1 their borrowers. Writing down the loans is value-salvaging for the banks. Hence it’s a “win-win”
2 for lender and borrower alike.
3

12.

The problem for America’s still struggling cities, however, is that very few

4 loans are portfolio loans of this sort. Most – and by far the most troubled – are private label
5 securitized (PLS) loans. The arrangements pursuant to which these loans are securitized,
6 formulated during the bubble years when few seem to have appreciated the prospect of a market7 wide price drop, do not provide for value-salvaging loan modifications or sales on the scale that the
8 crash has necessitated – not even when writedowns would be as good for the creditors as they are
9 for the debtors.
10

13.

The ways in which PLS securitization arrangements impede even value-

11 salvaging writedowns are manifold, but many if not most are either rooted in or kept in place by
12 the terms of the pooling and servicing agreements (PSAs) pursuant to which PLS loans were
13 securitized during the bubble years. Among other things, these contracts typically (a) authorize
14 trustees or servicers to modify or sell only small percentages of loans held by the trusts; (b) provide
15 for exceptions to those prohibitions only when ambiguously formulated or impossible criteria –
16 such as supermajority voting by thousands or more small-holding bondholders scattered world
17 wide – are met; (c) stipulate compensation arrangements for loan servicers per which the latter
18 derive greater fee revenue from protracted foreclosure than from creditor- and debtor-friendly loan
19 modifications or sales; and (d) name as servicers certain banking institutions – Wells Fargo being a
20 prominent example – that also hold second liens on properties that secure securitized loans, thereby
21 underwriting significant conflicts of interest when primary and secondary creditors’ interests
22 diverge as they do in the vicinity of debtor-insolvency.
23

14.

Arrangements of this sort made sense – they harmed no one and benefited many

24 – in a world where home prices in general only ascended and where delinquency and default were
25 accordingly rare and exceptional. Where prices fall marketwide and loan-to-value (LTV) ratios go
26 upside-down, however, so do these contract arrangements. They present the most senseless and
27 calamitous of “unintended consequences” – harming nearly all parties in interest by standing in the
28 way, post-bust, of even value-maximizing modifications or sales that aid debtor and creditor alike.
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Declaration of Robert Hockett, Case No. CV-13-3663-CRB

1 Were ultimate creditors to have practical control of these loans, they would be selling or writing
2 them down just as portfolio loan holders do. But under PLS loans’ securitization arrangements,
3 they do not have that control. An assortment of middlemen do – trustees, servicers, debt4 collectors, etc. – and none of these middlemen’s incentives align with those of the creditors or the
5 debtors.
6

15.

Because, as noted before, writedowns on deeply underwater debt benefit

7 creditor and debtor alike and continued suffering is accordingly needless, eminent domain plans for
8 underwater mortgage loans can be structured in “win-win” ways that require no expenditure of
9 public funds and no bilking of any parties in interest. I and others who have advocated plans of
10 this type since the housing price crash have accordingly framed them as means of enabling the
11 ultimate creditors on PLS loans – the bondholders – in effect to engage in the same form of
12 collaterally homeowner-benefitting “self-help” that portfolio loan-holders routinely do. Indeed,
13 ultimately the hope would be that more and more bondholders themselves could put up the funds
14 used to pay the condemnation awards because such plans ultimately would be to their advantage.
15

16.

In order to do what it is meant to do, it should here be noted, an eminent domain

16 plan should ultimately target both performing and non-performing underwater mortgage loans. For
17 the relevant loan characteristic is the fact that it is deeply underwater and accordingly subject to a
18 40%, 67%, 71% or similarly high chance of default5 – not the fact that it has or has not yet
19 defaulted. Again, today’s delinquent loans were among yesterday’s performing loans; and high
20 percentages of today’s performing loans, where they are underwater, will be tomorrow’s delinquent
21 and then defaulted loans. This is precisely why programs like the federal Home Affordable
22 Modification Program (“HAMP”) cover loans in which homeowners are current on payments but
23 nevertheless likely, pursuant to well established actuarial criteria, to default in the future.
24

17.

Recent claims of “recovery” on the part of housing prices in some markets do

25 not in any way diminish the need for fair and efficient value-salvaging eminent domain plans in
26 cities like Richmond. The reasons are principally three. First, the so-called “recovery” is highly
27 ___________________________________
5

The given figures, recall, are the sample GSE figures cited above.

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Declaration of Robert Hockett, Case No. CV-13-3663-CRB

1 localized in character, much as the crisis itself has been. While prices rise (for now) and
2 foreclosures diminish (for now) in some cities, the trends are reversed in other cities. Second,
3 much of the “recovery” of housing prices in such localities as have shown them is showing itself
4 thus far to be the product of (a) a search for yield among investment firms and private equity
5 companies, (b) low borrowing costs in the current monetary policy environment, and (c) a growing
6 inventory of low-price foreclosed homes that the aforementioned firms are speculatively
7 purchasing with a view to converting them into rental properties. Finally, and more fundamentally,
8 it is in a certain sense conceptually impossible for there to be recovery without principal-reduction
9 if we use price as the measure of recovery as claimants of “recovery” do. The prices in relation to
10 which some 11 to 13 million homeowners’ continuing mortgage debt obligations were determined
11 years back were bubble prices. This means that the only way most of these people can fully
12 “recover,” in the sense of rising above water, is either for principal to be reduced or for prices to
13 rise back to their bubble-era heights. The latter prospect is quite as unlikely as it is undesirable (a
14 new bubble would be nothing to celebrate), meaning that real recovery awaits value-salvaging
15 writedowns.
16

18.

I have reviewed the declarations submitted by plaintiffs in support of their

17 motion for a preliminary injunction, and I respectfully disagree with the opinions expressed therein
18 about the negative consequences of an eminent domain plan. For the reasons described above, it is
19 simply not true that eminent domain plans cannot succeed without harming the investors in PLS
20 trusts or the broader economy, or without discouraging future lending in the cities that adopt such
21 plans, or without raising borrowing costs. The targeted loans can (and indeed legally must) be
22 acquired for their full fair market value, simply exchanging one asset in the PLS trust for its equal
23 value in cash. The PLS trusts already receive cash in exchange for loans in the event of
24 foreclosures on non-recourse loans or short sales, and the acquisition of loans in an eminent
25 domain proceeding would be no different. Many of the issues raised in the Stevens and Burnaman
26 Declarations are simply factors to be taken into account in the valuation analysis; and their
27 assertions that condemnation will result in losses to trusts and their investors, then trigger a fanciful
28 parade of horribles that the declarants elaborate with admirable imaginative verve, is predicated in
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Declaration of Robert Hockett, Case No. CV-13-3663-CRB