Author Archives: David Reiss

FHA Whitewash, Redux

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Richard Brooks and Carol Rose have recently published their book Saving the Neighborhood:  Racially Restrictive Covenants, Law, and Social Norms.  This well-written book brings to mind my recent post on the FHA Whitewash which reviewed a recent paper by HUD-affiliated researchers.  The paper minimized the role that the FHA played in furthering housing discrimination.  I mentioned that Kenneth Jackson’s classic book, Crabgrass Frontier, documented this sorry chapter of the FHA’s history.  Saving The Neighborhood covers some of the same ground, but from a legal and legal history perspective.  By doing so, it adds depth and texture to the historic record.

The book makes clear just how much of a role the FHA played.  The FHA’s

Underwriting Manual reflected private developers’ and brokers’ views of the kinds of features that made housing values stable and secure. Those features clearly included racial segregation.  In a section on “Protection from Adverse influences,” the Manual stated bluntly that “[a] change in social or racial occupancy generally leads to instability and a reduction in values” (par. 233). Thus property evaluators were to investigate the surrounding areas for the presence of “incompatible racial and social groups” and to assess whether the location might be “invaded” (par. 233). The Manual specifically noted that deed restrictions on “racial occupancy” could create a “favorable condition” (par. 228). in the section on subdivisions that were still in the development stage, the Manual recommended deed restrictions that included, among other matters, “. . . (g) Prohibition of the occupancy of properties except by the race for which they are intended” (par. 284(3)). (109)

The authors argue that these preferences gave developers, even those who did not favor segregation, an incentive to employ racially restrictive covenants in their projects. (110)

The FHA’s record of racial discrimination during the first few decades of its existence is clear, for all to see.

Assignment Ball and Chain

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An undated Nationwide Title Clearing, Inc. “White Paper” (actually, more of an advertorial), Understanding Current Assignment Verification Practices, is making the rounds of the blogosphere. It opens,

The scrutiny of the completeness of collateral review and valid assignment chains has hit the mortgage industry hard, primarily because the industry went from  a securitization process that didn’t  require assignments to be recorded to a heavily scrutinized process requiring complete chains to be recorded at the county. This has made compliance extremely difficult for many lenders and others, especially because the industry went for so many years without this  level of scrutiny. (1)

I’ll say!

This widespread lack of assignments could have negative consequences under the REMIC Rules. This is particularly a concern if it undercuts claims by purported REMICs that they acquired mortgages within the time required by statute.

I also found this passage intriguing:

just because a loan is supposed to be in MERS doesn’t always mean it is. We’ve found many examples of loans never having been assigned to MERS on land record, as well as loans that have been assigned multiple times out of MERS by prior investors/servicers, I would assume due to a poor review and preparation process . . ..(4-5)

I am not sure how courts would unwind such transactions. But I am sure we will find out . . ..

Thrilla in Vanilla: Freddie v. Jumbo

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Kroll BondRatings issued an RMBS Commentary, Mortgage Credit Trends:  Freddie Mac vs. Prime Jumbo. This commentary is important because it offers some help in evaluating the proposed “risk sharing” securitizations that Fannie and Freddie are considering. It is also important because if compares plain vanilla agency issues with comparable private label jumbos as well as not-so-comparable limited doc jumbos.  The differences are revealing.

Kroll’s key findings are

  • Freddie Mac default and loss rates were much higher for vintages that experienced severe home price declines. The worst vintage was 2007, which experienced an estimated aggregate home price decline in excess of 18% with 12.3% of the original vintage balance liquidated to date.
  • A rapid and significant improvement in credit characteristics sharply curtailed Freddie Mac mortgage liquidation rates, which fell from 8.3% for the 2008 vintage to 0.9% for the 2009 vintage.
  • Current Freddie Mac originations continue to be of very high credit quality, with a weighted average (WA) FICO score of 767 and a WA loan-to-value ratio (LTV) of 70% for the 2012 vintage.
  • Credit performance of jumbo prime mortgages and Freddie Mac mortgages is highly comparable when controlling for characteristics such as FICO, LTV, balance, and income and asset documentation. (2)

I am most interested in the last finding. While Kroll controlled for many characteristics, the fact remained that Freddie, as a general rule, allows for fewer high risk characteristics like low doc loans and high CLTV [combined loan to value]. For instance, almost all of Freddie’s loans were full doc while about half of the private label loans were low doc. So, while Kroll appears to be correct in stating “that the credit analysis tools developed for analyzing jumbo prime loans can be productively applied to agency mortgages,” we should not take that to mean that the two products are effectively the same. (7)

 

State of the Nation’s Housing 2013: Build It and They Will Come

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The Joint Center for Housing Studies of Harvard University released The State of the Nation’s Housing 2013.  As always there is much of interest in this annual report. I was particularly intrigued by Figure 21 on page 20, “The Government Continues to Have an Outsized Footprint in the Mortgage Market.” The report states

Despite efforts to entice private capital into the mortgage market, the GSEs and FHA continue to back the vast majority of loans(Figure 21). In 2001, loans securitized into private-label securities or held in bank portfolios accounted for nearly half of loan originations. Their market share rose to about two-thirds at the height of the housing boom before retreating to the low single-digits. Beginning in 2009, government-backed loans have accounted for roughly 90 percent of all originations. While the private securities market was still moribund in 2012, portfolio lending by banks showed its first substantial increase in years (albeit to a modest level), bringing the government share down slightly. (20-21)

As Fannie and Freddie return to profitability, policymakers are acting as if only the government can provide credit to the residential mortgage market, but from Figure 21 we can see that over a relatively short time period, capital can meaningfully shift from the secondary market (private MBS) to the government (FHA, Fannie and Freddie) to the primary market (portfolio lenders). Instead of assuming that the present structure is the best of all possible worlds, we should design the system we want and incentivize capital to find it.

Build it and they will come.

BofA No Worm Ouroboros

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The Worm Ouroboros of myth was a gigantic serpent that encircled the earth only to bite its own tail. Judge Sweet (SDNY) has ruled that Bank of America is no modern-day Ouroboros that is so enormous that it must sue itself. In BNP Paribas Mortgage Corporation et al. v. Bank of America, N..A., No. 1:09-CV-09783 (June 6, 2013), Judge Sweet granted Bank of America’s motion to dismiss in its entirety (although this did not do away with all of the plaintiffs’ claims).

The Court noted that Bank of America served “in several distinct but related capacities for” what was a type of warehouse credit facility for Taylor, Bean & Whitaker Mortgage Corp. subsidiary, Ocala. (8) In particular, BoA served “as Indenture Trustee, Collateral Agent, Depositary and Custodian” for the transaction. (8) You may remember that the chairman of TBW was sentenced to 30 years in jail for running a massive fraud, from which this case ultimately springs.

The Plaintiffs “allege that BoA had contractual duties as Collateral Agent (under the Security Agreement) and as Indenture Trustee (under the Base Indenture) to sue itself in its other capacities for breaches of the  Custodial and Depositary Agreements,  respectively, and that it breached those duties by failing to bring suit against itself for these alleged cIaims.” (15, citations omitted)

Relying on well-settled law, the Court held that the transaction documents did not require BoA to sue itself. While this case does not really cover new legal terrain, its logic brings to mind S&P’s motion to dismiss DoJ’s FIRREA case.  In that case, S&P argued that “the Complaint fails to allege that S&P possessed the requisite intent to defraud the investors in the CDOs at issue. It is more than ironic that two of the supposed ‘victims,’ Citibank and Bank of America—investors allegedly misled into buying securities by S&P’s fraudulent ratings—were the same huge financial institutions that were creating and selling the very CDOs at issue.” (3) The aftermath of the financial crisis laid much bare about the securitization process, but the utter incestuousness of it can still shock.

This is not to say that this complexity and self-dealing are per se bad. Just that it seems that the sophisticated business people who put the deals together did not think through at all what would happen if deals went south.  Will they during the next boom?  Probably not.

So what does that mean for regulators?

More Misrepresentations, More Litigation

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Judge Pfaelzer (C.D. Cal.) issued an order in American International Group Inc. v. Bank of America Corp., No. 2:11-CV-10549 (May 6, 2013), which allowed AIG to proceed with its claim that it was fraudulently induced to buy MBS by Countrywide (now a part of BoA). This case joins a long list of cases where judges have allowed fraud and misrepresentation allegations to proceed in the context of MBS issuances (for instance, here, here and here).  AIG claims that the deal documents for the MBS “fraudulently misrepresented and concealed the actual credit quality of the mortgages by providing false quantitative data about the loans, thus masking the true credit risk of AIG’s investments.” (5, quoting the Amended Complaint)

in allowing some of the claims to proceed, the Court notes that  AIG “plausibly alleges that the underwriting guidelines stated in the Offering Documents were false. The Amended Complaint describes a company-wide culture of abandonment of underwriting standards and wholesale use of ‘exceptions’ to the normal standards. This raises an inference, however strong, that the loans in AIG’s RMBS deviated from the underwriting standards.” (28, citations omitted)

Judge Pfaelzer notes that she has repeatedly issued similar rulings regarding Countrywide’s behavior in other cases, so this comes as no surprise.  But once all of these MBS cases alleging fraud misrepresentation are decided, it will be interesting to see just what the contours of this body of law will look like.  Clearly, issuers can’t avoid liability by means of general disclaimers in the offering documents.  Will they provide clearer, more explicit disclaimers and carve-outs in the hopes of  avoiding liability in future deals or will they ensure that future deals hew more closely to the deal documents?  Time will tell.

The Future of Foreclosure

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Professor Roger Bernhardt  (Golden Gate University School of Law) has posted The Future of Foreclosure to SSRN.  This short article is ostensibly about a few recent California foreclosure decisions but I was more intrigued by its “case for going back to the courthouses”  and its rejection of nonjudicial foreclosure. (2) Bernhardt makes the common argument that for debtors, “judicial foreclosure would give them the opportunity to have their defenses heard before their property is taken away by foreclosure . . ..” (3)  But he also argues that lenders would benefit from a judicial-foreclosure-only regime because it could “effectively eliminate the risks and consequences that a challenged conduct will later be determined to have amounted to a fatal error.” (3)

Bernhardt does note that

National reform movements have always gone in the opposite direction: attempting to improve the nonjudicial foreclosure procedure in ways to eliminate its deficiencies (e.g., the Uniform Land Transactions Act, the Uniform Land Security Interests Act, the Uniform Nonjudicial Foreclosure Act, and now the (draft) Residential Real Estate Mortgage Foreclosure and Protections Act). But those approaches all concede a premise that may no longer be tenable—that the foreclosure process can be safely or efficiently run without contemporaneous judicial supervision. After-the-fact oversight is too time consuming and too late. (3)

I have not heard any lenders advocate for such a solution and would be curious to hear what they would have to say.  My sense is that they would not agree that they would benefit from such a regime, but it would be interesting to know if I am wrong.