Author Archives: David Reiss

Racial Discrimination in the Secondary Mortgage Market

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Judge Baer issued an opinion in Adkins et al. v. Morgan Stanley et al., No 1:12-cv-07667 (July 25, 2013), denying Morgan Stanley’s motion to dismiss the plaintiff-homeowners’ Fair Housing Act claims. The homeowners claimed “that Morgan Stanley’s policies and practices caused New Century Mortgage Company to target borrowers in the Detroit, Michigan region for loans that had a disparate impact upon African-Americans” in violation of the FHA. (1)

The Court found that the plaintiffs met their pleading burden sufficient to survive a motion to dismiss:

First, they have identified the policy that they allege has a disproportionate impact on minorities.  That policy consisted of Morgan Stanley

(1) routinely purchasing both stated income loans and loans with unreasonably high debt-to-income ratios,

(2) routinely purchasing loans with unreasonably high loan-to-value ratios,

(3) requiring that New Century’s loans include adjustable rates and prepayment penalties as well as purchasing loans with other high-risk features,

(4) providing necessary funding to New Century, and

(5) purchasing loans that deviated from basic underwriting standards.

Plaintiffs go on to state that these policies resulted in “New Century aggressively target[ing] African-American borrowers and communities . . . for the Combined-Risk Loans.”  (Compl. ¶ 81.) Indeed, Plaintiffs allege in detail the effect that New Century’s lending had upon the African-American community in the Detroit area. (Compl. ¶¶ 115–122).  That lending, according to Plaintiffs, was a direct result of Morgan Stanley’s policies.  And while Plaintiffs do not allege that they qualified for better loans, they allege discrimination based only upon the receipt of these predatory, toxic loans that placed them at high financial risk.  These risks exist regardless of Plaintiffs’ qualifications.  On a motion to dismiss, these allegations are sufficient to demonstrate a disparate impact. (11)

The opinion goes farther afield than the questions presented at points. For instance, Judge Baer writes,

Detroit’s recent bankruptcy filing only emphasizes the broader consequences of predatory lending and the foreclosures that inevitably result.  Indeed, “[b]y 2012, banks had foreclosed on 100,000 homes [in Detroit], which drove down the city’s total real estate value by 30 percent and spurred a mass exodus of nearly a quarter million people.”  Laura Gottesdiener, Detroit’s Debt Crisis:  Everything Must Go, Rolling Stone, June 20, 2013.  The resulting blight stemming from “60,000 parcels of vacant land” and “78,000 vacant structures, of which 38,000 are estimated to be in potentially dangerous condition” has further strained Detroit’s already taxed resources.  Kevyn D. Orr, Financial and Operating Plan 9 (2013).  And as residents flee the city, Detroit’s shrinking ratepayer base renders its financial outlook even bleaker.  Id.  Given these conditions, it is not difficult to conclude that Detroit’s current predicament, at least in part, is an outgrowth of the predatory lending at issue here.  See Monica Davey & Mary Williams Walsh, Billions in Debt, Detroit Tumbles Into Insolvency, N.Y. Times, July 18, 2013, at A1 (listing Detroit’s “shrunken tax base but still a huge, 139-square-mile city to maintain” as one factor contributing to the city’s financial woes). (3-4)

This kind of judicial history does not seem to speak to the legal issue at hand and may negatively impact its reception on appeal. Furthermore, all Fair Housing Act cases will be impacted by the Supreme Court’s decision in Mount Holly v. Mount Holly Gardens Citizens in Action, Inc. for which it has recently granted cert. In that case, the Supreme Court will decide whether disparate impact is a cognizable claim under the Fair Housing Act.

But, whatever happens in the future, Adkins proceeds apace for now.

MBS Representations Regarding Ratings Based on False Data Are Actionable

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In Capital Ventures International v. UBS Securities LLC et al., No. 11-11937 (D. Mass. July 22, 2013), Judge Casper held that the inclusion of credit ratings based upon “false data” in offering materials for mortgage-backed securities “constitutes an actionable misrepresentation and omission” under the Massachusetts Uniform Securities Act (the relevant provisions of which are substantively similar to those of the Securities Act of 1933). (11) The Court also held that UBS’ “representation that a certain [ratings] process will be used is an actionable statement of fact.” (12)

Capital Ventures had purchased over $100 million of certificates of RMBS that were underwritten by UBS.  The investors in those RMBS “were not given access to the loan files and had to rely upon the representations in the Offering Materials about the quality and nature of the loans that formed the security for their Certificates.” (2) The offering materials stated that the “rating process addresses structural and legal aspects associated with the Offered Certificates, including the nature of the underlying mortgage loans.” (3, emphasis in the original)

Capital Ventures alleged that “UBS knew the ratings were based on false and misleading data such as owner-occupancy and LTV statistics and underwriting quality and thus knew that the ratings were not the product of a process designed to judge the risk presented by the Certificates (as represented in the Offering Materials), but rather reflect the Rating Agencies’ judgment as to the risk presented by a ‘hypothetical security Capital Ventures was promised, but did not receive.'” (3, quoting amended complaint)

The holding in itself is important, but I am curious as to what effect it will have on representations in deals going forward.  Underwriters may very well give investors the opportunity to review the underlying mortgage loans in order to ensure that they are not exposed to this type of liability. Or perhaps the risk is remote enough that they will chance it again.  Time will tell.

Not That I’m Complaining, But

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Ian Ayres, Jeff Lingwall and Sonia Steinway have posted Skeletons in the Database: An Early Analysis of the CFPB’s Consumer Complaints on SSRN. It is interesting both for the details it documents, but also for what it represents.  Details first:

Analyzing a new data set of 110,000 consumer complaints lodged with the Consumer Financial Protection Bureau, we find that

(i) Bank of America, Citibank, and PNC Bank were significantly less timely in responding to consumer complaints than the average financial institution;

(ii) consumers of some of the largest financial services providers, including Wells Fargo, Amex, and Bank of America, were significantly more likely than average to dispute the company‘s response to their initial complaints; and

(iii) among companies that provide mortgages, OneWest Bank, HSBC, Nationstar Mortgage, and Bank of America all received more mortgage complaints relative to mortgages sold than other banks. (1)

The financial services industry has complained that the CFPB complaint system would unfairly expose companies to unverified complaints. But this kind of comparative look at financial services companies shows the great value of the CFPB’s approach. As the authors’ note, this dataset is a treasure trove for researchers and should result in helpful information for consumers and regulators alike.  Sunlight is the best disinfectant!

Borden and Reiss on Show Me The Note!

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Brad and I were e-interviewed by the Knowledge Effect, a Thomson Reuters blog on our recent article (co-authored with KeAupuni Akina), Show Me The Note!.  The interview is below:

Westlaw Journals: Your commentary is about the success of the “show me the note” defense to stop or delay a foreclosure.  Can you explain what the “show me the note” defense means during foreclosure proceedings? 

Bradley T. Borden and David J. Reiss:“Show me the note” can mean different things in different jurisdictions.  But the bottom line is that the homeowner is typically telling the court that the foreclosure should not proceed unless and until the foreclosing party can prove that it in fact owns or holds (or is the agent of the owner or holder of) the mortgage note that is secured by the mortgage that is being foreclosed upon.

WJ: What is the difference between a mortgage and a deed of trust, and does this have any bearing on the foreclosure defense?

BTB and DJR:The two documents are very similar in many ways – they both provide a security interest in real property.  The mortgage is the simpler of the two, involving just two parties.  The two parties are the mortgagor (the borrower) and the mortgagee (the lender).  The borrower uses its interest in real property to secure a loan made to it by the lender.  If the borrower fails to repay the loan or otherwise violates the terms of the loan transaction, the mortgagee can foreclose upon the real property.  The mortgagee forecloses through a judicial proceeding.

The deed of trust adds another party to a secured loan transaction.  Here, the borrower delivers a deed of trust to a trustee which states that the borrower’s real property is held as security for the loan made by the lender to the borrower.  The trustee of a deed of trust has the very limited role of following the provisions of the deed of trust.  Most importantly, it can foreclose on the deed of trust on behalf of the beneficiary of the deed of trust, the lender, if the terms of the loan transaction have been violated.  Because of the addition of this third party, foreclosure can (but need not) take place in a non-judicial proceeding.  The thinking is that the trustee will ensure that there will be some basic procedural protections in place for the foreclosure, obviating the need for judicial oversight. The big advantage of the deed of trust is the ability to foreclose quickly and cheaply by means of a non-judicial proceeding.

WJ: How do assignments of mortgages contribute to the confusion about what entity has the right to foreclose?

BTB and DJR: Let us count the ways!  On our blog, REFinblog.com, we track the litigation that arises from the foreclosure epidemic.  The absence of all of the relevant assignments in a transaction can play out one way in a judicial foreclosure (in mortgage-only jurisdictions), another way in a non-judicial foreclosure (in jurisdictions that allow for deeds of trust) and another way in a bankruptcy proceeding.  It plays out differently in different states.  It can play out one way if the mortgagee brings the suit, in another way if the servicer brings the suit and another if MERS (the Mortgage Electronic Recording System) brings the suit.  It can play out differently if the note is negotiable or if it is non-negotiable.  So to answer your question precisely, assignments of mortgages don’t contribute to the confusion – they are the confusion!

WJ: What is the difference between a judicial and non-judicial foreclosure?  Is the “show  me the note” defense more successful in states that use a non-judicial foreclosure proceeding or judicial proceeding?  What contrasts exists between the cases highlighted in your analysis? 

BTB and DJR: Keep in mind that states typically fall into two categories:  those that only allow judicial foreclosures and those that allow either judicial or non-judicial foreclosures.  In a judicial foreclosure, foreclosure actions are brought in court.  A judicial foreclosure can be brought where the security interest is a mortgage or deed of trust.  A non-judicial foreclosure does not – shocker! — involve a court proceeding.  Instead it is conducted using the power of sale contained in the deed of trust.  With the power of sale, the mortgaged property is sold at a public auction.

If we were to generalize, the rule is that state supreme courts do not require the foreclosing party to “show the note” in a non-judicial foreclosure (with Massachusetts one exception).  In addition, the general rule in a judicial foreclosure is that the foreclosing party must “show the note,” although it need not be the actual mortgage note holder, but merely one who has been assigned an interest in the mortgage note by the mortgage note holder.

We think the most interesting contrast is between the more typical Hogan v. Washington Mutual Bank, 277 P.3d 781 (Ariz. 2012), and the more cutting edge Eaton v. Federal National Mortgage Association, 969 N.E.2d 1118 (Mass. 2012).  Hogan strictly construes the state foreclosure law, but leads to some odd results, including the possibility that a borrower can be liable in competing foreclosure proceedings arising from just one deed of trust.  Eaton pushes the language of the statute a bit, but seems to ensure that borrowers are protected from inequitable results in foreclosure proceedings.  For a more in depth analysis, we would recommend a recent law review article by Dale Whitman and Drew Milner in the most recent issue of the Arkansas Law Review, Foreclosing on Nothing: The Curious Problem of the Deed of Trust Foreclosure Without Entitlement to Enforce the Note.

WJ: How does state law influence the success of the defense?   Are there any federal laws applicable to the “show me the note” defense?

BTB and DJR: While “show me the note” does come up in federal cases, federal courts defer to the applicable state law in reaching their results.  As our article demonstrates, the courts’ holdings tend to flow from a careful reading of the relevant state foreclosure statute, so a particular state’s law can have a big effect on the outcome.  We would note that many scholars and leaders of the bar are befuddled by courts’ failure to do a comprehensive analysis under the UCC as part of their reasoning in mortgage enforcement cases, but judges make the law, not scholars and members of the bar.  See Report of The Permanent Editorial Board for The Uniform Commercial Code Application of The Uniform Commercial Code to Selected Issues Relating to Mortgage Notes at 1 (Nov. 14, 2011).

WJ: What are the main points you want to emphasize for homeowners and their attorneys challenging a foreclosure action?

BTB and DJR: The main point is – the law matters and the jurisdiction matters.  Whether you are a homeowner trying to stave off foreclosure or a real estate finance lawyer structuring a securitization, you should expect that courts will enforce statutes as they are written in an adversarial proceeding.  What works in one jurisdiction may not work in another because the laws of the jurisdictions may vary.  Plan accordingly.

 

A REMIC Unraveling?

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An unpublished opinion, Glaski v. Bank of America, No. F064556 (7/31/13, Cal. 5th App. Dist.), presents one possible future for REMICs that failed to comply with the strict rules set for them by Congress and the IRS. Glaski, a homeowner, argues that the trial court erred by dismissing his case challenging the nonjudicial foreclosure of the deed of trust secured by his home. For my purposes, I am interested in the Court’s consideration of “whether a post-closing date transfer into a [REMIC] securitized trust is the type of defect that would render the transfer void.” (20) I am going to quote the opinion at length because the reasoning is somewhat complex:

The allegation that the WaMu Securitized Trust was formed under New York law supports the conclusion that New York law governs the operation of the trust.  New York Estates, Powers & Trusts Law section 7-2.4, provides:  “If the trust is expressed in an instrument creating the estate of the trustee, every sale, conveyance or other act of the trustee in contravention of the trust, except as authorized by this article and by any other provision of law, is void.”

Because the WaMu Securitized Trust was created by the pooling and servicing  agreement and that agreement establishes a closing date after which the trust may no longer accept loans, this statutory provision provides a legal basis for concluding that the trustee’s attempt to accept a loan after the closing date would be void as an act in contravention of the trust document.

We are aware that some courts have considered the role of New York law and rejected the post-closing date theory on the grounds that the New York statute is not interpreted literally, but treats acts in contravention of the trust instrument as merely voidable.

Despite the foregoing cases, we will join those courts that have read the New York statute literally.  We recognize that a literal reading and application of the statute may not always be appropriate because, in some contexts, a literal reading might defeat the statutory purpose by harming, rather than protecting, the beneficiaries of the trust.  In this case, however, we believe applying the statute to void the attempted transfer is justified because it protects the beneficiaries of the WaMu Securitized Trust from the potential adverse tax consequence of the trust losing its status as a REMIC trust under the Internal Revenue Code.  Because the literal interpretation furthers the statutory purpose, we join the position stated by a New York court approximately two months ago:  “Under New York Trust Law, every sale, conveyance or other act of the trustee in contravention of the trust is void.  EPTL § 7-2.4.  Therefore, the acceptance of the note and mortgage by the trustee after the date the trust closed, would be void.” [quoting Erobobo] Relying on Erobobo, a bankruptcy court recently concluded “that under New York law, assignment of the Saldivars’ Note after the start up day is void ab initio.  As such, none of the Saldivars’ claims will be dismissed for lack of standing.”(quoting Saldivar)

We conclude that Glaski’s factual allegations regarding post-closing date attempts to transfer his deed of trust into the WaMu Securitized Trust are sufficient to state a basis for concluding the attempted transfers were void.  As a result, Glaski has a stated cognizable claim for wrongful foreclosure under the theory that the entity invoking the power of sale (i.e., Bank of America in its capacity as trustee for the WaMu Securitized Trust) was not the holder of the Glaski deed of trust. (20-22, citations and footnotes omitted)

We are now seeing a trend that started with Erobobo and continued with Saldivar:  courts are finally addressing the REMIC attributes of the mortgage-backed securities at issue in downstream cases. I am not sure that the reasoning of those three cases will hold up on appeal, but it is interesting to see judges add another level of understanding to foreclosures in the age of of the mortgage-backed security.

[Hat tip April Charney]

UPDATE:  I just heard (August 8, 2013) from Richard L. Antognini, Glaski’s appellate lawyer, that the court has decided to publish this opinion. As he notes, “It now can be cited to other California and federal courts, and it is binding authority, until another court of appeal disagrees or the California Supreme Court decides to review it.”

Financial Literacy Literacy

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Personally, I was disappointed by the CFPB’s Financial Literacy Annual Report. It seems to me that the Bureau’s Division of Consumer Education and Engagement is thinking too small in setting forth its research agenda. For its financial education evaluation project,

The Bureau is conducting a quantitative evaluation of two existing financial coaching programs. Financial coaching generally involves one-on-one sessions with clients to increase clients’ awareness of their financial decisions and to provide support for clients to reach financial goals mutually set by the coach and client. (46)

Seems to me that there are some fundamental questions about financial literacy that need to be studied before small, resource-intensive projects like financial coaching are. I have blogged about these issues before, but the bottom line is that there is no solid empirical evidence that financial education achieves good results in general. So why study particular initiatives?

I would like to see the Bureau engage in a broad survey of financial literacy first and then develop a research agenda that reflects the big issues, including

  • do improved disclosures improve outcomes for consumers?
  • do consumers have the basic math skills to take advantage of disclosures?
  • what useful metrics exist for measuring the impact of financial literacy initiatives?

These are just a few big questions that I would want to answer before I looked at particular programs.

The Bureau should start from the premise that we have little reason to believe that financial education works.  Let’s build up a body of knowledge from there. If we assume that it works, as the Bureau’s current research agenda implies, then that assumption can lead us on a wild goose chase as we study program, after initiative, after project, looking for that golden-egg laying goose.

Cuomo and Lawsky: Mind The Gap Authority

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Law360 quoted me in a story, NY’s Powerful Financial Regulators Poised To Extend Reach (full story behind a paywall). The story reads in part,

New York’s proposed tougher standards for debt collectors marked state regulators’ first use of their unusual authority to fill gaps in financial regulation, proving state officials will use that power to take charge of the few areas of consumer finance they do not already oversee, attorneys say.
The New York Department of Financial Services has already proved to be an aggressive and creative regulator in its nearly two years of operation, taking on alleged money laundering at Standard Chartered PLC and force-placed insurance, among other moves. Until now, though, Gov. Andrew Cuomo and Financial Services Superintendent Benjamin Lawsky had not fully exploited the state’s “gap authority,” which allows them to regulate areas they feel aren’t sufficiently policed by existing state or federal laws.

* * *

That power makes New York state unique. In most other jurisdictions, state regulators can only regulate financial products and institutions based directly on statute. New York’s regulators can simply decide to enact rules where none exist, and do it quickly, said Brooklyn Law School professor David Reiss.
“You now have an activist government in New York saying, ‘We’re going to look broadly at using this authority we have. So if we hear about problems we can respond to them in six months, not three years,'” Reiss said.

* * *

In addition, there may be some confusion about where the lines between regulations set by the Consumer Financial Protection Bureau — which is considering its own rules for debt collectors — and the DFS may overlap. Technically, the DFS can only extend its gap authority into areas where it feels appropriate rules do not exist, either from state or federal regulators.
The CFPB has consistently asserted that it does not intend to preempt state regulations, and that its rules are merely a floor, Reiss said.

* * *

“We have a governor who has a strong view of gubernatorial authority. He’s appointed an active former prosecutor to a sleepy office and given him a lot of authority, and Lawsky has run with it,” Reiss said.