December 23, 2013

Michigan Court Dismisses Fraud & RESPA Claims

By Ebube Okoli

The court in deciding Neroni v. Bank of Am., N.A., 2013 U.S. Dist. LEXIS 149190 ( E.D. Mich. 2013) eventually granted the defendant’s motion to dismiss.

Plaintiffs alleged claims against defendant [Bank of America, N.A.] for infringement of the Real Estate Settlement Procedures Act (“RESPA”) (Counts I–IV), common law fraud (Count V), common law silent fraud (Count VI), and common law breach of contract (Count VII).

Defendant responded by asserting that plaintiffs’ RESPA claims should be dismissed because (1) defendant had no legal obligation under RESPA to respond or, alternatively, (2) plaintiffs failed to plead any actual damages related to their RESPA claims. Defendant further asserted that plaintiffs had failed to adequately plead claims for fraud or breach of contract relating to defendant’s legal standing to foreclose on Plaintiffs’ Home.

After considering the merits of both claims, the court ultimately agreed with the defendant and granted the defendant’s motion to dismiss.

December 23, 2013 | Permalink | No Comments

December 20, 2013

More on Misrepresentation

By David Reiss

NY Supreme Court Justice Schweitzer (NY County) issued a Decision and Order on a motion to dismiss in HSH Nordbank AG, et al., v. Goldman Sachs Group, Inc., et al., No. 652991/12 (Nov. 26, 2013) that builds on the NY jurisprudence of RMBS misrepresentation. The decision notes that “The gravamen of the complaint is that Goldman Sachs knew that” its metrics and representations regarding various RMBS “were false, but did not alert Nordbank.” (2) In particular,

Nordbank alleges that Goldman Sachs knew that loan originators had systematically abandoned underwriting guidelines described in the Offering Materials. It alleges that Goldman Sachs knowingly reported false credit ratings, owner-occupancy percentages, appraisal amounts, and loan-to-value ratios. It alleges that although Goldman Sachs represented otherwise in the Offering Materials, Goldman Sachs never intended to properly effectuate transfer of the underlying notes and mortgages that collateralized the Certificates. (2)

The Court found that Nordbank “sufficiently alleged that Goldman Sachs had knowledge that originators were deliberately inflating appraisal values to artificially obtain understated CLTV ratios that corresponded with lower risk.” (9) As a result, “the complaint sufficiently describes actionable misrepresentations regarding appraisal values, loan-to-value ratios, and owner-occupancy rates.” (9)

Nordbank also alleged

that it has suffered losses totaling more than $1.5 billion as a result of the alleged misrepresentations regarding the loans’ conformity with originators’ underwriting guidelines. Specifically, Nordbank alleges that it has been unable to transfer notes and mortgages that have declined in value because of the poor quality of the underlying loans. The representations at issue allegedly resulted in higher rates of default, an impaired ability to obtain forecloses, and ultimately, a lower cash flow to Certificate-holders like Nordbank. Because Nordbank has sufficiently alleged a chain of causation leading from the alleged abandonment of underwriting standards to a decline in the market value of the Certificates, the complaint cannot be dismissed for failure to allege lost causation. (20)

As this decision was on a motion to dismiss, none of these findings result in actual liability for Goldman Sachs, but they do provide a road map for what liability could look like.  As I have noted in the past, it will be interesting to see how this body of law will affect the securitization process going forward.

December 20, 2013 | Permalink | No Comments

December 19, 2013

Reiss on Predatory Online Lending

By David Reiss

E-Commerce Times quoted me in CFPB Suit Targets Predatory Online Lending Practices. It reads in part:

The Consumer Finance Protection Bureau this week put online finance companies on notice that it will not overlook them merely because they operate in cyberspace. Specifically, the bureau sued CashCall for collecting money consumers allegedly did not owe.  In its suit, the bureau charged that CashCall and its affiliates engaged in unfair, deceptive, and abusive practices, including illegally debiting consumer checking accounts for loans that were void.

CashCall and the associated companies are reportedly owned by J. Paul Reddam, a race-horse owner and philosophy professor-turned-businessman.

The Background

Beginning in late 2009, CashCall and its subsidiary, WS Funding, entered into an arrangement with online lender Western Sky Financial, according to the CFPB. Western Sky Financial has asserted that the laws in the state in which it is based — South Dakota — did not apply to it because it was based on an Indian reservation and owned by a member of the Cheyenne River Sioux Tribe.

The CFPB maintains Western Sky still must comply with state laws when it makes loans over the Internet to people in other states.

The loans ranged from US$850 to $10,000 and came with upfront fees, lengthy repayment terms and annual interest rates from nearly 90 percent to 343 percent, the CFPB said. Many of the loan agreements allowed payments to be debited directly from the borrower’s bank account.

By September 2013, Western Sky had become the subject of several states’ investigations and court actions, and it began to shut down its business. CashCall and its collection agency, Delbert Services, continued to take monthly installment payments from consumers’ bank accounts or otherwise sought to collect money from borrowers.

After its own investigation, the bureau concluded that the high-cost loans violated either licensing requirements or interest-rate caps, or both, in Arizona, Arkansas, Colorado, Indiana, Massachusetts, New Hampshire, New York and North Carolina, meaning the consumers did not owe that money that was being collected.

As part of its suit, the CFPB is seeking monetary relief, damages, and civil penalties.

The CFPB did not respond to our request for further details.

*     *     *

‘Particularly Weak’

 

While there might not be much controversy over the CFPB’s suit against an online lender, CashCall is certainly defending itself using other arguments.

Clearly, the action falls within the CFPB’s broad mission of protecting consumers from predatory behaviors in the financial services industry, asserted David Reiss, a professor of Law at Brooklyn Law School.

However, CashCall’s attorneys, Neil Barofsky and Katya Jestin, have said that the CFPB does not have a mandate to impose rate caps.

“Of all of CashCall’s arguments, this one seems particularly weak,” Reiss concluded, “as the CFPB is just seeking to enforce existing state laws that have been allegedly violated across the country.”

December 19, 2013 | Permalink | No Comments

December 18, 2013

Optimizing Principal Modifications

By David Reiss

S&P posted How Principal And Interest Rate Modifications Affect U.S. RMBS. Principal modifications — reducing the amount that the homeowner owes on the loan — have not been popular with lenders for obvious reasons. But they have also not been popular with politicians and even with the general populace for reasons that likely derive from variants of moral hazard: it just isn’t fair that some people don’t have to repay their debts. And if we give some people an out, won’t everyone else want one too?

Perhaps the better question to ask is whether principal modifications reduce defaults compared to other steps that lenders have taken with defaulting borrowers. S&P has looked at this question and they found “that even though rate reductions are the most common form of modification, principal reductions offer the most benefit to borrowers looking to avoid default.” (2)

While principal mods are good for borrowers — no big surprise there — their impact on investors is not so clear cut. S&P writes that

When it comes to principal reductions, investors can also have different outcomes based on the deal structure. A write-down in loan principal will cause an immediate reduction in credit enhancement, and bondholders would face greater exposure to collateral losses. But for deals with cumulative loss triggers, senior bondholders can receive extra principal diverted from subordinate classes once the triggers are tripped, thereby accelerating their recovery. . . . [S]tructural provisions and interest and principal payment mechanisms in RMBS transactions influence how loan modifications affect bondholders in RMBS transactions. Any type of modification brings with it nuances that may benefit the borrower while having a varied impact on investors. (5)

As we learn lessons that may apply in the next crisis, it is worth realizing that borrower workouts and investor outcomes are linked in ways that should be explicitly identified so that incentives can be properly aligned. With planning, mortgage-backed securities can be structured to be good for borrowers and investors, perhaps even Pareto optimal.

December 18, 2013 | Permalink | No Comments

December 17, 2013

Reiss on Myths of the Fed

By David Reiss

Bankrate.com quoted me in a story, 5 Myths Debunked About The Federal Reserve. it reads in part,

Assassination, foreign control and money printing: the stuff of a motion picture thriller?

Not in this case. They’re all the fodder for wild and surprisingly popular myths surrounding the nation’s central bank, the Federal Reserve.

It does wield considerable power, evident in the extraordinary measures taken during and after the financial crisis. But it’s amazing the things that otherwise reasonable people say about this admittedly complex U.S. government institution.

David Reiss, professor at the Brooklyn Law School, says, “To most of us, the Federal Reserve is a riddle, wrapped in a mystery inside an enigma, to borrow Winston Churchill’s phrase.”

With the Fed celebrating its centennial, the time is right to tackle some of these myths head-on. There are many myths out there regarding the Fed. Here are just a handful.

*     *     *

Myth 3: The Fed prints money

The notion is rooted in the Federal Reserve’s control of the nation’s money supply. The Bureau of Engraving and Printing, part of the U.S. Treasury, is responsible for printing currency.

“Although the Bureau of Printing and Engraving prints it, it delivers it to the Fed, and then the Fed gets to decide how much of it to put out into the economy,” says W. Michael Cox, director of the O’Neil Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business. He’s also former chief economist of the Federal Reserve Bank of Dallas.

In a way, Reiss of the Brooklyn Law School says, “the Fed can create money and does so in a variety of ways.” What he means is the Fed can increase the money supply through its monetary tools. Since the end of 2008, it has used “quantitative easing,” or QE, a term used to describe the Fed’s strategy to boost the supply of money. In the latest round of QE, the Fed has undertaken the monthly purchase of $85 billion in assets over the past year.

If you want to describe the process correctly, you might take a cue from St. Lawrence University’s Horwitz. The central bank isn’t in the printing business, but it has some control of the process.

“The money that the Fed creates is all done electronically in the form of bookkeeping entries that expand the deposit accounts that banks hold at the Fed,” he says.

December 17, 2013 | Permalink | No Comments

December 16, 2013

Reiss on “Sexy Tax Breaks” for Luxury Housing

By David Reiss

MainStreet.com quoted me in Luxury Real Estate with Sexy Tax Breaks. The story reads in part,

Buying a high end property doesn’t always cost a fortune for the wealthy especially if there are tax breaks attached.

Property tax deductions and even exemptions exist for buyers of luxury properties under special incentives, such as New York City’s J-51 and 421a program.

“A J-51 unit in a luxury building will likely sell for more than a comparable condo without a tax break, because monthly expenses are lower due to reduced property taxes. It’s a deal but not dollar for dollar, and that’s true everywhere you look for tax breaks in luxury properties,” said David Reiss, professor of real estate law at Brooklyn Law School.Benefits include no tax by reducing the assessed value of the property to the pre-renovated price and secondly by capping property taxes.

“These benefits phase out typically over a 14 year period for market rate properties,” Reiss told MainStreet.

Most J-51 buildings in the borough of Manhattan are above 110 Street due to state restrictions.

For example, for interested buyers there’s a two-bedroom J-51 condominum on West 140th Street available for $620,000 advertised on condo-living-west.com.

“The tax reduction will be priced into the cost of the home,” said Reiss.

A back end strategy would be to buy and sell early rather than buy early and sell late to make a profit after purchase.

“Because the closer you are to the 14 year phase out when you sell, the less of a benefit the tax break is to the owners’ sale price,” Reiss said.

The 421a program is another tax break available for new construction not rehabilitation or conversion of existing buildings in Manhattan.

For example, an owner in a $90 million duplex penthouse in Midtown Manhattan would normally pay $230,000 in taxes without an abatement and $20,000 in taxes under an abatement program.

About 150,000 units in New York City receive partial tax exemptions under 421a.

The downside is that taxes gradually go up as the abatement is phased out.

December 16, 2013 | Permalink | No Comments

December 13, 2013

Non-QM Mortgages Risks and Best Practices

By David Reiss

Moody’s issued a report, Non-QM US RMBS Face Higher Risk of Losses Than QM, but Impact on Transactions Will Vary, that discusses the risk that

US RMBS backed by non-qualified mortgages (those that do not meet a variety of underwriting criteria under new guidelines) will incur higher loss severities on defaulted loans than those backed by qualified mortgages. The key driver of the loss severities will be the higher legal costs and penalties for non-QM securitizations. In non-QM transactions, a defaulted borrower can more easily sue a securitization trust on the grounds that the loan violated the Ability-to-Repay (ATR) rule under the Dodd-Frank Act. . . . The extent of the risks for RMBS will vary, however, depending on the mortgage originators’ practices and documentation, the strength of the transactions’ representations and warranties, and whether the transactions include indemnifications that shield them from borrower lawsuits. (1)

The higher costs for non-QM investors may include longer foreclosure timelines and the resulting wear on the collateral.

If Moody’s analysis is right, however, the Dodd-Frank regime will be working as intended. It should incentivize mortgage originators to strengthen their compliance practices such as those relating to documentation, recordkeeping and third party due diligence. It should also incentivize securitizers to demand strong reps and warranties, put back and indemnification provisions. Sounds like a reasonable trade off to  me.

December 13, 2013 | Permalink | No Comments