Author Archives: David Reiss

Stealing Fannie and Freddie?

Posted on by

Jonathan Macey and Logan Beirne have posted a short working paper, Stealing Fannie and Freddie, to SSRN. It advocates a position similar to that taken by the plaintiffs in the GSE shareholder litigation. They argue,

Politicians are running rough-shod over the rule of law as they seek to rob private citizens of their assets to achieve their own amorphous political objectives. If we were speaking of some banana republic, this would be par for the course – but this is unfolding in the United States today.

“The housing market accounts for nearly 20 percent of the American economy, so it is critical that we have a strong and stable housing finance system that is built to last,” declares the Senate Banking Committee Leaders’ Bipartisan Housing Finance Reform Draft. The proposed legislation’s first step towards this laudable goal, however, is to liquidate the government sponsored enterprises Fannie Mae and Freddie Mac – in defiance of the rule of law. This paper analyzes the current House and Senate housing finance reform proposals and faults their modes of liquidation for departing from legal norms, thereby harming investors and creditors, taxpayers, and the broader economy.

Under proposals before Congress, virtually everyone loses. First, the GSEs’ shareholders’ property rights are violated. Second, taxpayers face the potential burden of the GSEs’ trillions in liabilities without dispensing via the orderly and known processes of a traditional bankruptcy proceeding or keeping the debts segregated as the now-profitable GSEs seek to pay them down. Finally, the rule of law is subverted, thereby making lending and business in general a riskier proposition when the country and global economy are left to the political whims of the federal government. (1)

I found a number of unsupported assertions throughout the piece. For instance, they assert, without support, that Fannie and Freddie “never reached the point of insolvency.” (3)  Badawi & Casey convincingly argue that without “government intervention, [Fannie and Freddie] would have defaulted on their guaranty obligations and more generally on obligations to all creditors.” (Badawi & Casey at 5) All in all, I don’t find this short working paper to be compelling reading — perhaps a more comprehensive one is in the works.

Watt’s up with Fannie and Freddie

Posted on by

There has been a lot of press coverage of FHFA Director Watt’s first public speech since taking on his job. Watt emphasized that

we must ensure that Fannie Mae and Freddie Mac operate in a safe and sound manner.  It means that we’ll work to preserve and conserve Fannie Mae and Freddie Mac’s assets.  And it means that we’ll work to ensure a liquid and efficient national housing finance market.  Our job at FHFA is to balance these obligations . . ..

He also set forth three goals for his FHFA:

Strategic Goal 1: MAINTAIN, in a safe and sound manner, foreclosure prevention activities and credit availability for new and refinanced mortgages to foster liquid, efficient, competitive and resilient national housing finance markets. 

Strategic Goal 2: REDUCE taxpayer risk through increasing the role of private capital in the mortgage market.

Strategic Goal 3: BUILD a new single-family securitization infrastructure for use by the Enterprises and adaptable for use by other participants in the secondary market in the future.

These goals are all totally reasonable for the FHFA to pursue. But it is also clear that Director Watt is taking the FHFA in a direction that is quite different than the one pursued by his predecessor, Acting Director DeMarco.  DeMarco had taken the position that the best way to protect taxpayers was to be pretty tough on everyone else. “Everyone else” included defaulting and underwater homeowners as well as originating lenders who had sold Fannie and Freddie tons of mortgages that did not comply with the reps and warranties that the parties had agreed to about the quality of those mortgages. DeMarco’s strategy was much criticized but also quite coherent.

Watt has made it clear that he is going to be more flexible with homeowners. He highlighted a pilot program in Detroit that will include “deeper loan modifications.”  He has also made it clear that he is going to be more flexible with lenders, relaxing rep and warranty standards for mortgages that Fannie and Freddie purchase from lenders. These may be very good policies to pursue, but it would be helpful if he set forth a clearer vision of how safety and soundness is best balanced with liquidity and efficiency. Federal housing finance policy typically goes off the rails when its goals get all mixed up. Director Watt should ensure that FHFA’s safety and soundness goals are clearly set forth and that other goals for Fannie and Freddie are designed to work in harmony with them.

Reiss on High Loan Fees

Posted on by

CRM Buyer quoted me in On-Premises Banks Stick It to Walmart Customers. It opens,

Walmart customers who use the banking services provided inside the chain’s stores are among the highest payers of fees — especially overdraft fees — in the U.S., a Wall Street Journal analysis of federal filings concluded.

The five banks with the most Walmart branches ranked among the top 10 U.S. banks in fee income as a percentage of deposits last year, the paper reported, compared to other U.S. banks that earn most of their income through lending.

It is a notable finding, especially given Walmart’s brand: First and foremost, the company has built a reputation for providing low-cost products at significant savings compared to other stores.

Walmart cannot be held completely responsible for the banks’ practices, of course. The financial sector is highly regulated, and no third-party retailer is in a position to set standards or make policies.

However, Walmart told the Journal that it has a thorough process for vetting banks to make sure they are in line with its philosophy.

Financial Reform? What Financial Reform?

Apart from the Walmart branding issue, the report highlights some other concerns. In spite of curbs on financial industry practices in the last few years, it still is possible for providers to levy high fees on consumers in the lowest economic brackets, making it more difficult for them to work their way out of debt. A new government agency, the Consumer Finance Protection Bureau, was established to curtail such activities. Why do they still occur?

The Wall Street Journal leads off its article with the story of a consumer who knowingly overdraws her checking account to pay for a needed car repair. The US$30 fee, which translated into an APR of more than 300 percent, was actually cheaper than a payday loan, the borrower said.

In the bank’s defense, there are certain financial, market, regulatory and business realities that cannot be ignored.

“While I am not going to defend high-cost fees for financial products, I would say that the lenders often have high fixed costs for each transaction that can work out to a higher percentage of the amount borrowed than they would be for larger transactions,” David Reiss, a professor at Brooklyn Law School, told CRM Buyer.

“So, I would say that there is some gouging going on in this market, but also some basic business reality,” he remarked.

Reiss on FHFA Leadership of Housing Finance Reform

Posted on by

Law360.com quoted me in FHFA Set To Take The Lead In Housing Finance Reform (behind a paywall). It reads in part,

With hopes for a legislative fix for the U.S. housing finance market fading after six key Democrats reportedly refused to support a reform bill pending in the Senate Banking Committee, the Federal Housing Finance Agency will become the central player in reshaping the market and set the terms for any future changes.

The Banking Committee’s leaders — Chairman Tim Johnson, D-S.D., and ranking member Mike Crapo, R-Idaho — were unable to scare up the overwhelming support their housing finance reform bill needed in a last-gasp effort at getting a vote from the full Senate. That leaves the bill’s prospects of getting to President Barack Obama prior to the midterm elections at near zero and the FHFA, the conservator for Fannie Mae and Freddie Mac since 2008, as the biggest player in reshaping the U.S. housing market.

“It was always my operating assumption that it was going to be exceedingly difficult to get congressional consensus. Most of the action was going to take place by way of the actions at the FHFA,” said former Republican Rep. Rick Lazio, now a partner at Jones Walker LLP.

The lack of legislation also throws a wild card into the equation, since FHFA head Mel Watt has essentially been silent about his intentions for the FHFA since he won Senate confirmation in December.

“Hopefully, Watt will have a positive vision of the future of the two companies,” said Brooklyn Law School professor David Reiss.

More than five years after Fannie Mae and Freddie Mac were placed under FHFA conservatorship after receiving a more-than-$187 billion taxpayer bailout in the fall of 2008, Congress has yet to act on creating a new system for home purchases and eliminating the two companies.

And then, beginning last spring, Congress kicked into gear.

First, Sen. Bob Corker, R-Tenn., and Sen. Mark Warner, D-Va., introduced a bill that Johnson and Crapo would use as the basis for their own legislation, leaving a limited role for government in guaranteeing the mortgage market.

Soon after, the House Financial Services Committee passed its own housing finance reform bill looking to eliminate the government’s role in the housing market entirely.

Johnson and Crapo released their bill, which would eliminate Fannie and Freddie within five years and replace it with a mortgage insurance agency modeled on the Federal Deposit Insurance Corp., in March. They scheduled a markup and vote on the bill for late April.

But the two senators delayed the vote at the last minute when it became clear that while they had the 12 votes needed to pass the bill out of the 22-member committee, they lacked the 16 to 18 votes needed to force Senate Majority Leader Harry Reid to bring it up for a vote.

Johnson and Crapo said they would continue negotiations with six undecided Democrats, but according to media reports, those negotiations foundered on worries about access to affordable housing in the bill.

Undeterred, Johnson vowed to bring the bill up for a vote next week.

“Those involved in the negotiations have indicated they are interested in continuing to work together to try and find common ground, so the Banking Committee will keep working after favorably reporting out the bill next week,” Sean Oblack, a Democratic spokesman for the committee, said in a Thursday statement.

Still, the failure to get overwhelming support for the Johnson-Crapo bill essentially dooms the prospects for housing finance legislation this year, Lazio said.

“The administration will probably wait until early next Congress to make a decision about whether they think reform is possible,” he said.

But reform efforts will not stop, since the FHFA has a large amount of discretion over the futures of Fannie Mae and Freddie Mac.

“The regulator here is very powerful,” Reiss said.

*     *    *

Settling NY Foreclosures

Posted on by

Three legal services providers issued Stalled Settlement Conferences: A Report on Residential Foreclosure Settlement Conferences in New York City. The report opens,

New York has coped with the foreclosure crisis by implementing a pioneering settlement conference process administered by the court system, designed to promote negotiation of affordable home-saving solutions. These conferences present a remarkable opportunity for lenders and borrowers to meet face-to-face in a court supervised settlement conference at which creative solutions can be forged, and have allowed thousands of New Yorkers to avert foreclosure. But banks routinely flout the law by appearing without required information or settlement authority, causing delays that cost borrowers money and can make home-saving settlements impossible. The process can be far more effective, and less prone to delay, if the courts rigorously enforce the requirements of the settlement conference law, as this report recommends.

Notwithstanding media reports about rebounding real estate markets, New York remains mired in a foreclosure crisis. In fact, in 2013 foreclosure cases represented approximately one third of the judiciary’s civil case load. New York State’s courts experienced a significant increase in foreclosure fi lings during 2013, with the pending inventory increasing more than 16% in 2013, with over 84,000 foreclosure cases pending as of the last report issued by the judiciary, and with 44,035 projected new filings for calendar year 2013 (representing an increase of nearly 20,000 new filings over 2012). (2)

This is clearly an advocacy document, but it is also clear that it is documenting a real problem, one that has cropped up time after time in judicial decisions. It may, however, go too far when it states that “banks and their lawyers themselves are largely responsible for prolonging the process.” (3) In fact, NY’s foreclosure process was longer than most before the mandatory conferences were implemented and remain long even as other jurisdictions adopt similar requirements.

Nonetheless, lenders should comply with the letter and spirit of the law. The report advocates for courts to “vigorously enforce the settlement conference law and deter banks from violating it by penalizing parties who appear in court without the authority and information needed to negotiate in good faith.” (2) Seems like a pretty reasonable recommendation to me.

Reiss on Bloomberg Terminals regarding GSE Litigation

Posted on by

I was quoted on the Bloomberg Terminals (behind a very expensive paywall!) on May 6th about the Fannie and Freddie litigation:

Even if the Junior Preferred Shareholders get the Court to void the Third Amendment to the PSPA, they cannot force the companies to issue dividends so that shareholders receive a payoff. And if the government were to lower the guarantee fee that the two companies can charge or if it were to remove the government’s guarantee of the two companies, Fannie and Freddie’s profits would dissipate altogether.

Given that junior preferred shareholders have developed a multi-pronged strategy to squeeze as much value out of their shares as possible, it is worth attempting to determine the possible endgames that they have in mind. It is hard for me to identify a litigation outcome that results in money in their pockets for the reasons stated above. So the litigation strategy must be part of a broader strategy that involves lobbying over housing finance reform in Congress, lobbying the FHFA and other regulators or negotiating with the two companies. Given the amount of money at stake and the depth of the pockets of the junior preferred shareholders, one can imagine that they are playing a very long-term game, one that might last longer than all of the current decision-makers in DC right now. Some disputes arising out of the S&L crisis took many, many years to resolve so there is reason to think that the junior preferred shareholders have a multi-year or even decades-long perspective on this. And the farther away we are from the events of the 2000s and the emotions that they elicit from decisionmakers, the more likely it is that the junior preferred shareholders can negotiate a favorable result for themselves.

Rebirthing NYC Neighborhoods

Posted on by

One can imagine Mayor de Blasio thinking about his ambitious housing plan with one voice saying “Density!” over one shoulder and another voice saying “Preservation!” over the other.  But which voice is the angel’s and which is the devil’s?

Peter Byrne has posted a short essay, The Rebirth of the Neighborhood, to SSRN. The essay represents the voice of Preservation and engages with Edward Glaeser, a voice of Density. Byrne argues that

new urban residents primarily seek a type of community properly called a neighborhood. “Neighborhood” refers to a legible, pedestrian-scale area that has an identity apart from the corporate and bureaucratic structures that dominate the larger society. Such a neighborhood fosters repeated, casual contacts with neighbors and merchants, such as while one pursues Saturday errands or takes children to activities. Dealing with independent local merchants and artisans face-to-face provides a sense of liberation from large power structures, where most such residents work. Having easy access to places of sociability like coffee shops and bars permits spontaneous “meet-ups,” contrasting with the discipline of professional life. Such a neighborhood conveys an indigenous identity created by the efforts of diverse people over time, rather than marketing an image deliberatively contrived to control the perceptions of customers. At its best, a neighborhood provides a refuge from the ennui of the workplace and the idiocy of consumer culture, substituting for churches (or synagogues), labor unions, and ethnic clubs that structured earlier urban social life. (1596-97)

Byrne argues that the “three chief legal tools for neighborhoods have been zoning for urban form, historic district preservation, and environmental protection.” (1597) In criticizing Glaeser and his ilk, Byrne writes that they often complain “such “laws destroy or take private property.” (1603) Byrne replies that “historic district regulations enhance property values by protecting the setting within which any urban property sits and from whence it derives most of its value.” (1603)

I am not going to resolve this debate in a blog post, but I will make a few points. First, a lot of these assertions are not self-evidently true and should be empirically tested, if possible. Second, the perspective of the Essay is that of the “new urban residents” who actually make up a small proportion of the total residents of a city.  Those “old urban residents” are more likely focused on the affordability of their own homes, the quality of their children’s schools and the safety of their streets. Third, it is possible that Preservation and Density can work together intelligently as we rework the urban fabric.

As Mayor de Blasio struggles with the implementation of his housing plan, it is worth remembering that Preservation and Density can each be an angel, can each be a devil. It is the Mayor’s job to make both of them listen to their better natures.