Author Archives: David Reiss

Reiss on Predatory Online Lending

Posted on by

E-Commerce Times quoted me in CFPB Suit Targets Predatory Online Lending Practices. It reads in part:

The Consumer Finance Protection Bureau this week put online finance companies on notice that it will not overlook them merely because they operate in cyberspace. Specifically, the bureau sued CashCall for collecting money consumers allegedly did not owe.  In its suit, the bureau charged that CashCall and its affiliates engaged in unfair, deceptive, and abusive practices, including illegally debiting consumer checking accounts for loans that were void.

CashCall and the associated companies are reportedly owned by J. Paul Reddam, a race-horse owner and philosophy professor-turned-businessman.

The Background

Beginning in late 2009, CashCall and its subsidiary, WS Funding, entered into an arrangement with online lender Western Sky Financial, according to the CFPB. Western Sky Financial has asserted that the laws in the state in which it is based — South Dakota — did not apply to it because it was based on an Indian reservation and owned by a member of the Cheyenne River Sioux Tribe.

The CFPB maintains Western Sky still must comply with state laws when it makes loans over the Internet to people in other states.

The loans ranged from US$850 to $10,000 and came with upfront fees, lengthy repayment terms and annual interest rates from nearly 90 percent to 343 percent, the CFPB said. Many of the loan agreements allowed payments to be debited directly from the borrower’s bank account.

By September 2013, Western Sky had become the subject of several states’ investigations and court actions, and it began to shut down its business. CashCall and its collection agency, Delbert Services, continued to take monthly installment payments from consumers’ bank accounts or otherwise sought to collect money from borrowers.

After its own investigation, the bureau concluded that the high-cost loans violated either licensing requirements or interest-rate caps, or both, in Arizona, Arkansas, Colorado, Indiana, Massachusetts, New Hampshire, New York and North Carolina, meaning the consumers did not owe that money that was being collected.

As part of its suit, the CFPB is seeking monetary relief, damages, and civil penalties.

The CFPB did not respond to our request for further details.

*     *     *

‘Particularly Weak’

 

While there might not be much controversy over the CFPB’s suit against an online lender, CashCall is certainly defending itself using other arguments.

Clearly, the action falls within the CFPB’s broad mission of protecting consumers from predatory behaviors in the financial services industry, asserted David Reiss, a professor of Law at Brooklyn Law School.

However, CashCall’s attorneys, Neil Barofsky and Katya Jestin, have said that the CFPB does not have a mandate to impose rate caps.

“Of all of CashCall’s arguments, this one seems particularly weak,” Reiss concluded, “as the CFPB is just seeking to enforce existing state laws that have been allegedly violated across the country.”

Optimizing Principal Modifications

Posted on by

S&P posted How Principal And Interest Rate Modifications Affect U.S. RMBS. Principal modifications — reducing the amount that the homeowner owes on the loan — have not been popular with lenders for obvious reasons. But they have also not been popular with politicians and even with the general populace for reasons that likely derive from variants of moral hazard: it just isn’t fair that some people don’t have to repay their debts. And if we give some people an out, won’t everyone else want one too?

Perhaps the better question to ask is whether principal modifications reduce defaults compared to other steps that lenders have taken with defaulting borrowers. S&P has looked at this question and they found “that even though rate reductions are the most common form of modification, principal reductions offer the most benefit to borrowers looking to avoid default.” (2)

While principal mods are good for borrowers — no big surprise there — their impact on investors is not so clear cut. S&P writes that

When it comes to principal reductions, investors can also have different outcomes based on the deal structure. A write-down in loan principal will cause an immediate reduction in credit enhancement, and bondholders would face greater exposure to collateral losses. But for deals with cumulative loss triggers, senior bondholders can receive extra principal diverted from subordinate classes once the triggers are tripped, thereby accelerating their recovery. . . . [S]tructural provisions and interest and principal payment mechanisms in RMBS transactions influence how loan modifications affect bondholders in RMBS transactions. Any type of modification brings with it nuances that may benefit the borrower while having a varied impact on investors. (5)

As we learn lessons that may apply in the next crisis, it is worth realizing that borrower workouts and investor outcomes are linked in ways that should be explicitly identified so that incentives can be properly aligned. With planning, mortgage-backed securities can be structured to be good for borrowers and investors, perhaps even Pareto optimal.

Reiss on Myths of the Fed

Posted on by

Bankrate.com quoted me in a story, 5 Myths Debunked About The Federal Reserve. it reads in part,

Assassination, foreign control and money printing: the stuff of a motion picture thriller?

Not in this case. They’re all the fodder for wild and surprisingly popular myths surrounding the nation’s central bank, the Federal Reserve.

It does wield considerable power, evident in the extraordinary measures taken during and after the financial crisis. But it’s amazing the things that otherwise reasonable people say about this admittedly complex U.S. government institution.

David Reiss, professor at the Brooklyn Law School, says, “To most of us, the Federal Reserve is a riddle, wrapped in a mystery inside an enigma, to borrow Winston Churchill’s phrase.”

With the Fed celebrating its centennial, the time is right to tackle some of these myths head-on. There are many myths out there regarding the Fed. Here are just a handful.

*     *     *

Myth 3: The Fed prints money

The notion is rooted in the Federal Reserve’s control of the nation’s money supply. The Bureau of Engraving and Printing, part of the U.S. Treasury, is responsible for printing currency.

“Although the Bureau of Printing and Engraving prints it, it delivers it to the Fed, and then the Fed gets to decide how much of it to put out into the economy,” says W. Michael Cox, director of the O’Neil Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business. He’s also former chief economist of the Federal Reserve Bank of Dallas.

In a way, Reiss of the Brooklyn Law School says, “the Fed can create money and does so in a variety of ways.” What he means is the Fed can increase the money supply through its monetary tools. Since the end of 2008, it has used “quantitative easing,” or QE, a term used to describe the Fed’s strategy to boost the supply of money. In the latest round of QE, the Fed has undertaken the monthly purchase of $85 billion in assets over the past year.

If you want to describe the process correctly, you might take a cue from St. Lawrence University’s Horwitz. The central bank isn’t in the printing business, but it has some control of the process.

“The money that the Fed creates is all done electronically in the form of bookkeeping entries that expand the deposit accounts that banks hold at the Fed,” he says.

Reiss on “Sexy Tax Breaks” for Luxury Housing

Posted on by

MainStreet.com quoted me in Luxury Real Estate with Sexy Tax Breaks. The story reads in part,

Buying a high end property doesn’t always cost a fortune for the wealthy especially if there are tax breaks attached.

Property tax deductions and even exemptions exist for buyers of luxury properties under special incentives, such as New York City’s J-51 and 421a program.

“A J-51 unit in a luxury building will likely sell for more than a comparable condo without a tax break, because monthly expenses are lower due to reduced property taxes. It’s a deal but not dollar for dollar, and that’s true everywhere you look for tax breaks in luxury properties,” said David Reiss, professor of real estate law at Brooklyn Law School.Benefits include no tax by reducing the assessed value of the property to the pre-renovated price and secondly by capping property taxes.

“These benefits phase out typically over a 14 year period for market rate properties,” Reiss told MainStreet.

Most J-51 buildings in the borough of Manhattan are above 110 Street due to state restrictions.

For example, for interested buyers there’s a two-bedroom J-51 condominum on West 140th Street available for $620,000 advertised on condo-living-west.com.

“The tax reduction will be priced into the cost of the home,” said Reiss.

A back end strategy would be to buy and sell early rather than buy early and sell late to make a profit after purchase.

“Because the closer you are to the 14 year phase out when you sell, the less of a benefit the tax break is to the owners’ sale price,” Reiss said.

The 421a program is another tax break available for new construction not rehabilitation or conversion of existing buildings in Manhattan.

For example, an owner in a $90 million duplex penthouse in Midtown Manhattan would normally pay $230,000 in taxes without an abatement and $20,000 in taxes under an abatement program.

About 150,000 units in New York City receive partial tax exemptions under 421a.

The downside is that taxes gradually go up as the abatement is phased out.

Non-QM Mortgages Risks and Best Practices

Posted on by

Moody’s issued a report, Non-QM US RMBS Face Higher Risk of Losses Than QM, but Impact on Transactions Will Vary, that discusses the risk that

US RMBS backed by non-qualified mortgages (those that do not meet a variety of underwriting criteria under new guidelines) will incur higher loss severities on defaulted loans than those backed by qualified mortgages. The key driver of the loss severities will be the higher legal costs and penalties for non-QM securitizations. In non-QM transactions, a defaulted borrower can more easily sue a securitization trust on the grounds that the loan violated the Ability-to-Repay (ATR) rule under the Dodd-Frank Act. . . . The extent of the risks for RMBS will vary, however, depending on the mortgage originators’ practices and documentation, the strength of the transactions’ representations and warranties, and whether the transactions include indemnifications that shield them from borrower lawsuits. (1)

The higher costs for non-QM investors may include longer foreclosure timelines and the resulting wear on the collateral.

If Moody’s analysis is right, however, the Dodd-Frank regime will be working as intended. It should incentivize mortgage originators to strengthen their compliance practices such as those relating to documentation, recordkeeping and third party due diligence. It should also incentivize securitizers to demand strong reps and warranties, put back and indemnification provisions. Sounds like a reasonable trade off to  me.

Reiss on New Mortgage Rules

Posted on by

The Redding Record Searchlight interviewed me in Experts Worry New Loan Standards, Lending Limits Could Hurt Housing Market. It reads in part,

New mortgage qualification rules and lower FHA lending limits that take effect next year threaten to slow the housing market’s recovery.

*     *     *

David Reiss, a law professor at Brooklyn Law School in New York, said there is nothing wrong with tying the price of a loan to the risk.

“There is some talk that if it’s not a Qualified Mortgage loan, the cost for the creditor or lender will be higher and the cost will be passed on to the homeowner. That will probably be true,” Reiss said.

But Lawrence of Silverado Mortgage said just because one in five loans written today wouldn’t pass Qualifying Mortgage muster doesn’t necessarily suggest the loan would not be approved and closed under the new standards.

“Making a minor adjustment such as using a different interest rate and closing cost combination may allow a loan to meet the standard that it wouldn’t otherwise,” Lawrence said.

Lawrence knows there will be some loans for which an alternative can be found to resolve a Qualifying Mortgage issue.

“But I think most buyers start with getting pre-qualified before they find the home they’re interested in purchasing,” Lawrence said.

Reiss on Watt Confirmation

Posted on by

Law360 interviewed me about the Senate confirmation of Mel Watt as the Director of the Federal Housing Finance Agency in Fannie, Freddie’s Footprint Could Grow Under New FHFA Head. The article reads in part,

The U.S. mortgage industry is in for a sea change as Rep. Mel Watt, D-N.C., takes the helm of the Federal Housing Finance Agency, experts say, predicting Watt will seek to expand Fannie Mae and Freddie Mac, veering sharply from his predecessor’s plans but lining up more closely with President Barack Obama’s.

The confirmation came Tuesday in a 57-41 vote after months of delay ended by Senate Democrats’ implementation of the so-called “nuclear option” eliminating the filibuster of presidential nominees. Senate Republicans had expressed concern about the choice of a politician like Watt — as opposed to an academic or economist — to head the agency.

Members of the real estate finance community are also divided about whether Watt’s confirmation will have a positive or negative impact on the industry, but most agree that a major change is ahead.

“I think Watt, as director, could end up having a very big impact both in terms of reversing some changes that have been implemented, and also taking the agency in a very different direction,” said David Reiss, a professor at Brooklyn Law School.

Since 2009, interim FHFA head Ed DeMarco has made an effort to shrink the footprint of the regulator and its government-sponsored enterprises, Fannie and Freddie, in the U.S. residential mortgage market.

DeMarco faced pushback in these efforts from industry groups and lawmakers, causing him to backpedal a bit in November when the FHFA announced that it would hold off on reducing the size of mortgages that Fannie and Freddie can guarantee for at least the first half of next year.

Obama also did not share DeMarco’s ideology, but experts believe Watt’s plans for the GSEs are much more in line with those of the president. He appears cautious about allowing Fannie and Freddie to back away from the market entirely and may in fact favor policies that will increase the GSEs’ role in the mortgage market.

“My guess is that Watt will further enmesh Fannie and Freddie in the operations of the mortgage markets, whereas DeMarco was actually shrinking their footprint,” Reiss said.

*     *     *

The difference between the short-term and long-term impacts of Watt’s expected actions will be significant, experts say.

DeMarco’s moves made short-term waves, but supporters believed the aim was long-term equilibrium and an eventual balance of public and private capital in the mortgage market. Watt may have more potential for positive short-term results, but there will still be a question as to whether this will translate into a stable market for the next generation, Reiss said.

“Often when people are talking about government intervention, they want help for problems now, but they’re also setting up the rules of the game for once the crisis has passed,” he said.