Editor: David Reiss
Brooklyn Law School

A Member of the Law Professor Blogs Network

June 24, 2015

High Risk at Fannie and Freddie

By David Reiss

FHFA Director Watt

The Federal Housing Finance Agency released its 2014 Report to Congress. It summarizes many interim reports and press releases that were released over the previous year, many of which have been covered by REFinBlog as they came out. I was struck, however, by the passages about the operational risk that Fannie and Freddie face.  I have been concerned with operational risk at Fannie and Freddie for some time, as the two enterprises have languished in conservatorship limbo for far too long.

The Report of the Annual Examination of Fannie Mae states that

The level of operational risk remains high and largely reflects the risk posed by execution of Fannie Mae’s strategic plan to replace its existing information technology infrastructure. Management has made significant progress in stabilizing the current information technology environment, with improvements in the change management process and reductions in production outages. Further, progress was made in establishing an out-of-region data center that is a critical component for supporting information systems and providing for business continuity in the event of a disaster. As Fannie Mae implements this plan, however, the level of operational risk will remain elevated. Risks associated with the execution, deployment, and integration with the CSP [Common Securitization Platform] and the move to a Single Security, while addressing ongoing IT infrastructure issues, will also introduce a significant level of inherent operational risk to the organization. Effective project management will be critical to mitigate the operational risk arising from these efforts.(14, emphasis added)

The Report of the Annual Examination of Freddie Mac indicates that Freddie faces somewhat different operational risks:

Operational risk, including risks associated with information technology systems, remains a concern primarily because of resource requirements and operational complexities of major strategic initiatives (including integration with the CSP), developing information security and privacy protection capabilities, and heightened risk during the transition to the new risk management structure.

Information security is one of the primary operational risks Freddie Mac faces given the proliferation of cyber crimes and the high probability of new cyber attacks targeted at large organizations. Freddie Mac’s operational framework is highly complex. Information security within the Enterprise is more important than ever given the pervasiveness of cyber-related threats. In addition to external threats, Freddie Mac faces other challenges that may continue to elevate operational risk and increase the likelihood of significant operational incidents and losses. (17, emphasis added)

While neither of these passages is terrifying — as in, here-is-the-next-trigger-for-a-bailout terrifying — they do make me pause and ask whether the GSEs in their current form are up to the challenge of handling this period of “heightened risk.”

Those in Congress who are impeding GSE reform are on notice that Fannie and Freddie face high levels of operational risk. If the next crisis results from that risk, it is on them.

June 24, 2015 | Permalink | No Comments

Wednesday’s Academic Roundup

By Shea Cunningham

June 24, 2015 | Permalink | No Comments

June 23, 2015

What’s Behind Rising Mortgage Bond Issuance?

By David Reiss quoted me in What Else Is Behind Rising Mortgage Bond Issuance, Demand?. It opens,

Investor demand for mortgage bonds, both that have agency backing and not, is quite high these days.

Last week Bloomberg reported that issuance of home-loan securities that don’t have government backing reached more than $32 billion this year, compared to $18 billion a year ago, citing data compiled by Bloomberg and Bank of America Corp. These securities include rental-home bonds, a relatively new asset class that developed after the recession.

Agency and GSE securities are also in high demand, as a recent report from the Mortgage Bankers Association indicates. The level of commercial/multifamily mortgage debt outstanding increased by $40.4 billion in the first quarter of 2015 — a 1.5% increase over the fourth quarter of 2014. Said Jamie Woodwell, MBA’s Vice President of Commercial Real Estate Research with the report’s release: “Multifamily mortgages continued to grow even more quickly than the market as a whole, with banks increasing their portfolios by $8 billion and agency and GSE portfolios and MBS increasing their holdings by $10 billion.”

There are a number of economic-based drivers behind the demand for mortgage bonds of course: the fundamentals in the real estate space and the low interest rates that have driven investors to consider all manner of securities to eek out yield.

However, there is another possibility to consider as well and that is that the changing financial regulations are driving both issuance and investment.

On one hand, mortgages and private-label mortgage backed securities are much more regulated per Dodd-Frank and its Qualified Mortgage and Qualified Residential Mortgage rules, according to David Reiss, professor of Law and research director of the Center for Urban Business Entrepreneurship (CUBE) at Brooklyn Law School. On the other, post-crisis rules put in place for mortgage bonds have made these securities far more attractive for banks to hold as various news reports suggest.

For example, new rules have made ratings on mortgage bonds less crucial, allowing US lenders to use an alternative approach to calculating capital requirements, according to another recent article in Bloomberg. In essence, these rules allow lenders to reduce the amount needed for junk-rated mortgage bonds that are trading at discounts.

In addition, banks are finding that “treasury debt and MBS pass-throughs meet regulators’ standards much more easily than other assets”, according to a report by Deutsche Bank analysts Steven Abrahams and Christopher Helwig, per a third recent article in Bloomberg.

Two Opinions

With these facts in mind we turned to two experts to see how much of an impact new regulations are having. As it turned out, they are driving some of the change – but what is actually moving the needle in terms of demand is yet another trend. Read on.

For starters, there are some caveats. It can be misleading to throw the new rental home bonds in the mix in such a comparison, Reiss tells “They are a post-crisis product when Wall Street firms saw that single-family housing prices were so low that they could make money from buying them up in bulk and then renting them out,” he says.

“They are not regulated in the same way as private-label MBS.”

Meanwhile issuers are still navigating Dodd-Frank’s Qualified Mortgage and Qualified Residential Mortgage rules, he says. They “are still trying to figure out how to operate within these rules — and outside of them, with the origination of non-QM mortgages. The market is still in transition with these products.”

As he sees it, the surge in issuance is a reflection of market players trying to understand how to operate in a new regulatory environment. They “are increasing their issuances as they get a better sense of how to do so.”

June 23, 2015 | Permalink | No Comments

Tuesday’s Regulatory & Legislative Round-Up

By Serenna McCloud

  • U.S. Department of Housing and Urban Development (HUD) is proposing policy changes to improve access to low-poverty neighborhoods – recent research (summarized here) indicates that place has a lot to do with educational attainment and earning power throughout life.  HUD’s housing choice voucher program is proposing new rules that  will increase access to lower poverty neighborhoods by allowing higher fair market rent calculations.

June 23, 2015 | Permalink | No Comments

June 22, 2015

New FHA Guidelines No Biggie

By David Reiss


(Original Purchases in Levittown Funded in Large Part by FHA Mortgages)

Law360 quoted me in New Guidelines For Bad FHA Loans Won’t Boost Lending (behind paywall). It opens,

The federal government on Thursday provided lenders with a streamlined framework for how it determines whether the Federal Housing Administration must be paid for a loan gone bad, but experts say the new framework will have limited effect because it failed to alleviate the threat of a Justice Department lawsuit.

The U.S. Department of Housing and Urban Development provided lenders with what it called a “defect taxonomy” that it will use to determine when a lender will have to indemnify the FHA, which essentially provides insurance for mortgages taken out by first-time and low-income borrowers, for bad loans. The new framework whittled down the number of categories the FHA would review when making its decisions on loans and highlighted how it would measure the severity of those defects.

All of this was done in a bid to increase transparency and boost a sagging home loan sector. However, HUD was careful to state that its new default taxonomy does not have any bearing on potential civil or administrative liability a lender may face for making bad loans.

And because of that, lenders will still be skittish about issuing new mortgages, said Jeffrey Naimon, a partner with BuckleySandler LLP.

“What this expressly doesn’t address is what is likely the single most important thing in housing policy right now, which is how the Department of Justice is going to handle these issues,” he said.

The U.S. housing market has been slow to recover since the 2008 financial crisis due to a combination of economics, regulatory changes and, according to the industry, the threat of litigation over questionable loans from the Justice Department, the FHA and the Federal Housing Finance Agency.

In recent years, the Justice Department has reached settlements reaching into the hundreds of millions of dollars with banks and other lenders over bad loans backed by the government using the False Claims Act and the Financial Institutions Reform, Recovery and Enforcement Act.

The most recent settlement came in February when MetLife Inc. agreed to a $123.5 million deal.

In April, Quicken Loans Inc. filed a preemptive suit alleging that the Justice Department and HUD were pressuring the lender to admit to faulty lending practices that they did not commit. The Justice Department sued Quicken soon after.

Policymakers at the Federal Housing Finance Agency, which serves as the conservator for Fannie Mae and Freddie Mac, and HUD have attempted to ease lenders’ fears that they will force lenders to buy back bad loans or otherwise indemnify the programs.

HUD on Thursday said that its new single-family loan quality assessment methodology — the so-called defect taxonomy — would do just that by slimming down the categories it uses to categorize mortgage defects from 99 to nine and establishing a system for categorizing the severity of those defects.

Among the nine categories that will be included in HUD’s review of loans are measures of borrowers’ income, assets and credit histories as well as loan-to-value ratios and maximum mortgage amounts.

Providing greater insight into FHA’s thinking is intended to make lending easier, Edward Golding, HUD’s principal deputy assistant secretary for housing, said in a statement.

“By enhancing our approach, lenders will have more confidence in how they interact with FHA and, we anticipate, will be more willing to lend to future homeowners who are ready to own,” he said.

However, what the new guidelines do not do is address the potential risk for lenders from the Justice Department.

“This taxonomy is not a comprehensive statement on all compliance monitoring or enforcement efforts by FHA or the federal government and does not establish standards for administrative or civil enforcement action, which are set forth in separate law. Nor does it address FHA’s response to patterns and practice of loan-level defects, or FHA’s plans to address fraud or misrepresentation in connection with any FHA-insured loan,” the FHA’s statement said.

And that could blunt the overall benefits of the new guidelines, said David Reiss, a professor at Brooklyn Law School.

“To the extent it helps people make better decisions, it will help them reduce their exposure. But it is not any kind of bulletproof vest,” he said.

June 22, 2015 | Permalink | No Comments

Monday’s Adjudication Roundup

By Shea Cunningham

June 22, 2015 | Permalink | No Comments

June 19, 2015

CFPB Roundup

By David Reiss


The Consumer Financial Protection Bureau released its Semi-Annual Report. From a news perspective, it is a snoozer — dog bites man — as it is really just a summary of what the Bureau has done (and already issued press releases about) over the last year. That being said, it is a great compendium of the CFPB’s actions for those who are looking to sketch the forest after six months of peering at the trees. I note a few interesting aspects of the report.

Director Cordray writes that “our supervisory actions resulted in financial institutions providing more than $114 million in redress to over 700,000 consumers.” (2) In this era of billion dollar settlements, this amount seem relatively small. In fact, “$114 million in redress to over 700,000 consumers” comes out to just $163 per affected consumer. I am not sure exactly what that means, but $163 per consumer does not sound as impressive as $114 million. It would be helpful to have had more detail about those supervisory actions. This is not to say that big settlements are a good unto themselves, but it would be helpful to know whether the punishment fit the crime.

I also found the appendices to be particularly interesting, at least for CFPB geeks:

  • Appendix B contains a list of all of the CFPB’s reporting requirements
  • Appendix C lists all of the significant rules, orders and initiatives adopted by the Bureau in the past year
  • Appendix D lists the consent orders the Bureau has entered into with certain regulated entities
  • Appendix E lists significant state attorney general and regulatory actions
  • Appendix F lists CFPB reports from the past year
  • Appendix G lists Congressional testimony given by CFPB officials over the past year
  • Appendix H lists speeches given by Director Cordray and Deputy Director Antonakes over the past year.

All in all, the report is a thorough review of the state of the CFPB. Enjoy!

June 19, 2015 | Permalink | No Comments