Author Archives: David Reiss

Subprime Mortgage Conundrums

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Joseph Singer has posted Foreclosure and the Failures of Formality, or Subprime Mortgage Conundrums and How to Fix Them (also on SSRN). Singer writes,

One of the striking features of the subprime era is that banks acted without adequate regard for state property law. They were intent on serving the national and international financial markets with new and more profitable products, and they treated state property law as an obstacle to get around rather than a foundation on which to build. Rather than sell mortgages to families that could afford them, they hoodwinked the vulnerable by picking their pockets. Rather than honestly disclose the high risks associated with subprime loans, they paid rating agencies to give them AAA ratings, inducing investors to take risks they neither were prepared for nor understood. The banks made huge amounts of money marketing mortgages to people who could not afford to pay them back while offloading the risks of such deals onto hapless third parties. And rather than observe longstanding laws and customs designed to clarify property titles, banks evaded requirements of publicity and formality that traditionally governed real estate transactions. In short, the banks misled both borrowers and investors while undermining property titles. This was both a clever and a profitable way to engage in  business, but it was neither honorable nor responsible. (501, footnotes omitted)

Brad Borden and I have made a similar point in our debate with Joshua Stein, but Singer’s article plays it out in far greater depth. The article is a property prof’s cri de coeur over the near death of real property law principles during the early 2000s subprime boom, but it is also a very thorough inquest. The article concludes with a review of tools that are available to respond to failures in the mortgage market. All in all, it provides a nice overview of what led to the crisis as well as potential policy tools that are available to prevent future ones.

 

FIRREA Does the Hustle

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Judge Rakoff has issued another Opinion in U.S. v. Countrywide Fin. Corp. et al., 12 Civ. 1422 (Feb. 17, 2014).  Rakoff reconfirms his broad reading of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which covers fraudulent behavior that is self-affecting; that is, where the perpetrator and victim of the fraud are one and the same financial institution. This Opinion goes further, however, based on on developments in the litigation since that earlier opinion.

The Opinion notes that the defendants were found liable at trial and finds that

Based on the charge as given to the jury, the jury, by finding liability, necessarily found that the defendants intentionally induced two government-sponsored entities, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), to purchase from the Bank Defendants thousands of loans that Fannie Mae and Freddie Mac would not otherwise have purchased. The defendants did so, the jury necessarily found, by misrepresenting that the loans they were selling were “investment quality” and that they knew of nothing that might cause investors to regard the mortgages as poor investments, when in fact the defendants knew that their underwriting process, known as the “High Speed Swim Lane,” “HSSL,” or “Hustle,” was calculated to produce loans that were not of investment quality. (3)

The Court had previously found that “the fraud here in question, perpetrated by the Countrywide defendants and Ms. Mairone, had a huge effect on Bank of America defendants, which, as a result of Bank of America’s purchase of Countrywide, paid, directly or through affiliates, billions of dollars to settle repurchase claims brought by Fannie Mae and Freddie Mac.” (4) The opinion concludes that

It is highly improbable that Congress would have intended to place beyond the reach of FIRREA those defendants whose misconduct “affects” federally insured banks that have the great fortune to be fully insured [by their affiliates] for such losses. Even less so can it be imagined that the device of having BAC [the BoA parent holding company] indemnify BANA [the BoA federally insured bank] for losses that otherwise would result from Countrywide’s fraud immunizes Countrywide from liability under FIRREA. Indeed, defendants’ labeling of this theory of liability as the “self-affecting” theory is something of a misnomer; Countrywide’s fraud, which culminated before the merger with BANA, directly affected, not just Countrywide, but its merger partner, BANA, as well. While the effect on Countrywide might be “self-affecting,” the effect on BANA was not. (5)

This Opinion seems to bolster Rakoff’s broad reading of FIRREA.  As of now, FIRREA gives the federal government a powerful tool to pursue alleged wrongdoing affecting federally insured financial institutions.  The caselaw reads FIRREA broadly and the statute’s ten-year statute of limitations means that additional suits may still be coming down the pike.

Long-Term Homeownership Affordability

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Amnon Lehavi has posted Can the Resale Housing Market Be Split to Facilitate Long-Term Affordability? to SSRN.  The paper argues that

a comprehensive affordable housing policy requires the formal splitting of the homeownership market into (at least) two distinct segments: one designated for the general public and following a conventional pricing mechanism through free market supply and demand, and the other designated for eligible households and controlling both initial supply and subsequent resale of housing units through regulated affordability-oriented pricing mechanisms.

While regulation of the pricing of affordable housing units during their initial allocation is a standard feature of housing policy–whether such affordable units are produced by a public authority or a private developer–regulation of pricing upon resale to subsequent buyers has received less attention as a matter of both theory and practice, thus leaving a substantial gap in

design mechanisms aimed at promoting a sustainable affordable housing policy.(1)

This is not really a new argument, but the paper takes the position that existing efforts to regulate resales of affordable housing in the homeownership market can be scaled up significantly. The paper does not take on some of the bigger questions that this position implicates — for instance, should scarce homeownership dollars be spent on rental housing instead — but it does develop a concrete proposal:

This paper seeks to enrich policy design options by introducing two alternative cap-on-resale mechanisms for the affordable housing segment: “Mixed Indexed Cap” (MIC) and “Pure Indexed Cap” (PIC). It explains how such models could be utilized to attain a policy goal of promoting long-term social mobility, allowing multiple low- and modest-income households to engage in capital building by sequentially enjoying increments of appreciation of properties in the affordable housing segment.

In so doing, the paper addresses a series of challenges posed by the design of a cap-on-resale mechanism: Could such a mechanism ensure that the homeowner is granted a fair return upon resale, providing the owner with proper incentives to invest efficiently in the property during the tenure, while setting up a resale rate that would make the unit truly affordable for future homebuyers? (1)

New York Ciy has experimented with affordable homeownership and has not come up with an ideal solution to the problem of affordability upon resale. Given the renewed focus on affordable housing policy in NYC, this attention to affordable homeownership policy is most welcome.

Reiss on Single Family Rental-Backed Bonds

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Law360 Quoted me in Newest Property-Secured Bonds Invite Scrutiny (behind a paywall). It reads in part,

The Blackstone Group LP’s recent groundbreaking move to sell bonds secured by single-family rental homes may have created the next securitization blockbuster, but attorneys say the product could attract the same type of litigation that has plagued the commercial and residential mortgage-backed securities markets.

Blackstone is among a growing group of entities that amassed large numbers of foreclosed homes after the crisis and are turning them into profitable rentals. Now some are hoping to take that profitability one step further, extending loans secured by these single-family homes and securitizing them.

This process offers benefits both to players like Blackstone and to smaller landlords that own groups of single-family rentals and can’t get traditional lenders to lend against their assets. Blackstone’s debut product — sold to a syndicate led by Deutsche Bank AG — has been very well-received, but attorneys caution that many questions remain unanswered, and REO-to-rental-backed bonds could pose litigation risks.

*    *    *

Blackstone’s $480 million deal, in which it pooled 3,200 homes owned by its portfolio company Invitation Homes and used them to secured a single loan that it then securitized, made waves as the first of its kind.

Several other opportunistic real estate investment companies, including American Homes 4 Rent and Colony Capital LLC, are expected to follow suit, but they are treading lightly as the new product is assessed by the market and investors.

*    *    *

The homes themselves may also be subject to condemnation or landlord-tenant litigation that could encumber the overall loan indirectly by affecting the value of the collateral, according to David Reiss, a real estate finance professor at Brooklyn Law School.

Before the recession, single-family homes were considered too expensive to be managed by a large institution like Blackstone or American Homes 4 Rent because of their geographic diversity and because it was hard to control property management on so many different homes, according to Reiss.

The financial crisis made distressed single-family homes cheaper and more attractive to opportunistic investors, and the low price may compensate for the other issues, he said.

“This is a new asset class, and it is not yet clear whether Blackstone has properly evaluated its risks,” Reiss said.  “Time will tell whether these bonds will become a significant new category of asset-backed securities or whether the financial crisis presented a one-time financial opportunity for some firms.”

Reiss on Mortgage Availability

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The Consumer Eagle quoted me in Will Mortgages be Harder to Get in 2014? It reads in part,

David Reiss, Professor of Law at Brooklyn Law School, also sees some benefit in more conservative guidelines. “The QM rules and ability-to-repay rules legislate commonsense things like making sure people can repay loans that they take out, which was something that was given up not only in the last boom but in the boom that preceded it. So from the consumer perspective, you now know that when you get a mortgage you’re probably going to be able to pay it back,” Reiss says. “Some consumers and some people in the industry would say let people make their own decisions with minimal consumer protection regulation, but we had a phase of that and it ended poorly for all of us.”

Borrowers who are self-employed or have irregular income may have a harder time qualifying for a loan under the new rules. Reiss notes that those who are ineligible for a QM may still be able to get a non-qualified mortgage. “What we haven’t seen is what this non-QM market is going to look like in 2014 and beyond,” Reiss says. “It’s a new market.”

Members of the banking industry have expressed concerns about the changes. In recent testimony before the House Committee on Financial Services, William Emerson, CEO of Quicken Loans and vice chair of the Mortgage Bankers Association, said the rules “are likely to unduly tighten mortgage credit for a significant number of creditworthy families who seek to buy or refinance a home” and “may impair credit access for many of the very consumers they are designed to protect.”

Reiss notes that consumer protections are always a compromise. “Regulators want to be conservative to protect consumers, but they also don’t want to keep people who would pay back their loans from getting credit,” he says. “There’s always a dance.”

Calling All RE Law Profs!

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I have been asked to post this announcement by Rutgers Professor Jay Soled.  He indicated that they were very interested in hearing from law professors who do research in this area.

Paul V. Profeta Chair in Real Estate

The Finance and Economics Department of the Rutgers Business School at Newark and New Brunswick, Rutgers University invites nominations and applications for the inaugural holder of the Paul V. Profeta Chair in Real Estate. The School and University are strongly committed to recruiting an accomplished scholar necessary to lead the school’s ambition to be a leader in research and teaching in Real Estate. The successful candidate will become the Founding Executive Director of the Rutgers Center for Real Estate Studies.  The center is envisioned to facilitate scholarship activities and promote the education of real-estate issues in its various degree granting and continuing education programs.  The Finance and Economics Department has 35 full-time faculty members.  The Rutgers Business School offers BS, MBA, Masters of Quantitative Finance, and Ph.D. programs that include finance and applied economics concentrations.  Please submit your application (cover letter, three names of your letter writers, research paper[s], and CV) electronically at https://www.business.rutgers.edu/faculty-research/teaching-opportunities. The search will continue until the position is filled.

Reiss in Bloomberg on CS Lawsuit

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Bloomberg quoted me in Credit Suisse Waits for $11 Billion Answer in N.Y. Fraud Suit.  It reads in part,

As Credit Suisse Group AG (CSGN) sees it, time has run out on New York Attorney General Eric Schneiderman’s pursuit of Wall Street banks for mortgage fraud that helped trigger the financial crisis.

Schneiderman sued Credit Suisse in 2012 as part of a wide-ranging probe into mortgage bonds. He claimed Switzerland’s second-largest bank misrepresented the risks associated with $93.8 billion in mortgage-backed securities issued in 2006 and 2007.

Credit Suisse asked a Manhattan judge in December to dismiss Schneiderman’s case, as well as his demand for as much as $11.2 billion in damages. The bank argued that New York, by waiting so long to file the lawsuit, missed a three-year legal deadline for suing. The state countered that it had six years to file its complaint.

If the bank wins, Schneiderman will face a new roadblock as he considers similar multibillion-dollar claims against a dozen other Wall Street firms. The judge in New York State Supreme Court could rule at any time.

“It would obviously tilt everything in the favor of Credit Suisse and similarly situated financial institutions,” said David Reiss, a professor at Brooklyn Law School, hindering New York’s remaining efforts to hold banks accountable for mistakes that spurred a recession.

*     *     *

Since the latest bonds cited in Schneiderman’s suit originated in 2006 and 2007, if the judge chooses the bank’s argument, the lawsuit may be dismissed. If the judge takes Schneiderman’s more expansive view, most or all of the suspect bonds may still be covered by the litigation.

“The entire case is time-barred,” Richard Clary, a lawyer for the bank, told Friedman at the December hearing. Lawyers for the state argued that such limits weren’t intended to apply to the attorney general.

“We’ve successfully resolved cases filed within six years,” Deputy Attorney General Virginia Chavez Romano said, citing last year’s JPMorgan accord. “It has been our decades-long practice.”

So far, New York’s courts have broadly interpreted the statute in finding a six-year period, Brooklyn Law School’s Reiss said. That may be changing as legal scholars and financial industry lawyers question its propriety.

“Having these incredibly long and ambiguous statutes of limitations is not particularly fair,” he said.

*     *     *

Friedman’s ruling in the Credit Suisse case may be crucial to Schneiderman’s probe of close to a dozen other banks, and whether he can sue them successfully.

New York agreed with the firms in October 2012 that any legal deadline for bringing fraud claims against them would be suspended while he continues his investigation, a person familiar with the matter said.

Such tolling agreements stopped the clock on any statute of limitations and ensured Schneiderman can bring fraud claims against banks for conduct going as far back as 2006, said the person.

Brooklyn Law School’s Reiss said the banks may have agreed to the delay to avoid forcing Schneiderman to file a “kitchen sink complaint with every possible allegation in it” just to beat the clock. Doing so also builds good will with regulators and may also facilitate a favorable settlement.

The agreements don’t necessarily mean that suits will be filed, the person said. If Schneiderman sues any of the banks, they may then assert the statute of limitations is three years, and not six, just as Credit Suisse has done.

*     *     *

This may be a more potent argument if Friedman rules for the Swiss bank in the pending case.

A three-year statute-of-limitations would mean they can’t be held responsible for transactions before 2009, while a six-year deadline would allow Schneiderman to reach back to 2006.

There’s “great uncertainty” about whether Schneiderman can move forward with the Credit Suisse case in light of the statute of limitations arguments, said James Cox, a corporate law professor at Duke University in Durham, North Carolina.

Reiss said that any ruling would probably be challenged all the way to the Court of Appeals in Albany, the state’s highest court.