October 23, 2014
Todd Zywicki has posted The Behavioral Law and Economics of Fixed-Rate Mortgages (and Other Just-So Stories) to SSRN. The article contains
a spoof, in order to make a larger point.
The abstract reads,
A major cause of the recent financial crisis was the traditional American mortgage, which is distinctive for the following features: it is a thirty-year, self-amortizing loan with an unlimited right to prepay. The United States is unique in the world for standardizing on a mortgage product with these features. Yet not only have a majority of the foreclosures that occurred during the financial crisis been fixed-rate mortgages, the fixed-interest-rate characteristics have undermined efforts by the Federal Reserve and government to assist recovery of the housing market. Moreover, the long fixed-rate term and ability to refinance are highly expensive and suboptimal features for many consumers. Nevertheless, many consumers persist in purchasing this mortgage. Drawing on the methodology of behavioral law and economics, this article provides rationalizations for how behavioral law and economics can explain the persistence of a product that is so harmful to many consumers and to the economy at large. The article then draws conclusions about what this analysis means for the behavioral law and economics research program generally and for the use of behavioral law and economics in government policymaking.
I have a lot to say about this article but I don’t want to ruin it for you! Suffice it to say, the article is a provocative critique of behavioral law and economics. Those of us who hope to see a healthy mortgage market develop would do well to take this critique seriously — even if you end up rejecting its broader implications.
October 22, 2014
Collinson and Ganong have posted The Incidence of Housing Voucher Generosity to SSRN. The abstract of this important paper is a little technical for non-economists. It reads:
What is the incidence of housing vouchers? Housing voucher recipients in the US typically pay their landlord a fixed amount based on their income and the government pays the rest of the rent, up to a rent ceiling. We consider a policy that raises the generosity of the rent ceiling everywhere, which is equivalent to an income effect, and a policy which links generosity to local unit quality, which is equivalent to a substitution effect.
Using data on the universe of housing vouchers and quasi-experimental variation from HUD policy changes, we analyze the incidence of these policies. Raising the generosity of the rent ceiling everywhere appears to primarily benefit landlords, who receive higher rents with very little evidence of medium-run quality improvements. Setting ZIP code-level rent ceilings causes rent increases in expensive neighborhoods and decreases in low-cost neighborhoods, with little change in aggregate rents. The ZIP code policy improves neighborhood quality as much as other, far more costly, voucher interventions.
The eye-catching part is that raising “the generosity of the rent ceiling everywhere appears to primarily benefit landlords, who receive higher rents with very little evidence of medium-run quality improvements.” The paper itself fleshes this out more: “a $1 increase in the rent ceiling raises rents by 41 cents; consistent with this policy change acting like an income effect, we find very small quality increases of around 5 cents, meaning that as much as 89% of the increase in government expenditure accrues to landlords.” (20-21)
Given the inelasticity of the supply in many housing markets, this is not such a surprising result. That is, if demand increases because of an increase in income but supply does not, the producer (landlords) can capture more of that income just by raising prices. This finding should give policymakers pause as they design and implement voucher programs. The question that drives them.should be — how can they maximize the portion of the subsidy that goes to the voucher recipient?
October 21, 2014
Law360 quoted me in With Lessons Learned, FHFA Lets Mortgage Giants Ease Credit (behind a paywall). It reads in part,
The Federal Housing Finance Agency’s plan to boost mortgage lending by allowing Fannie Mae and Freddie Mac to purchase loans with 3 percent down payments may stir housing bubble memories, but experts say better underwriting standards and other protections should prevent the worst subprime lending practices from returning.
FHFA Director Mel Watt on Monday said that his agency would lower the down payment requirement for borrowers to receive the government-sponsored enterprises’ support in a bid to get more first-time and lower-income borrowers access to mortgage credit and into their own homes.
However, unlike the experience of the housing bubble years — where subprime lenders engaged in shoddy and in some cases fraudulent underwriting practices and borrowers took on more home than they could afford — the lower down payment requirements would be accompanied by tighter underwriting and risk-sharing standards, Watt said.
“Through these revised guidelines, we believe that the enterprises will be able to responsibly serve a targeted segment of creditworthy borrowers with lower down payment mortgages by taking into account ‘compensating factors,’” Watt said at the Mortgage Bankers Association’s annual meeting in Las Vegas, according to prepared remarks.
* * *
The realities of the modern mortgage market, and the new rules that are overseeing it, should prevent the lower down payment requirements from leading to Fannie Mae, Freddie Mac, and by extension taxpayers taking on undue risk, Brooklyn Law School professor David Reiss said.
Tighter underwriting requirements such as the Consumer Financial Protection Bureau’s qualified mortgage standard and ability to repay rules have made it less likely that people are taking on loans that they cannot afford, he said.
Prior to the crisis, many subprime mortgages had the toxic mix of low credit scores, low down payments and low documentation of the ability to repay, Reiss said.
“If you don’t have too many of those characteristics, there is evidence that loans are sustainable” even with a lower down payment, he said.
The FHFA is also pushing for private actors to take on more mortgage credit risk as a way to shrink Fannie Mae and Freddie Mac. There is a very good chance that private mortgage insurers could step in to take on the additional risks to the system from lower down payments, rather than taxpayers, Platt said.
“You’ll need a mortgage insurer to agree to those lower down payment requirements because they’re going to have to bear the risk of that loss,” he said.
The 97 percent loan-to-value ratio that the FHFA will allow for Fannie Mae and Freddie Mac backing is not significantly higher than the 95 percent that is currently in place, Platt said.
Having the additional risk fall to insurers could mean that the system can handle that additional risk, particularly with the FHFA looking to increase capital requirements for mortgage insurers, Reiss said.
“It could be that the whole system is capitalized enough to take this risk,” he said.
October 20, 2014
Inside ABS & MBS quoted me in Experts: New AG Likely to Continue Aggressive Use of FIRREA Against Industry, Individual Executives Targeted (behind a paywall). It reads in part,
Mortgage industry executives should be aware and expect continued – and perhaps even more muscular – use of a 1989 federal law by government prosecutors to pursue mortgage-related claims. At the direction of Attorney General Eric Holder, the Department of Justice embraced the use of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) in MBS lawsuits. Despite Holder’s announcement late last month that he is stepping down after six years as AG, there is little reason to expect that President Obama’s new attorney general will surrender use of such a “potent statute” that has employed a lower burden of proof and long statute of limitations to exact large tribute from the mortgage industry, according to Marjorie Peerce of the Ballard Spahr law firm.
* * *
Brooklyn Law School Professor David Reiss agrees. He added that throughout President Obama’s term, the White House at the highest level has set an agenda for corporate accountability so it’s likely that one of the chief mandates of Holder’s successor will be the continuation of the DOJ’s vigorous use of tools such as FIRREA.
During a speech last month prior to announcing his resignation, Holder called for making the FIRREA statute even stronger, with whistleblower bounties raised to induce more testimony. However, Reiss noted it’s unlikely the White House would be keen to encourage lawmakers to take another look at FIRREA given that Congress next year will likely be in Republican hands.
However, Reiss called attention to a part of Holder’s speech where the AG expressed frustration with the DOJ’s inability to hold financial services executives criminally liable for alleged misconduct. Holder suggested several ways for the DOJ to do so, including extending the “responsible corporate officer doctrine” to the financial services industry.
Under this doctrine, an individual may be prosecuted criminally under the Food, Drug and Cosmetic Act even absent culpable intent or knowledge of wrongdoing if the executive was in a position to prevent the wrongdoing and failed to do so.
“Focusing on individual culpability could be a new charge of the new attorney general,” said Reiss. “Given the events of the last 10 years, [a significant number of] people think that fewer individuals were held accountable for the financial crisis than should have been, so I think the Department of Justice may have heard that message as well.”
October 17, 2014
While there has been a lot of attention over Judge Lamberth’s ruling on the shareholders’ cases regarding Fannie and Freddie’s conservatorships, much less has been given to Judge Cooke’s dismissal of Samuels v. FHFA (No. 13-22399 S.D. Fla. ) (Sept. 29, 2014 ). The low-income and organizational plaintiffs in Samuels challenged the FHFA’s decision to suspend Fannie and Freddie’s obligation to fund the Housing Trust Fund after they entered into conservatorship. The Housing Trust Fund was to be funded by contributions by that were based on Fannie and Freddie’s annual purchases. The FHFA took the position that they GSEs need not pay into the fund while they themselves were in such a precarious financial position. Judge Cooke held that “The Individual and Organizational Plaintiffs lack Article III standing because their alleged injuries are too remote from and not fairly traceable to the Defendants’ allegedly unlawful conduct.” (13)
I found the dicta in the case to be the most interesting. The court found that the relevant provision from the Housing and Economic Recovery Act of 2008
provides no meaningful standards for determining when “an enterprise” is financially instable, undercapitalized, or in jeopardy of unsuccessfully completing a capital restoration plan. Considering the history of Fannie Mae and Freddie Mac; the government’s placing Fannie Mae and Freddie Mac in conservatorship; the Treasury Department providing liquidity to Fannie Mae and Freddie Mac through preferred stock purchase agreements, the mortgage backed securities purchase program, and an emergency credit facility; it is not for this Court to judicially review Defendants’ statutorily mandated suspension of payments into the Housing Trust Fund. (13)
My takeaway from this opinion is that we now have another federal judge finding that the federal government is to be given great deference in its handling of the financial crisis. And this deference derives not just from the text of the relevant statute but also from the particular historical events that led to its adoption and that followed it. This seems like an important trend, as far as I am concerned.
October 16, 2014
MainStreet.com quoted me in You Can Save Thousands on Your Mortgage By Taking This Tiny Step. It reads in part,
Homeowners can save thousands of dollars when they work with counselor to get their mortgages modified and decrease their odds of defaulting again.
A new study for NeighborWorks America by the Urban Institute determined that homeowners were able to avoid spending millions of dollars annually because of the National Foreclosure Mitigation Counseling (NFMC) program. Homeowners working with NFMC program counselors are nearly three times more likely to obtain a mortgage modification and are nearly twice as likely to get their mortgage back on track without a modification.
After working with counselors, homeowners are 60% less likely to re-default after curing a serious delinquency and able to complete short sales faster than homeowners who don’t work with counselors.
The research is based on analysis of nearly 240,000 homeowners with outcomes observed through June 2013. More than 1.8 million homeowners have been helped by the NFMC program, administered by NeighborWorks America since it began in March 2008.
* * *
Since buying a home is something that most people only do once or twice in their lives, there is no question that homeowners whose mortgages are in default or at risk of default should look for assistance as soon as possible, said David Reiss, professor of law at Brooklyn Law School in New York.
“Losing their home is something that most never do at all, so to think that going it alone is the best strategy is a mistake,” he said. “Foreclosure counselors know the range of options available to borrowers and may have access to more direct lines of communication with lenders. They also will have a better sense of when to complain to regulators about bad behavior by lenders.”
October 15, 2014
Newsday quoted me in State Faults Venture Capital Firm (registration required for full access). The story reads in part,
New York State officials say Canrock Ventures, a venture capital firm in Brookville, failed to notify them of potential conflicts of interest when it invested taxpayer money in local technology startups.
An official with Empire State Development, the state’s primary business-aid agency, said under the terms of a written agreement with the state, Canrock should have convened a “valuation committee” to review its proposed investments of federal funds in four computer software startups.
The four businesses were co-founded by a Canrock partner, and the venture firm holds sizable stakes in them. The official requested anonymity.
Mark Fasciano, the Canrock partner, said yesterday that he disclosed all of Canrock’s holdings and his roles in the companies to the state at the start of the investment process.
* * *
Canrock’s 2013 contract with New York State, obtained by Newsday under the state Freedom of Information Law, stipulates that conflicts of interest are to be weighed by a valuation committee.
The Empire State Development official said the committee is composed of two state representatives and a Canrock representative, and can only been convened by the venture firm, not New York State.
“They [Canrock] have to disclose potential conflicts of interest to the valuation committee,” the official said last month. “They did not meet that requirement.”
* * *
Valuation committees were also included in the state contracts of six other venture firms investing Innovate NY money. None of the six called valuation committee meetings to handle conflicts of interest “because no conflicts had arisen,” an Empire State Development spokesman said.
Some experts questioned whether the valuation committees were effective.
David Reiss, a law professor and research director for Brooklyn Law School’s Center for Urban Business Entrepreneurship, said, “a self-reporting system,” such as the valuation committees, would only deter fraud if the probability of getting caught is high and the consequences are grave.
“The likelihood of getting caught here sounds pretty low,” he said.