Banking Law

The Senate passed S 896 today which, among other things, would protect loan servicers from lawsuits by investors if the servicers modify or refinance loans to borrowers under one of the thus-far unsuccessful federal loan modification loan programs, such as (No)Hope For Homeowners (see Section 201 of S. 896). Servicers want that protection because investors have already launched lawsuits against large servicers (such as Bank of America) that have agreed to engage in systematic loan modification programs promoted by the FDIC, Treasury and the current Administration.

I thought that the "safe harbor" idea was boneheaded when Sheila Bair first floated it over a year ago. In today's political climate, boneheadedness rules the day. When I discussed this topic a few months ago, I predicted that it would result in a litigation bonanza for trial lawyers who actually think that the 5th Amendment to the US Constitution might provide a basis for suing the US Government in the US Court of Claims. In Monday's The Wall Street Journal, investor advisors Eric Brenner and Hamish Hume made it clear that argument has legs.

By rewriting contracts so that servicers can overturn well-established rules regarding priority among creditors, the proposed safe harbor runs headlong into the Takings Clause of the Fifth Amendment. That provision is intended to prevent the government from forcing an unlucky few to bear public burdens that should be borne by the population at large. The investors in securities backed by first mortgages manage these investments on behalf of employee pension funds, charitable organizations, college endowments, 401(k) plans and many others. The Constitution protects against irrational legislation that takes valuable contractual rights from investors to line the pockets of big banks.



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The government has tried ripping up financial contracts in the past only to get burned in the process. Two decades ago, in the Savings and Loan Crisis, regulators entered into contracts with financial institutions that took over failing thrifts. Congress then substantially eliminated the benefits contained in those contracts. What followed was years of costly litigation that eventually compelled the government to pay damages. The value of those damages may run into the billions of dollars. Congress should not make the same mistake this time.

Well, the Senate made the same mistake, and the House has passed an even more generous safe harbor provision. Let's all get ready to go Dancing With The Bear, one more time.