May 24, 2016
The Court of Appeals for the Second Circuit reversed the District Court’s judgment (SDNY, Rakoff, J.) against Bank of America defendants for actions arising from Countrywide’s infamous “Hustle” mortgage origination program. The case has a lot of interesting aspects to it, not the least of which is that it does away with more than one billion dollar in civil penalties levied against the defendants.
The opinion itself answers the narrow question, when “can a breach of contract also support a claim for fraud?” (2) The Court concluded that “the trial evidence fails to demonstrate the contemporaneous fraudulent intent necessary to prove a scheme to defraud through contractual promises.” (3)
I think the most important aspect of the opinion is how it limits the reach of the Financial Institutions Reform, Recover, and Enforcement Act of 1989 (FIRREA). Courts have have been reading FIRREA very broadly to give the federal government immense power to go after financial institutions accused of wrongdoing.
FIRREA provides for civil penalties for violations of federal mail or wire fraud statutes, but the Court found that there was no fraud at all. It made its point with a hypothetical:
Imagine that two parties—A and B—execute a contract, in which A agrees to provide widgets periodically to B during the five-year term of the agreement. A represents that each delivery of widgets, “as of” the date of delivery, complies with a set of standards identified as “widget specifications” in the contract. At the time of contracting, A intends to fulfill the bargain and provide conforming widgets. Later, after several successful and conforming deliveries to B, A’s production process experiences difficulties, and the quality of A’s widgets falls below the specified standards. Despite knowing the widgets are subpar, A decides to ship these nonconforming widgets to B without saying anything about their quality. When these widgets begin to break down, B complains, alleging that A has not only breached its agreement but also has committed a fraud. B’s fraud theory is that A knowingly and intentionally provided substandard widgets in violation of the contractual promise—a promise A made at the time of contract execution about the quality of widgets at the time of future delivery. Is A’s willful but silent noncompliance a fraud—a knowingly false statement, made with intent to defraud—or is it simply an intentional breach of contract? (10)
This case emphasizes that “a representation is fraudulent only if made with the contemporaneous intent to defraud . . .” (14) While this is not really new law, it is a clear statement as to the limits of FIRREA. This will act as a limit on how the government can deploy this powerful tool as new cases crop up. Unless, of course, the Supreme Court were to reverse it on appeal.
May 20, 2016
The University of Minnesota Law School’s Institute on Metropolitan Opportunity has issued a report, The Rise of White-Segregated Subsidized Housing. While the report is focused on Minnesota, it raises important issues about affordable housing program demographics throughout the country:
- To what extent do the populations served by programs match those of their catchment areas?
- To what extent do the served populations match the eligible populations of their catchment areas?
- To what extent do the served populations match the demographics of those who have applied for the programs?
- To what extent do variants among those metrics matter?
The Executive Summary opens,
Subsidized housing in Minneapolis and Saint Paul is segregated, and this segregation takes two forms – one well-known, and the other virtually unknown.
At this point it is widely recognized that most Minneapolis and Saint Paul subsidized housing is concentrated in racially diverse or segregated neighborhoods, with few subsidized or otherwise-affordable units in affluent, predominately white areas. Because subsidized units are very likely to be occupied by families of color, this pattern increases the region’s overall degree of segregation.
But what has been overlooked until today, at least publicly, is that a small but important minority of subsidized projects are located in integrated or even-predominately white areas. Unlike typical subsidized housing, however, the residents of these buildings are primarily white – in many instances, at a higher percentage than even the surrounding neighborhood. These buildings thus reinforce white residential enclaves within the urban landscape, and intensify segregation even further.
What’s more, occupancy is not the only thing distinguishing these buildings from the average subsidized housing project. They are often visually spectacular, offering superior amenities – underground parking, yoga and exercise studios, rooftop clubrooms – and soaring architecture. Very often, these white-segregated subsidized projects are created by converting historic buildings into housing, with the help of federal low-income housing tax credits, historic tax credits, and other sources of public funding. Frequently, these places are designated artist housing, and – using a special exemption obtained from Congress by Minnesota developers in 2008 – screen applicants on the basis of their artistic portfolio or commitment to an artistic craft.
These places cost far more to create than traditional subsidized housing, and include what are likely the most expensive subsidized housing developments in Minnesota history, both in terms of overall cost and per unit cost. These include four prominent historic conversions, all managed by the same Minneapolis-based developer – the Carleton Place Lofts ($430,000 per unit), the Schmidt Artist Lofts ($470,000 per unit), the upcoming Fort Snelling housing conversion ($525,000 per unit), and the A-Mill Artist lofts ($665,000 per unit). The combined development cost of these four projects alone exceeds $460 million. For reference, this is significantly more than the public contribution to most of the region’s sports stadiums; it is $40 million less than the public contribution to the controversial downtown football stadium.
These four buildings contained a total of 870 units of subsidized housing, most of which is either studio apartments or single-bedroom. For the same expense, using 2014 median home prices, approximately 1,590 houses could have been purchased in the affluent western suburb of Minnetonka.
In short, Minneapolis and Saint Paul are currently operating what is, in effect, a dual subsidized housing system. In this system, the majority of units are available in lower-cost, utilitarian developments located in racially segregated or diverse neighborhoods. These units are mostly occupied by families of color. But an important subset of units are located in predominately white neighborhoods, in attractive, expensive buildings. These units, which frequently are subject to special screening requirements, are mostly occupied by white tenants.
As a matter of policy, these buildings are troubling: they capture resources intended for the region’s most disadvantaged, lowest-income families, and repurpose those resources towards the creation of greater segregation – which in turn causes even more harm to those same families.
Legally, they may well run afoul of the Fair Housing Act and other civil rights law. Recent developments have established that the Fair Housing Act forbids public or private entities from discriminating in the provision of housing by taking actions that create a disparate impact on protected classes of people, including racial classes. Moreover, recipients of HUD funding, such as the state and local entities which contribute to the development of these buildings, have an affirmative obligation to reduce segregation and promote integration in housing. (1-2)
No doubt, this report will spur a lot of soul searching in Minnesota. It may also spur some litigation. Other communities with subsidized housing programs should take a look at themselves in the mirror and ask if they like what they see. They should also ask whether federal judges would like it.
May 19, 2016
S&P Capital IQ has posted some Structured Finance Research: The Conforming Loan Limit And Its Effect On The U.S. Private-Label Mortgage Market. It contains interesting thoughts on how a stabilized secondary mortgage market should be split between government-backed and private-label securitizations. More particularly, it finds that
- The U.S. private-label mortgage market has failed to recapture the market share that it ceded to the agency [Fannie & Freddie] market after the financial crisis of 2007–2009.
- Partly because of changes in underwriting requirements, the private-label market is synonymous with jumbo collateral: loans that exceed the conforming loan limit set by the Federal Housing Finance Agency (FHFA).
- As a result, the conforming limit now acts as a gateway, controlling how much financing and securitization volume is accommodated by the agency channel relative to that of the private-label market. (1)
It notes, “As rising home prices restore the historical relationship between the conforming limit and median home price, it will be interesting to see if there is a corresponding return to the pre-2003 market share split between agency and private-label securitization.” (Id.)
S&P further explains that
For the last 10 years, the conforming limit (which herein excludes dwellings with more than one unit) has remained at $417,000. Historically, the ratio of the median new home sale price to the conforming loan limit has been near 50%. When the housing market crashed, the ratio dropped to near 40%. However, the recovering housing market is restoring the historical relationship. Because the conforming loan limit acts as mechanism to regulate the market share breakdown between the private-label and agency markets, it is likely to be a determinant in the future growth of the struggling private-label sector.
Private-Label/Agency Market Share
Prior to 2003, the market share of the agency sector was a bit greater than 80%, with the remainder being private-label issuance. After 2008, however, the agency share rose to over 95%. So while a new equilibrium appears to have been achieved, it is one in which a good deal of market share has been shifted away from the private-label market and absorbed by the agencies. While the general market consensus seems to be that the private-label share might not reach 2005–2007 levels again, the question remains as to when (if at all) the private-label mortgage market will recover to the levels of issuance prior to 2003.” (1-2, chart omitted)
Implicit in all of this is that the pre-2003 state of affairs reflects some kind of natural state of equilibrium. This ignores the fact the national mortgage market has always been one that the government has shaped. While it is worth considering what balance between government and private-label securitization is best, historical precedent in itself is an insufficient guide.
I would rather focus on fundamentals. Should the government subsidize residential mortgages? How much exposure should the government have to credit risk? How much credit risk can the private sector handle? Should the government incentivize the origination of mortgage products (like the 30 year FRM) that private-label investors might not find so attractive? I care about the answers to these questions a whole lot more than I care about how the secondary mortgage market was divvied up one or two decades ago.
May 18, 2016
Realtor.com quoted me in How Much Are Closing Costs? What Home Buyers and Sellers Can Expect. It reads, in part,
Closing costs are the fees paid to third parties that help facilitate the sale of a home, and they vary widely by location. But as a rule, you can estimate that they typically total 2% to 7% of the home’s purchase price. So on a $250,000 home, your closing costs would amount to anywhere from $5,000 to $17,500. Yep that’s one heck of a wide range. More on that below.
Both buyers and sellers typically pitch in on closing costs, but buyers shoulder the lion’s share of the load (3% to 4% of the home’s price) compared with sellers (1% to 3%). And while some closing costs must be paid before the home is officially sold (e.g., the home inspection fee when the service is rendered), most are paid at the end when you close on the home and the keys exchange hands.
* * *
Why Closing Costs Vary
The reason for the huge disparity in closing costs boils down to the fact that different states and municipalities have different legal requirements—and fees—for the sale of a home.
“If you live in a jurisdiction with high title insurance premiums and property transfer taxes, they can really add up,” says David Reiss, research director at the Center for Urban Business Entrepreneurship at Brooklyn Law School. “New York City, for instance, has something called a mansion tax, which adds a 1% tax to sales that exceed $1 million. And then there are the surprise expenses that can crop up like so-called ‘flip taxes’ that condos charge sellers.”
To estimate your closing costs, plug your numbers into an online closing costs calculator, or ask your Realtor, lender, or mortgage broker for a more accurate estimate. Then, at least three days before closing, the lender is required by federal law to send buyers a closing disclosure that outlines those costs once again. (Meanwhile sellers should receive similar documents from their Realtor outlining their own costs.)
Word to the wise: “Before you close, make sure to review these documents to see if the numbers line up to what you were originally quoted,” says Ameer. Errors can and do creep in, and since you’re already ponying up so much cash, it pays, literally, to eyeball those numbers one last time before the big day.
May 16, 2016
The Department of the Treasury has issued a report, Opportunities and Challenges in Online Marketplace Lending. Online marketplace lending is still in its early stages, so it is great that regulators are paying attention to it before it has fully matured. This lending channel may greatly increase options for borrowers, but it can also present opportunities to fleece them. Treasury is looking at this issue from both sides. Some highlights of the report include,
- There is Opportunity to Expand Access to Credit: RFI [Request for Information] responses suggested that online marketplace lending is expanding access to credit in some segments by providing loans to certain borrowers who might not otherwise have received capital. Although the majority of consumer loans are being originated for debt consolidation purposes, small business loans are being originated to business owners for general working capital and expansion needs. Distribution partnerships between online marketplace lenders and traditional lenders may present an opportunity to leverage technology to expand access to credit further into underserved markets.
- New Credit Models and Operations Remain Untested: New business models and underwriting tools have been developed in a period of very low interest rates, declining unemployment, and strong overall credit conditions. However, this industry remains untested through a complete credit cycle. Higher charge off and delinquency rates for recent vintage consumer loans may augur increased concern if and when credit conditions deteriorate.
- Small Business Borrowers Will Likely Require Enhanced Safeguards: RFI commenters drew attention to uneven protections and regulations currently in place for small business borrowers. RFI commenters across the stakeholder spectrum argued small business borrowers should receive enhanced protections.
- Greater Transparency Can Benefit Borrowers and Investors: RFI responses strongly supported and agreed on the need for greater transparency for all market participants. Suggested areas for greater transparency include pricing terms for borrowers and standardized loan-level data for investors.
* * *
- Regulatory Clarity Can Benefit the Market: RFI commenters had diverse views of the role government could play in the market. However, a large number argued that regulators could provide additional clarity around the roles and requirements for the various participants. (1-2)
As we move deeper and deeper into the gig economy, the distinction between a consumer and a small business owner gets murkier and murkier. Thus, this call for greater protections for small business borrowers makes a lot of sense.
Online marketplace lending is such a new lending channel, so it is appropriate that the report ends with a lot of questions:
- Will new credit scoring models prove robust as the credit cycle turns?
- Will higher overall interest rates change the competitiveness of online marketplace lenders or dampen appetite from their investors?
- Will this maturing industry successfully navigate cyber security challenges, and adapt to appropriately heightened regulatory expectations? (34)
We will have to live through a few credit cycles before we have a good sense of the answers to these questions.