Dealing with the Mortgage Mess: Judge Tchaikovsky Does His Job and Judges
Tanta of Calculated Risk has very sharp eyes, and a very quick wit:
Calculated Risk: BK Judge Rules Stated Income HELOC Debt Dischargeable: This is a big deal, and will no doubt strike real fear in the hearts of stated-income lenders everywhere. Our own Uncle Festus sent me this decision, in which Judge Leslie Tchaikovsky ruled that a National City HELOC that had been "foreclosed out" would be discharged in the debtors' Chapter 7 bankruptcy. Nat City had argued that the debt should be non-dischargeable because the debtors made material false representations (namely, lying about their income) on which Nat City relied.... The court agreed that the debtors had in fact lied... but it held that the bank did not "reasonably rely" on the misrepresentations....
[T]he whole point of stated income lending was to make the borrower the fall guy: the lender can make a dumb loan--knowing perfectly well that it is doing so--while shifting responsibility onto the borrower, who is the one "stating" the income and--in theory, at least--therefore liable for the misrepresentation. This is precisely where Judge Tchaikovsky has stepped in and said "no dice." This is not one of those cases where the broker or lender seems to have done the lying without the borrower's knowledge; these are not sympathetic victims of predatory lending. In fact, the very egregiousness of the borrowers' misrepresentations and chronic debt-binging behavior is what seems to have sent the Judge over the edge here, leading her to ask the profoundly important question of how a bank like National City could have "reasonably relied" on these borrowers' unverified statements of income to make this loan....
[T]he published guidelines by which the loans were made and evaluated... made it "fast and easy" for fraud to occur. Judge Tchaikovsky directly addresses the issue of the bank's reliance on "guidelines" that should, in essence, never have been relied upon in the first place.... In re Hill (City National Bank v. Hill), United States Bankruptcy Court, Northern District of California, Case No. A.P. 07-4106 (May 28, 2008)....
If you make a "liar loan," the Judge is saying here, then you cannot claim you were harmed by relying on lies. And if you rely on an inflated appraisal, that's your lookout, not the borrower's. This is going to give a lot of stated income lenders--and investors in "stated income" securities--a really bad rotten no good day. As it should. They have managed to give the rest of us a really bad rotten no good couple of years, with no end in sight...
This adversary proceeding is a poster child for some of the practices that have led to the current crisis in our housing market...
Moreover, the Hills, while not highly educated, were not unsophisticated. They had obtained numerous home and car loans and were familiar with the loan application process. They knew they were responsible for supplying accurate information to a lender concerning their financial condition when obtaining a loan. Even if the Court were persuaded that they had signed and submitted the October Loan Application without verifying its accuracy, their reckless disregard would have been sufficient to satisfy the third and fourth elements of the Bank’s claim...
However, the Bank’s suit fails due to its failure to prove the sixth element of its claim: i.e., the reasonableness of its reliance. As stated above, the reasonableness of a creditor’s reliance is judged by an objective standard. In general, a lender’s reliance is reasonable if it followed its normal business practices. However, this may not be enough if those practices deviate from industry standards or if the creditor ignored a “red flag.” See Cohn, 54 F.3d at 1117. Here, it is highly questionable whether the industry standards–-as those standards are reflected by the Guidelines–-were objectively reasonable. However, even if they were, the Bank clearly deviated to some extent from those standards. In addition, the Bank ignored a “red flag” that should have called for more investigation concerning the accuracy of the income figures...
Based on the foregoing, the Court concludes that either the Bank did not rely on the Debtors representations concerning their income or that its reliance was not reasonable based on an objective standard. In fact, the minimal verification required by an “income stated” loan, as established by the Guidelines, suggests that this type of loan is essentially an “asset based” loan. In other words, the Court surmises that the Bank made the loan principally in reliance on the value of the collateral: i.e., the House. If so, the Bank obtained the appraisal upon which it principally relied in making the loan. Subsequent events strongly suggest that the appraisal was inflated. However, under these circumstances, the Debtors cannot be blamed for the Bank’s loss, and the Bank’s claim should be discharged...
