Author Archives: David Reiss

GSEs Are Giants of Multifamily Sector Too

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In discussions about the future of Fannie and Freddie, we tend to emphasize their outsized role in the single-family sector.  We often forget that they have an even bigger footprint in multifamily.  A recent Kroll BondRatings report, FHFA Slowdown May Spur Multifamily Resurgence in Conduit CMBS, shows just how big it is. Chart 1 shows Multifamily Loans as a Percentage of the New Issuance Market by Year. Fannie, Freddie and Ginnie had a 15 to 47 percent market share at points during the eight years from 2000 through 2007.  It jumped to 85 to as high as 100% (!!!) at points during the following five years.Kroll notes that the private sector (CMBS Conduits) has begun to increase market share dramatically, although this is measured from a very small base.

Kroll concludes that

it is evident that private lending sources will experience continued growth in multifamily lending as the GSEs reduce their commitment to the space. Conduits are well positioned to participate in this growth, provided the spread environment doesn’t impede conduit lenders’ ability to offer attractive financing rates. Multifamily fundamentals will also inevitably play a role in overall financing volumes, and while it isn’t clear the sector’s outsized performance will continue, housing and demographic trends suggest the sector will remain relatively strong over the next couple of years. While the question of whether and when conduits will surpass GSE originations remains to be seen, we anticipate that the percentage of multifamily product in CMBS will trend upward throughout next year. When 2015 rolls around we may even see the proportion of multifamily in CMBS approach or exceed levels last seen in the mid 2000’s, when it represented, on average, 18% of the CMBS universe, with some recent deals in the conduit universe starting to trend closer to 20%. (4)

What is clear to me is that we should not forget about the relatively small multifamily housing finance sector as we think about the appropriate role for Fannie and Freddie in the single-family sector. They are completely different sectors. The one is akin to a wholesale business and the other is akin to a retail business, each with very different underwriting.

We should be open to very different policy outcomes for the two sectors. The policy reasons that might support a large government role in the single-family sector do not necessarily carry over to the multifamily sector. As I have noted elsewhere (and here) in the context of the multifamily sector, a market failure or liquidity crisis is the typical rationale that justifies government intervention in a particular market. It is incumbent on those who argue for a very active role for the government in the multifamily sector to clearly explain the market failure that government policy intends to address.

Levitin on the Uncertainty of Mortgage Title

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Adam Levitin has posted The Paper Chase: Securitization, Foreclosure, and the Uncertainty of Mortgage Title to SSRN.  This paper adds to a small (here and here, for instance), but important body of literature that seeks to harmonize the application of foreclosure laws with the Uniform Commercial Code. Levitin’s abstract reads

The mortgage foreclosure crisis raises legal questions as important as its economic impact. Questions that were straightforward and uncontroversial a generation ago today threaten the stability of a $13 trillion mortgage market: Who has standing to foreclose? If a foreclosure was done improperly, what is the effect? And what is the proper legal method for transferring mortgages? These questions implicate the clarity of title for property nationwide and pose a too- big-to-fail problem for the courts.

The legal confusion stems from the existence of competing systems for establishing title to mortgages and transferring those rights. Historically, mortgage title was established and transferred through the “public demonstration” regimes of UCC Article 3 and land recordation systems. This arrangement worked satisfactorily when mortgages were rarely transferred. Mortgage finance, however, shifted to securitization, which involves repeated bulk transfers of mortgages.

To facilitate securitization, deal architects developed alternative “contracting” regimes for mortgage title: UCC Article 9 and MERS, a private mortgage registry. These new regimes reduced the cost of securitization by dispensing with demonstrative formalities, but at the expense of reduced clarity of title, which raised the costs of mortgage enforcement. This trade-off benefitted the securitization industry at the expense of securitization investors because it became apparent only subsequently with the rise in mortgage foreclosures. The harm, however, has not been limited to securitization investors. Clouded mortgage title has significant negative externalities on the economy as a whole.

This Article proposes reconciling the competing title systems through an integrated system of note registration and mortgage recordation, with compliance as a prerequisite to foreclosure. Such a system would resolve questions about standing, remove the potential cloud to real-estate title, and facilitate mortgage financing by clarifying property rights.

I had to agree with one of his conclusions:  “Reduction of transaction costs is ultimately a second-order move for commercial law. The first-order move, so elemental it is easy to forget, is clarification of the property being transferred.” (723-24) The others are pretty compelling too.

Is Banks’ $200 Billion Payout from RMBS Lawsuits Enough?

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S&P issued a brief, The Largest U.S. Banks Should Be Able To Withstand The Ramifications Of Legal Issues, that quantifies the exposure that big banks have from litigation arising from the Subprime Crisis:

Since 2009, the largest U.S. banks (Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo) together have paid or set aside more than $45 billion for mortgage representation and warranty (rep and warranty) issues and have incurred roughly $50 billion in combined legal expenses .  . . This does not include another roughly $30 billion of expenses and mortgage payment relief to consumers to settle mortgage servicing issues. We estimate that the largest banks may need to pay out an additional $55 billion to $105 billion to settle mortgage-related issues, some of which is already accounted for in these reserves. (2)

S&P believes “that the largest banks have, in aggregate, about a $155 billion buffer, which includes a capital cushion, representation and warranty reserves, and our estimate of legal reserves, to absorb losses from a range of additional mortgage-related and other legal exposures.” (2) As far as their ratings go, S&P has already incorporated “heightened legal issues into our ratings, and we currently don’t expect legal settlements to result in negative rating actions for U.S. banks.” (2) But it warns, “an immediate and unexpected significant legal expense could result in the weakening of a bank’s business model through the loss of key clients and employees, as well as the weakening of its capital position.” (2) S&P also acknowledges that there are some not yet quantifiable risks out there, such as DoJ’s FIRREA suits.

As the endgame of the financial crisis begins to take shape and financial institutions are held accountable for their actions, one is left wondering about a group who is left relatively unscathed: financial institution employees who received mega bonuses for involving these banks in these bad deals. As we think about the inevitable next crisis, we should ask if there is a way to hold those individuals accountable too.

Happy New Year for Mortgages?

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S&P has posted How Will Mortgage Loan Originators, Borrowers, And RMBS Securitization Trusts Fare Under The New Ability-To-Repay Rules?  This research report finds that

  • The ATR [Ability to Repay] and QM [Qualified Mortgages] standards under TILA [the Truth in Lending Act] will require loan originators to make a reasonable, good faith determination of a borrower’s ability to repay a loan using reliable, third-party written records.
  • If violated, originators and assignees can face liabilities and litigation brought on by borrowers during foreclosure proceedings and even outside of foreclosure proceedings. However, they can be protected from some of these liabilities if a loan meets the QM standards.
  • Depending on the loan’s status, increased loss expectations resulting from additional assignee liability, longer liquidation timelines resulting from borrower defenses in foreclosure proceedings, and additional loan modification experience can affect securitization trust performance.
  • Sensitivity testing using the damages outlined in the rule suggests that additional loss experience will generally be mild for prime jumbo backed securitizations even under conservative assumptions for litigation risks. Trusts backed by loans with higher credit risk, lower balances, and originated by unfamiliar or below-average originators will be at risk of higher losses than prior to the rule.
  • We expect that while the rule will prevent underwriting standards from loosening towards the more risky mortgages originated during the 2006 and 2007 financial crisis, it may also limit credit access to borrowers and make it more difficult to obtain a mortgage loan. (1)

I think that only the last two points are really newsworthy, particularly the last one. Whether the credit markets tighten too much from the new rules is the $64,000 question.

S&P appears to be arguing that the rules will constrain good credit too much. Time will tell if that is the case, as lenders fill the QM sector and the non-QM sector. The non-QM sector provides, for example, interest-only mortgages. There was a lot of bad lending involving interest-only mortgages, so it will be interesting to see what that market sector looks like as it matures over the next few years.

Dirty REMICs: A Debate

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Brad, Joshua Stein and I have posted Dirt Lawyers and Dirty REMICs: A Debate to SSRN (also on BePress). Brad and I had posted our side of the debate at various points, but the entire back and forth is contained in this one handy download. The abstract reads:

In mid-2013, Professors Bradley T. Borden and David J. Reiss published an article in the American Bar Association’s PROBATE & PROPERTY journal (May/June 2013, at 13), about the disconnect between the securitization process and the mechanics of mortgage assignments. The Borden/Reiss article discussed potential legal and tax issues caused by sloppiness in mortgage assignments.

Joshua Stein responded to the Borden/Reiss article, arguing that the technicalities of mortgage assignments serve no real purpose and should be eliminated. That article appeared in the November/December 2013 issue of the same publication, at 6.

Stein’s response was accompanied by a commentary from Professors Borden and Reiss, which also appeared in the November/December 2013 issue, at 8.

Reducing The Cost of Affordable Housing Development: Lessons for NYC?

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Enterprise and the Urban Land Institute have issued a report, Bending the Cost Curve on Affordable Rental Development: Understanding the Drivers of Cost, that identifies affordable housing development’s “most commonly cited cost drivers, provides a brief overview of their impact and applicability, and includes high-level recommendations to promote a more efficient delivery system.” (4). As the report notes,

Affordable housing delivery is shaped by a number of procedures, regulations, and policies instituted at all levels of the system—each with associated costs. Development costs may be dictated by site constraints, design elements, local land use and zoning restrictions, building codes, delays in the development process, efforts to reduce long-term operating costs, and the affordable housing finance system. Most affordable developments rely on multiple funding streams, both equity and debt, each of which carries its own set of requirements and compliance costs. While there may be some alignment of affordable housing land use regulations, financing tools, or programs, far too often developers must seek a complex series of approvals or obtain waivers to bring a project to fruition. This process alone can introduce costs through delays to the development timeline as well as introduce additional uncertainty and risk, which, in addition to regulatory barriers, can also increase costs. (3)

While the report offers no shocking insights into affordable housing’s cost drivers, it does provide a good overview. It also brings to mind research that NYU’s Furman Center did some years ago about the drivers of the high cost of housing construction in New York City.

Given that Mayor-Elect de Blasio has put affordable housing at the center of his campaign, his team should focus on reducing these costs as part of his overall affordable housing strategy. Mayors Bloomberg and Giuliani were not able to make any significant progress on this issue, even though doing so would be quite consistent with their approach to governance. Perhaps that makes it even more of a compelling goal for the de Blasio Administration.

Reiss on Government’s Role in Housing Finance

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The Urban Land Institute New York Blog posted Housing Finance Leaders Gather to Discuss the Future of Freddie and Fannie about a recent panel on the housing finance market. It begins,

Housing finance industry leaders came together last week to debate the future role of government-sponsored lending giants, Fannie Mae and Freddie Mac. Both entities were placed under the conservatorship of the Federal Housing Finance Agency (FHFA) during the financial crisis from which they have yet to emerge.

Panelists included David Brickman, Head of Multifamily for Freddie Mac, Robert Bostrom, Co-Chair of the Financial Compliance and Regulatory Practice at Greenberg Traurig, Mike McRoberts, Managing Director at Prudential Mortgage Capital Company, David Reiss, Professor of Law at Brooklyn Law School, and Alan H. Weiner, Group Head at Wells Fargo Multifamily Capital.

The debate centered around the proper role for the mortgage giants and to what extent government-backed entities should intervene in capital markets.

A market failure or liquidity crisis is the only reasonable basis for government intervention in the housing market, according to Reiss. “However, it is not possible for the government to create liquidity only in moments of crisis, so there is a need to have a permanent platform that is capable of originating liquidity at all times,” said Brickman. Fannie Mae, which was created during the Great Depression and Freddie Mac, which was created during the Savings and Loan crisis, were both responses to past market failures.