Author Archives: David Reiss

Conservative Underwriting or Regulatory Uncertainty?

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Jordan Rappaport (Federal Reserve Bank of Kansas City) and Paul Willen (Federal Reserve Bank of Boston) have posted a Current Policy Perspectives,Tight Credit Conditions Continue to Constrain The Housing Recovery. They write,

Rather than cutting off access to mortgage credit for a subset of households, ongoing credit tightness more likely takes the form of strict underwriting procedures applied to all households. Lenders require conservative appraisals, meticulous documentation, and the curing of even the slightest questions of title. To the extent that these standards constitute sound lending practices, adhering to them is a positive development. But the level of vigilance suggests that regulatory uncertainty may also be playing a role.

Since the housing crisis, the FHA, the Federal Housing Finance Agency, the Consumer Financial Protection Bureau, and other government and private organizations have been continually developing a new regulatory framework. Lenders fear that departures from the evolving standards will result in considerable costs, including the forced buyback of loans sold to Fannie and Freddie and the rescinding of FHA mortgage guarantees. The associated uncertainty has caused lenders to act as if strict interpretations of possible restrictive future standards will apply. (2-3)

The authors raise an important question: has the federal government distorted the mortgage market in its pursuit of past wrongdoing and its regulation of behavior going forward? Anecdotal reports such as those about Chase’s withdrawal from the FHA market seem to suggest that the answer is yes. But it appears to me that Rappaport and Willen may be jumping the gun based on the limited data that they analyze in their paper.

Markets cycle from greed to fear, from boom to bust. The mortgage market is still in the fear part of the cycle and government interventions are undoubtedly fierce (just ask BoA). But the government should not chart its course based on short-term market conditions. Rather, it should identify fundamentals and stick to them. Its enforcement approach should reflect clear expectations about compliance with the law. And its regulatory approach should reflect an attempt to align incentives of market actors with government policies regarding appropriate underwriting and sustainable access to credit. The market will adapt to these constraints. These constraints should then help the market remain vibrant throughout the entire business cycle.

One Hour Left To Nominate REFinblog for Blawg 100!

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The ABA Journal is soliciting suggestions for the Blawg 100, its annual listing of the 100 best legal blogs. Please consider nominating REFinblog.  The nomination form is here and nominations are due by 5:00 pm EST on Friday, August 8th.  Thank you for your consideration!

Unfair Loan Mod Negotiations

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The Ninth Circuit issued an Opinion in Compton v. Countrywide Financial Corp. et al., (11-cv-00198 Aug. 4, 2014).  The District Court had dismissed Compton’s unfair or deceptive act or practice [UDAP] claim because she had failed to allege that the lender had “exceeded its role as a lender and owed an independent duty of care to” the borrower. (14) The Court of Appeals concluded, however, that the homeowner/plaintiff had

sufficiently alleged that BAC engaged in an “unfair or deceptive act or practice” for the purpose of withstanding a motion to dismiss. As previously noted, Compton does not base her UDAP claim on allegations that BAC failed to determine whether she would be financially capable of repaying the loan. Rather, the gist of Compton’s complaint is that BAC misled her into believing that BAC would modify her loan and would not commence foreclosure proceedings while her loan modification request remained under review. As a result of these misrepresentations, Compton engaged in prolonged negotiations, incurred transaction costs in providing and notarizing documents, and endured lengthy delays. The complaint’s description of BAC’s misleading behave or sufficiently alleges a “representation, omission, or practice” that is likely to deceive a reasonable consumer.(15)

This seems to be an important clarification about what a reasonable consumer, or at least a reasonable consumer in Hawaii, should be able to expect from a lender with which she does business.

While the Court reviews a fair amount of precedent that stands for the proposition that a lender does not owe much of a duty to a borrower, Compton seems to stand for the proposition that lenders must act consistently, at least in broad outline, with how we generally expect parties to behave in consumer transactions: telling the truth, negotiating in good faith, minimizing unnecessary transaction costs; and minimizing unnecessary delays.

In reviewing many cases with allegations such as these, it seems to me that judges are genuinely shocked by lender behavior in loan modification negotiations. It remains to be seen whether such cases will change UDAP jurisprudence in any significant way once we have worked through all of the foreclosure crisis cases.

Offering Opinions About MBS Exposure

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The Tenth Circuit issued an opinion in MHC Mutual Conversion Fund, L.P. v. Sandler O’Neill & Partners, L.P. et al. (No. 13-1016 Aug. 1, 2014). The case concerns a 2009 stock offering by Bancorp. Bancorp was significantly exposed to mortgage-backed securities (MBS) and said as much in its securities filings. It also predicted that the market for MBS would rebound soon.

The highly readable opinion asks,

When does section 11 of the Securities Act of 1933 impose liability on issuers who offer opinions about future events? The statute prohibits companies from making statements that are false or misleading. Establishing that an opinion about the future failed to pan out in the end may go some way to meeting that standard but it doesn’t go all the way. After all, few of us would label a deeply studied, carefully expressed, and earnestly held opinion about the future as false or misleading at the time it’s made simply because later events proved it wrong. To establish liability for an opinion about the future more is required. But what? Answering that question is the challenge posed by this case.

The opinion provides a clear overview of what differentiates opinion from fact in securities offering statements. The Court does this by carefully walking through three theories of opinion liability under section 11:

  1. “no one should depend on the puffery of salesmen . . . especially when the salesman’s offering a guess about the future” (5-6)
  2. “an opinion can qualify as a factual claim by the speaker regarding his current state of mind.” (7)
  3. “some subset of opinions about future events contain within them an implicit factual warranty that they rest on an objectively reasonable basis” (13)

In this case, the Court found that the plaintiffs could not establish liability under any theory.

The opinion provides a nice, clean framework for understanding section 11 liability claims.  This framework should apply to offering statements for MBS that set forth opinions about future events as well as those for any other type of security that does the same.

TARP’s Smallish Rogues Gallery

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The Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) issued its Quarterly Report to Congress on July 30, 2014. There is a lot to digest in this 500+ page document, but I thought that readers of this blog might be interested in the rogues gallery found at Figure 1.3 on pages 54-56 (note that this is the pagination found in the document, which is different from the pdf’s pagination of the document). Figure 1.3 lists the 85 people sentenced to prison as a result of a SIGTARP investigation, the sentences they received, and their affiliations:

Many of the criminal schemes uncovered by SIGTARP had been ongoing for years, and involved millions of dollars and complicated conspiracies with multiple co-conspirators. On average, as a result of SIGTARP investigations, criminals convicted of crimes related to TARP’s banking programs have been sentenced to serve 77 months in prison. Criminals convicted for mortgage modification fraud schemes or other mortgage fraud related investigations by SIGTARP were sentenced to serve an average of 39 months in prison. Criminals investigated by SIGTARP and convicted of investment schemes such as Ponzi schemes and sales of fake TARP-backed securities were sentenced to serve an average of 88 months in prison. (53-54)

Hard to tell if that is many or only a few people being held accountable. But it is interesting to note that restitution and forfeiture from crimes related to TARP have so far “resulted in more than $5.11 billion in court orders for the return of money to victims or the Government.” (59) That comes out to roughly $60 million for each of the 85 prisoners and about $800,000 for each of the 77 months each of them was sentenced (on average) to prison. While these metrics are merely impressionistic, they certainly make me wonder if this report is right to being touting SIGTARP as an agent of accountability so much.

FHFA Wins on “Actual Knowledge”

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Judge Cote issued an Opinion and Order in Federal Housing Finance Agency v. HSBC North America Holdings Inc., et al. (11-cv-06189 July 25, 2014). The opinion and order granted the FHFA’s motion for partial summary judgment concerning whether Fannie and Freddie knew of the falsity of various representations contained in offering documents for residential mortgage-backed securities (RMBS) issued by the remaining defendants in the case.

I found there to be three notable aspects of this lengthy opinion. First, it provides a detailed exposition of the process by which Fannie and Freddie purchased mortgages from the defendants (who included most of the major Wall Street firms, although many of them have settled out of the case by now). it goes into great length about how loans were underwritten and how originators and aggregators reviewed them as they were evaluated  as potential collateral for RMBS issuances.

Second, it goes into great detail about the discovery battle in a high, high-stakes dispute with very well funded parties. While not of primary interest to readers of this blog, it is amazing to see just how much of a slog discovery can be in a complex matter like this.

Finally, it demonstrates the importance of litigating with common sense in mind. Judge Cote was clearly put off by the inconsistent arguments of the defendants. She writes, with clear frustration,

It bears emphasis that at this late stage — long after the close of fact discovery and as the parties prepare their Pretrial Orders for three of these four cases — Defendants continue to argue both that their representations were true and that underwriting defects, inflated appraisals and borrower fraud were so endemic as to render their representations obviously false to the GSEs. Using the example just given, Goldman Sachs argues both that Fannie Mae knew that the percentage of loans with an LTV ratio below 80% was not 67%, but also that the true figure was, in fact, 67%. (65)