Author Archives: David Reiss

S&P on Rating Mortgage-Backed Securities Before The Crisis

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S&P has posted The Role of Credit Rating Agencies in The Financial System, remarks by its president at the United Nations. The remarks reflect S&P’s narrative of the events leading up to the Subprime Crisis. This narrative is, unsurprisingly, self-serving but revealing nonetheless.

  • We, like others, did not anticipate the U.S. housing downturn, which led to the financial crisis. But with the exception of our ratings on U.S. mortgage-related securities, our ratings have performed as expected. (3) 

Seems like a perfect example of the exception swallowing the rule . . ..

  • In September of 2008, we were all in the depths of the financial crisis. During that time the vast majority of the securities S&P rated performed as we anticipated, including many structured finance ratings. But the performance of our ratings of certain U.S. residential mortgage-related securities was a major disappointment. Like nearly every other market participant, analyst and interested government entity, we did not anticipate the U.S. housing collapse and its effect on the economy as a whole. (4)

As I have said before, this is self-serving revisionism, when S&P’s own analysts predicted the collapse of many of the mortgage-backed securities that they rated before the Bust.

  • We have taken significant actions to further strengthen our independence from issuer influence. We have long had policies to manage potential conflicts of interest such as a separation of analytic and commercial activities, a ban on analysts from participating in fee negotiations, and de-linking analyst compensation from the volume of securities they rate or the type of ratings they assign. After the crisis, we decided to strengthen analytical independence by rotating the analysts assigned to a particular issuer and enhancing analyst training. (4)

No mention here of the fact that their longstanding policies appeared to have not been up to the task of controlling for conflicts as far as anyone was concerned . . ..

  • For mortgage-related securities, for example, we significantly increased the credit enhancement required to achieve a ‘AAA’ rating and made it more difficult for securities to achieve high ratings. (4)

Thank goodness for that! Time will tell if these new assumptions adequately reflect the risk of default for complex MBS.

Reiss on Buying a Home

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MainStreet.com interviewed me in Guess the Unexpected Best Time to Buy a Home. It reads in part,

Hunting for a new home during the holidays can have many hidden advantages for buyers, despite conventional wisdom.

While there is less inventory to choose from in the fall, house hunting in November and December also means there is less competition with other buyers out there. Sellers might also be willing to strike a better deal for potential home owners.

Home buyers can take advantage of sellers who are eager to sell. The end of the year is a great time to look above your price range and negotiate for a lower price, said Alison Bernstein, president of The Suburban Jungle Realty Group.

“Sellers want to clear inventory before the spring and will be open to price adjustments to make the sale,” she said.

Consumers can find the best prices after Thanksgiving and before the Super Bowl because most home owners do not want to wait until the winter months when the bulk of potential buyers disappear, Bernstein said.

Seeing a home during the winter months shows both the house and the neighborhood in its “true colors,” she said.

Many sellers could also have tax reasons to sell by the end of the year, said David Reiss, a professor at the Brooklyn Law School who teaches a course that covers residential real estate transactions. However, this could prove to be a double-edged sword for buyers.

It might motivate sellers to get a deal done quickly and to compromise easily on price or other terms. On the other hand, sellers may insist on draconian penalties if the buyer fails to close by the end of the year, he said.

“Buyers must tread very carefully in such circumstances, be confident that their lender will come through by the drop dead date and certain that they will not be held liable for the delays caused by others, such as sellers themselves or escrow agents,” Reiss said.

 

 

Reiss on Countrywide Verdict

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Law360 interviewed me in DOJ’s Countrywide Win Could Force More Bank Settlements (behind a paywall).  The story opens

The U.S. Department of Justice’s victory in a case against Bank of America Corp.’s Countrywide subsidiary over a housing-bubble-era mortgage program shows the power of a 1980s fraud statute, and could further encourage banks to settle future financial crisis cases, attorneys say.

A federal jury in New York on Wednesday unanimously found that Countrywide Financial Corp. and one of its former executives defrauded Fannie Mae and Freddie Mac through a program designed to speed up mortgage issuing in 2007 and 2008.

The court victory was significant in part because of U.S. Attorney Preet Bharara’s use of the Financial Institutions Reform Recovery and Enforcement Act, a law that grew out of the 1980’s savings-and-loan crisis, to bring a case over the 2007-09 financial crisis. With a fairly low standard of proof and a 10-year statute of limitations, a jury’s verdict based on FIRREA bodes well for future government cases, said Brooklyn Law School professor David Reiss.

“This successful use of FIRREA makes it much more likely that financial institutions are going to settle with the government,” he said.

Qualified Mortgage Fair Lending Concerns Quashed

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Federal regulators (the FRB, CFPB, FDIC, NCUA and OCC) announced that “a creditor’s decision to offer only Qualified Mortgages would, absent other factors, elevate a supervised institution’s fair lending risk.” This announcement was intended to address lenders’ concerns that they could be stuck between a rock (QM regulations) and a hard place (fair lending requirements pursuant to the Equal Credit Opportunity Act and the Fair Housing Act). For instance, a lender might want to limit its risk of lawsuits relating to the mortgages it issues that could arise under a variety of state and federal consumer protection statutes by only issuing QMs only to find itself the defendant in a Fair Housing Act lawsuit that alleges that its lending practices had a disproportionate adverse impact on a protected class.

The five agencies issued an Interagency Statement on Fair Lending Compliance and the Ability-to-Repay and Qualified Mortgage Standards Rule that gives some context for this guidance:

the Agencies recognize that some creditors’ existing business models are such that all of the loans they originate will already satisfy the requirements for Qualified Mortgages. For instance, a creditor that has decided to restrict its mortgage lending only to loans that are purchasable on the secondary market might find that — in the current market — its loans are Qualified Mortgages under the transition provision that gives Qualified Mortgage status to most loans that are eligible for purchase, guarantee, or insurance by Fannie Mae, Freddie Mac, or certain federal agency programs.

With respect to any fair lending risk, the situation here is not substantially different from what creditors have historically faced in developing product offerings or responding to regulatory or market changes. The decisions creditors will make about their product offerings in response to the Ability-to-Repay Rule are similar to the decisions that creditors have made in the past with regard to other significant regulatory changes affecting particular types of loans. Some creditors, for example, decided not to offer “higher-priced mortgage loans” after July 2008, following the adoption of various rules regulating these loans or previously decided not to offer loans subject to the Home Ownership and Equity Protection Act after regulations to implement that statute were first adopted in 1995. We are unaware of any ECOA or Regulation B challenges to those decisions. Creditors should continue to evaluate fair lending risk as they would for other types of product selections, including by carefully monitoring their policies and practices and implementing effective compliance management systems. As with any other compliance matter, individual cases will be evaluated on their own merits. (2-3)

 Lenders and their representatives have raised this issue as a significant obstacle to a vibrant residential mortgage market. This interagency statement should put this concern to rest.

Private Capital and the Mortgage Markets

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The American Securitization Forum recently wrote to the Federal Housing Finance Agency to argue for at least a small reduction in the size of the loans that Fannie and Freddie can guaranty. While this makes sense to me, it is pretty controversial.  The ASF argues that “incremental reductions are appropriate for the following reasons:”

(i) as a means to begin scaling back the outsized role the GSEs currently play in the U.S. housing finance system and encourage the return of private capital;

(ii) FHFA has the legal authority in its role as conservator to act according to its dual mandate; and

(iii) the timing of any Congressional action on wide-ranging housing finance reform remains uncertain. (1)

Various groups like the Realtors and some members of Congress argue that any restriction of credit is unwarranted while the housing recovery is so tentative. The ASF notes, however, that the federal government is insuring roughly 90% of new residential mortgages. Virtually no one supports such a level of government support for the mortgage market, so the only question is one of timing. Do we start cutting back now or do we wait for better market conditions?

Others argue that there is not enough private capital to replace the government guaranteed capital in the market. But scaling back the Fannie/Freddie loan limit is a great way to work private capital back into the market gradually. The long term health of the American mortgage market is best assured by having private capital assume as much of the credit risk as it can responsibly handle. This private capital should also be subject to consumer protection regulation to ensure that it is not put to predatory uses. The Consumer Financial Protection Bureau has rules in place to provide that consumer protection. The FHFA should complement that regulatory action with its own. It should reduce the Fannie and Freddie loan limits starting in 2014.

Access to Sustainable Credit

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Reid & Quercia have posted Risk, Access and the QRM Reproposal. This document is intended to influence the most recent proposed rulemaking for the Qualified Residential Mortgages (QRMs). The rulemaking process for the QRM has been controversial and the stakes could not be higher for the health of the residential mortgage market. The first  proposed rulemaking in 2011 would have required QRMs to have substantial down payments. A broad coalition of lenders and consumer groups believed that this requirement would excessively restrict credit and so the regulators responsible for the QRM rule issued an new proposed rulemaking in 2013 that removed the requirement for down payments from the QRM definition.

Reid & Quercia argue that the more restrictive 2011 proposed QRM rule only provided marginal benefits over the 2013 proposed QRM rule, while significantly restricting credit particularly for households of color. They note that the “objective of weighing the marginal benefit of stricter QRM requirements against the costs of cutting off access to the mainstream mortgage market is an important one.” (7) They have created simple metrics “for evaluating the tradeoffs of reducing the number of defaults against the number of successful borrowers who would not be able to obtain a QRM loan as a result of stricter down payment and credit score requirements” (7)

While Reid & Quercia do not say so explicitly, I believe that their metrics, such as the benefit ratio, should be explicitly worked into the final QRM rule so that regulators are constantly considering the two sides of credit: availability and sustainability. There is a lot of pressure to increase access to residential mortgage credit by a range of players — consumer advocates, lenders and politicians to name just a few. But credit that cannot be sustained by homeowners leads to mortgage default and foreclosure. We will be doing new homeowners no favors by letting them take out mortgages with payments that they cannot consistently make, year in and year out.

 

Making Sense of Finance Charges

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The Consumer Financial Protection Bureau has a very helpful Finance Charge Chart (page 13) in its Truth In Lending Act examination procedure manual.  The manual is “intended for use by CFPB examiners in examining the mortgage companies and other financial institutions subject to the new regulations.”

Figuring out the finance charge for the purposes of calculating the Annual Percentage Rate (APR) can be very difficult. The manual states that the finance charge

initially includes any charge that is, or will be, connected with a specific loan. Charges imposed by third parties are finance charges if the creditor requires use of the third party. Charges imposed on the consumer by a settlement agent are finance charges only if the creditor requires the particular services for which the settlement agent is charging the borrower and the charge is not otherwise excluded from the finance charge. (14)

The chart makes clear which charges are always included, which are included unless certain conditions are met, which are typically not included and which are never included.

The guide also has a useful history of TILA and overview of Regulation Z (which implements TILA).  It also includes (on page 9) a flowchart that explains what kind of credit is covered by Regulation Z.