Rewriting frankenstein contracts: Workout prohibitions in residential mortgage-backed securities

Southern California Law Review

Volumn 82, Issue 6, 2009, Pages 1075-1152

  Gelpern, Anna ^a   Levitin, Adam J ^b  

^a AMERICAN UNIVERSITY   (United States)

^b GEORGETOWN UNIVERSITY LAW CENTER   (United States)

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EID: 70350700854     PISSN: 00383910     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (573)

1. MARY WOLLSTONECRAFT SHELLEY, FRANKENSTEIN; OR, THE MODERN PROMETHEUS 72 (Susan J. Wolfson ed., Pearson Educ, Inc. 2007) (1818).
2. See, e.g., Helping Families Save Their Homes in Bankruptcy Act of 2009 and the Emergency Homeownership and Equity Protection Act: Hearing on H. R. 200 and H. R. 225 Before the H. Comm. on the Judiciary, 111th Cong. (2009) ;
3. Oren Bar-Gill, The Law, Economics and Psychology of Subprime Mortgage Contracts, 94 CORNELL L. REV. 1073 (2009) ;
4. Stan Liebowitz, New Evidence on the Foreclosure Crisis, WALL ST. J., July 3, 2009, at A13;
5. Eric Posner & Luigi Zingales, The Better, Cheaper Mortgage Fix: How to Renegotiate All Those Bad Loans at No Cost to the Taxpayer, SLATE, Mar. 2, 2009, http://www.slate.com/id/2212649/.
6. See infra Part IV. A.
7. See infra Part IV. B.
8. See infra Part IV. B.
9. See infra Part IV. B.
10. See, e.g., Steven L. Schwarcz, The Alchemy of Asset Securitization, 1 STAN. J. L. BUS. & FIN. 133, 134 (1994).
11. See SHELLEY, supra note 1, at 23-36.
12. See id. at 34.
13. See id. at 38, 176.
14. Id. at 72.
15. See Financial Industry Regulatory Agency, The Bond Market, http://apps.finra.org/investor-information/smart/bonds/401000.asp [hereinafter FINRA] (listing mortgage-related bonds as $8.9 trillion, corporate bonds as $6.3 trillion, and U. S. Treasury bonds as $5.9 trillion in a bond market of more than $33.5 trillion) (last visited Oct. 24, 2009). Of the $8.9 trillion in mortgage-related bonds, over $6.8 trillion are RMBS.
16. See id.;
17. INSIDE MORTGAGE FIN., 2009 MORTGAGE MARKET STATISTICAL ANNUAL 10 (2009).
18. See supra note 12. The remainder are commercial mortgage-backed securities ("CMBS"). The true share of mortgage-related securities may be higher because home equity loans and home equity lines of credit are usually categorized as "asset-backed" rather than "mortgage-backed" securities.
19. See VINOD KOTHARI, SECURITIZATION: THE FINANCIAL INSTRUMENT OF THE FUTURE 352 (John Wiley & Sons (Asia) Pte Ltd ed. 2006).
20. Most, but not all, GSE RMBS carry this guaranty. Some older series of Freddie Mac participation certificates, for example, only guarantee timely payment of interest and eventual payment of principal.
21. Private-label RMBS include all securitizations of subprime, scratch-and-dent, and "jumbo" mortgages (prime mortgages that are larger than the statutory conforming loan limit for the GSEs), and almost all alt-A securitizations.
22. 12 U. S. C. § 1721 (g) (1) (2006) (Ginnie Mae full faith and credit guaranty) ;
23. INSIDE MORTGAGE FIN., supra note 12, at 10 (market shares).
24. The GSEs are now in federal conservatorship, and their obligations carry an "effective guarant[y]" from the federal government, see, e.g., Dawn Kopecki, Fannie, Freddie Have "Effective" Guarantee, FHFA Says, BLOOMBERG. COM, Oct. 23, 2008, http://www.bloomberg.com/apps/news?pid= 20601087&sid=aO5XSFgElSZA (quoting Federal Housing Finance Agency director James Lockhart), but do not enjoy a full faith and credit backing
25. see 12 U. S. C. § 1719 (e) (stating explicitly that GSE debts are not government debts). The difference, if any, between the "effective guaranty" and "full faith and credit" is uncertain.
26. See BD. OF GOVERNORS OF THE FED. RESERVE SYS., FLOW OF FUNDS ACCOUNTS FOR THE UNITED STATES: FLOWS AND OUTSTANDINGS, FIRST QUARTER 2009, at 94 tbl. L.218 (2009).
27. See 2 INSIDE MORTGAGE FIN., supra note 12, at 13.
28. Id.
29. For a more detailed description of RMBS transactions, see Adam J. Levitin & Tara Twomey, Mortgage Servicing 9-68 (Georgetown Univ. Law Ctr., Bus., Econ. & Regulatory Pol'y Working Paper Series, Paper No. 1324023, 2009) (on file with authors).
30. There are significant distinctions within the RMBS market. The most essential is the difference in credit risk among Ginnie Mae, GSE, and private-label RMBS. Investors in Ginnie Mae and GSE RMBS are assuming interest rate risk, not credit risk; investors in private-label RMBS are also assuming credit risk. This Article is generally focused on private-label RMBS, as Ginnie Mae and GSE RMBS have more complex regulatory systems and greater flexibility for renegotiation because nonperforming loans can be purchased out of the securitized pools by the securitization sponsor, thus removing securitization-related obstacles to loan renegotiation.
31. Another distinction exists between true securitization and synthetic securitization through the use of credit derivatives. This Article only addresses true securitizations. For an explanation of synthetic securitizations, see Ian Bell & Petrina Dawson, Synthetic Securitization: Use of Derivative Technology for Credit Transfer, 12 DUKE J. COMP. & INT'L L. 541 (2002).
32. See KOTHARI, supra note 13, at 10-12;
33. STEVEN L. SCHWARCZ, BRUCE A. MARKELL & LISSA LAMKIN BROOME, SECURITIZATION, STRUCTURED FINANCE AND CAPITAL MARKETS 2-3 (2004).
34. See infra Part III. C.
35. See. e.g., COMPTROLLER OF CURRENCY, U. S. DEP'T OF TREASURY, ASSET SECURITIZATION: COMPTROLLER'S HANDBOOK 2, 4-5 (1997) [hereinafter OCC Handbook].
36. For a detailed discussion of the advantages of securitization to issuers, see KOTHARI, supra note 13, at 97-102.
37. For a discussion of why banks securitize, see Fed. Reserve Bd., Trading and Capital-Markets Activities Manual § 3020.1, at 1-2 (Jan. 2009), available at http://federalreserve.gov/boarddocs/supmanual/trading/200901/ 0901trading.pdf.
38. See KOTHARI, supra note 13, at 100-01.
39. See id. at 100-01, 104-05.
40. Steven L. Schwarcz, Securitization Post-Enron, 25 CARDOZO L. REV. 1539, 1560 (2004).
41. KOTHARI, supra note 13, at 97, 100.
42. See Schwarcz, supra note 7, at 136.
43. See KOTHARI, supra note 13, at 97. The typical subprime residential private-label RMBS deal has fifteen tranches.
44. See Ingo Fender & Peter Hördahl, Estimating Valuation Losses on Subprime MBS with the ABXHE Index-Some Potential Pitfalls, BIS Q. REV., June 2008, at 6, 7 n. 7, available at http://www.bis.org/publ/qtrpdf/r-qt0806.pdf.
45. See Claire A. Hill, Securitization: A Low-Cost Sweetener for Lemons, 74 WASH. U. L. Q. 1061, 1075 (1996).
46. See id. at 1073.
47. Id. at 1071.
48. The originator need not, and does not normally, pass on all its cost savings from securitization to its borrowers. Thus, if the securitized assets are mortgage loans with an annual yield of 8 percent, but the average coupon promised to the SPV investors is 6 percent, the originator can capture some of the 2 percent spread.
49. See Adam B. Ashcraft & Til Schuermann, Fed. Reserve Bank of N. Y., Staff Report No. 318, Understanding the Securitization of Subprime Mortgage Credit 30 (Mar. 2008), available at http://www.newyorkfed.org/research/staff- reports/sr318.pdf.
50. See KOTHARI, supra note 13, at 100.
51. See also id. at 102 (noting that improved accounting profits "might well top the list" of the benefits of securitization).
52. See Hill, supra note 31, app. D, at 1123-25 (mentioning the "capital adequacy ratio" regulatory requirement, which requires institutions to maintain a certain amount of capital relative to their risk-weighted assets).
53. See OCC HANDBOOK, supra note 24, at 18-19;
54. SCHWARCZ ET AL., supra note 22, at 113-17 (discussing two securitization vehicles recognized by the federal tax code that specifically avoid entitylevel tax) ;
55. infra note 85.
56. See generally Claire A. Hill, Latin American Securitization: The Case of the Disappearing Political Risk, 38 VA. J. INT'L L. 293 (1998) (analyzing the use of cross-border securitization to reduce investors' political risk exposure).
57. Enron's structured vehicles are the most famous example.
58. This risk transfer is part of the "true sale" concept.
59. See, e.g., SECURITIZATION OF FINANCIAL ASSETS § 2.02, at 2-14 (Jason H. P. Kravitt & Mayer Brown eds., 2d ed. Supp. 2008) (broadly defining a "true sale" as "a transfer of financial assets that, for the purpose of specific laws, accounting principles or regulatory concerns, constitutes a sale of such assets as distinguished from a financing of the seller thereof secured by such assets").
60. See also SCHWARCZ ET AL., supra note 22, at 6-8, 145;
61. Kenneth C. Kettering, Securitization and Its Discontents: The Dynamics of Financial Product Development, 29 CARDOZO L. REV. 1553, 1585-1632 (2008) (arguing that securitization is inherently a fraudulent transfer).
62. Investors are expecting to carry interest rate and other market risk. OCC HANDBOOK, supra note 24, at 13, 19-20.
63. See also SCHWARCZ ET AL., supra note 22, at 6-8, 145.
64. OCC HANDBOOK, supra note 24, at 11, 19-23.
65. Id. at 11.
66. We discuss tranching in more detail in Part III. D infra.
67. SCHWARCZ ET AL., supra note 22, at 9.
68. A large literature attests to this rigidity.
69. Obstacles to mortgage modification include prepayment penalties, see, e.g., Frank S. Alexander, Mortgage Prepayment: The Trial of Common Sense, 72 CORNELL L. REV. 288 (1987)
70. statutory restrictions on mortgage modification in bankruptcy, see Adam J. Levitin, Resolving the Foreclosure Crisis: Modification of Mortgages in Bankruptcy, 2009 WIS. L. REV. 565, 579-82, and the existence of multiple liens on the same property, which precludes senior mortgagees from making concessions that would benefit junior mortgagees before improving the debtor's payment capacity
71. see id.
72. OCC HANDBOOK, supra note 24, at 10. The servicer is often, but not always, a corporate affiliate of the originator. Many large servicers are subsidiaries of bank holding companies.
73. Three kinds of agreements form the core of a securitization transaction: a pooling agreement, in which the SPV purchases a pool of assets from the originator or an intermediary; a servicing agreement between the servicer and the SPV that sets forth the duties and compensation of the servicer; and an indenture, which sets forth the rights of the investors in the SPV's securities and the duties of the trustee that oversees the securities and the SPV. Typically, these three agreements are combined into a single document (the PSA).
74. See id. at 13 (noting that the PSA generally governs the structure of the securitization transaction).
75. See also DB Structured Prods., Inc. v. Am. Home Mortgage Holdings, Inc. (In re Am. Home Mortgage Holdings, Inc.), 402 B. R. 87, 100 ¶ 40, 103 ¶ 49 (Bankr. D. Del. 2009) (holding that servicing rights were severable from a mortgage loan purchase agreement and therefore were assignable by the bankrupt servicer rather than forfeited).
76. See, e.g., Asset Backed Funding Corp., Option One Mortgage Corp. & Wells Fargo Bank, Pooling and Servicing Agreement (Form 8-K), at EX-4 § 3.01 (Nov. 25, 2005), available at http://www.secinfo.eom/dRSm6.z251.d.htm#6f6m [hereinafter ABFC PSA] ("The Servicer, as independent contract servicer, shall service and administer the Mortgage Loans in accordance with this Agreement and the normal and usual standards of practice of prudent mortgage servicers servicing similar mortgage loans and, to the extent consistent with such terms, in the same manner in which it services and administers similar mortgage loans for its own portfolio, and shall have full power and authority, acting alone, to do or cause to be done any and all things in connection with such servicing and administration which the Servicer may deem necessary or desirable and consistent with the terms of this Agreement (the 'Servicing Standard').") ;
77. Goldman Sachs Mortgage Co. & Bank One, N. A., Seller's Purchase, Warranties and Servicing Agreement (Form 8-K), at EX-10. 1.3 §4.01 (Mar. 8, 2002), available at http://www.sec.gov/Archives/edgar/data/807641/ 000095017202000467/s575865.txt ("The Servicer shall service and administer the Mortgage Loans through the exercise of the same care that it customarily employs for its own account.").
78. Servicers are required to advance payments of principal and interest on nonperforming loans held by the SPV. The advances are reimbursable, but not with interest. One agency concern is that servicers might be tempted to modify nonperforming loans in order to avoid the obligation of making advances, even if the modified loan has a lower net present value than would result if it proceeded to foreclose on the nonperforming loan. Of course, the opposite situation-where modification would yield a greater return than foreclosure-could well hold.
79. See, e.g., Fed. Nat'l Mortgage Ass'n, Single-Family Master Trust Agreement for Guaranteed Mortgage Pass-Through Certificates § 5.3 (4) (June 1, 2007), available at http://www.fanniemae.com/mbs/pdf/ singlefamilytrustagreement-June2007.pdf ("For so long as a Mortgage Loan remains in a Pool, the Mortgage Loan may not be modified if the modification has the effect of changing the principal balance (other than as a result of a payment actually received from or on behalf of the Borrower), changing the Mortgage Interest Rate (other than in accordance with any adjustable rate provisions stated in the Mortgage Documents), or delaying the time of payment beyond the last scheduled payment date of that Mortgage Loan...."). Note that this is not a private-label securitization and that Fannie Mae can purchase defaulted loans out of its securitized pools and modify them.
80. See, e.g., ABFC PSA, supra note 49, § 3.03 ("In the event that any payment due under any Mortgage Loan is not paid when the same becomes due and payable, or in the event the Mortgagor fails to perform any other covenant or obligation under the Mortgage Loan and such failure continues beyond any applicable grace period, the Servicer shall take such action as it shall deem to be in the best interest of the Certificateholders. With respect to any defaulted Mortgage Loan, the Servicer shall have the right to review the status of the related forbearance plan and, subject to the second paragraph of Section 3.01, may modify such forbearance plan; including extending the Mortgage Loan repayment date for a period of one year or reducing the Mortgage Interest Rate up to 50 basis points.").
81. Morgan Stanley Capital I Inc/Trust 2006-HE1, Pooling and Servicing Agreement (Form 8-K), at EX-4 § 3.01 (c) (May 11, 2006) ("Notwithstanding anything in this Agreement to the contrary... the Servicer shall not (i) permit any modification with respect to any Mortgage Loan that would change the Mortgage Rate, reduce or increase the principal balance (except for reductions resulting from actual payments of principal) or change the final maturity date on such Mortgage Loan....") ;
82. Morgan Stanley Capital I Inc/Trust 2006-NC2, Pooling and Servicing Agreement (Form 8-K), at EX-4 § 3.01 (c) (May 11, 2006) (same). We thank John Hunt for bringing our attention to these particularly restrictive PSAs.
83. See, e.g., ABFC PSA, supra note 49, § 3.01 ("The [net interest margin security] Insurer's prior written consent shall be required for any modification, waiver or amendment if the aggregate number of outstanding Mortgage Loans which have been modified, waived or amended exceeds 5% of the number of Mortgage Loans as of the Cut-off Date.").
84. CREDIT SUISSE, THE DAY AFTER TOMORROW: PAYMENT SHOCKS AND LOAN MODIFICATIONS 7 (2007).
85. See, e.g., CWALT Inc., Prospectus Supplement, Alternative Loan Trust 2005-leb: Mortgage Pass-Through Certificates (Form 4249 (b) (5)), at S-60 (Feb. 1, 2005), available at http://www.sec.gov/Archives/edgar/data/1269518/ 000095012905000801/v04622b5e424b5.txt ("The master servicer may modify any mortgage loan, provided that the master servicer purchases the mortgage loan from the trust fund immediately following the modification. A mortgage loan may not be modified unless the modification includes a change in the interest rate on the related mortgage loan to approximately a prevailing market rate. Any purchase of a mortgage loan subject to a modification will be for a price equal to 100% of the Stated Principal Balance of that mortgage loan, plus accrued and unpaid interest on the mortgage loan up to the next Due Date at the applicable net mortgage rate, net of any unreimbursed advances of principal and interest on the mortgage loan made by the master servicer.") ;
86. Complaint ¶ 34, Greenwich Fin. Servs. Distressed Mortgage Fund, LLC v. Countrywide Fin. Corp., No. 650474-2008E (N. Y. Civ. Ct. Dec. 1, 2008), available at http://www.businessweek.com/pdfs/2008/1201-complaint.pdf (quoting CWALT PSA § 3.11 (b)) [hereinafter Greenwich Complaint] ("Countrywide may agree to a modification of any Mortgage Loan (the 'Modified Mortgage Loan') if... Countrywide purchases the Modified Mortgage Loan from the Trust Fund....").
87. See CREDIT SUISSE, supra note 55, at 7.
88. See Vikas Bajaj, For Some Subprime Borrowers, Few Good Choices, N. Y. TIMES, Mar. 22, 2007, at C1.
89. See John P. Hunt, What Do Subprime Securitization Contracts Actually Say About Loan Modification? Preliminary Results and Implications 2-3, 6-10 (Mar. 25, 2009) (unpublished manuscript), available at http://papers.ssrn.com/sol3/ papers.cfin?abstract-id=1369286 (surveying the 614 subprime home mortgage securitization deals from 2006).
90. 15 U. S. C. §§ 77aaa-77bbbb (2006).
91. Id. § 77 ppp (b) ("Notwithstanding any other provision of the indenture.... the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security, on or after the respective due dates expressed in such indenture security, or to institute suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of such holder....") •
92. The TIA does not require any particular threshold of consent for other modifications to the indenture, but most RMBS supererogate and require either a simple majority vote or a two-thirds majority vote for modifications not affecting cashflow. The TIA does, however, require simple majority consent for waivers of past defaults.
93. Id. § 77 ppp (a) (1).
94. The servicer might argue that the real alternative to modification is not payment on the original schedule, but unpredictable recovery from foreclosures. Investors might respond that foreclosure need not compromise the SPV's-and hence the investors'-right to receive the original principal and interest on schedule; it is just a means of collecting some of the payments through a sale of collateral. The argument's permutations are numerous, and the outcome uncertain, reflecting the variety of economic and legal arrangements in the market.
95. See, e.g., Citibank N. A. v. MBIA Assurance S. A., [2006] EWHC (Ch) 3215
96. aff d, [2007] EWCA (Civ) 11. This recent British case illustrates the deep uncertainty that exists regarding legal duties in securitization structures, as well as the tranche warfare that workouts can create. In this case, a Dutch SPV held some of the debt of Eurotunnel (owner of the English Channel tunnel, or the "Chunnel"), against which it had issued bonds.
97. Id. [l]-[3]. Eurotunnel had to restructure its debt obligations, and the restructuring provided for some of the Eurotunnel debt held by the SPV to be exchanged for Eurotunnel notes redeemable as Eurotunnel shares plus cash, but it included an option to exchange the debt for cash alone at 61.9 percent of par value. Citibank, [2007] EWCA (Civ) 11, [6].
98. The SPV's indenture provided that the trustee and the credit-enhancing insurer, MBIA, had to approve such deals. Citibank, [2006] EWHC (Ch) 3215, [7]. MBIA instructed the trustee, Citibank, to exercise the all-cash option.
99. Id. [18]. The holder of a junior tranche of SPV bonds objected to this deal.
100. Id. [17]. It seems that if the all-cash option were exercised, the junior trancheholder would have been out of the money because the cash was at 61.9 percent of par value, whereas with the combination of notes redeemable as shares and cash, the junior trancheholder would have received some value.
101. See id. The issue before the court was whether MBIA could direct Citibank, as trustee, to exercise the option and, if not, whose interests Citibank had to consider in evaluating whether to exercise the option. The court ruled that MBIA had the right under the indenture to direct Citibank's action; but the case shows that there is sufficient legal uncertainty about rights and duties in securitization structures, including the duties of the trustee (like a servicer) to act in the interests of the trust as a whole, given that the junior trancheholder was willing to litigate in the U. K.'s loser-pays-all- attomey's-fees litigation system.
102. See, e.g., ABFC PSA, supra note 49, § 11.01 ("[T]his agreement may be amended from time to time... provided, however, that no such amendment or waiver shall (x) reduce in any manner the amount of, or delay the timing of, payments on the Certificates which are required to be made on any Certificate without the consent of the Holder of such Certificate, (y) adversely affect in any material respect the interests of the Holders of any Class of Certificates or the Swap Provider in a manner other than as described in clause (x) above, without the consent of the Holders of Certificates of such Class evidencing at least 66 2/3% of the Voting Rights evidenced by such Class....").
103. Some PSAs permit the trustee or servicer to execute, without RMBS holder consent, amendments to the PSA necessary to preserve real estate mortgage investment conduits' pass-through tax status.
104. THOMAS H. JACKSON, THE LOGIC AND LIMITS OF BANKRUPTCY LAW 7-19 (1986).
105. See id.
106. See KOTHARI, supra note 13, at 11-12 (describing "bankruptcy remoteness").
107. See id.
108. See SCHWARCZ ET AL., supra note 22, at 54. Outright advance waivers of bankruptcy rights are historically disfavored by U. S. courts.
109. See, e.g., In re Weitzen, 3 F. Supp. 698, 698 (S. D. N. Y. 1933) ("The agreement to waive the benefit of bankruptcy is unenforceable.") .
110. Only "persons" are eligible to file for bankruptcy.
111. See 11 U. S. C. § 109 (a) (2006). The Bankruptcy Code defines "person" to include an "individual, partnership, and corporation, " but it does not include a "governmental unit."
112. Id. § 101 (41). The definition of "corporation, " however, includes a "business trust."
113. Id. § 101 (9) (A) (v).
114. See, e.g., Shawmut Bank Conn. v. First Fid. Bank (In re Secured Equip. Trust of E. Air Lines, Inc.), 38 F.3d 86, 88-91 (2d Cir. 1994) ;
115. z.ast; 12 (E. D. Pa. Sept. 16, 1998) (stating that "[t]he various courts that have addressed the issue have applied different factors to determine the existence of a business trust").
116. See, e.g., ABFC PSA, supra note 49, § 3.28 (b) ("Each party to this Agreement agrees that it will not file an involuntary bankruptcy petition against the Trustee or the Trust Fund or initiate any other form of insolvency proceeding until after the Certificates have been paid.").
117. See, e.g., id. § 3.28 (a) (stating that "the Trust is not authorized and has no power" to "borrow money or issue debt, " to "merge with another entity, reorganize, liquidate or sell assets, " or to "engage in any business or activities").
118. See Stephen H. Case, I nought I Put That Where You Couldn't Reach It: Bankruptcy-Remote Entities, Special-Purpose Vehicles and Other Securitization Issues, in DEALING WITH SECURED CLAIMS AND STRUCTURED FINANCIAL PRODUCTS IN BANKRUPTCY CASES 66 (2004) (PLI Commercial Law and Practice, Course Handbook Series 2002).
119. KOTHARI, supra note 13, at 11.
120. See also id. at 207-08 (discussing the complexity of structuring the transfer of receivables).
121. See Case, supra note 76, at 76 ("Because a securitization transaction is based on the premise that the assets being financed have been isolated from the risks that the transferor/originator will default on debt or enter bankruptcy, the legal conclusion that the assets after transfer to the [SPV] have ceased to be the property of the originator and have become the property of the [SPV] are critical for bankruptcy purposes.... Characterization of the transaction as a 'true sale' achieves these goals....") ;
122. Kenneth M. Ayotte & Stav Gaon, Asset-Backed Securities: Costs and Benefits of "Bankruptcy Remoteness" 3 (May 14, 2006) (unpublished manuscript), available at http://www.newyorkfed.org/research/conference/2006/ cffVAyotte.pdf (explaining that unlike a debtor's collateral, which can be seized "on demand" by credtors, "assets that were transferred in a 'true sale' to the SPV are not considered part of the debtor's bankruptcy estate, but instead continue to be used for the benefit of the SPV investors").
123. KOTHARI, supra note 13, at 208. The concern is that the securitization could be declared a fraudulent conveyance by the originator and the securitized assets could be consolidated with the originator's. In that event, the securitization would be treated as an unperfected secured financing, with little or no prospect of recovery for the investors.
124. See First Interim Report of Neal Batson, Court-Appointed Examiner at 43, In re Enron Corp., 2009 Bankr. LEXIS 2094 (Bankr. S. D. N. Y. Aug. 4, 2009) (No. 01-16034 (AJG)), available at http://www.enron.com/media/lst-Examiners-Report. pdf ("One of the more important considerations in this analysis that is common to many of the Selected Transactions is the existence of one or more instruments... that had the economic effect of transferring both the obligation to repay the financing and the economic risks and rewards of the 'sold' asset back to Enron. ").
125. See also Case, supra note 76, at 81-83 (noting that fraudulent transfers are avoidable in bankruptcy proceedings and mentioning ways to ensure that a securitization is not treated as a fraudulent transfer). Similarly, where the originator is a U. S. bank not subject to the Bankruptcy Code, securitization requires measures to prevent the assets from being dragged into bank resolution proceedings by the Federal Deposit Insurance Corporation.
126. See OCC HANDBOOK, supra note 24, at 19-20 (discussing the structure of various levels of risk in securitization transactions) ;
127. SCHWARCZ ET AL., supra note 22, at 151-54.
128. See 11 U. S. C. § 1322 (b) (2) (2006).
129. See generally Levitin, supra note 46 (discussing the policy assumptions behind the home loan modification prohibition and testing these policy assumptions empirically).
130. See supra Paitlll. B.
131. See infra Part III. D.
132. If the SPV could file or be placed in bankruptcy, it could reject the PSA with the servicer as an executory contract. See 11 U. S. C. § 365 (a), (h). The servicer would receive only an unsecured prepetition claim for damages, and the SPV would then be free to recontract for servicing under nonrestrictive terms. All contracts may be breached of course, regardless of bankruptcy, but rejection of a contract under § 365 of the Bankruptcy Code is treated as a prebankruptcy breach, rather than a postbankruptcy breach, which changes the treatment of the counterparty's claim.
133. See id. § 365 (g). To reject a contract under § 365, the contract must be executory, a term not defined in the Bankruptcy Code but commonly held to mean that material performance is due from both parties to the contract such that "the failure of either to complete performance would constitute a material breach excusing the performance of the other."
134. See Vem Countryman, Executory Contracts in Bankruptcy: Part 1, 57 MINN. L. REV. 439, 460 (1973). Because most PSAs are also part of the MBS indenture, there is the question of whether the PSA is executory. While the servicer and the SPV have ongoing mutual obligations, the MBS holders do not, and unless the PSA is severable, the nonexecutory nature of the MBS holders' relationship with the SPV might render the PSA nonexecutory and therefore not rejectable.
135. Hunt, supra note 59, at 7.
136. Most RMBS are structured to qualify as real estate mortgage investment conduits ("REMICs") under the Internal Revenue Code. See 26 U. S. C. § 860A (2006) (REMIC tax treatment). Generally, investors in a Subchapter C corporation are subject to double taxation-the corporation is taxed directly on its earnings, and then the investors are taxed on any distributions from the corporation. REMICs, however, receive pass-through tax status, meaning that the investors, rather than the entity, are taxed on the REMICs earnings.
137. Id. § 860A (b).
138. See also ACCOUNTING FOR TRANSFERS AND SERVICING OF FIN. ASSETS AND EXTINGUISHMENTS OF LIABILITIES, Statement of Fin. Accounting Standards No. 140 (Fin. Accounting Standards Bd. 2000) (off-balance sheet accounting treatment). To qualify as a REMIC, the entity must be essentially passive in its management of mortgages.
139. SCHWARCZ ET AL., supra note 22, at 114.
140. It is limited in its ability to change what mortgage loans it owns, see 26 U. S. C. § 860D (a) (4) (limiting REMICs to holding "qualified mortgages" and "permitted investments") ;
141. id. § 860G (a) (3) (defining "qualified mortgage") ;
142. id. § 860G (a) (5) (defining "permitted investments"), or to alter the terms of the mortgage loans
143. see 26 C. F. R. § 1.860G-2 (b) (2008).
144. To qualify as a REMIC under the Internal Revenue Code, substantially all of the REMICs assets must be qualified mortgages and permitted investments. 26 U. S. C. § 860D (a) (4). "Qualified mortgage" is defined as "any obligation (including any participation or certificate of beneficial ownership therein) which is principally secured by an interest in real property."
145. Id. § 860G (a) (3). It includes "foreclosure property, "
146. see id., which is defined as property "which is acquired in connection with the default or imminent default of a qualified mortgage held by the REMIC, "
147. id. § 860G (a) (8) (B).
148. The Treasury regulations note, however, that if a mortgage is significantly modified, other than in the event of a "default or reasonably foreseeable default, " then "the modified [mortgage] is treated as one that was newly issued in exchange for the unmodified obligation that it replaced, " which means that the modified mortgage will not be a qualified mortgage. 26 C. F. R. § 1.860G-2 (b).
149. The tax consequence of this recharacterization is that the deemed disposition of the unmodified obligation will be a prohibited transaction that is subject to a 100 percent tax. 26 U. S. C. § 860F (a).
150. The relevance of a mortgage modification depends on whether the modification is considered "significant" under one of five specific categories. 26 C. F. R. § 1.1001-3 (b), (e). Most relevant for mortgage modification purposes is the specific category describing certain yield changes as significant modifications.
151. See id. § 1.1001-3 (e) (2). A modification that results in a change in the yield on the mortgage loan of greater of twenty-five basis points, or 5 percent of the annual unmodified yield, is considered significant.
152. Id. § 1.1001-3 (e) (2) (ii).
153. If a modification does not fit into any of the specific significant modification categories, then whether the modification alters legal rights or obligations in an economically significant manner must be analyzed. Id. § 1.1001-3 (e) (1). Moreover, all modifications are considered collectively.
154. Id. Two consequences flow from a modification being significant. First, the modified mortgage held by the trust will not be a qualified mortgage. If a trust has too many nonqualified mortgages, the trust loses its REMIC status. Second, the trust will incur 100 percent taxation on the net gain in the exchange deemed to have occurred in the modification. Therefore, too many modifications without imminent default will result in the loss of the SPV's REMIC pass-through status, not just for specific transactions, but overall. The Internal Revenue Service has relaxed application of REMIC rules to mortgage loan modification programs where the mortgage is secured by owner-occupied property and there is a significant risk of foreclosure.
155. See Rev. Proc. 2008-28, 2008-23 I. R. B. 1054, 1054-55. Because pass-through tax status is a crucial element of RMBS' economic value, trusts are often structured to ensure that REMIC status is protected, such as by specifically limiting servicers' ability to modify loans in ways that would endanger REMIC status.
156. Accounting concerns dovetail with tax exemption requirements: both require the trust to be passively managed. The servicer is frequently the originator, and in order to ensure that the securitized assets may be removed from the originator's balance sheet and that the originator can recognize the gain on the sale of the mortgage loans in its transaction with the SPV, the SPV must be "qualified, " which means inter alia that the originator must have no control over the assets.
157. See ACCOUNTING FOR TRANSFERS AND SERVICING OF FIN. ASSETS AND EXTINGUISHMENTS OF LIABILITIES, Statement of Fin. Accounting Standards No. 140, ¶¶ 8-13 (Fin. Accounting Standards Bd. 2008), available at http://www.fasb.org/pdf/aop-FAS140.pdf (amending the 2000 version). Financial accounting standards do not specify what would constitute "control, " but the possibility of balance sheet consolidation makes originator-servicers chary of active management of securitized mortgages, including modification of their terms. Securities and Exchange Commission staff, however, have indicated that they do not believe that modifications of imminently defaulting loans would require on-balance sheet accounting.
158. Letter from Christopher Cox, SEC Chairman, to Rep. Barney Frank, Chairman of the Comm. on Fin. Servs., U. S. House of Representatives (July 24, 2007), available at http://financialservices.house.gov/072407SEC.pdf;
159. Letter from Conrad Hewitt, SEC Chief Accountant, to Arnold Hanish, Chairman of the Comm. on Corporate Reporting, Fin. Executives Int'l, and Sam Ranzilla, Chairman of the Prof 1 Practice Executive Comm., Am. Inst, of Certified Pub. Accountants (Jan. 8, 2008), available at http://www.sec.gov/info/ accountants/staffletters/hanish010808.pdf.
160. See OCC HANDBOOK, supra note 24, at 19-20.
161. See id. See also FRANK J. FABOZZI, ANAND K. BHATTACHARYA & WILLIAM S. BERLINER, MORTGAGE-BACKED SECURITIES: PRODUCTS, STRUCTURING, AND ANALYTICAL TECHNIQUES 23 (2007) ;
162. Patricia A. McCoy, Andrey D. Pavlov & Susan M. Wachter, Systemic Risk Through Securitization: The Result of Deregulation and Regulatory Failure, 41 CONN. L. REV. 1327, 1331-32 (2009).
163. See OCC HANDBOOK, supra note 24, at 24.
164. FABOZZI ET AL., supra note 88, at 22-24. Private-label securitization covers all securitization other than by Fannie Mae, Freddie Mac, and Ginnie Mae. Fannie Mae, Freddie Mac, and Ginnie Mae RMBS are not tranched for credit risk, as all GSE RMBS have a GSE credit guaranty and all Ginnie Mae RMBS bear a federal guaranty. Some Fannie Mae, Freddie Mac, and Ginnie Mae collateralized mortgage obligations ("CMOs") are tranched for prepayment priority, however, as a way of allocating interest rate risk.
165. See Standard & Poor's RatingsDirect, U. S. Housing's Long and Winding Road to Recovery 8 (Apr. 14, 2009), available at http://www2.standardandpoors. com/spf/pdfyfixedincorne/US-Housing-Long.pdf.
166. This is related to David Skeel's idea of a "pivotal" class in corporate bankruptcy.
167. See David Arthur Skeel, Jr., The Nature and Effect of Corporate Voting in Chapter 11 Reorganization Cases, 78 VA. L. REV. 461, 480 (1992).
168. 11 U. S. C. § 510 (a) (2006).
169. FABOZZI ET AL., supra note 88, at 23-24.
170. Id. at 23.
171. See McCoy et al., supra note 88, at 1331.
172. CDOs are often actively managed. Jennifer E. Bethel, Allen Ferrell & Gang Hu, Legal and Economic Issues in Litigation Arising from the 2007-2008 Credit Crisis 10-11 (John M. Olin Ctr. for Law, Econ. & Bus., Harvard Law Sch., Faculty Discussion Paper No. 612, 2008), available at http://ssm.com/ abstract=1096582.
173. See McCoy et al, supra note 88, at 1331.
174. See id.
175. FABOZZI ET AL, supra note 88, at 23;
176. McCoy et al, supra note 88, at 1331.
177. Lloyd Blankfein, Do Not Destroy the Essential Catalyst of Risk, FIN. TIMES (London), Feb. 8, 2009, at 7.
178. FABOZZI ET AL., supra note 88, at 199.
179. Id.
180. Id.
181. CMBS servicers cannot generally modify performing loans without risking adverse tax consequences for the trust. See Lingling Wei, New Rules Ease the Restructuring of CMBS Loans, WALL ST. J., Sept. 16, 2009, at C6 (noting that the U. S. Department of Treasury had relaxed some tax provisions in light of such adverse consequences).
182. See, e.g.. Bear Stearns Commercial Mortgage Securities Trust 2002-TOP6, Pooling and Servicing Agreement (Form 8-K), at EX-4.1 § 9.5 (c) (Apr. 3, 2002), available at hftp://www.secinfo.com/$/SEC/Registrant.asp?CIK=l 168574 ("Subject to the Servicing Standard and Sections 9.39 and 9.40, and the rights and duties of the Master Servicer under Section 8.18, the Special Servicer may enter into any modification, waiver or amendment (including, without limitation, the substitution or release of collateral or the pledge of additional collateral) of the terms of any Specially Serviced Mortgage Loan, including any modification, waiver or amendment to (i) reduce the amounts owing under any Specially Serviced Mortgage Loan by forgiving principal, accrued interest and/or any Prepayment Premium, (ii) reduce the amount of the Scheduled Payment on any Specially Serviced Mortgage Loan, including by way of a reduction in the related Mortgage Rate, (iii) forbear in the enforcement of any right granted under any Mortgage Note or Mortgage relating to a Specially Serviced Mortgage Loan, (iv) extend the Maturity Date of any Specially Serviced Mortgage Loan and/or (v) accept a principal prepayment on any Specially Serviced Mortgage Loan during any period during which voluntary Principal Prepayments are prohibited, provided, in the case of any such modification, waiver or amendment, that (A) the related Mortgagor is in default with respect to the Specially Serviced Mortgage Loan or, in the reasonable judgment of the Special Servicer, such default is reasonably foreseeable, (B) in the reasonable judgment of the Special Servicer, such modification, waiver or amendment would increase the recovery on the Specially Serviced Mortgage Loan to Certificateholders on a net present value basis (the relevant discounting of amounts that will be distributable to Certificateholders to be performed at related Mortgage Rate).... In no event, however, shall the Special Servicer (i) extend the Maturity Date of a Specially Serviced Mortgage Loan beyond a date that is two years prior to the Rated Final Distribution Date---") ;
183. Credit Suisse Commercial Mortgage rust/Series2007-C1http://www.secinfo. com/dRSm6.us2.c.htm#lstPage [hereinafter Credit Suisse 2007-C1 PSA] ("The Special Servicer (solely as to the Specially Serviced Mortgage Loans) or the Master Servicer (solely as to the Performing Mortgage Loans) may (consistent with the Servicing Standard) agree to any modification, waiver or amendment of any term of, extend the maturity of, defer or forgive interest (including Default Interest and Post-ARD Additional Interest) on and principal of, defer or forgive late payment charges and Yield Maintenance Charges on, permit the release, addition or substitution of collateral securing, and/or permit the release, addition or substitution of the Borrower on or any guarantor of, any Mortgage Loan....");
184. Credit Suisse Commercial Mortgage Trust Series 2007-C5, Pooling and Servicing Agreement (Form 8-K), at EX-4.1 § 3.20 (d) (Nov. 27, 2007), available at http://www.secinfo.com/dRSm6.u2fr.c.htm#ggyk [hereinafter Credit Suisse 2007-C5 PSA] ("Notwithstanding Sections 3.20 (a) (ii) and 3.20 (c), but subject to Sections 3.20 (e) and 3.20 (0), the Special Servicer may (i) reduce the amounts owing under any Specially Serviced Mortgage Loan by forgiving principal, accrued interest and/or any Yield Maintenance Charge or Static Prepayment Premium, (ii) reduce the amount of the Monthly Payment on any Specially Serviced Mortgage Loan, including by way of a reduction in the related Mortgage Rate, (iii) forbear in the enforcement of any right granted under any Note or Mortgage relating to a Specially Serviced Mortgage Loan, (iv) extend the maturity of any Specially Serviced Mortgage Loan, (v) waive Excess Interest if such waiver conforms to the Servicing Standard, (vi) permit the release or substitution of collateral for a Specially Serviced Mortgage Loan and/or (vii) waive a Yield Maintenance Charge or Static Prepayment Premium or accept a Principal Prepayment during any lockout period; provided that (A) the related Borrower is in default with respect to the Specially Serviced Mortgage Loan or, in the judgment of the Special Servicer, such default is reasonably foreseeable and (B) in the sole good faith judgment of the Special Servicer and in accordance with the Servicing Standard, such modification would result in recovery that equals or exceeds recovery for liquidation on the subject Mortgage Loan to Certificateholders... as a collective whole, on a present value basis (the relevant discounting of amounts that will be distributable to Certificateholders or a B Loan Holder or Companion Loan Holder to be performed at a rate not less than the related Mortgage Rate)."). CMBS PSAs will typically place limits on term stretchouts. Like RMBS PSAs, they limit term stretchouts to ensure that the trusts' revenues will have durations that match the trusts' obligations.
185. See. e.g.. Credit Suisse 2007-C5 PSA, supra note 105, § 3.11 (b) ;
186. id. § 1.01 (defining "Special Servicing Fee" and "Special Servicing Fee Rate" as thirty-five basis points per annum per loan, with a minimum $4000 per month, reducible by the Directing Certificateholder.).
187. See, e.g., id. § 3.11 (b) ("The Special Servicer shall also be entitled to additional servicing compensation in the form of a Workout Fee with respect to each Corrected Mortgage Loan at the Workout Fee Rate. The Workout Fee shall be payable out of, and shall be calculated by application of the Workout Fee Rate to, each collection of interest, other than Default Interest and Excess Interest, and principal... received on such Mortgage Loan for so long as it remains a Corrected Mortgage Loan. The Workout Fee with respect to any Corrected Mortgage Loan will cease to be payable if such Mortgage Loan again becomes a Specially Serviced Mortgage Loan; provided that a new Workout Fee will become payable if and when such Mortgage Loan again becomes a Corrected Mortgage Loan. ") ;
188. id. § 1.01 (defining "Workout Fee" and "Workout Fee Rate" as 1 percent).
189. See, e.g., id. § 3.03 (d) ("In connection with its recovery of any Servicing Advance... [the] Servicer, the Special Servicer and the Trustee shall each be entitled to receive... interest at the Reimbursement Rate in effect from time to time, accrued on the amount of such Servicing Advance from and including the date made to, but not including, the date of reimbursement....") ;
190. id. § 1.01 (defining "Reimbursement Rate" as "the Prime Rate") ;
191. Morgan Stanley Capital I Trust Commercial Mortgage 2007-Top25, Pooling and Servicing Agreement (Form 8-K), at EX-4.1 § 4.5 (Feb. 14, 2007) ("Any unreimbursed Advance funded from the Master Servicer's, the Special Servicer's or the Trustee's own funds shall accrue interest on a daily basis, at a per annum rate equal to the Advance Rate, from and including the date such Advance was made to but not including the date on which such Advance has been reimbursed....") ;
192. id. § 1.1 (defining "Advance Rate" as "a per annum rate equal to the Prime Rate as published in the 'Money Rates' section of The Wall Street Journal from time to time or such other publication as determined by the Trustee in its reasonable discretion").
193. There is variation in PSA terminology for this controlling shareholder.
194. See, e.g., Credit Suisse 2007-C5 PSA, supra note 105, § 1.01 (defining "Controlling Class" to be, "[a]s of any date of determination, the Class of Principal Balance Certificates with the lowest payment priority pursuant to Sections 4.01 (a) and 4.01 (b), that has a then outstanding Class Principal Balance that is not less than 25% of its initial Class Principal Balance; provided that, if no Class of Principal Balance Certificates has a Class Principal Balance that satisfies the foregoing requirement, then the Controlling Class shall be the Class of Principal Balance Certificates with the lowest payment priority pursuant to Sections 4.01 (a) and 4.01 (b), that has a then outstanding Class Principal Balance greater than zero... [and] [a]s of the Closing Date, the Controlling Class shall be the Class S Certificates") ;
195. id. (defining the "Series 2007-C5 Directing Certificateholder" as "[t]he particular Holder... of Certificates of the Controlling Class selected by the Holders... of Certificates representing more than 50% of the Percentage Interests in the Controlling Class...; provided, however, that until a Series 2007-C5 Directing Certificateholder is so selected or after receipt of a notice from the Holders... of Certificates representing more than 50% of the Percentage Interests in the Controlling Class that a Series 2007-C5 Directing Certificateholder is no longer designated, the particular Certificateholder... that beneficially owns Certificates of the Controlling Class that represents the largest aggregate Percentage Interest in the Controlling Class shall be the Series 2007-C5 Directing Certificateholder").
196. See, e.g., Credit Suisse 2007-C1 PSA, supra note 105, § 1.01 ("'Controlling Class' shall mean, as of any date of determination, the eligible Class of Principal Balance Certificates with the lowest payment priority pursuant to Sections 4.01 (a) and 4.01 (b), that has a then outstanding Class Principal Balance that is not less than 25% of its initial Class Principal Balance; provided that, if no eligible Class of Principal Balance Certificates has a Class Principal Balance that satisfies the foregoing requirement, then the Controlling Class shall be the eligible Class of Principal Balance Certificates with the lowest payment priority pursuant to Sections 4.01 (a) and 4.01 (b), that has a then outstanding Class Principal Balance greater than zero.... As of the Closing Date, the Controlling Class shall be the Class T Certificates.") ;
197. id. § 3.23 (a) ("The Holders... of Certificates representing more than 50% of the Class Principal Balance of the Controlling Class shall be entitled in accordance with this Section 3.23 to select a representative (each, a 'Controlling Class Representative') having the rights and powers specified in this Agreement (including those specified in Section 3.24) or to replace an existing Controlling Class Representative.").
198. See, e.g., id. § 3.24 (c) ("Each Certificateholder acknowledges and agrees, by its acceptance of its Certificates, that: (i) the Controlling Class Representative may have special relationships and interests that conflict with those of Holders of one or more Classes of Certificates; (ii) the Controlling Class Representative may act solely in the interests of the Holders of the Controlling Class; (iii) the Controlling Class Representative does not have any duties to the Holders of any Class of Certificates other than the Controlling Class (and with respect to such Controlling Class Holders shall have no liability for any action taken or omitted which does not constitute negligence, bad faith or willful misfeasance) ; (iv) the Controlling Class Representative may take actions that favor interests of the Holders of the Controlling Class over the interests of the Holders of one or more other Classes of Certificates; and (v) the Controlling Class Representative shall have no liability whatsoever for having so acted or for any action taken or omitted, and no Certificateholder may take any action whatsoever against the Controlling Class Representative or any director, officer, employee, agent or principal thereof for having so acted.").
199. See, e.g., id. § 3.24 (a) ("Upon reasonable request, the Special Servicer shall provide the Controlling Class Representative with any information in such Special Servicer's possession with respect to such matters [as foreclosure and modification and real estate-owned sales], including, without limitation, its reasons for determining to take a proposed action. The Master Servicer or the Special Servicer, as applicable, shall notify the Controlling Class Representative of any release or substitution of collateral for a Mortgage Loan even if such release or substitution is in accordance with the related Mortgage Loan Documents.") ;
200. id. § 11.10 ("The Trustee, the Master Servicer or the Special Servicer, as the case may be, shall deliver to the Controlling Class Representative a copy of each notice or other item of information such Person is required to deliver to the Rating Agencies pursuant to Section 11.09, in each case simultaneously with the delivery thereof to the Rating Agencies, to the extent not already delivered pursuant to this Agreement.").
201. See, e.g., id. § 3.24 (a) ("The Controlling Class Representative will be entitled to advise the Special Servicer with respect to the Special Servicer's taking, or consenting to the Master Servicer's taking, any of the actions identified in clauses (i) through (x) of the following sentence. In addition, notwithstanding anything in any other Section of this Agreement to the contrary, but in all cases subject to Section 3.20 (g) and Section 3.24 (b), the Special Servicer will not be permitted to take, or consent to the Master Servicer's taking, any of the actions identified in clauses (i) through (x) of this sentence, unless and until such Special Servicer has notified the Controlling Class Representative in writing of such Special Servicer's intent to take or permit the particular action and the Controlling Class Representative has consented (or has failed to object) thereto in writing within five Business Days of having been notified thereof in writing and having been provided with all reasonably requested information with respect thereto: (i) any proposed foreclosure upon or comparable conversion (which may include acquisitions of an REO Property) of the ownership of the property or properties securing any Specially Serviced Mortgage Loans as come into and continue in default; (ii) any modification, amendment or waiver of a monetary term (including any change in the timing of payments but excluding the waiver of Default Charges) or any material non-monetary term (excluding any waiver of a 'due-on-sale' or 'due-on-encumbrance' clause, which clauses are addressed in clause (ix) below) of a Mortgage Loan; (iii) any acceptance of a discounted payoff with respect to any Specially Serviced Mortgage Loan; (iv) any proposed sale of an REO Property for less than the Stated Principal Balance of, and accrued interest (other than Default Interest and Post-ARD Additional Interest) on, the related Mortgage Loan, except in connection with a termination of the Trust Fund pursuant to Section 9.01; (v) any determination to bring an REO Property into compliance with applicable environmental laws or to otherwise address Hazardous Materials located at an REO Property; (vi) any release of collateral for any Mortgage Loan (other than in accordance with the specific terms which do not provide for lender discretion of, or upon satisfaction of, such Mortgage Loan) ; (vii) any acceptance of substitute or additional collateral for any Specially Serviced Mortgage Loan (other than in accordance with the specific terms of such Mortgage Loan) ; (viii) any release (other than in accordance with the related Mortgage Loan Documents and in an amount less than $50, 000) of Earn-Out Reserve Funds or related Letter of Credit with respect to a Mortgaged Property securing a Mortgage Loan; (ix) any waiver of a due-on-sale or due-on-encumbrance clause in any Mortgage Loan; and (x) any consent to a change in franchise with respect to a hospitality loan or a change in the property manager of a Mortgage Loan with a principal balance greater than $5, 000, 000; provided that, if the Special Servicer or the Master Servicer, as applicable, determines that immediate action is necessary to protect the interests of the Certificateholders (as a whole), the Special Servicer or the Master Servicer, as the case may be, may take any such action without waiting for the response of the Controlling Class Representative to the Special Servicer. In addition, subject to Section 3.24 (b), the Controlling Class Representative may direct the Special Servicer to take, or to refrain from taking, such actions as such Controlling Class Representative may deem advisable or as to which provision is otherwise made herein. Upon reasonable request, the Special Servicer shall provide the Controlling Class Representative with any information in such Special Servicer's possession with respect to such matters, including, without limitation, its reasons for determining to take a proposed action. The Master Servicer or the Special Servicer, as applicable, shall notify the Controlling Class Representative of any release or substitution of collateral for a Mortgage Loan even if such release or substitution is in accordance with the related Mortgage Loan Documents.").
202. See, e.g., id. § 3.24 (b) ("Notwithstanding anything herein to the contrary, (i) the Special Servicer shall not have any right or obligation to consult with or to seek and/or obtain consent or approval from the Controlling Class Representative prior to acting... and (ii) no advice, direction or objection from or by the Controlling Class Representative, as contemplated by Section 3.24 (a) or any other provision of this Agreement, may (and the Master Servicer and Special Servicer shall ignore and act without regard to any such advice, direction or objection that such Master Servicer or Special Servicer, as the case may be, has determined, in its reasonable judgment, would) (A) require or cause the Master Servicer, such Special Servicer or the Trustee to violate applicable law, the terms of any Mortgage Loan or any other Section of this Agreement, including such Master Servicer's or Special Servicer's obligation to act in accordance with the Servicing Standard, (B) result in an Adverse REMIC Event with respect to either Trust REMIC or an Adverse Grantor Trust Event with respect to the Grantor Trust, (C) expose the Trust, the Depositor, the Master Servicer, the Special Servicer, the Trustee, or any of their respective Affiliates, members, managers, officers, directors, employees or agents, to any material claim, suit or liability, or (D) expand the scope of the Master Servicer's or Special Servicer's responsibilities under this Agreement").
203. See, e.g., id. § 3.25 (a) ("Subject to Section 3.25 (b), the Controlling Class Representative may, upon not less than ten days' prior written notice to the respective parties hereto, remove any existing Special Servicer hereunder (with or without cause) and appoint a successor Special Servicer; provided that, if any such removal is made without cause, men the costs of transferring the special servicing responsibilities to a successor Special Servicer will, upon such removal or other termination, be paid by the Certificateholders of the Controlling Class.") ;
204. Credit Suisse 2007-C5 PSA, supra note 105, § 7.01 (d) ("The Series 2007-C5 Directing Certificateholder shall be entitled to terminate the rights and obligations of the Special Servicer under this Agreement, with or without cause, upon 10 Business Days prior written notice to the Master Servicers, the Special Servicer and the Trustee, and to appoint a successor Special Servicer....").
205. See Levitin & Twomey, supra note 20, at 68-69 (discussing the limitations of reputational discipline for RMBS servicers).
206. Cf. Hunt, supra note 59, at 10-12 (recommending the implementation of certain measures that would facilitate interpreting PSAs as allowing mortgage loan modification).
207. This appears to have been the case with Ocwen Financial, a major subprime servicer that began doing principal modifications of defaulted mortgages it serviced without regard to PSAs.
208. See Kate Berry, Debt Forgiveness: Ocwen Enters Uncharted Waters, AM. BANKER, June 24, 2008, at 1. Ocwen lacked a captive funding source, so foreclosures were very expensive for it, as it was obligated to make servicing advances of principal and interest on foreclosed mortgages until it realized funds on the property. Servicing advances are recoverable, but without interest, so the time value can place a heavy strain on a servicer's liquidity.
209. See, e.g., Greenwich Complaint, supra note 56, ¶ 3 ("The... object of this action is a declaration that, under the substantially identical agreements that govern the trust that sold the securities owned by plaintiffs and the 373 other trusts in the CWL and CWALT securitizations that sold the securities owned or held by other members of the plaintiff class, Countrywide is required to purchase any loan on which it agrees to reduce the payments [as required by the terms of the PSA].").
210. See Posting of Joe Nocera to N. Y. Times Executive Suite, http://executivesuite.blogs.nytimes.com/2008/11/18/what-securitization-problem- the-fdic-weighs-in / (Nov. 18, 2008, 18: 45 EST) (citing both industry arguments that securitization contracts preclude modification and the FDIC's contrary interpretation). At a minimum, this suggests that the contractual framework was designed to be rigid and is perceived as such by the relevant market actors, and that the FDIC feels less legally and financially constrained than private actors to test the limits of the contractual framework.
211. See COMPTROLLER OF CURRENCY, U. S. DEP'T OF TREASURY, OCC AND OTS MORTGAGE METRICS REPORT: DISCLOSURE OF NATIONAL BANK AND FEDERAL THRIFT MORTGAGE LOAN DATA, FOURTH QUARTER 2008, at 23 (2009), available at http://www.occ. treas.gov/ftp/release/2009-37a.pdf (finding significantly higher redefault rates for securitized loans than for other loans and attributing the difference to the decreased flexibility of securitized loans) ;
212. Alan M. White, Rewriting Contracts, Wholesale: Data on Voluntary Mortgage Modifications from 2007 and 2008 Remittance Reports, 36 FORDHAM URB. L. J. 509, 525-29 (2009) (interpreting modification data to suggest virtually no reduction in payment flows to securitization vehicles) ;
213. Tomasz Piskorski, Amit Seru & Vikrant Vig, Securitization and Distressed Loan Renegotiation: Evidence from the Subprime Mortgage Crisis 1-2, 21-22 (Univ. of Chi. Booth Sch. of Bus., Working Paper No. 09-02, 2008), available at http://papers.ssm.com/sol3/papers.cfm?abstract-id=1321646 (finding less renegotiation and more foreclosures among securitized loans than among those held directly by the lender).
214. See Hunt, supra note 59. Hunt's empirical study of PSA language is extremely valuable, but the question it explores does not cover the full range of contract rigidity.
215. See, e.g., Lee C. Buchheit, How Ecuador Escaped the Brady Bond Trap, INT'L FIN. L. REV., Dec. 2000, at 17 (describing a debt restructuring in the face of an explicit prohibition and a unanimous consent requirement for modification).
216. E.g., Greenwich Complaint, supra note 56. To date, litigation over improper servicing action has not materialized, excluding the Greenwich Financial Services case, which was predicated on Countrywide's unique PSAs, as well as Countrywide's settlement with the California and Illinois attorneys general, in which Countrywide pledged to modify mortgages it had securitized and was servicing.
217. See, e.g., Stipulated Judgment and Injunction ¶ 6.3. 1-3, People v. Countrywide Fin. Corp., No. LC083076 (Cal. Super. Ct. Oct. 20, 2008), available at http://ag.ca.gov/cms-attachments/press/pdfs/nl618-cw-judgment.pdf.
218. See also David Greising, Deal to Help 21, 000 in State Keep Homes, CHI. TRIB., Oct. 6, 2008, at C1.
219. See, e.g., Manuel Adelino, Kristopher Gerardi & Paul S. Willen, Why Don't Lenders Renegotiate More Home Mortgages? Redefaults, Self-Cures, and Securitization (Fed. Reserve Bank of Atlanta, Working Paper No. 2009-17, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=1433777 (comparing the incidence of modification between securitized and portfolio loans and arguing that redefault risk, not securitization, is responsible for low rates of modification). The authors also note the rarity of explicit modification bans in securitization contracts.
220. Id. at 24. On the other hand, recent government data suggest a dramatic difference in the type of modification effected by portfolio and investor-held mortgages: the latter accounted for eight out of 17, 574 principal reductions in the first two quarters of 2009, despite there being more than twice as many investor-held mortgages modified (223, 274 compared to 104, 244).
221. See Cong. Oversight Panel, October Oversight Report: An Assessment of Foreclosure Mitigation Efforts After Six Months 56, 57 fig.21, 59 fig.23 (Oct. 9, 2009), available at http://cop. senate.gov/documents/cop-100909-report.pdf. Similarly, term extensions are rare for private-label securitization mortgage modifications, but not for loans in portfolio.
222. Id. at 60 fig.24, 61 fig.25. Relating this research and data to the underlying law and institutions is a rich subject for further empirical study.
223. See supra notes 120-21, 125.
224. Beatty v. Guggenheim Exploration Co., 122 N. E. 378, 381 (N. Y. 1919). The clause at issue was a bar on oral modification.
225. See id.
226. See, e.g., PATRICK BOLTON & MATHIAS DEWATRIPONT, CONTRACT THEORY 573-75 (2005) ;
227. Kevin E. Davis, The Demand for Immutable Contracts: Another Look at the Law and Economics of Contract Modifications, 81 N. Y. U. L. REV. 487, 494-504 (2006) (describing four situations in which immutability would be theoretically desirable) ;
228. Christine Jolls, Contracts as Bilateral Commitments: A New Perspective on Contract Modification, 26 J. LEGAL STUD. 203, 210-24 (1997) ;
229. Alan Schwartz & Robert E. Scott, Contract Theory and the Limits of Contract Law, 113 YALE L. J. 541, 611-14 (2003).
230. See Jolls, supra note 128, at 209-19.
231. Cf. Levitin & Twomey, supra note 20, at 89 (suggesting that servicers would be more likely to accept prohibitions of modification-barring provisions if such prohibitions were accompanied by clarifications that servicers owed duties of care to all beneficiaries as opposed to individual tranches).
232. See Davis, supra note 128 (noting coordination problems in contracts involving multiple parties).
233. The signaling mechanism may be ineffective where, for example, good and bad borrowers alike can easily adopt contracts that bar modification. See. e.g., Anna Gelpern & Mitu Gulati, Public Symbol in Private Contract: A Case Study, 84 WASH. U. L. REV. 1627, 1712 (2006).
234. See Mark J. Roe, The Voting Prohibition in Bond Workouts, 97 YALE LJ. 232, 250-52 (1987) (noting that William O. Douglas and the Securities and Exchange Commission intended immutability to induce bankruptcy because of their distrust of insider control of bond issues).
235. Id. at 235-39 (referring to minority holdups as the "buoying up effect").
236. See also Michael W. McConnell & Randal C. Picker, When Cities Go Broke: A Conceptual Introduction to Municipal Bankruptcy, 60 U. Chi. L. Rev. 425, 449-50 (1993) (citing municipal bondholder complaints about unanimity as an obstacle to compromise in 1933).
237. See, e.g., Roe, supra note 132, at 266-67 (discussing the flaws of immutability as a "bondholder protection").
238. See H. COMM. ON INTERSTATE & FOREIGN COMMERCE, H. R. REP. NO. 1016, TRUST INDENTURE BILL OF 1939, at 24, 30-33 (1939) ;
239. S. COMM. ON BANKING & CURRENCY, S. REP. SNO. 248, TRUST INDENTURE ACT OF 1939, at 4-8 (1939). Roe and others observe that these stories were in fact unusual because the law of negotiable instruments at the time gave each bondholder veto power over the terms of his contract as a condition of negotiability.
240. See, e.g.. Lee C. Buchheit & G. Mitu Gulati, Sovereign Bonds and the Collective Will, 51 EMORY L. J. 1317, s1332 (2002) ;
241. Roe, supra note 132, at 256-57 (citing Enoch v. Brandon, 220 N. Y. S. 294, 296 (1927), and contemporaneous treatises).
242. Trust Indenture Act (TIA) of 1939, 15 U. S. C. §§ 77aaa-77bbbb (2006).
243. The consent provisions of the TIA also served another function: they protected bondholders against conflicts of interest between bond trustees and bond issuers. The TIA's restrictions responded to the widespread chicanery in the real estate bond market in the 1920s and '30s. The likes of "Straus bonds, " "Greenebaum bonds, " and "Miller bonds" financed the construction of Manhattan's most famous art deco skyscrapers. See JAMES GRANT, MONEY OF THE MM) : BORROWING AND LENDING IN AMERICA FROM THE CIVIL WAR TO MICHAEL MILKEN 162-69 (1992). These were single-asset real estate bonds, issued against the earning power of a particular mortgaged building, often not yet completed. Real estate bonds of the '20s and '30s featured all manner of self-dealing and conflicts of interest, including having the underwriter or the underwriter's affiliate serve as bond indenture trustee. A "pet trustee" did not serve as an effective monitor of bond performance or advocate for the bondholders. Such malfeasances were a major impetus for the TIA's enactment. Indeed, the Act's original list of conflicts of interest was essentially a description of the real estate bond industry.
244. See TIA § 310, 15 U. S. C. §77jjj. Single-asset real estate bonds were in some ways forerunners of securitization as they provided a dedicated cashflow to investors based on real estate mortgage payments. They also were forerunners of the CDO-a securitization vehicle whose assets (which might be actively managed) consist heavily of interests in other securitizations. Thus, S. W. Straus & Co. was, by the mid-1920s, marketing "collateral trust bonds, " which were described by a court as "a potpourri of indifferent subordinate mortgages owned by the borrower and pledged as security, besides debentures of corporations owning real estate."
245. GRANT, supra, at 163. Interestingly, it appears that the market began to respond to the problems of single-asset real estate bonds before the TIA. For example, the single-asset real estate bonds at issue in the famous case of Aladdin Hotel, which were issued in 1938, contained a contractual unanimous consent provision. Aladdin Hotel Co. v. Bloom, 200 F.2d 627, 628-30 (8th Cir. 1953). The Aladdin still stands in downtown Kansas City.
246. The reasons for this are disputed and, in any case, irrelevant here. Sovereign bonds are specifically exempt from the TIA. See 15 U. S. C. § 77dd. Conventional wisdom holds that unanimity provisions were mindlessly copied from corporate bond indentures
247. see Buchheit & Gulati, supra note 135, at 1331, or naively inserted in Brady bonds, which represented restructured loans, to deter redefault
248. see James Hurlock & Troy Alexander, The Fire Next Time: The Dangers in the Next Debt Crisis, INT'L FIN. L. REV., Mar. 1996, at 14, 14-15 (discussing the development of Brady bonds).
249. See, e.g., Anne Krueger, First Deputy Managing Dir., IMF, International Financial Architecture for 2002: A New Approach to Sovereign Debt Restructuring, Address at the National Economists' Club Annual Members' Dinner (Nov. 26, 2001), available at http://www.imf.org/extemal/np/speeches/2001/112601.htm.
250. See Roe, supra note 132, at 232-35.
251. See generally BARRY EICHENGREEN ET AL. CRISIS? WHAT CRISIS? ORDERLY WORKOUTS FOR SOVEREIGN DEBTORS (1995) (arguing for majority modification provisions in sovereign bond contracts) ; Hurlock & Alexander, supra note 138 (arguing that new rigid sovereign bonds will be more difficult to manage in distress than older sovereign loans).
252. See, e.g., Jeremy Bulow & Kenneth Rogoff, Multilateral Developing-Country Debt Rescheduling Negotiations: A Bargaining-Theoretic Framework (IMF, Working Paper No. 88/35, 1988), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=884729 (referring to sovereign debt restructuring as a tripartite negotiation with creditor country taxpayers) ;
253. John B. Taylor, Under Sec'y of the Treasury for Int'l Affairs, Sovereign Debt Restructuring: A U. S. Perspective, Remarks at "Sovereign Debt Workouts: Hopes and Hazards?" Institute for International Economics Conference (Apr. 2, 2002), available at http://www.treasury.gov/press/releases/ po2056.htm (suggesting an official subsidy for debtors and creditors to adopt collective action provisions in sovereign bonds).
254. See supra note 128 and accompanying text. For a discussion of how to deal with a defaulting sovereign, see, for example, Arturo C. Porzecanski, From Rogue Creditors to Rogue Debtors: Implications of Argentina's Default, 6 CHI. J. INT'L L. 311, 326-32 (2005) (examining the specific case of Argentina in the 1990s).
255. To some extent all sovereign debtors must be good debtors since, as Walter Wriston observes, countries never go bankrupt. Walter B. Wriston, Banking Against Disaster, N. Y. TIMES, Sept. 14, 1982, at A27.
256. See also FEDERICO STURZENEGGER & JEROMIN ZETTELMEYER, DEBT DEFAULTS AND LESSONS FROM A DECADE OF CRISES 38 (2006) (arguing that the effort to disentangle ability and willingness to pay may be futile).
257. This is the case, for example, with embassies and military bases.
258. See CIBC Bank & Trust Co. v. Banco Central do Brasil, 886 F. Supp. 1105, 1107 (S. D. N. Y. 1995) (considering a case in which the creditors of Brazil sought to prevent a Brazilian government instrumentality from voting Brazilian government debt) ; William W. Bratton & G. Mini Gulati, Sovereign Debt Reform and the Best Interest of Creditors, 57 VAND. L. REV. 1, 56-60 (2004) (citing Patrick Bolton & David S. Scharfstein, Optimal Debt Structure and the Number of Creditors, 104 J. POL. ECON. 1 (1996)) ;
259. id. at 64-71 (arguing for intercreditor good faith duties) ;
260. Buchheit & Gulati, supra note 135, at 1339-42 (analyzing the facts of the CIBC case and considering the implications regarding how courts will treat intercreditor duties of sovereign debtors). Some have argued that "insider" status should extend to all institutions regulated by the sovereign borrower. Emerging Mkts. Creditors Ass'n, Model Covenants for New Sovereign Debt Issues 1 (May 3, 2002) (on file with authors).
261. See Gelpern & Gulati, supra note 131, at 1628-29.
262. See id. at 1712.
263. For example, Ecuador, Argentina, and Uruguay, among others, established corporate restructuring tools, such as exchange offers and exit consents, to limit the impact of unanimity. See STURZENEGGER & ZETTELMEYER, supra note 144, at 147-201, 211-26.
264. See also Buchheit, supra note 123.
265. See Davis, supra note 128;
266. Roe, supra note 132. Moreover, while Roe favors contractual composition and majority voting, Davis appears to take no position on immutability as such, even as he comes out against enforcement of no-amendment clauses.
267. See infra Part V.
268. See, e.g., Kurt Eggert, Comment on Michael A. Stegman et al. 's "Prevenlative Servicing Is Good for Business and Affordable Homeownership Policy": What Prevents Loan Modifications?, 18 HOUSING POL'Y DEBATE 279, 290-91 (2007) (describing how tranche warfare acts as a barrier to modification).
269. Elizabeth Wan-en & Jay Lawrence Westbrook, Contracting Out of Bankruptcy: An Empirical Intervention, 118 HARV. L. REV. 1197, 1199 & sn. 6 (2005).
270. See. e.g., Robert K. Rasmussen, Debtor's Choice: A Menu Approach to
271. Warren & Westbrook, supra note 153, at 1201 (stating that contractualists believe "that a bankruptcy regime negotiated in the marketplace will be far more efficient than the standardized 'contract' provided by Congress in the Bankruptcy Code").
272. The creditors' bargain theory explains bankruptcy law as reflecting the bargain that creditors would reach about the disposition of an insolvent firm absent coordination problems. See, e.g., Thomas H. Jackson, Bankruptcy, Non-Bankruptcy Entitlements and the Creditors' Bargain, 91 YALE L. J. 857, 860 (1982). The driving insight of the creditors' bargain theory is that bankruptcy is designed to overcome a common pool problem and prevent a destructive race to seize the firm's assets.
273. See, e.g., id.; JACKSON, supra note 67, at 7-19;
274. Douglas G. Baud & Thomas H. Jackson, Bargaining After the Fall and the Contours of the Absolute Priority Rule, 55 U. CHL. L. REV. 738 (1988) vt (explaining how the absolute priority rule deals with these issues in various contexts) ;
275. Douglas G. Baird & Thomas H. Jackson, Corporate Reorganizations and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy, 51 U. CHI. L. REV. 97, 105-09 (1984) [hereinafter Baird & Jackson, Corporate Reorganizations];
276. Douglas G. Baird, Loss Distribution. Forum Shopping, and Bankruptcy: A Reply to Warren, 54 U. CM. L. REV. 815 (1987).
277. SCHWARCZ et AL., supra note 22, at 54.
278. Douglas G. Baird, The Uneasy Case for Corporate Reorganizations, 15 J. LEGAL STUD. 127, 145-46 (1986).
279. See Lucian Arye Bebchuk, A New Approach to Corporate Reorganizations, 101 HARV. L. REV. 775, 776-77 (1988). Bebchuk called for an automated bankruptcy, aimed at avoiding a fire sale and a judicial valuation. Id. In Bebchuk's design, absolute priority (determined ex ante by contract) would be enforced in all reorganizations and liquidations through a system in which existing classes of creditors and equity holders would be required to purchase all senior interests at face value or forfeit their own interest.
280. Id. at 785-88. The lowest priority class to bid in would own the company, with everyone senior being paid in full.
281. Id. at 782-83, 785-88. The seniority of classes of creditors would be contractually determined and would include the bankruptcy bidding option.
282. See id. at 781-88.
283. See Philippe Aghion, Oliver Hart & John Moore, The Economics of Bankruptcy Reform, 8 J. L. ECON. & ORG. 523 (1992). Aghion, Hart, and Moore responded to Bebchuk's proposal with one in which a judge would allocate rights in the bankrupt firm among the claims holders and solicit bids for control of the firm.
284. Id. at 524. As they explained, [The] proposed scheme is a decentralized variant on Chapter 7, in which noncash (as well as cash) bids are allowed, and ownership of the firm is homogenized (to all equity), so that the owners can decide (by vote) which of the bids to accept. However, insofar as noncash bids allow for reorganization/recapitalization, [the] proposal can also be viewed as a decentralized version of Chapter 11, in which conflicts of interest among different claimant groups are avoided through homogenization of ownership. Id. (footnote omitted).
285. See Barry E. Adler, Financial and Political Theories of American Corporate Bankruptcy, 45 STAN. L. REV. 311, 319-24 (1993) [hereinafter Adler, Financial Theories]. Adler rejects the common pool justification for bankruptcy and proposes an alternative automated bankruptcy regime in which an insolvent firm's equity is transferred to the highest-priority class of creditors that cannot be paid on time rather than using a bidding process. This process would be specified under the terms of financial instruments issued by the firm.
286. See Barry E. Adler, Finance's Theoretical Divide and the Proper Role of Insolvency Rules, 67 S. CAL. L. REV. 1107, 1110 & sn. 13 (1994) (arguing that "Chameleon Equity"-a multipriority contractual hierarchy of preferred equity-would better resolve financial distress than bankruptcy legislation) ;
287. Adler, Financial Theories, supra, at 323-33 (same) ;
288. Barry E. Adler, A Theory of Corporate Insolvency, 72 N.s. Y. U. L. REV. 343, 352-57 (1997) (same) ;
289. Barry E. Adler, A World Without Debt, 72 WASH. U. L. Q. 811 (1994) (same).
290. See Michael Bradley & Michael Rosenzweig, The Untenable Case for Chapter 11, 101 YALE L. J. 1043, 1078 (1992).
291. Rasmussen has proposed a different model of contract bankruptcy where firms may choose a bankruptcy regime in their organizational charter from a menu of state-provided options. The choice would be locked in unless every creditor consented to change it. Because creditors would know the applicable bankruptcy regime before extending credit, they could price accordingly. The firm would thus be able to balance between lower present costs of capital and greater bankruptcy protection in the future, which would produce (absent hyperbolic discounting) the most efficient outcome. Involuntary creditors would continue to be protected by mandatory rules, since they would not price credit based on the organizational choices of their debtor. See Rasmussen, supra note 154.
292. Schwartz has proposed another model of contractual bankruptcy, where firms and their creditors choose between a contractually locked-in ("renegotiation-proof) insolvency regime and one that is chosen by the firm (a "renegotiation contract" regime). Alan Schwartz, Essay, A Contract Theory Approach to Business Bankruptcy, 107 YALE L. J. 1807, 1827-30 (1998) [hereinafter Schwartz, Contract Theory Approach]. A "'renegotiation-proof contract... will induce the firm to choose the optimal bankruptcy system in the event of insolvency."
293. Id. at 1827. Absent the entry of a new creditor, however, the terms of the contract to ensure the optimal bankruptcy regime would remain locked in. "The contract is called renegotiation proof because no party will have an incentive to propose changes in it in light of later events."
294. Id. Alternatively, in a "renegotiation contract" regime, creditors rely on the unincentivized firm to choose the optimal bankruptcy regime. If reorganization is likely to have a sufficiently higher value than liquidation, creditors would do better under a renegotiation regime. To address the concern that the optimal bankruptcy regime may change over time, Schwartz introduces a middle ground between lock-in and firm choice-a "partially renegotiation-proof contract" in which a firm's creditors' renegotiation-proof contracts are adjusted to reflect the deal negotiated by the newest creditor of the firm.
295. See id. at 1831. Such a readjustment would ensure that the firm remains incentivized to choose the optimal regime.
296. See id. at 1827. To ensure an optimal renegotiation-proof contract, the firm must be bribed to permit it to keep a percentage of the insolvency monetary return, regardless of the specific regime. This will incentivize the firm to choose the regime that maximizes monetary returns so long as it is a high enough percentage to offset any private benefits the firm wishes to consume.
297. See id. at 1827.
298. See also Alan Schwartz, Essay, Bankruptcy Contracting Reviewed, 109 YALE L. J. 343, 343 (1999) ("If the rule against contracting for a preferred bankruptcy system were relaxed, parries would write 'bankruptcy contracts' that would induce a borrowing firm to choose the system that would be optimal for it and its creditors were it to become insolvent.").
299. See, e.g., Christopher W. Frost, Bankruptcy Redistributive Policies and the Limits of the Judicial Process, 74 N. C. L. REV. 75, 85-91 (1995) (describing the debate over the efficiency as a valid criterion) ;
300. Donald R. Korobkin, Rehabilitating Values: A Jurisprudence of Bankruptcy, 91 COLUM. L. REV. 717, 762 (1991) ("At best, the economic account offers an undermining explanation of a bankruptcy system that recognizes noneconomic outcomes as independent values. At worst, the economic account does not explain 'bankruptcy law' at all, but merely restates its own economic assumptions---In contrast, the value-based account is founded on a deeper understanding of the concern to which bankruptcy law is addressed. Bankruptcy law is a response to the problem of financial distress-not only as an economic, but as a moral, political, personal, and social problem that affects its participants.") ;
301. Donald R. Korobkin, The Role of Normative Theory in Bankruptcy Debates, 82 IOWA L. REV. 75 (1996) (examining the debate over normative justifications for bankruptcy policy) ;
302. Lawrence Ponoroff & F. Stephen Knippenberg, The Implied Good Faith Filing Requirement: Sentinel of an Evolving Bankruptcy Policy, 85 NW. U. L. REV. 919, 962 (1991) (counseling against "any closed-end theory or understanding of the law") ;
303. Elizabeth Warren, Essay, Bankruptcy Policymaking in an Imperfect World, 92 MICH. L. REV. 336, 336-40 (1993) [hereinafter Warren, Bankruptcy Policymaking]. Other important considerations have been proposed.
304. See, e.g., Jean Braucher, Bankruptcy Reorganization and Economic Development, 23 CAP. U. L. REV. 499, 517-18 (1994) (arguing for the need to protect employee interest because of inability to diversify labor capital) ;
305. Donald R. Korobkin, Employee Interests in Bankruptcy, 4 AM. BANKR. INST. L. REV. 5 (1996) (arguing for the need to protect employee interest because of inability to diversify labor capital) ;
306. Raymond T. Nimmer, Negotiated Bankruptcy Reorganization Plans: Absolute Priority and New Value Contributions, 36 EMORY L. J. 1009, 1032-34 (1987) ;
307. Warren, Bankruptcy Policymaking, supra, at 352-61 (suggesting various distributional goals besides economic efficiency and emphasizing the need to internalize costs of business failure) ;
308. Elizabeth Warren, A Theory of Absolute Priority, 1991 ANN. SURV. AM. L. 9 (arguing for the need to account for the interests of the community, including potential customers, suppliers of the firm, and taxing authorities).
309. See, e.g., Lucian Arye Bebchuck & Jesse M. Fried, The Uneasy Case for the Priority of Secured Claims in Bankruptcy, 105 YALE L. J. 857 (1996) ;
310. Susan Block-Lieb, The Logic and Limits of Contract Bankruptcy, 2001 U. ILL. L. REV. 503, 548-49 (citing transaction costs) ;
311. Lynn M. LoPucki, The Case for Cooperative Territoriality in International Bankruptcy, 98 MICH. L. REV. 2216, 2243 (2000) ;
312. Jay Lawrence Westbrook, The Control of Wealth in Bankruptcy, 82 TEX. L. REV. 795, 830-37 (2004).
313. See generally Lynn M. LoPucki, Essay, Contract Bankruptcy: A Reply to Alan Schwartz, 109 YALE L. J. 317 (1999) (criticizing Schwartz's model) ; Warren & Westbrook, supra note 153 (using empirical data to critique the contractualist position).
314. See Rasmussen, supra note 54, at 114-16 (discussing the adverse selection problem) ;
315. Warren & Westbrook, supra note 153, at 1201-02.
316. Warren & Westbrook, supra note 153, at 1201-02.
317. See id. at 1202.
318. See Randal C. Picker, Security Interests, Misbehavior, and Common Pools, 59 U. CHI. L. REV. 645, 649-53 (1992) (noting various ways in which secured credit can serve as a bankruptcy contract) ;
319. Steven L. Schwarcz, Rethinking Freedom of Contract: A Bankruptcy Paradigm, 77 TEX. L. REV. 515, 597-99 (1999) (suggesting that securitization transactions should be enforceable as bankruptcy waiver contracts).
320. Cf. Schwartz, Contract Theory Approach, supra note 163, at 1833 ("Because bankruptcy contracts are currently illegal, there is no data about real contracts that could support [the argument that differences in creditor preferences of bankruptcy systems could be overcome].").
321. This is sometimes reinforced by covenants. See supra note 75. The major exception would be claims and counterclaims from obligors on the SPV's assets.
322. Schwartz, Contract Theory Approach, supra note 163, at 1833.
323. See supra Part III. C-D.
324. See, e.g., Schwartz, Contract Theory Approach, supra note 163, at 1814.
325. E.g., id. at 1817 ("It is unnecessary for bankruptcy law to protect communities when thick markets exist. In a thick market, there are good substitutes for the firm's performance.") ;
326. Baird & Jackson, Corporate Reorganizations, supra note 155, at 101-02 ("The failure of a firm affects many who do not, under current law, have cognizable ownership interests in the firm outside of bankruptcy. The economy of an entire town can be disrupted when a large factory closes. Many employees may be put out of work. The failure of one firm may lead to the failure of those who supplied it with raw materials and those who acquired its finished products. Some believe that preventing such consequences is worth the costs of trying to keep the firm running and justifies placing burdens on a firm's secured creditors." (footnote omitted)).
327. So thoroughly has the firm-centered framing of the bankruptcy debate taken root that even its most vigorous critics, such as Warren, ultimately succumb to it after expanding the list of constituents slightly to include communities surrounding the firm.
328. See, e.g., Warren, Bankruptcy Policymaking, supra note 164, at 352-61 (suggesting various distributional goals besides economic efficiency).
329. See supra notes 104-17 and accompanying text.
330. Compare Adelino et al., supra note 125, at 14, 25-26 (finding a small role for contract frictions in the context of renegotiation and suggesting that modifications were not necessarily in the best interest of investors)
331. with Cong. Oversight Panel, supra note 125 (noting differences in modification type based on securitization status).
332. See Levitin & Twomey, supra note 20, at 73-75 (discussing cognitive issues in mortgage lending).
333. See also Bar-Gill, supra note 2 (explaining how the contractual design features of subprime loans can be explained as responses to the imperfect rationality of borrowers).
334. See. e.g., WILLIAM C. APGAR & MARK DUDA, COLLATERAL DAMAGE: THE MUNICIPAL IMPACT OF TODAY'S MORTGAGE FORECLOSURE BOOM 6 (2005), available at http://www.995hope.org/content/pdf7Apgar-Duda-Study-Short-Version. pdf;
335. Dan Immergluck & Geoff Smith, The Impact of Single-Family Mortgage Foreclosures on Neighborhood Crime, 21 HOUSING STUD. 851, 855-56 (2006).
336. See. e.g., APGAR & DUDA, supra note 179, at 5;
337. DAN IMMERGLUCK & GEOFF SMITH, WOODSTOCK INST., THERE GOES THE NEIGHBORHOOD: THE EFFECT OF SINGLE-FAMILY MORTGAGE FORECLOSURES ON PROPERTY VALUES (2005), available at http://www.woodstockinst.org/index.php?option=com- docman&task=doc-download&gid=52 (estimating that in Chicago the 3750 foreclosures that took place between 1997 and 1998 reduced surrounding property values by almost $6 million) ;
338. Dan Immergluck & Geoff Smith, The External Costs of Foreclosure: The Impact of Single-Family Mortgage Foreclosures on Property Values, 17 HOUSING POL'Y DEBATE 57 (2006) (same).
339. See GLOBAL INSIGHT, THE MORTGAGE CRISIS: ECONOMIC AND FISCAL IMPLICATIONS FOR METRO AREAS 2 (2007), available at http://www.vacantproperties.org/ resources/documents/USCMmortgagereport.pdf;
340. John Kroll, Foreclosure Study Says Vacant Properties Cost Cleveland §35+ Million, PLAIN DEALER (Cleveland), Feb. 19, 2008, available at http://blog.cleveland.com/metro/2008/02/foreclosure-study-says-vacant.html.
341. See Adam J. Levitin, Helping Homeowners: Modification of Mortgages in Bankruptcy, 3 HARV. L. & POL'Y REV. ONLINE 1, 1 (2009), http://www. hlpronline.com/Levitin-HLPR-011909.pdf; Levitin, supra note 46, at 569.
342. See Daniel Denoon, Foreclosures Worsen Spread of West Nile, CBSNEWS. COM, Oct. 23, 2008, http://www.cbsnews.com/stories/2008/10/02/health/webmd/ main4495947.shtml.
343. See Garrett Hardin, The Tragedy of the Commons, 162 SCIENCE 1243 (1968).
344. See, e.g., Gillian Tett, Aline Van Duyn & Paul J. Davies, A Re-Emerging Market?: Bankers Are Seeking Simpler Ways to Sell on Debt, FIN. TIMES (London), July 1, 2008, at 9 (noting the decadesold emergence of securitization and its significant growth since 2000).
345. This discussion does not address RMBS attributes that may make valuation difficult but that do not relate to PSA rigidity. These include leverage, opacity, and poor due diligence.
346. See, e.g., id.
347. Other implications for government intervention are less visible. When the link between debtor and creditor has been severed-replaced with impermeable, hyperrigid layers of securitization-regulatory tools premised on the existence of that link become worthless. For example, regulatory accounting treatment of a portfolio loan on the creditor's books can have a direct effect on that creditor's willingness to restructure the loan. Marking assets to market creates an incentive to modify a problem asset where renegotiation can produce a mark-to-market gain; if a bank is carrying an impaired mortgage at SO cents on the dollar, it has the incentive to grant a homeowner relief so long as the modified instrument can be valued at more than 50 cents. Regulatory forbearance (for example, letting the bank carry the loan at 80 cents) might force some loss-sharing with the borrower. The same dynamic holds with conventional debt securities. In contrast, where assets are RMBS, changing the accounting treatment on the investor's books would have little or no impact on the prospects of restructuring the underlying mortgage since the relationship between the value of the mortgage and the value of the RMBS slice held by any given investor is indirect at best. (This is true even without taking into account the formidable challenge of valuing RMBS in a depressed market.)
348. 11 U. S. C. § 365 s (a) (2006).
349. See JACKSON, supra note 67; infra Part VI. C.
350. An attempt to establish a sovereign bankruptcy regime by treaty using antirigidity arguments-among others-failed in 2003. Statutory sovereign bankruptcy was a political nonstarter. No state would cede authority over its debt management to an international body; no debtor or creditor was prepared to accept an IMF-run regime (even a weak one) ; and no other governance options were on the table.
351. See Krueger, supra note 139 (presenting the IMF's proposal of such a system in 2002).
352. See generally Brad Setser, IPD Task Force on Sovereign Debt, The Political Economy of the SDRM (June 8, 2009) (unpublished manuscript, on file with authors) (describing the political forces that led to the failure of the IMF's proposed sovereign debt restructuring mechanism ("SDRM") on worldwide policy debates). For normative objections to the sovereign bankruptcy regime
353. see Daniel K. Tarullo, Rules, Discretion, and Authority in International Financial Reform, 4 J. INT'L ECON. L. 613, 627-40 (2001).
354. See generally Kenneth Rogoff & Jeromin Zettelmeyer, Bankruptcy Procedures for Sovereigns: A History of Ideas, 1976-2001 (IMF, Working Paper sNo. 02 /133, 2002) (on file with authors) (surveying the recent history of sovereign bankruptcy proposals).
355. See Home Bldg. & Loan Ass' n v. Blaisdell, 290 U. S. 398, 415-16, 422-23 (1934).
356. European and Canadian governments advocated mandatory sovereign debt standstills.
357. See PAUL BLUSTEIN, THE CHASTENING: INSIDE THE CRISIS THAT ROCKED THE GLOBAL FINANCIAL SYSTEM AND HUMBLED THE IMF 170-74 (2001) ;
358. Andy Haldane & Mark Kruger, The Resolution of International Financial Crises: Private Finance and Public Funds 10-15 (Nov. 2001) (unpublished manuscript), available at http://www.bankofengland.co.uk/publications/other/ financialstability/boeandboc.pdf. U. S. officials raised the idea of paying the parties to sovereign bond contracts to adopt majority modification provisions.
359. See Taylor, supra note 142. On the other hand, the latest standard U. S. bilateral investment treaties ("BITs") deny expropriation protection to creditors under sovereign bonds that require unanimous consent to amend payment terms.
360. See, e.g.. Treaty Concerning the Encouragement and Reciprocal Protection of Investment, U. S.-Uru., Annex G, ¶ 2 s (b) (iii), Nov. 4, 2005.
361. See Michael S. Barr & James A. Feldman, Ctr. for Am. Progress, Issue Brief: Overcoming Legal Barriers to the Bulk Sale of At-Risk Mortgages 2-3 (Apr. 2008), available at hrrp://www.americanprogress.org/issues/2008/04/pdf7reimc- brief.pdf.
362. See. e.g., U. S. Dep't of Treasury, Homeowner Affordability and Stability Plan Fact Sheet 5 (Feb. 18, 2009), available at http://www.treas.gov/press/ releases/20092181117388144.htm;
363. Press Release, U. S. Dep't of Treasury, Neel Kashkari Remarks on GSE, HOPE Now Streamlined Loan Modification Program (Nov. 11, 2008), available at http://www.treas.gov/press/releases/archives/200811. html.
364. See also Christopher Mayer, Edward Morrison & Tomasz Piskorski, A New Proposal for Loan Modifications, 26 YALE J. ON REG. 417, 420 (2009).
365. See Howell E. Jackson, Op-Ed, The Paulson Plan Should Target Bad Loans, Not Burned Investors, CHRISTIAN SCI. MONITOR, Sept. 25, 2008, available at http://www.csmonitor.com/2008/0925/p09s02-coop. html;
366. Lauren E. Willis, Stabilize Home Mortgage Borrowers, and the Financial System Will Follow 1-2 (Loyola Law Sch. L. A., Legal Studies Paper No. 2008-28, 2008), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=l273268.
367. Both Jackson and Willis contend that the federal government should exercise eminent domain, but eminent domain power could also be exercised by the states. The potential expense of a widescale exercise of eminent domain is one factor that reduces its appeal as a solution.
368. See infra Part VI. C.
369. Barry Eichengreen, GOLDEN FETTERS: THE GOLD STANDARD AND THE GREAT DEPRESSION, 1919-1939, at 329 (1992) ;
370. WILLIAM E. LEUCHTENBURG, Franklin D. Roosevelt and THE NEW DEAL 38-39, 42-43 (1963).
371. LEUCHTENBURG, supra note 197, at 39.
372. EICHENGREEN, supra note 197, at 324-29. Roosevelt's Attorney General Homer Cummings later claimed that between February and early March, more than $476 million in gold had been withdrawn from Federal Reserve banks and the U. S. Treasury, of which $311 million appeared to head abroad.
373. Oral Argument of Attorney General Homer Cummings at 265, Norman v. Bait. & Ohio R. R., 294 U. S. 240 (1935) [hereinafter Cummings Argument].
374. See LEUCHTENBURG, supra note 197, at 38.
375. See also Kenneth W. Dam, From the Gold Clause Cases to the Gold Commission: A Half Century of American Monetary Law, 50 U. CM. L. REV. 504, 504 (1983) (citing Roosevelt's campaign criticism of Hoover's alleged soft money leanings).
376. See Michal R. Belknap, The New Deal and the Emergency Powers Doctrine, 62 TEX. L. REV. 67, 73 (1983).
377. Emergency Banking Relief Act, ch. 1, §§ 2, 3, 48 Stat. 1, 1-2 (1933).
378. LEUCHTENBURG, supra note 197, at 50.
379. See Agricultural Adjustment Act, Pub. L. No. 73-10, § 43 (b), 48 Stat. 31, 52-53 (1933).
380. Id. §§ 2, 43 (b), 48 Stat. at 32, 52-53. 206.
381. See ARTHUR M. SCHLESINGER, JR., THE COMING OF THE NEW DEAL, 237, 242 (First Mariner Books 2003) (1958).
382. See also LEUCHTENBURG, supra note 197, at 51.
383. Gold Reserve Act of 1934, ch. 6, Pub. L. No. 73-87, §l§ 5, 12, 48 Stat. 337, 340, 342*3.
384. Proclamation No. 2072, 48 Stat. 1730 (Jan. 31, 1934).
385. Ignore Indenture "Payable in Gold": Agents for Bonds with Coupons Due Fail to Give Coin When Demand Is Made; Court Action Possible, N. Y. TIMES, May 2, 1933, at 2; Randall S. Kroszner, Is It Better to Forgive Than to Receive? An Empirical Analysis of the Impact of Debt Repudiation 2 (Nov. 2003) (unpublished manuscript, on file with the University of Chicago Graduate School of Business).
386. See Gold Obligations Are §100, 000, 000, 000; Federal Bonds Total $22, 000, 000, 000, N. Y. Times, May 27, 1933, at 2.
387. Cummings Argument, supra note 199, at 2SS-S6, 265. Whether the clauses were to be read as promising payment in gold coin, or in paper dollars but in the amount equivalent to the gold value of the debt at the time of the contract, was not entirely clear and was a subject of dispute in subsequent litigation.
388. See, e.g., id.; Henry M. Hart, Jr., The Gold Clause in United States Bonds, 48 HARV. L. REV. 1057, 1071 (1935).
389. See U. S. Dep't of Commerce, Bureau of Econ. Analysis, National Income and Products Accounts, Table 1.1.5: Gross Domestic Product, available at http://bea.gov/national/nipaweb/SelectTable.asp (select Table 1.1.5 and select annual data for 1933 and 1934) vt (listing U. S. GDP as $56.4 billion in 1933 and $66.0 billion in 1934).
390. Kroszner, supra note 209, at 2.
391. See also Cummings Argument, supra note 199, at 256 (warning of a return to chaos).
392. For example, news reports in 1933 cite a British case construing similar clauses against the creditor.
393. See. e.g., Turner Catledge, Gold-Bond Clause Awaits Court Test, N. Y. TIMES, May 7, 1933, at XX2 (reporting a case in which a British court substituted currency as an example of Britain's experience with gold clause debt). Creditors' briefs in the subsequent U. S. Gold Clause Cases refer to indexed Serbian and Brazilian debt.
394. See, e.g.. Oral Argument of Reconstruction Finance Corp. at 277, Norman v. Bait. & Ohio R. R., 294 U. S. 240 (1935). The Court itself highlights German reparation obligations.
395. See Norman, 294 U. S. at 299 sn. 3.
396. See also Arthur Nussbaum, Comparative and International Aspects of American Gold Clause Abrogation, 44 YALE LJ. 53, 60-61 (1934) (noting the numerous other countries that abrogated gold clauses).
397. See generally KEITH S. ROSENN, LAW AND INFLATION 130-54, 267-88 (1982) (discussing more recent domestic and international experiences with contract indexation) ;
398. Artur Nussbaum, Multiple Currency and Index Clauses, 84 U. PA. L. REV. 569, 579-82 (1936) (comparing the U. S. experience with indexation to that of European countries).
399. See Dam, supra note 200, at 507;
400. Daniel W. Levy, A Legal History of Irrational Exuberance, 48 CASE W. RES. L. REV. 799, 856 (1998).
401. However, the prevailing view of the law of negotiable instruments at the time would have made renegotiation difficult or impossible. See supra note135.
402. Text of the Two Reports on the Gold Resolution, N. Y. Times, May 30, 1933, at 2.
403. Joint Resolution to Assure Uniform Value to the Coins and Currencies of the United States, H. R. J. Res. 192, 73d Cong. (1933) (known as the "Gold Clause resolution").
404. See, e.g.. Second Gold Fight in Supreme Court: RFC Appeals Case to Test Validity of President's Decree Voiding Clause in Contracts; Bond Payment at Stake, N. Y. TIMES, Nov. 6, 1934, at 2.
405. See v1John P. Dawson, The Gold Clause Decisions, 33 MICH. L. REV. 647, 676 sn. 57 (1935) (citing ten articles published in the run-up to the Supreme Court argument, all predicting that the joint resolution would be sustained).
406. ARTHUR M. SCHLESINGER, JR., THE POLITICS OF UPHEAVAL, 1935-1936, at 256 (First Mariner Books 2003) (1960). Administration advocates referred to the litigants as people who wanted "$1.69 for their dollar."
407. Id. Characteristically, the creditors painted a different picture: a $1000 bank deposit paid back at an arbitrary discount. Norman C. Norman, Letters to the Editor, Our Gold Certificates, N. Y. TIMES, June 1, 1933.
408. SCHLESINGER, supra note 221, at 257-58;
409. KATHLEEN M. SULLIVAN & GERALD GUNTHER, CONSTITUTIONAL LAW 24 (15th ed. 2004) (providing an excerpt from the drafted radio address). Roosevelt's Fireside Chat of Match 9, 1937, in which he proposed his "Court- packing" plan, began by recounting the narrow 5-4 majority by which the gold clause legislation was upheld, and argued that it was too dangerous for reforms to depend on a single vote.
410. See FDR'S FIRESIDE CHATS 85 (Russell D. Buhite & David W. Levy eds., 1992).
411. See Perry v. United States, 294 U. S. 330, 358 (1935) ;
412. Norman v. Bait. & Ohio R. R., 294 U. S. 240 (1935).
413. See also Nortz v. United States, 294 U. S. 317 (1935) ;
414. United States v. Bankers Trust Co., 294 U. S. 240 (1935). We focus on private contracts in this Article. The decisions on government debt said that the United States did in fact repudiate its debt but the plaintiffs suffered no damage because they had no use for gold and, thanks to deflation, had lost no purchasing power.
415. See Perry, 294 U. S. at 358;
416. Nortz, 294 U. S. at 329-30. The opinion's peculiar reasoning attracted the bulk of the commentary in the aftermath of the Gold Clause Cases. For a prominent contemporary criticism of the government debt decisions
417. see generally Hart, supra note 211. For a more recent view
418. see Dam, supra note 200, at 518-25.
419. See generally Norman, 294 U. S. 240 (rejecting the plaintiffs' retroactivity, takings, and due process claims). The two private contract cases, Norman and Bankers Trust, were consolidated.
420. See id. at 308-09 (grounding the decision on Congress's power to regulate commerce without addressing the parties' arguments on the status of emergency measures).
421. See, e.g., id. at 303 ("The broad and comprehensive national authority over the subjects of revenue, finance and currency is derived from the aggregate of the powers granted to the Congress, embracing the powers to lay and collect taxes, to borrow money, to regulate commerce with foreign nations and among the several States, to coin money, regulate the value thereof, and of foreign coin....").
422. See. e.g., Dawson, supra note 220, at 676 sn. 57 (citing the general expectation that the Court would uphold the resolution) ;
423. John Dickinson, The Gold Decisions, 83 U. PA. L. REV. 715, 715 (1935) ("The decision in the private bond cases was distinctly conservative---").
424. See also Richard D. Friedman, Switching Time and Other Thought Experiments: The Hughes Court and Constitutional Transformation, 142 U. PA. L. REV. 1891, 1924 (1994) ("For the Justices that had constituted the majority in Blaisdell, [Norman] was an easy case.") ;
425. Seth P. Waxman, The Physics of Persuasion: Arguing the New Deal, 88 GEO. L. J. 2399, 2416 (2000) (arguing that the private contracts cases were the easiest Gold Clause Cases to argue). For an example of a modern-day view of the federal government's power to regulate private contracts
426. see Pension Benefit Guaranty Corp. v. R. A. Gray & Co., 467 U. S. 717, 732-34 (1984).
427. Norman, 294 U. S. at 309-10. Cummings was yet more colorful: [T]hese gold contracts have invaded the federal field. It is not a case of federal activity reaching out into a private area. So obsessed are our opponents by the idea of the sanctity of contracts that they are even prepared to assert their validity when they preëmpt the federal field. To me this seems a monstrous doctrine. These claimants are upon federal territory. They are squatters in the public domain, and when the Government needs the territory they must move on.
428. Cummings Argument, supra note 199, at 257.
429. SCHLESINGER, supra note 221, at 260.
430. See Norman, 294 U. S. at 316 (McReynolds, J., dissenting).
431. LEUCHTENBURG, supra note 197, at 144;
432. SCHLESINGER, supra note 221, at 260; Justice McReynolds' Remarks on Gold Case Decision, WALL ST. J., Feb. 23, 1935, at 1.
433. See Kroszner, vt supra note 209, at 10-25 (tracing the progression of the Gold Clause Cases and evaluating the impact of the gold clause abrogation).
434. See. e.g., Seese v. Bethlehem Steel Co. Shipbuilding Div., 168 F.2d 58, 62 (4th Cir. 1948) (citing Norman to refute a claim that the government's interference with a private contract constituted a taking).
435. See Norman, 294 U. S. at 313-14; Second Gold Fight, supra note 219.
436. See, e.g., Norman, 294 U. S. at 310.
437. LEUCHTENBURG, supra note 197, at 156-57 (quoting Louis Brandeis) ;
438. SCHLESINGER, supra note 221, at 307 (quoting Senator Burton K. Wheeler's remarks introducing the Wheeler-Rayburn bill that became PUHCA).
439. See also JOEL SELIGMAN, THE TRANSFORMATION OF WALL STREET 247 (1995) (referring to PUHCA's enforcement as "the most effective antitrust enforcement program in United States history").
440. See SCHLESINGER, supra note 221, at 302-05;
441. SELIGMAN, supra note 236, at 127-31.
442. See Public Utility Holding Company Act (PUHCA) of 1935, Pub. L. No. 74-333, § 11 (b), 49 Stat. 803, 820-21 (repealed 2005) ;
443. SCHLESINGER, supra note 221, at 306. Early drafts of the law compelled dissolution;
444. the version that passed put the burden on the SEC to prove that the structures were "unduly or unnecessarily complicate[d]" and served no useful purpose. PUHCA § 1 1 (b), 49 Stat. at 820-21;
445. SCHLESINGER, supra note 221, at 306, 308.
446. SCHLESINGER, supra note 221, at 303-04;
447. SELIGMAN, supra note 236, at 127. Schlesinger writes of control; Seligman describes sixteen holding companies with "ownership interests" in over 90 percent of the nation's private electrical output. The statistics in both accounts come from three reports on the utility holding companies. The Federal Trade Commission, the House Interstate Commerce Committee, and the National Power Policy Committee all investigated the holding company problem in great detail. Their reports, published in 1935, formed the basis for the legislation.
448. SELIGMAN, supra note 236, at 128-30.
449. SELIGMAN, supra note 236, at 127-28 (citing FED. TRADE COMM'N, UTILITY CORPORATIONS, Part 72-A, at 136-54 (1935)). At the extreme, an investment of $23, 000 could buy control of a $1.2 billion empire.
450. Id. at 128.
451. SCHLESINGER, supra note 221, at 303-04;
452. SELIGMAN, supra note 236, at 128-29.
453. See SCHLESINGER, supra note 221, at 305, 312. Schlesinger recounts Roosevelt's Freudian slip in the 1935 State of the Union address: where his text read "abolition of the evil features of holding companies, " the president said "abolition of the evil of holding companies."
454. Id. at 305.
455. See id. at 303-05, 307, 310, 312.
456. SELIOMAN, supra note 236, at 127-28. The Supreme Court later framed the control, leverage, and financial speculation problems as linked: Most of the financing of the various companies in the structure occurred through the sale to the public of bonds and preferred stock having low fixed returns and generally carrying no voice in the managements.... [A] relatively small but strategic investment in common stock... in the higher levels of a pyramided structure often resulted in absolute control of underlying operating companies---A tremendous "leverage" in relation to that stock was thus produced; the earnings of the top holding company were greatly magnified by comparatively small changes in the earnings of the operating companies. The common stock of the top holding company might quickly rise in value and just as quickly fall, making it a natural object for speculation and gambling.
457. Am. Power & Light Co. v. SEC, 329 U. S. 90, 101-02 (1946) (footnote omitted).
458. See SCHLESINGER, supra note 221, at 308;
459. SELIGMAN, supra note 236, at 179-82.
460. LEUCHTENBURG, supra note 197, at 158.
461. SCHLESINGER, supra note 221, at 304.
462. William O. Douglas, Address to the American Bar Association (July 26, 1938), excerpted in
463. SELIGMAN, supra note 236, at 181.
464. SCHLESINGER, supra note 221, at 309.
465. Id. at 320.
466. Id. at 308. vtSchlesinger characterized Willkie's effort as an attempt to present the holding company as "an affable, inarticulate giant."
467. Id. at 320.
468. Id. at 304.
469. Public Utility Holding Company Act (PUHCA) of 1935, Pub. L. No. 74-333, § 1 (c), 49 Stat. 803, 804 (repealed 2005).
470. Am. Power & Light Co. v. SEC, 329 U. S. 90, 100 (1946).
471. Cf. Ban-& Feldman, supra note 193.
472. SCHLESINGER, supra note 221, at 305.
473. See PUHCA § 11 (b) (2), 49 Stat. at 821.
474. Investment Company Act of 1940, 15 U. S. C. §§ 80a-l to 80a-52 (2006).
475. See SELIGMAN, supra note 236, at 222, 226-27.
476. See id. at 127-38, 181-83, 218-22, 241-64.
477. See SCHLESINGER, supra note 221, at 308, 310.
478. See SELIGMAN, supra note 236, at 131-38, 250.
479. See Elec. Bond & Share Co. v. SEC, 303 U. S. [419 (1938).
480. See SELIGMAN, supra note 236, at 250.
481. See id. at 179-80.
482. Public Utility Holding Company Act (PUHCA) of 1935, Pub. L. No. 74-333, § ll (e), 49 Stat. 803, 822 (repealed 2005) (providing that a holding company or a subsidiary of a holding company could "submit a plan... for the divestment of control, securities, or other assets, or for other action... for the purpose of enabling such company or any subsidiary company thereof to comply with the provisions" required under the death sentence section).
483. See SELIGMAN, supra note 236, at 252-55, 257. Otis & Co. v. SEC, 323 U. S. 624 (1945), rejected a challenge to the SEC's policy of ignoring absolute priority in Section 11 cases. The Supreme Court held that the term "liquidation" both in the contract and in bankruptcy law did not apply to Section 11 proceedings. It also held-like the Norman Court before it-that contracts "cannot be permitted to operate" in the aftermath of contrary federal legislation.
484. See id. at 638.
485. N. Am. Co. v. SEC, 327 U. S. 686 (1946).
486. Am. Power & Light Co. v. SEC, 329 U. S. 90, 100 (1946).
487. Id. at 104.
488. Robert M. Blair-Smith & Leonard Helfenstein, A Death Sentence or a New Lease on Life? A Survey of Corporate Adjustments Under the Public Utility Holding Company Act, 94 U. PA. L. REV. 148, 201 (1945) (internal quotation marks omitted).
489. See Lee J. Alston, Farm Foreclosures in the United States During the Interwar Period, 43 J. ECON. HIST. 885, 886-88 & tbl.l (1983).
490. See also MICHAEL L. COOPER, DUST TO EAT: DROUGHT AND DEPRESSION IN THE 1930s, at 28 (2004) ;
491. DAVID E. HAMILTON, FROM NEW DAY TO NEW DEAL: AMERICAN FARM POLICY FROM HOOVER TO ROOSEVELT, 1928-1933, at 148-69 (1991) (describing the farm credit crisis) ;
492. VAN L. PERKINS, CRISIS IN AGRICULTURE: THE AGRICULTURAL ADJUSTMENT ADMINISTRATION AND THE NEW DEAL, 1933, at 10-35 (1969) (same) ;
493. THEODORE SALOUTOS & JOHN D. HICKS, AGRICULTURAL DISCONTENT IN THE MIDDLE WEST:1900-1939 (1951).
494. See, e.g.. Civilian Conservation Corps Act, Pub. L. No. 75-163, 50 Stat. 319 (1937) (creating the Civilian Conservation Corps) ;
495. Rural Electrification Act of 1936, Pub. L. No. 74-604, 49 Stat. 1363 (creating the Rural Electrification Administration) ;
496. vtSoil Conservation and Domestic Allotment Act, Pub. L. No. 74-46, 49 Stat. 163 (1935) ;
497. Federal Farm Mortgage Corporation Act of 1934, Pub. L. No. 73-88, 48 Stat. 344;
498. Authority Act of 1933, Pub. L. No. 73-17, 48 Stat. 58, upheld by Ashwander v.
499. TVA, 297 U. S. 288, 339-40 (1936) ;
500. Emergency Farm Mortgage Act of 1933, Pub. L. No. 73-10, 48 Stat. 41 (repealed 1947) ;
501. Agricultural Adjustment Act of 1933, Pub. L. No. 73-10, 48 Stat. 31.
502. Emergency Farm Mortgage Act, 48 Stat. 41.
503. The Federal Farm Loan Act of 1916, Pub. L. No. 64-158, 39 Stat. 360 (repealed 1971), established twelve FLBs in districts that mirrored those of the Federal Reserve System. The FLBs were sipervised by the Federal Farm Loan Board, which was comprised of the Treasury secretary and four other members.
504. Id. § 3, 39 Stat. at 360-62. One of these members served as the Board's executive and the Farm Loan Commissioner. Id. The FLBs' stock could be held by state and federal governments and private entities, but a substantial portion was to be held by hundreds of National Farm Loan Associations ("NFLAs"), which were also created by the Federal Farm Loan Act.
505. See id. § 7, 39 Stat. at 365-67. The NFLAs' membership and stock ownership were restricted to farm mortgage borrowers.
506. Id. § 8, 39 Stat. at 367-68. An NFLA could be formed by any group of ten or more natural persons owning or about to own farm land that could serve as collateral for an FLB mortgage.
507. Id. § 7, 39 Stat. at 365-In the FLB system, farmers obtained loans from their local NFLA (or if there was none, from an FLB agent or even directly). To obtain an FLB loan via the NFLA, a farmer had to purchase stock equal to S percent of the loan in one of the NFLAs.
508. Id. § 8, 39 Stat. at 367-68. The stock served as collateral for the loan, in addition to the mortgaged property.
509. Id. § 11, 39 Stat. at 369-70. NFLAs were permitted to take only first mortgages in farm property. The NFLA funded the loan by borrowing from the local FLB. To do so, the NFLA purchased stock in the local FLB equal to 5 percent of the loan.
510. Id. § 7, 39 Stat. at 365-67. This stock served as collateral, in addition to the mortgage on the farm property. When the loan was repaid, the NFLA's stock in the FLB was retired, as was the borrower's stock in the NFLA. Id. §§ 7-8, 39 Stat. at 365-68. The FLBs funded their loans to the NFLAs by issuing tax-exempt, mortgage-backed bonds through the Federal Farm Loan Board.
511. See id. § 26, 39 Stat. at 380 (exemption from taxation). An FLB that wished to raise capital outside of a stock sale would provide mortgages as security to the Federal Farm Loan Board, which would issue bonds against the mortgages.
512. Id. § 18, 39 Stat. at 375-76. The FLB providing the mortgage collateral for the bonds would be primarily liable on the bonds, but there was a cross-guaranty by the other FLBs.
513. Id. § 21, 39 Stat. at 377-78. There was no federal guaranty of the bonds whatsoever, although the federal government regulated the bonds' issuance. As the major assets of the FLBs were farm mortgages, these bonds were essentially farm mortgage-backed securities. In addition to the FLBs, the Federal Farm Loan Act created joint-stock land banks. These were federally chartered entities that had virtually the same powers as FLBs, but in which no government investment was permitted.
514. Id. § 16, 39 Stat. at 374-75. The joint-stock land banks were limited to operating in two contiguous states. Id. The joint-stock land banks issued bonds via the Federal Farm Loan Board just like FLBs, but the bonds were physically distinguished. Id.
515. ARCHIBALD M. WOODRUFF, JR., FARM MORTGAGE LOANS OF LIFE INSURANCE COMPANIES 138-39 (1937). The refinanced loans were to be at reduced interest rates and with amortization payments deferred for five years.
516. Id. at 139.
517. Id. at 139. The FLBs were permitted to issue bonds with interest backed by the U. S. government until the sooner of the yield on their bonds being no more than 4 percent or two years after issuance. Id.
518. Id.
519. Id. These loans were at 5 percent interest, with amortization commencing three years after issuance. Emergency Farm Mortgage Act § 32, 48 Stat. at 48. The amortization period was between ten and twenty years.
520. See id. The loans were originally for a maximum of $5000. Id. The lending limit was raised in 1934 to $7500. Federal Farm Mortgage Corporation Act of 1934, Pub. L. No. 73-88, sec. 10, § 32, 48 Stat. 344, 347. The Farm Loan Commissioner's loans were financed by a loan from the Reconstruction Finance Corporation.
521. Emergency Farm Mortgage Act § 32, 48 Stat. at 48.
522. WOODRUFF, supra note 276, at 145. This book was published as the winner of Williams College's David A. Wells, Class of 1847 Prize for best economics essay, subject to the curious restriction that [n]o subject shall be selected for competitive writing on investigation and no essay shall be considered which in any way advocates or defends the spoliation of property under form or process of law; or the restriction of Commerce in times of peace by Legislation, except for moral or sanitary purposes; or the enactment of usury laws; or the impairment of contracts by the debasement of coin; or the issue and use by Government of irredeemable notes or promises to pay intended to be used as currency and as a substitute for money; or which defends the endowment of such "paper, " "notes" and "promises to pay" with the legal tender quality. Walter Buckingham Smith, Foreword to id. at iii, iii. This Article would not qualify.
523. WOODRUFF, supra note 276, at 145-46.
524. Act of 1933, Pub. L. No. 72-420, § 75, 36 Stat. 1467, 1470-73 (codified at 11 U. S. C. § 75 (1933)). The law had a sunset provision of 1938.
525. Id. § 75 (c), 36 Stat. vtat. 1471.
526. See id. § 75 (c), 36 Stat. at 1471.
527. Id. § 75 (g), 36 Stat. at 1472.
528. Id. § 750), 36 Stat. at 1472.
529. Id. § 75 (i), 36 Stat. at 1472.
530. ALBERT GAILORD HART, DEBT AND RECOVERY: A STUDY OF CHANGES IN THE INTERNAL DEBT STRUCTURE FROM 1929 TO 1937 AND A PROGRAM FOR THE FUTURE 143 (1938).
531. Frazier-Lemke Farm Bankruptcy Act of 1934, Pub. L. No. 73-486, 48 Stat. 1289, invalidated by Louisville
532. Joint Stock Land Bank v. Radford, 295 U. S. 555 (1935).
533. Id.
534. W. §3, 48 Stat. at 1290.
535. Id.§ 1, 48 Stat. at 1289.
536. Id. § 2, 48 Stat. at 1289-90.
537. Id. §6, 48 Stat. at 1290.
538. This is essentially what is allowed in a redemption under § 722 of the Bankruptcy Code. 11 U. S. C. § 722 (2006). In redemption, the debtor need only pay the allowed secured claim, which cannot be greater than the fair market value of the property. See id. §§ 506 (a) (1), 722. Redemption, however, does not allow for deferred payments, which makes it of little value to most debtors, as they are not flush with cash. The Frazier-Lemke Act, in contrast, restored the income-producing farm to the debtor immediately and allowed the debtor to use the farm's income to redeem the farm.
539. Frazier-Lemke Act of 1934 § 7, 48 Stat. at 1291.
540. Id.
541. Cf. U. S. Sav. Ass'n of Tex. v. Timbers of Inwood Forest, 484 U. S. 365 (1988) (finding that an undersecured creditor was not entitled to postpetition interest-economically equivalent to market rents-on foreclosure value of property).
542. Louisville Joint Stock Land Bank v. Radford, 295 U. S. 555 (1935).
543. Frazier-Lemke Act of 1935, Pub. L. No. 74-384, 49 Stat. 942 (codified as amended at 11 U. S. C. § 203 (1940)).
544. Wright v. Vinton Branch of Mountain Trust Bank of Roanoke, 300 U. S. 440 (1937).
545. E.g., Home Bldg. & Loan Ass'n v. Blaisdell, 290 U. S. 398, 447-48 (1934) ; Roe, supra note 132.
546. Frazier-Lemke Act of 1935 §§ 5-6, 49 Stat. at 943-45.
547. Id. §§ 4, 6, 49 Stat. at 942-45.
548. Louisville Joint Stock Land Bank v. Radford, 295 U. S. 555, 594-95 (1935).
549. Frazier-Lemke Act of 1935 § 6, 49 Stat. at 943-45.
550. HART, supra note 287, at 140-41 (noting that twenty-two states passed moratorium laws preventing foreclosure sales).
551. Id. at 154.
552. HAMILTON, c supra note 272;
553. PERKINS, supra note 272;
554. SALOUTOS & HICKS, supra note 272.
555. HART, supra note 287, at 143.
556. Id. at 139 fig. 12.
557. See generally Home Bldg. & Loan Ass'n v. Blaisdell, 290 U. S. 398 (1934).
558. Farm Credit Administration, History of FCA and the FCS, http://www.fca.gov/about/history/historyFCA-FCS.html (last visited Sept. 1, 2009).
559. See NEIL E. HARL, THE FARM DEBT CRISIS OF THE 1980s, at 275 (1990).
560. See 11 U. S. C. § 1222 (b) s (2) (2006).
561. See 11 U. S. C. § 109 (e) (creating secured and unsecured debt limits as part of Chapter 13 eligibility).
562. Originally, Chapter 12 had a sunset of September 30, 1993.
563. It was later extended to a sunset of September 30, 1998, and then made permanent.
564. See Davis, supra note 128.
565. See TARP Reform and Accountability Act of 2009, H. R. 384, 111th Cong. §205 ("Notwithstanding any other provision of law, and notwithstanding any investment contract between a servicer and a securitization vehicle or investor, a servicer-(i) shall not be limited in the ability to modify mortgages, the number of mortgages that can be modified, the frequency of loan modifications, or the range of permissible modifications....").
566. Cf. Mayer et al., supra note 194, at 417 (proposing legislative mortgage contract modification).
567. We are grateful to Ian Ayres for this insight. 320. See, e.g., Jolls, supra note 128, at 203-06, 236-37. 321. Note that the reasons for banning antimodification provisions are not limited to our arguments about spillover effects. See, e.g., Beatty v. Guggenheim Exploration Co., 122 N. E. 378, 381 (N. Y. 1919) (invalidating an antimodification clause essentially on freedom of contract grounds-which can cut both ways).
568. Cf. Marcus Miller & Joseph Stiglitz, Bankruptcy Protection Against Macroeconomic Shocks: The Case for a "Super Chapter 11" (Dec. 1999) (unpublished manuscript), available at http://www2.warwick.ac.uk/fac/soc/csgr/ research/keytopic/global/mib5tig.pdf (recommending acrossthe-board "Super Chapter 11" debt relief triggered by exchange rate devaluation) ;
569. Posner & Zingales, supra note 2 (recommending ex post mortgage modification in line with property value reductions by zip code).
570. See generally RICHARD E. SPEIDEL, CONTRACTS IN CRISES (2007) (discussing the application of the contractual doctrine of excuse in response to government interference with contracts in crisis).
571. On April 30, 2009, the Senate voted 45-51 vtagainst an amendment to S. 896 (11 lth Cong.), the Helping Families Save Their Homes Act of 2009, which would have allowed principal residence mortgage modification in Chapter 13 bankruptcy. The House version of the bill, H. R. 1106, had a bankruptcy modification provision, but due to the amendment's defeat in the Senate, the final law did not provide for bankruptcy modification.
572. See Helping Families Save Their Homes Act of 2009, Pub. L. No. 111-22, 123 Stat. 1632. The final version was passed on May 20, 2009.
573. See Horatio Spector, Constitutional Transplants and the Mutation Effect, 83 CHI.-KENT L. REV. 129, 144-45 (2008) (arguing that Argentina's experience rewriting contracts every ten years is unlike the United States' experience rewriting them every hundred).