I attended the Saint Petersburg International Legal Forum in May and gave a series of talks on American law to an international audience. My lecture on Real Estate Transactions in the United States was recorded and is now on YouTube.
This lecture provides an overview of the basic U.S. residential real estate transaction for those who know very little about the subject.
Judge Lamberth issued an opinion in Fairholme Funds, Inc. v. FHFA (Civ. No.13-1439) (Sept. 28, 2018) that gives some hope to the private shareholders of Fannie Mae and Freddie Mac. These shareholders have been on the losing end of nearly every case brought against the government relating to its handling of the conservatorships of the two companies. Readers of this blog know that I have long been a skeptic of the shareholders’ claims because of the broad powers granted the government by the Housing and Economic Recovery Act of 2008, passed during the height of the financial crisis, as well as the highly regulated environment in which the two companies operate. This highly regulated environment means that GSE profits are driven by regulatory decisions much more than those of other financial institutions. As such, Fannie and Freddie live and die by the sword of government intervention in the mortgage market.
Judge Lamberth had dismissed the plaintiffs’ claims in their entirety, but was reversed in part on appeal. In this case, he revisits the issues arising from the reversal of his earlier dismissal. Once again, Judge Lamberth dismisses a number of the plaintiffs’ claims, but he finds that that their claim that the government breached the duty of good faith survives.
The opinion gives a road map that shareholders can follow to success. The judge identifies allegations that, if true, would be a sufficient factual basis for a holding that the government breached the implied covenant of good faith and fair dealing. It is plausible that the preponderance of proof may support these allegations. Some evidence has already come to light that indicates that at least some government actors had good reason to believe that Fannie and Freddie were on the cusp of sustained profitability when the government implemented the net worth sweep. The net worth sweep had redirected the net profits of the two companies to the U.S. Treasury.
Judge Lamberth highlights some of aspects of the plaintiffs’ argument that he found compelling at the motion to dismiss phase of this litigation. First, he notes that absence of “any increased funding commitment” is atypical when senior shareholders receive “enhanced disbursement rights,” as was the case when the government implemented the net worth sweep. (21) He also states that the plaintiffs would not have expected that the GSEs would have extinguished “the possibility of dividends arbitrarily or unreasonably.” (22)
While this opinion is good news for the plaintiffs, it is still unclear what their endgame would be if they were to get a final judgment that the net worth sweep was invalid. Depending on the outcome of regulatory and legislative debates about the future of the two companies, the win may be a pyrrhic one. Time will tell. In the interim, expect more discovery battles, motions for summary judgment and even a trial in this case. So, while this opinion gives shareholders some hope of ultimate success, and perhaps some leverage in political and regulatory debates, I do not see it as a game changer in itself.
In terms of the bigger picture, there are a lot of changes on the horizon regarding the future of the housing finance system. The midterm elections; Hensarling and Corker’s departure from Congress; and the Trump Administration’s priorities are all bigger drivers of the housing finance reform train, at least for now.
The Congressional Budget Office released a report, Transitioning to Alternative Structures for Housing Finance: An Update. The report updates a 2014 analysis
to inform policymakers about how different approaches to restructuring the housing finance system would affect federal costs, risks to taxpayers, and mortgage interest rates. The study focuses on the secondary mortgage market, in which financial institutions buy residential mortgages, pool them into mortgage-backed securities (MBSs), and sell the securities to investors with a guarantee against defaults on the underlying loans. That market is dominated by Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs) that have been under the control of the federal government since the financial crisis of 2008.
• Federal Costs. CBO projects that under current policy, the GSEs will guarantee almost $12 trillion in new MBSs over the next 10 years and that those guarantees will cost the government about $19 billion on a fair-value basis. That cost represents the estimated amount that the government would have to pay private guarantors to bear the credit risks of the new guarantees. New structures for the secondary mortgage market that emphasized private capital would greatly reduce federal costs, compared with current policy, and would decrease taxpayers’ exposure to credit risk, but mortgage borrowers would face slightly higher costs.
• Risks to the Government. Three of the four approaches to restructuring the secondary market that CBO analyzed would keep some type of explicit federal guarantee of MBSs to provide stability to the market during a financial crisis. Under those approaches, the government would continue to bear most of the risks on new guarantees during a financial crisis, but the approaches differ in the extent to which private guarantors and investors would share risks under normal market conditions. Alternatively, if the secondary market were largely privatized, there would be no explicit federal guarantees on most residential mortgages. But some type of government intervention might be necessary to stabilize mortgage markets during a financial crisis.
• Availability of Mortgages and Changes in Interest Rates. New structures for the secondary market that emphasized private capital would lead to slightly higher interest rates and slightly lower home prices under normal conditions (because the fees that the GSEs currently charge for their guarantees are close to the prices that CBO judges private firms would charge). If the market were controlled by a single, fully federal agency, interest rates could fall slightly. During a financial crisis, however, borrowers could face significant constraints on the availability of mortgages and higher interest rates under a largely private secondary market, though not under the other structures, unless the government chose to intervene.
This report is particularly valuable because it focuses on the transition from the limbo state of conservatorship that we find ourselves in to a more stable one that is built to last. The report considers four possible pathways:
Things still are very much up in the air as to which way things will go when Congress finally turns its attention to this issue, but this report helps to plan for the transition no matter which path is followed.
The United States Court of Appeals for the Eighth Circuit issued an opinion in Saxton v. FHFA (No. 17-1727, Aug. 23, 2018). The Eighth Circuit joins the Fifth, Sixth, Seventh and D.C. Circuits in rejecting the arguments of Fannie and Freddie shareholders that the Federal Housing Finance Agency exceeded its authority as conservator of Fannie Mae and Freddie Mac and acted arbitrarily and capriciously. The Court provides the following overview:
The financial crisis of 2008 prompted Congress to take several actions to fend off economic disaster. One of those measures propped up Fannie Mae and Freddie Mac. Fannie and Freddie, which were founded by Congress back in 1938 and 1970, buy home mortgages from lenders, thereby freeing lenders to make more loans. See generally 12 U.S.C. § 4501. Although established by Congress, Fannie and Freddie operate like private companies: they have shareholders, boards of directors, and executives appointed by those boards. But Fannie and Freddie also have something most private businesses do not: the backing of the United States Treasury.
In 2008, with the mortgage meltdown at full tilt, Congress enacted the Housing and Economic Recovery Act (HERA or the Act). HERA created the Federal Housing Finance Agency (FHFA), and gave it the power to appoint itself either conservator or receiver of Fannie or Freddie should either company become critically undercapitalized. 12 U.S.C. § 4617(a)(2), (4). The Act includes a provision limiting judicial review: “Except as provided in this section or at the request of the Director, no court may take any action to restrain or affect the exercise of powers or functions of the [FHFA] as a conservator or a receiver.” Id. § 4617(f).
Shortly after the Act’s passage, FHFA determined that both Fannie and Freddie were critically undercapitalized and appointed itself conservator. FHFA then entered an agreement with the U.S. Department of the Treasury whereby Treasury would acquire specially-created preferred stock and, in exchange, would make hundreds of billions of dollars in capital available to Fannie and Freddie. The idea was that Fannie and Freddie would exit conservatorship when they reimbursed the Treasury.
But Fannie and Freddie remain under FHFA’s conservatorship today. Since the conservatorship began, FHFA and Treasury have amended their agreement several times. In the most recent amendment, FHFA agreed that, each quarter, Fannie and Freddie would pay to Treasury their entire net worth, minus a small buffer. This so-called “net worth sweep” is the basis of this litigation.
Three owners of Fannie and Freddie common stock sued FHFA and Treasury, claiming they had exceeded their powers under HERA and acted arbitrarily and capriciously by agreeing to the net worth sweep. The shareholders sought only an injunction setting aside the net worth sweep; they dismissed a claim seeking money damages. Relying on the D.C. Circuit’s opinion in Perry Capital LLC v. Mnuchin, 864 F.3d 591 (D.C. Cir. 2017), the district court dismissed the suit.
What amazes me as a longtime watcher of the GSE litigation is how supposedly dispassionate investors lose their heads when it comes to the GSE lawsuits. They cannot seem to fathom that judges will come to a different conclusion regarding HERA’s limitation on judicial review.
While I do not rule out that the Supreme Court could find otherwise, particularly if Judge Kavanaugh is confirmed, it seems like this unbroken string of losses should provide some sort of wake up call for GSE shareholders. But somehow, I doubt that it will.
The Trump Administration released its fourth and final report on Nonbank Financials, Fintech, and Innovation in its A Financial System That Creates Economic Opportunity series. The report differs from the previous three as it does not throw the Consumer Financial Protection Bureau under the bus when it comes to the regulation of mortgage lending.
The report highlights how nonbank mortgage lenders, early adopters of fintech, have taken an immense amount of market share from traditional mortgage lenders like banks:
Treasury recognizes that the primary residential mortgage market has experienced a fundamental shift in composition since the financial crisis, as traditional deposit-based lender-servicers have ceded sizable market share to nonbank financial firms, with the latter now accounting for approximately half of new originations. Some of this shift has been driven by the post-crisis regulatory environment, including enforcement actions brought under the False Claims Act for violations related to government loan insurance programs. Additionally, many nonbank lenders have benefitted from early adoption of financial technology innovations that speed up and simplify loan application and approval at the front-end of the mortgage origination process. Policymakers should address regulatory challenges that discourage broad primary market participation and inhibit the adoption of technological developments with the potential to improve the customer experience, shorten origination timelines, facilitate efficient loss mitigation, and generally deliver a more reliable, lower cost mortgage product. (11)
I am not sure that the report has its causes and effects exactly right. For instance, why would banks be more disincentivized than other financial institutions because of False Claims Act lawsuits? Is the argument that banks have superior lending opportunities that are not open to nonbank mortgage lenders? If so, is that market segmentation such a bad thing?
That being said, I think the report is right to highlight the impact of fintech on the contemporary mortgage lending environment. Consumers will certainly benefit from a shorter and more streamlined mortgage application process.
CBS2’s Mary Calvi, photo by Marc A. Hermann / MTA New York City Transit
I was interviewed by Mary Calvi on CBS New York in Man Wants Back Property NYC Took From His Family In 1967 (click here to watch the segment). The transcript of the segment reads, in part,
There is a property battle that has been brewing in the Bronx for some time.
A man is fighting to get back a piece of land that he claims belongs to his family.
He says the city took the land five decades ago saying it wants to extend a road, but all these years later nothing has changed, CBS2’s Mary Calvi reported Monday.
Fred Filomio fixes what’s broken on trucks in the Bronx. For decades, one problem has lingered, unfixed.
You see, back in 1967, when he was entering military service, the city of New York, using eminent domain, took part of his family’s property.
“When my uncle Freddie came back from World War II, they bought the whole block,” Filomio said.
A 13,000-square foot piece that sits up 22 feet above street level is a small part of a larger piece of property on Boston Road in the Bronx for his family’s trucking business. Back those 50 years ago, the city said it had to have the property in order to widen a street adjacent to it.
“They haven’t used one square foot of the property,” Filomio said, adding it looks the same as it did five decades ago.
In 50 years, the city has literally done nothing with the property. Filomio even uses it to park his trucks. His lawyer, Richard Apat, has filed suit.
“We feel showing number one it was an excess taking. Number two, it’s now being held as a proprietary. Number three, that we have been in possession we should get it back. But even with that, Fred is a reasonable person. If the city will talk to us and say let’s work something out, he’ll pay them some money, he’ll start paying taxes and that’s why I say I think it’s win-win,” Apat said.
The city responded to CBS2’s numerous requests for comment, with only the following from a spokesperson: “The property involved in this ongoing litigation is not subject to a claim of adverse possession, as a matter of law. We have no further comment while this litigation is pending.”
Professor David Reiss teaches students about eminent domain at Brooklyn Law School. He said he believes this one, like most others, is a difficult one to win.
“It looks like they have a tough row to hoe,” Reiss said. “Once the government takes ownership of the property, generally it’s theirs.”
The Wall Street Journal quoted me in In Cooling Housing Markets, ‘Bump Clauses’ Help Seal Win-Win Deals. It opens,
What to do when a home-seller gets an offer but holds out hope for something better?
Enter the bump clause.
A bump clause lets sellers enter into a contract with a buyer while still continuing to market the property. If the sellers get a better deal, they can “bump” the original buyer.
It’s most commonly used when a buyer’s offer has some contingency, usually that they need to sell their current home first. It can help coax the sellers into contract by offering them the ability to seek alternate buyers who don’t have a home-sale contingency or who are offering higher prices.
The clause tends to become more popular in markets that are “transitional,” where once-hot home sales are cooling but sellers haven’t yet adjusted their expectations. The tactic can be “a savvy technique” to help the sellers feel they could still get a better offer, says David Reiss, a Brooklyn Law School professor who specializes in real estate.
If the sellers do get another written offer they want to take, they must notify the original buyer. The buyer then typically has a few days to tell the seller they’ve sold their house, or that they’ve decided to waive the contingency. If not, the original contract terminates. The original buyer gets back the money they put down, and the sellers enter into contract with the new buyer.
The sellers can only keep marketing the property until the buyers satisfy or waive the contingency. So once the buyers notify the seller they’ve sold their existing home, the seller’s right to market the property ends.
Rebekah Carver, a real-estate broker with Douglas Elliman Real Estate in Brooklyn, N.Y., says Brooklyn has been a hot market for a long time, and bump clauses haven’t been common. But now she’s representing buyers on a deal where the seller had resisted signing a contract with a home-sale contingency, even though the property had been on the market for about six months. Ms. Carver offered the bump clause to try to put the seller’s mind at ease.
In general, the bump clause can “give the seller some sense of security and comfort,” says Ms. Carver. The bump clause can be proposed by either the buyer’s or seller’s side, but is often offered by the buyer’s agent as a way to get the seller to accept a contingency.
Robin Sheridan, a real-estate broker with Realogics Sotheby’s International Realty in Seattle, says that when she is representing a seller facing a home-sale contingency, Ms. Sheridan often does her own due diligence. “I want to be certain the other property is one that will sell quickly,” she says. “I vet the buyers via their lender and ensure all their ducks are in a row to navigate the two nearly consecutive transactions. Knowing the bump clause is a possibility is comforting to a seller, but most of my clients remain firmly committed to the contract in hand.”
Here are some things to consider with bump clauses.
For sellers:
• Use it as leverage. Since the house is already under contract, a seller can use the clause as a negotiating tactic with any other buyers that show interest. The seller can try to get the other buyers to outbid the current price or negotiate a contract without contingencies.
• Don’t get greedy. If the seller receives a second offer, he may be tempted to “bump” the first buyer and sell to the second. But sellers should make sure the second offer is at least as strong as the first, which means looking deeper than price and contingencies. The new buyers may have poor credit, for example, and be less likely to obtain a mortgage. “It’s a bird in the hand,” says Mr. Reiss. “If they walk away and are stuck negotiating with a second offer that’s weak, they could end up with nothing.”
