Author Archives: David Reiss

Round One to California in Suit Against S&P

Posted on by

California Superior Court Judge Karnow issued a Memorandum Order Overruling Defendants’ Demurrers in California v. The McGraw-Hill Cos. et al., CGC-13-528491 (Aug. 14, 2013 San Francisco County).   California Attorney General Harris alleged “that S&P intentionally inflated its ratings for the investments and that these knowingly false ratings were material to the investment decisions of [California Public Employees’ Retirement System (PERS) and the California State Teachers’ Retirement System (STRS)], in violation of the False Claims Act and other statutes.” (2)

S&P demurred to the False Claims Act causes of action [asked for the causes of action to be dismissed], because, among other reasons,

(l) the complaint does not plead that any ‘claims’ were ever “presented” to the state;

(2) if claims were presented, they did not involve ‘state funds’ . . .. (4)

S&P asserts, among other things, that because it “was not the seller, it did not “present” any claims for payment.” (4) The Court stated, however, that the False Claims Act “imposes liability on any person who ’causes’ a false or fraudulent claim to be presented or ’causes to be made or used a false . . . statement material to a false or fraudulent claim.’ C. 12651(a)(1)-(a}(2).” (4, citation omitted) The Court inferred “from the complaint that S&P ’caused’ PERS and STRS to purchase the securities. This is good enough for present purposes.” (4, citation omitted)

I am a longstanding critic of the rating agencies, but I have to say that I am struck by how broadly courts have interpreted statutes relied upon by the federal government and the states as they pursue alleged wrongdoing by financial institutions involved in financial crisis. In the courts’ defense, they typically rely on the plain language of the statutes, but, boy, do they interpret them broadly.

In this case, giving a rating can “cause” someone to purchase a security — is there any limit on what is a sufficient “cause” to trigger the statute? In DoJ’s case against Bank of America, a financial institution may be liable under FIRREA for a fraud it perpetrates even if the only entity affected by the fraud is — Bank of America! Similar broad interpretations of NY’s Martin Act make it relatively easy for NY government to bring a securities fraud case against a financial institution because our normal intuitions about intent are not relevant under that act.

Pursuing alleged wrongdoers: good.

Pursuing alleged wrongdoers with broad, ambiguous and powerful tools:  worrisome.

Just Shoot Me

Posted on by

Florida Twelfth Judicial Circuit Magistrate Bailey issued a Recommended Order in HSBC Bank USA, National Association, et al. v. Marra, No. 2008 CA 000630 NC (Aug. 14, 2013) that makes you want to give up.  Not because of the judge, but  because of what she documents in what is in all likelihood a run of the mill foreclosure in Florida.

Somewhat amazingly, the defendant was unrepresented but was able to get the Court to focus on various inconsistencies in the court filings and implausible assertions made by the Plaintiff, particularly those relating to whether the plaintiff owned and held the note and mortgage as it alleged in the complaint.

It would require about as many words to summarize the opinion as are in it, so I refer you to the link above if you want to see it in all of its glory. Let me leave you with the Court’s conclusion:

After taking into consideration the above-cited information from the [Pooling and Servicing Agreement], it appears that the transfers that have been variously asserted by the Plaintiff in several Motions and/or documents attached to those Motions as conferring standing upon it could  not possibly have occurred as the Plaintiff represents. Further, the Magistrate cannot  conceive of any manner in which the Plaintiff could possibly create additional  documentation in an effort to manufacture standing in this action. (5)

Said less politely, the Plaintiff appear to have lied to the Court or at least been unbelievably negligent in preparing its papers.  The Court also had these things to say about the Plaintiff’s filings:

  • the procedural history recounted by the Plaintiff in its Motion is inaccurate. (4)
  • it is not even likely that GreenPoint was the “owner and holder” of Marra’s loan documents at the time this case was filed in 2008, as was alleged in the original Complaint. (4)

As a law professor, I teach students about the importance of procedure to the functioning and legitimacy of our system of adjudication.  Reading cases like this, replete with a factual summary of obfuscation and possibly outright lies, I wonder what the lesson is that we should take away from the foreclosure epidemic.

One lesson is that you can say anything you want in court and you are unlikely to be punished even if you are caught.  If that is the lesson we are left with, just shoot me now.

An alternative lesson is that we should severely punish those who treat the courthouse as no better than a white-collar fight cage where trained mercenaries lord it over ill-prepared amateurs, with no holds barred. If that is the one we take, lower your gun, roll up your sleeves and start thinking about what a well-functioning judicial system would look like for unrepresented parties in civil suits, such as homeowners in foreclosure and consumers facing debt collectors.

[HT April Charney]

Reiss on the Future of Fannie and Freddie

Posted on by

I will be speaking at NYU Law next week on

The Future of Fannie and Freddie

Friday, September 20, 2013
9:00 am – 5:00pm
Reception to follow

Greenberg Lounge, NYU School of Law
40 Washington Square South
New York, NY 10012

Jointly sponsored by:
The Classical Liberal Institute & NYU Journal of Law & Business

 

This conference will bring together leaders in law, finance, and economics to explore the challenges to investment in Fannie Mae and Freddie Mac, and the future possibilities for these government-sponsored entities (GSEs).  Panels will focus on the reorganization of Fannie and Freddie, as well as the recent litigation surrounding the Treasury’s decision to “wind down” these GSEs.  Panelists will explore the legal issues at stake in the wind down, including the administrative law and Takings Clause arguments raised against the Treasury and Federal Housing Finance Agency.  Panelists will also look at economic policy and future prospects for Fannie and Freddie in light of legislation proposed in the House and the Senate.

Conference Panels:

  • The Reorganization of Fannie Mae and Freddie Mac
  • Fannie Mae, Freddie Mac, and Administrative Law
  • Conservatorship and the Takings Clause
  • The Future of Fannie and Freddie

Confirmed Participants:

  • Professor Barry Adler (NYU)
  • Professor Adam Badawi (Washington University)
  • Professor Anthony Casey (Chicago)
  • Charles Cooper (Cooper & Kirk PLLC)
  • Professor Richard Epstein (NYU)
  • Randall Guynn (Davis Polk & Wardwell LLP)
  • Professor Todd Henderson (Chicago)
  • Professor Troy Paredes (former SEC Commissioner)
  • Professor David Reiss (Brooklyn)
  • Professor Lawrence White (NYU Stern)

Borden and Reiss on High-Stakes MBS Litigation

Posted on by

Brad and I posted Goliath Versus Goliath in High-Stakes MBS Litigation on SSRN (and BePress).  The abstract reads,

The loan-origination and mortgage-securitization practices between 2000 and 2007 created the housing and mortgage-backed securities bubble that precipitated the 2008 economic crisis and ensuing recession. The mess that the loan-origination and mortgage-securitization practices caused is now playing out in courts around the world. MBS investors are suing banks, MBS sponsors and underwriters for misrepresenting the quality of loans purportedly held in MBS pools and failing to properly transfer loan documents and mortgages to the pools, as required by the MBS pooling and servicing agreements. State and federal prosecutors have also filed claims against banks, underwriters and sponsors for the roles they played in creating defective MBS and for misrepresenting the quality of the assets purportedly held in MBS pools. This commentary focuses on the state of this upstream litigation. It reviews claims of several complaints and discusses some decisions on motions for summary judgment in several of the cases. The commentary is not a comprehensive review of all the activity in this area, but it does provide an overview of the issues at stake in this litigation. The litigation in this area is still relatively new, but with hundreds of billions of dollars at stake, it will likely last for years to come and should reshape the MBS landscape.

Myths About Home Buying

Posted on by

I was quoted by MainStreet.com in Top 5 Myths About Home Buying Today.  It reads in part,

 

The fact is, buying a home today is absolutely, totally different from buying one in 2003. And right there is why so many myths swirl around a process that, in many ways, is utterly novel from what it has been. What was true isn’t anymore.

* * *

Myth 3: Fixed rate mortgages are the only way to go.

Not true, said David Reiss, a professor at Brooklyn Law School who specializes in real estate. He elaborated: “The necessity of getting a 30-year fixed rate mortgage is one of the biggest myths about homebuying. The average American household stays in their home for about seven years. Typically, 30-year fixed rate mortgages have higher interest rates than adjustable rate mortgages (ARMs). Homebuyers should take a hard look at their plans for the new home.”

Only 6.5% of applications for mortgages in a recent period were for ARMs, according to the Mortgage Bankers Association. A typical ARM went out at 3.21% interest, versus 4.69% for a typical 30 year fixed rate. That adds up to a difference worth tens of thousands of dollars over, say, a seven year probable life of the loan.

Do the math.

 

Benefit Ratios for Qualified Residential Mortgages

Posted on by

As I had noted previously,

the long awaited Proposed Rule that addresses the definition of Qualified Residential Mortgages has finally been released, with comments due by October 30th. The Proposed Rule’s preferred definition of a QRM is the same as a Qualified Mortgage. There is going to be a lot of comments on this proposed rule because it indicates that a QRM will not require a down payment. This is a far cry from the 20 percent down payment required by the previous proposed rule (the 20011 Proposed Rule).

The Proposed Rule notes that in “developing the definition of a QRM in the original proposal,” the six agencies [OCC, FRS, FDIC, FHFA, SEC and HUD] responsible for it “articulated several goals and principles.” (250)

First, the agencies stated that QRMs should be of very high credit quality, given that Congress exempted QRMs completely from the credit risk retention requirements.

Second, the agencies recognized that setting fixed underwriting rules to define a QRM could exclude many mortgages to creditworthy borrowers. In this regard, the agencies recognized that a trade-off exists between the lower implementation and regulatory costs of providing fixed and simple eligibility requirements and the lower probability of default attendant to requirements that incorporate detailed and compensating underwriting factors.

* * *

Fourth, the agencies sought to implement standards that would be transparent and verifiable to participants in the market.” (250)

After reviewing the comments to the 2011 Proposed Rule, the agencies concluded that “a QRM definition that aligns with the definition of a QM meets the statutory goals and directive of section 15G of the Exchange Act to limit credit risk, preserves access to affordable credit, and facilitates compliance.” (256)

I was somewhat disturbed, however, by the following passage. The agencies are

concerned about the prospect of imposing further constraints on mortgage credit availability at this time, especially as such constraints might disproportionately affect groups that have historically been disadvantaged in the mortgage market, such as lower-income, minority, or first-time homebuyers. (263)

While it is important to make residential credit broadly available, the agencies will be doing borrowers no favors if their loans are not sustainable and they end up in default or foreclosure. The agencies should come up with a metric that balances responsible underwriting with access to credit and apply that metric to the definition of a QRM.

Quercia et al. have developed one such metric, which they refer to as a “benefit ratio.” The benefit ratio compares “the percent reduction in the number of defaults to the percent reduction in the number of borrowers who would have access to QRM mortgages.” (20) A metric of this sort would go a long way to ensuring that there is transparency for homeowners as to the likelihood that they can not only get a mortgage but also pay it off and keep their homes.

Reiss on the FHA and Low Downpayment Mortgages

Posted on by

I will be speaking at the Cleveland Fed’s 2013 Policy Summit on Housing, Human Capital, and Inequality on Thursday, September 19 from 2:40PM-4:10PM.  My panel is on

Affordable Housing, Mortgage Underwriting, and Default: The Case of the FHA

In the past few years FHA’s market share has increased substantially, as have its default and foreclosure rates. Recently, the White House announced that the FHA may have to make a capital call to Treasury for the first time in its history, prompting much debate over the future of the organization. In this session, a panel of experts will discuss the FHA’s financial situation, its role in providing affordable housing, and explore potential policy responses.

Moderator:

Emre Ergungor, Senior Research Economist, Federal Reserve Bank of Cleveland

Speakers:

Edward J. Pinto, Resident Fellow, American Enterprise Institute, How the FHA Hurts Working-Class Families

David Reiss, Professor, Brooklyn Law School, How Low is Too Low? The Federal Housing Administration and the Low Downpayment Loan

Joseph Tracy, Executive Vice President and Senior Advisor to the President, Federal Reserve Bank of New York
Interpreting the Recent Developments in Housing Markets

My summary and implications are below and those for the other speakers can be found at the link above.

Summary and Findings
The Federal Housing Administration (FHA) has been a flexible tool of government since it was created during the Great Depression. It succeeded wonderfully, with rapid growth during the late 1930s. The federal government repositioned it a number of times over the following decades to achieve a variety additional social goals. It achieved success with some of its goals and had a terrible record with others. Today’s FHA is suffering from many of the same unrealistic underwriting assumptions that have done in so many subprime lenders as well as Fannie and Freddie. The FHA has come under attack for its poor execution of some of its additional mandates and leading commentators have called for the federal government to stop undertaking them. This article takes the long view and demonstrates that the FHA also has a history of successfully undertaking new programs. It also identifies operational failures that should be noted to prevent them from occurring if the FHA were to undertake similar ones in the future. The article first sets forth the dominant critique of the FHA and a history of its constantly changing role. It then addresses the dominant critique of the FHA and evaluates its priorities in the context of legitimate housing policy objectives. It concludes that the FHA has focused on an unthinking “more is better” approach to housing, but that the FHA can responsibly address objectives other than the provision of liquidity to the residential mortgage market.

Implications for Policy and Practice
Leading commentators on the FHA do not fully appreciate the extent to which down payment requirements alone drive the success and failure of new FHA initiatives. Central to any analysis of the FHA’s role is an understanding of its policies relating down payment size. Much of the FHA’s performance is driven by its down payment requirements, which have trended ever downward so that homeowners were able to get loans for 100% of the value of the house in recent times. As is obvious to all, the larger the down payment, the safer the loan. What appears to have been less obvious is that very small down payments are unacceptably risky. Given that the FHA insures 100% of the losses on its mortgages, the down payment requirement is a key driver of its performance. From an underwriting perspective, 20% is clearly desirable as the risk of default is very low even in a down market. But from an opportunity perspective, a 20% down payment requirement would keep large swaths of potential first-time homeowners from entering the market. If down payments are set too high, than an important social goal may be left by the wayside. So it is important that the public discourse weighs the costs and benefits of setting a fixed down payment requirement versus taking a risk layering approach to down payments. In either case, the FHA must balance the goal of safe underwriting with the goal of making homeownership available to households who could maintain it for the long term.