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Inside Mortgage Finance quoted me in a story, GSE Jr. Preferred Shareholders Have a Tough ‘Row to Hoe’ in Winning Their Lawsuits (behind a paywall). It reads,

Expect a long and winding legal road to resolution of investor lawsuits challenging the Treasury Department’s “net worth sweep” of Fannie Mae and Freddie Mac earnings, warn legal experts.

More than a dozen lawsuits filed against the government – including hedge funds Perry Capital and Fairholme Capital Management – are pending in federal district court in Washington, DC, and in the Court of Federal Claims. The private equity plaintiffs allege that the Treasury’s change in the dividend structure of its preferred stock leaves the government-sponsored enterprises with no funds to pay anything to junior shareholders.

The complaints raise complex constitutional and securities law issues, according to Emily Hamburger, a litigation analyst for Bloomberg Industries. “It may be a year before the crucial questions can be answered by the courts because the parties are still in the early stages of gathering evidence,” explained Hamburger during a recent webinar.

Brooklyn Law School Professor David Reiss agrees. “The plaintiffs, in the main, argue that the federal government has breached its duties to preferred shareholders, common shareholders, and potential beneficiaries of a housing trust fund authorized by the same statute that authorized their conservatorships. At this early stage, it appears that the plaintiffs have a tough row to hoe,” notes Reiss in a draft paper examining the GSE shareholder lawsuits.

Government attorneys argue that Treasury has authority to purchase Fannie and Freddie stock when it’s determined such actions are necessary to provide stability to the financial markets, prevent disruptions in the availability of mortgage finance and protect the taxpayer. The government also argues that the plaintiffs do not have a legal property interest for purposes of a Fifth Amendment “takings” claim due to the GSEs’ status in conservatorship.

Hamburger predicted that the judges in the various suits won’t be able to ignore the “obvious equitable tensions” involved. “The government is changing the terms years after their bailout, but on the other hand, the timing and motivation of investors is going to be challenged too,” she noted.

While Reiss agrees that the junior shareholders “look like they are receiving a raw deal from the federal government,” it’s a tall order to sue the federal government even under the most favorable of circumstances. The plaintiffs will have to overcome the government’s sovereign immunity, unless it is waived, and the government has additional defenses, including immunity from Administrative Procedures Act claims, under the Housing and Economic Recovery Act of 2008.

Reiss explained that HERA states that except “at the request of the Federal Housing Finance Agency, no court may take any action to restrain or affect the exercise of powers or functions of [FHFA] as conservator or receiver.” It remains to be seen how this language might apply to Treasury’s change in the preferred stock agreement, but Reiss said it could be read to give the government broad authority to address the financial situation of the two companies.

“The litigation surrounding GSE conservatorship raises all sorts of issues about the federal government’s involvement in housing finance,” said Reiss. “These issues are worth setting forth as the proper role of these two companies in the housing finance system is still very much up in the air.”

The full paper, An Overview of the Fannie and Freddie Conservatorship Litigation (SSRN link), can also be found on BePress.

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Adam Smith (not that one) and Todd Zywicki have posted Behavior, Paternalism, and Policy: Evaluating Consumer Financial Protection to SSRN. It opens,

The Consumer Financial Protection Bureau (CFPB) is one of the most powerful and least accountable regulatory agencies in American history. Immune from budgetary oversight by Congress and headed by a single director whom the president cannot remove except under special circumstances, the agency wields unconstrained, vaguely defined powers to regulate virtually every consumer and small business credit product in America In part, the CFPB has justified its ongoing intervention into financial credit markets based on a prior belief in the inability of consumers to competently weigh their decisions. This belief is founded on research conducted in the area of behavioral economics, which shows that people are prone to a variety of errors in their decision-making.

Beginning with the seminal work of Nobel Laureate Daniel Kahneman and his coauthor Amos Tversky, behavioral economics has identified numerous purported behavioral “anomalies” through extensive laboratory investigation. Anomalies (or behavioral biases) are defined as observed behavioral deviations from the predictions of neoclassical economic theory, where it is assumed that people rationally optimize according to a given set of information and constraints. Behavioral economists have sought to explain the sources of such anomalous choices by identifying and cataloging a variety of cognitive limitations and psychological biases.

Building on these findings, behavioral theorists have exported their research into the policy realm. This program, led by such luminaries as Richard Thaler and Cass Sunstein—and known as behavioral law and economics (BLE)—applies the insights gleaned from studies of human behavior to improve existing institutions by designing rules to compensate for (or take advantage of) behavioral biases. Starting from the premise that observed choices are inconsistent with neoclassical theory, behavioral economists argue that intervention is necessary to generate desirable outcomes for consumers who would otherwise make poor choices. (3-4, citation omitted)

As regular readers of this blog know, I am generally a fan of the CFPB. I recommend this paper to those who want the CFPB to be an effective tool of government. The paper critiques the CFPB in a variety of ways. I find a number of them convincing and one key one to be incredibly wrongheaded.

Convincing

  • The CFPB must avoid “confirmation bias” in its decision-making and its evidence-based analyses. (7)
  • The CFPB’s behavioral law and economics approach needs “a complementary behavioral political economy framework” to apply to the CFPB itself as a political actor. (39)
  • The CFPB should account for the ways that its actions might drive consumers to worse choices than they would face in the absence of heavy regulation of the credit markets. The paper gives illegal loan sharking as an example of a possible worse choice.
  • The CFPB would benefit from “‘adversarial review’ by a body of experts housed elsewhere in the Federal Reserve.” (40) This seems like a reasonable way to ensure that the CFPB both maintains its independence and avoids the echo chamber effect that an agency with one director (as opposed to an agency led by a bipartisan commission) might suffer from.

Wrongheaded

It amazes me that in 2014, commentators could say — “autonomous consumer choice should receive greater priority. Regulatory bodies inevitably will have an effect on the services firms choose to offer” — without addressing the negative impact of the unfettered consumer choices of the Subprime Boom that were a factor in the Subprime Bust. (39) We have not even finished with the foreclosure crisis that was the inevitable result of that boom and bust cycle. Yet law and economics scholars are already bemoaning the reduction of consumer choice caused by the regulatorily-favored Qualified Mortgage without also considering the Wild West atmosphere that characterized the mortgage market in the early 2000s. The regulatory state may not be able to craft a perfect credit market but the unfettered market failed to do so as well.

This paper does not take the full range of possible market structures (from heavy regulation to no regulation) seriously and so it is seriously flawed. It also cherry picks its facts and scholarly support at points. That being said, it does offer some trenchant comments and criticisms about the CFPB as currently structured and is therefore worth a read.

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NYU’s Furman Center released a report, Unlocking the Right to Build: Designing a More Flexible System for Transferring Development Rights. While its title does not reflect it, the report is really about increasing the supply of affordable housing in New York City. It opens,

New York City faces a severe shortage of affordable housing.  . . . Addressing this shortage of affordable housing is one of the biggest challenges facing the new de Blasio administration. The city’s affordable housing policy will undoubtedly require many strategies, from preserving the existing stock of affordable units to encouraging the construction of new affordable units. Over the past decades, the city has managed to subsidize the development of new affordable units in part by providing developers with land the city had acquired when owners abandoned properties or lost them through tax foreclosures during the fiscal crisis of the 1970s. Almost none of that land remains available, and the high cost of privately owned land poses significant barriers to the production of new affordable housing.

In this brief, we explore the potential of one strategy the city could use to encourage the production of affordable housing despite the high cost of land: allowing the transfer of unused development rights. As we describe in further detail below, the city’s zoning ordinance currently allows owners of buildings that are underbuilt to transfer their unused development capacity (often referred to as transferable development rights or TDRs) to another lot in certain circumstances. (1-2, footnotes omitted)

The report estimates that buildings below 59th Street in Manhattan that cannot use all of their development rights because of landmark restrictions could generate sufficient TDRs to produce about 7,000 affordable housing units. That number would be a significant step toward Mayor de Blasio’s goal of producing or preserving 200,000 units of affordable housing, so there is no doubt that this policy is worth a look. And the fact that one of the authors of the report, Vicki Been, is now the Commissioner of NYC’s Department of Housing Preservation and Development will ensure that it does get such a look!

The report acknowledges that loosening the restrictions on TDRs has downsides as well, such as the possible construction of big buildings that are out context of neighboring properties. But the report is intended as a “first step” in the exploration of an innovative land use policy. (19) And it certainly is a step in the right direction.

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The court in deciding M & T Bank v. Strawn, 2013-Ohio-5845 (Ohio Ct. App., Trumbull County, 2013) ultimately affirmed the lower court’s decision.

The court decided that the bank’s possession of the note was shown by the affidavit, along with attached copies of the note endorsed to the bank, and the court found that one in possession of a note endorsed to that party was a holder, for purposes of R.C. 1301.201(B)(21)(a). As such the court decided that the bank was thus entitled to enforce the instrument under R.C. 1303.31.

The court found that the affidavit for the bank clearly stated that the bank had been in possession of the original promissory note, and the affidavit was sufficient for the lower court to have held that the affiant had personal knowledge. The court further noted that nothing suggested that voided endorsements affected the bank’s status as a holder, and thus it did not create an issue of fact.

Lastly the court found that the bank acquired an equitable interest in the mortgage when it became a holder of the note, regardless of whether the mortgage was actually or validly assigned or delivered. Based on these conclusions this court affirmed the lower court’s judgment.

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The court in deciding Deutsche Bank Nat’l Trust Co. v. Santisi, 2013-Ohio-5848 (Ohio Ct. App., Trumbull County, 2013) ultimately denied the motion to vacate and affirmed the lower court’s decision.

Santisi appealed the lower court’s decision and raised the following assignments of error:

1) plaintiff (appellee) failed to present an affidavit or any other record evidence sufficient to meet its burden to establish it had standing to pursue a foreclosure action.

2) Plaintiff (appellee) failed to establish standing as there was no admissible evidence to explain material inconsistencies regarding the promissory note.

The bank asserted its standing to foreclose the mortgage by alleging that it was the holder and owner of a note in its complaint, and that allegation was legally sufficient to establish the bank’s standing to foreclose. The bank also provided evidence of standing by virtue of holding the note. The also bank established its interest in both the note and the mortgage, which was not disputed by the mortgagor prior to judgment and, thus, properly invoked the trial court’s jurisdiction. Based on these facts this court upheld the lower court’s decision.

 

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Larry Wall of the Federal Reserve Bank of Atlanta has posted one of his Notes from the Vault, Have the Government-Sponsored Enterprises Fully Repaid the Treasury? It opens,

Have U.S. taxpayers been fully compensated for their bailout of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac? The Treasury is reported to have argued that “the value of Treasury’s commitment to the GSEs was “incalculably large,’” with the implication that it could never be repaid. Richard Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution [and who discloses that he consults "with several hedge funds with positions in Fannie and Freddie"], responded that “the level of the Treasury commitment was not ‘incalculably large’: it was $188 billion, all of which will shortly be repaid.” The significance of Epstein’s argument is that if Treasury has been fully compensated for its bailout of Fannie and Freddie, a case can be made that the future profits of the two GSEs should go to their private shareholders.

As an accounting matter, one could argue that Epstein is correct; the dividends equal the amount of Treasury funds provided to the GSEs. And as a legal matter, the issue may ultimately be resolved by the federal courts. However, as an economic matter, the value of the government’s contribution clearly exceeds $188 billion once the risk borne by taxpayers is taken into account.

In this Notes from the Vault I examine the value of the taxpayers’ contribution to Fannie and Freddie from an economic perspective. My analysis of these contributions is divided into three parts: (1) the GSEs’ profitability prior to the 2008 conservatorship agreement (bailout), (2) the value of the taxpayer promise at the time of the bailout, and (3) support of new investments since they were placed in conservatorship. (1)

The article goes on to explain each of these three parts of the taxpayers’ contribution and concludes,

The claim that the taxpayers and Treasury have been fully repaid for their support of Fannie Mae and Freddie Mac is based on an accounting calculation that does not withstand economic analysis. The claim that Treasury’s commitment has been fully repaid attributes no dividend payments to Treasury starting in 2012, attributes no value to the government guarantee to absorb whatever losses arose in the pre-conservatorship book of business, and arguably reflects Treasury setting too low of a dividend rate on its senior preferred stock. Moreover, the profits that are being used to pay the dividends did not arise from the contributions of private shareholders but rather entirely reflect risks borne by the Treasury and taxpayers. Thus, the Treasury claim that the value of the aid was “incalculable” is an exaggeration; the value surely can be fixed within reasonable bounds. However, the implication of this claim, that the GSEs cannot repay the economic value on behalf of their common shareholders, is nevertheless accurate. (2)

This article offers a useful corrective to the story one hears from those representing Fannie and Freddie’s shareholders. They have constructed a simple narrative of the bailout of the two companies that ignores the way that the two companies’ fortunes have been intrinsically tied to the federal government’s support of them. That simple narrative just nets out the monies that Treasury fronted Fannie and Freddie with the payments that the two companies made back to Treasury.  After netting the two, they say, “Case closed!” Wall has demonstrated that there are a lot more factors at play than just those two.

I would also highlight something that Wall did not: the federal government actually determines the level of profits that Fannie and Freddie can make by setting the fees the two companies charge for guaranteeing mortgages. So, the federal government could wipe away future profits by lowering the guaranty fees. And wiping away those profits would make those outstanding shares worthless.

So the question remains: what is the endgame for the investors who have brought these lawsuits?

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The National Mortgage Settlement Monitor issued his Final Crediting Report. The report states that

In total, the servicers have provided more than $50 billion of gross dollar relief, which translates into more than $20 billion in credited relief under the Settlement’s scoring system. More than 600,000 families received some form of relief under the Settlement. Aggregate credited relief includes:

• $7,589,277,740, or 37 percent of total credited relief, of first lien principal forgiveness.

• $3,105,152,359, or 15 percent of total credited relief, of second lien forgiveness.

• $3,587,672,814, or 17 percent of total credited relief, of refinancing assistance.

• $6,410,554,173, or 31 percent of total credited relief, of other forms of relief, including, but not  limited to, assistance related to short sales and deeds in lieu of foreclosure. (2)

I am not going to criticize the substance of the mortgage settlement. But I have a hard time translating these massive numbers into an understanding of how much help people got from the settlement. $20 Billion of credited relief divided by 600,000 households comes out to about $33,000 in relief per household. The Monitor gives us no sense as to whether that $33,000 made a difference to the affected families.

Perhaps going forward, massive settlements like this should include metrics that help to break down these large numbers into categories that make more intuitive sense:  for instance, did the mortgage relief reduce the monthly payment to a sustainable level?  What percent reduction was there in monthly mortgage payments? How many mortgages were converted from underwater mortgages into ones that were in the money as a result of the settlement? Metrics such as these would help give an understanding of how many people were helped (certainly more than one of the metrics often repeated by the monitor, “My team spent 36,000 hours reviewing and testing the consumer relief and refinancing activities reported by the banks.

As counter-intuitive as the question may seem, do we have enough information to really know whether $50 Billion of mortgage relief made a meaningful difference for American households?