Author Archives: David Reiss

GSE Litigation Through Corporate Law Lens

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Adam Badawi and Anthony Casey have posted The Fannie and Freddie Bailouts Through the Corporate Lens to SSRN. The paper takes a look at the bailouts as if they were simple insolvent private firms. This is a helpful thought experiment even though the two federally chartered and heavily regulated firms are anything but simple, private firms. They write that while it is politically controversial to wipe out the shareholder equity in the two firms, doing so

is consistent with what often happens to stockholders of distressed companies. Indeed that is the more likely outcome when a corporation is sold or reorganized under Chapter 11 of the Bankruptcy Code. There remains little doubt that the Entities [Fannie and Freddie] were highly distressed at the time of the PSPAs [Preferred Stock Purchase Agreements] and Amendments [to the PSPAs]. Thus, while procedurally suspect, these actions did not substantively violate the norms of corporate law and finance that would apply to private companies in the same position. To the contrary, in the private context there may have been no action available that would have legally allocated any future interest in the Entities to the (junior) preferred and common shareholders. (1, footnotes omitted)

They add, that in “the private context, there would have been pressure to file for bankruptcy to liquidate the assets and eliminate the risk to creditors. And once in bankruptcy, the directors would have been entirely barred from taking actions to benefit equity at the expense of creditors.” (3) And they conclude that “the substance of Treasury’s and the Entities’ actions – in September 2008 and August 2012 – were generally in line with acceptable actions of creditors and debtors involved in restructuring distressed corporations in Chapter 11 bankruptcy or in out-of-court reorganizations.” (3-4)

I could excerpt selection after selection, but instead, I recommend that you read this interesting paper for yourself!

Reiss on New Residential Real Estate Exchange

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NationSwell quoted me in Can’t Afford a Down Payment? Let Investors Help You Buy Your Home. It reads in part,

Enter PRIMARQ, the world’s first residential real-estate equity exchange — a soon-to-launch venture of San Francisco entrepreneur Steve Cinelli. Can’t afford a down payment? Let investors put together the capital you can’t, without relinquishing all your clout as a homeowner. By letting “co-owners” buy shares in your home, you’re able to put down a bigger down payment, which means you end up carrying less debt and can get a loan free of mortgage insurance, which is commonly tacked on for down payments of less than 20 percent. “I think the market is overly dependent on mortgage-debt financing,” Cinelli says. “The application of debt has gone way too far.”

Investors can bet on housing without having to deal with the actual house. They’ll get their money back (plus profits if there are any), under one of several circumstances: when you sell your home, when you decide to buy back your shares, or when the investor sells his shares back to the PRIMARQ exchange itself, which offers a “liquidity guaranteed” 90 percent of their value. So, if an investor puts up $10,000, and then wants to cash out for any reason before you sell your home, they’ll walk away with no less than $9,000 (unless the home price drops) — and it doesn’t affect you either way.

Not all homebuyers and not all houses can qualify for PRIMARQ funding. If there’s a mortgage involved, the buyer has to meet strict credit-score criteria, and the home has to have a certain expected price appreciation — meaning it’s got to be a decent property in a good location. That doesn’t necessarily rule out homes in lower-income neighborhoods, but it does stand to reason that unless those neighborhoods are deemed “up-and-coming,” the homes there might not qualify for PRIMARQ.

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To be sure, the PRIMARQ model involves risks for both investors and homeowners — not the least of which is a gaming of the system by nefarious investors, says David Reiss, a professor of law at Brooklyn Law School in New York who researches and writes about the American housing-finance sector. While Reiss calls PRIMARQ a “supercool idea” for all the aforementioned reasons, he could imagine various ways for unsophisticated homeowners to get fleeced without proper consumer protection regulations (the program has not yet been reviewed by a government regulatory agency). Unscrupulous investors could demand fees or increased equity in exchange for agreeing to help fund a second mortgage, for example. By participating in PRIMARQ as a homeowner, “you are not the master of your own destiny,” Reiss says.

Reiss on Housing Shortgage

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MainStreet.com quoted me in Housing Shortage Presents Challenges for Buyers. It reads in part,

While the housing demand continues to outpace supply in various urban pockets around the U.S., potential homeowners are faced with competing bids from other buyers.

The pent-up demand has created bidding wars from New York to San Francisco, putting additional pressure on homebuyers, many who are buying their first home in an unprecedented climate.

Despite weaker job growth, there remains a shortage in housing supply to satisfy current demand, said Jeff Meyers, president of Meyers Research, a Beverly Hills, Calif. data provider for real estate. Job growth is expected to pick up throughout this year, which will only increase demand. Unemployment will finish at 6.4% in 2014, which will be its fourth consecutive year of improvement, according to a forecast from Zonda, a mobile application for the residential homebuilding industry.

While all local markets experience their own dynamics and quirks, areas such as San Mateo county in California have more demand for housing because of a strong job market and limited development activity compared to weak demand in Wayne County in Michigan due to poor labor market conditions and an embattled housing market, he said.

Consumers with extra cash have the upper hand in trying to win a bid, especially in markets such as Manhattan where demand for a two-to-three bedroom apartment has pushed prices up to the $1.5 million to $3 million range, said Kinnaird Fox, director of development at Fenwick Keats Real Estate in New York which specializes in residential properties.

“This fierce competition created bidding wars with nearly every new listing since the beginning of 2014,” she said. “Cash rules for obvious reasons in a market like this.”

The bidding war frenzy has turned off many qualified buyers who are wary of the increase in prices, Fox said.

“Despite what seems like a booming sellers’ market, many qualified buyers may be looking, but choose not to jump in,” she said. “With buyers losing out on their bids, buyer fatigue sets in and some withdraw from the market. One could say the lack of inventory masks the actual demand.”

While some cities have a weak demand for housing, many have an even weaker supply, which yields in a housing shortage, said David Reiss, professor of law at Brooklyn Law School in New York.

“Some communities place severe restrictions on new housing construction so even modest upticks in demand can push rents and prices higher,” he said.

Buyers should not forget the fundamental rule of real estate. Location can have far reaching effects, especially if you are moving a significant distance, said Reiss.

“Perhaps first and foremost, ask whether the house you are considering is the right one for your family,” he said. “If the answer is yes, then you are probably on the right track because a house is first and foremost a home and secondly an investment.”

Mortgage Sustainability Tool Launched

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Freddie Mac has created a useful new tool, the Multi-Indicator Market Index(SM) (MiMi(SM)).The press release states that it is

a new publicly-accessible tool that monitors and measures the stability of the nation’s housing market, as well as the housing markets of all 50 states, the District of Columbia, and the top 50 metro markets.

MiMi combines proprietary Freddie Mac data with current local market data to calculate a range of equilibrium for each single-family housing market covered. Monthly, MiMi uses this data to show, at a glance, where each market stands relative to its own stable range. MiMi also indicates how each market is trending — whether it is moving closer to, or further away from, its stable range. A market can fall outside its stable range by being too weak to generate enough demand for a well-balanced housing market or by overheating to an unsustainable level of activity.

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In today’s first release of MiMi, several key findings emerged that highlight the current state of the nation’s housing market as of January 2014:

  • The national MiMi value stands at -3.08 points indicating a weak housing market overall. From December to January the national MiMi improved by 0.03 points and by 0.81 points from one year ago. The nation’s housing market is improving based on its 3-month trend of +0.17 points and moving closer to its stable and in range status. The nation’s all-time MiMi low of -4.49 was in November 2010 when the housing market was at its weakest.
  • Eleven of the 50 states plus the District of Columbia are stable and in range with North Dakota, the District of Columbia, Wyoming, Alaska, and Louisiana ranking in the top five.
  • Four of the 50 metros are stable and in range, San Antonio, Houston, Austin and New Orleans.
  • The five most improving states from December to January were Florida (+0.11), Tennessee (+0.11), Michigan (+0.09), Louisiana (+0.07), Nevada (+0.07), and Texas (+0.07). From one year ago the most improving states were Florida (+2.12), Nevada (+1.84), California (+1.26), Texas (+1.06) and D.C. (+1.05).
  • The five most improving metros were Miami (+0.11), Detroit (+0.10), Orlando (+0.09), San Antonio (+0.09), and Chicago (+0.08). From one year ago the most improving metros were Miami (+2.54), Orlando (+2.08), Riverside (+1.87), Las Vegas (+1.81), and Tampa (+1.77).
  • Overall, in January of 2014, 25 of the 50 states plus the District of Columbia are improving based on their 3-month trend and 35 of the 50 metros are improving.

 

Reiss on Paying off Underwater Mortgages

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MainStreet.com quoted me in What Bills Should You Pay First? It reads in part,

Consumers started prioritizing their mortgage payments ahead of their credit card payments as of September 2013, according to a new TransUnion study.

This reverses a trend that began in September 2008 when the mortgage crisis drove consumers to pay their credit cards bills ahead of mortgages. Consumers have placed an emphasis on paying their auto loans before their mortgages and credit card payments by a wide margin – since at least 2003, TransUnion said. The study obtained anonymous consumer information from December 2002 through December 2012, and each monthly sample included about 2.5 million consumers.

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Many consumers were faced with devaluing home prices and chose to preserve their credit line, said David Reiss, professor of law at Brooklyn Law School in New York.

“The underwater mortgage may have seemed like a sinkhole when prices were dropping and putting limited funds into it might have seemed like throwing good money after bad,” he said. “When a household’s income can’t cover all of its expenses, it has to prioritize its payments. If the mortgage is underwater, it may make sense to use those limited funds to protect assets that are integral to daily living and wage earning like an auto or to focus on tools like credit cards that may have some use going forward, if there is still any available credit left.”

Homeowners have reversed that logic with the rebound of housing prices, Reiss said.”If homeowners have equity in their home from those rising prices, prioritizing the mortgage protects that equity and keeps the household in the house to boot,” he said. “Not everyone makes such a calculation, but many do.”

Visualizing The Residential Mortgage Market

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Compass Point Research & Trading, LLC has a nice graph, The Mortgage Market Overview, that helps to make sense of the massive U.S. residential mortgage market. It breaks down the $20 trillion dollar U.S. residential housing market into debt and equity and then further breaks down debt into the various available types, by market share: GSE; portfolio; private-label MBS; etc.  A picture can be worth twenty trillion words . . ..

Reiss on Rising Interest Rates

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ABC News quoted me in Small Interest Rate Changes Mean Big Money for Home Buyers.  The story reads in part,

As the economy continues to recover from the worst recession since the 1930s, mortgage interest rates remain at historically low levels.

The Primary Mortgage Market Survey, produced by Freddie Mac, reported in mid-March the average rate for 30-year fixed-rate mortgages was 4.32 percent; 15-year fixed-rate mortgages averaged 3.32 percent and interest rates 5-year Treasury-indexed hybrid adjustable rate mortgages averaged 3.02 percent. Nonetheless, Frank Nothaft, chief economist for Freddie Mac, speculated the Fed’s gradual tapering of its stimulus efforts may prompt a rise in mortgage interest rates.

If mortgage interest rates do rise significantly in the future, what, if any effect will there be on the home buying market? According to Steve Calk, chairman and Chief Executive Officer of The Federal Savings Bank, interest rates have never been the deciding factor for whether potential home buyers actually purchase a home.

“Whether interest rates are 5.5 percent or 7.5 percent, when people are ready to buy, they’ll buy a home,” Calk said.

Price, location, size, appreciation value – these are factors many would-be homeowners consider long before mortgage interest rates enter into the picture. However, once they begin actively searching for a home, interest rates often play a role in their ultimate buying decision.

This is especially the case when interest rates are high, according to David Reiss, Professor of Law at Brooklyn Law School.

“When people think about buying houses, they think about the price of the house. But what they really should be thinking of are the monthly costs. The average 25-year-old might not think about housing rates until they go to a mortgage broker.
“Then they discover that 8 percent interest may mean that instead of a $200,000 home they can only afford a $160,000 home,” Reiss said.

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Tight credit and persistent high unemployment have almost certainly played a role in depressing home buying figures during the recovery, as has the large numbers of home owners who perhaps bought homes at the height of the bubble who now find themselves underwater on their mortgages. However, many underwater homeowners could be missing out on a unique opportunity presented by the present financial climate. In a housing market where prices are depressed and borrowing is cheap, home buyers with solid incomes and good credit can find lenders willing to extend credit on favorable terms, ultimately putting them ahead financially, even if they sell their present homes at a loss, according to Reiss.

“Many people feel stuck in place because they are underwater or the market is bad. But although it may be counterintuitive, it could actually be a smart move to sell in a bad market. It’s a bit more sophisticated strategy, but you could move out of a cheap home into a better home for not that much money,” Reiss said.

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Education and due diligence in maintaining good credit are the most potent tools that potential home buyers can employ, whether they are seeking their first home, a larger home or are scaling down to smaller quarters as empty nesters. Obtaining prequalification can provide home seekers with a better idea of precisely how much house they can afford, Reiss said.