Author Archives: David Reiss

Show Me The Note!

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KeAupuni Akina, Brad Borden and I have posted Show Me The Note! to  SSRN and BePress.  The abstract reads

News outlets and foreclosure defense blogs have focused attention on the defense commonly referred to as “show me the note.” This defense seeks to forestall or prevent foreclosure by requiring the foreclosing party to produce the mortgage and the associated promissory note as proof of its right to initiate foreclosure.

The defense arose in two recent state supreme-court cases and is also being raised in lower courts throughout the country. It is not only important to individuals facing foreclosure but also for the mortgage industry and investors in mortgage-backed securities. In the aggregate, the body of law that develops as a result of the foreclosure epidemic will probably shape mortgage law for a long time to come. Courts across the country seemingly interpret the validity of the “show me the note” defense incongruously. Indeed, states appear to be divided on its application. However, an analysis of the situations in which this defense is raised provides a framework that can help consumers and the mortgage industry to better predict how individual states will rule on this issue and can help courts as they continue to grapple with this matter.

 

FHA Whitewash

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While preparing for my talk tomorrow on The FHA and Housing Affordability, I was reviewing some of the recent literature on the FHA. I came across a recent HUD working paper with some interesting data about recent FHA crises but also with a disturbing spin on the FHA’s history. The FHA Single-Family Insurance Program: Performing a Needed Role in the Housing Finance Market states that in its early years “race was not explicitly regarded as a factor in FHA’s mortgage insurance operations.” (9) This is flat out wrong and has been known to be flat out wrong at least since Kenneth Jackson published Crabgrass Frontier in 1987. Jackson clearly demonstrated that race was “explicitly regarded as a factor in FHA’s mortgage insurance operations.”

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Jackson writes that the FHA’s Underwriting Manual from those early years stated that “[i]f a neighborhood is to retain stability, it is necessary that properties shall be continued to be occupied by the same social and racial classes” and recommended that owners employ restrictive covenants to exclude African Americans (and some other groups). (208) The working paper has other extraordinary statements that minimize the FHA’s central role in promoting segregation during the mid-20th Century. For instance, it states that the FHA’s “early policy may have inadvertently promoted redlining practices.” (18) There was nothing “inadvertent” about it.

I typically find that federal government reports make great efforts to be factually accurate, so this paper is a great exception.  One might think that the authors deserve some leeway in their interpretation, but Jackson’s history has only been confirmed by later research, such as last year’s Do Presidents Control Bureaucracy? The Federal Housing Administration During the Truman-Eisenhower Era which was published in Political Science Quarterly. It makes much the same point as Crabgrass Frontier. I would be curious to hear the authors’ response to my assessment, but I really can’t see how they can deny it.

“Those who cannot remember the past are condemned to repeat it.” (Santayana)

Mass. Appeals Court Applies Eaton Retroactively

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The intermediate appeals court of Massachusetts applied Eaton retroactively in Lyons v. MERS et al., 11-P-560 (June 5, 2013) notwithstanding the Mass. Supreme Court’s holding that Eaton would only apply prospectively. Eaton held that “a mortgagee may foreclose under a power of sale only if it either holds the note or is acting under the direction or as the agent of the note holder.” (1)

The intermediate appeals court found that it would be inequitable to do otherwise:  “Not only was the present case on appeal when Eaton was decided, the Lyonses actually brought their action before Eaton had even been decided in the trial court. Because the Lyonses are in an identical situation to the plaintiffs in Eaton, not a ‘somewhat similar[]’ position,” the court held “that the rule of Eaton is applicable to the Lyonses’ case, and reverse[d] the judgment” of the trial court. (1, citations omitted)

Mass. Trial Court Upholds MERS Foreclosure

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Judge Cutler granted MERS and Countrywide’s motion to dismiss plaintiff Lyons challenge to the validity of a foreclosure deed arising from a foreclosure sale conducted by MERS in Lyons v. MERS et al. Misc. 09 416377 (Jan. 4, 2011). The court held that “the Plaintiffs expressly granted the Mortgage to MERS (as nominee for the Lender), with the power of sale. As a result of this grant, MERS needed no assignment” from Countrywide.” (3) The court found that “such an arrangement is entirely consistent with the express terms of the Mortgage, as well as with Massachusetts law.” (3) The court found it intolerable to reach a result where “the logic of a denial of MERS’s foreclosure right as mortgagee would lead to anomalous and perhaps inequitable results, to wit, if MERS cannot foreclose though named as mortgagee, then either [the lender] can foreclose though not named as mortgagee or no one can foreclose, outcomes not reasonably or demonstrably intended by the parties.” (3) Not sure that those are the only possibilities (for instance, MERS could assign the mortgage to its beneficial owner), but there you have it.

REMIC Armageddon on the Horizon?

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Brad Borden and I have warned that an unanticipated tax consequence of the sloppy mortgage origination practices that characterized the boom is that MBS pools may fail to qualify as REMICs.  This would have massively negative tax consequences for MBS investors and should trigger lawsuits against the professionals who structured these transactions. Courts deciding upstream and downstream cases have not focused on this issue because it is typically not relevant to the dispute between the parties.

Seems that is changing. Bankruptcy Judge Isgur (S.D. Tex.) issued an opinion in In re: Saldivar, Case No. 11-1-0689 (June 5, 2013)) which found, for the purposes of a motion to dismiss, that “under New York law, assignment of the Saldivars’ Note after the start up day [of the REMIC] is void ab initio.  As such, none of the Saldivars’ claims” challenging the validity of the assignment of their mortgage to the REMIC trust  “will be dismissed for lack of standing.” (8)

If this case holds up on appeal, it will have a massive impact on many purported REMICs which had sloppy practices for transferring mortgages to the trusts. That is a big “if,” as the case relies upon Erobobo for its take on the relevant NY law. Erobobo, a NY trial court opinion, itself reached a controversial result and is hardly the last word on NY trust law. The Court also acknowledges that additional evidence may be proffered relating to a subsequent ratification of the conveyance of the mortgage, but for the purposes of a motion to dismiss, the homeowners have met their burden.

For those few REMIC geeks out there, it is worth quoting from the opinion at length (everyone else can stop reading now):

The Notice of Default indicates that the original creditor is Deutsche Bank, as Trustee for Long Beach Mortgage Loan Trust 2004-6. The Trust is a New York common law trust created through a Pooling and Servicing Agreement (the “PSA”). Under the PSA, loans were purportedly pooled into a trust and converted into mortgage-backed securities. The PSA provides a closing date for the Trust of October 25, 2004. As set forth below, this was the  date on which all assets were required to be deposited into the Trust. The PSA provides that New York law governs the acquisition of mortgage assets for the Trust.

The Trust was formed as a REMIC trust. Under the REMIC provisions of the Internal Revenue Code (“IRC”) the closing date of the Trust is also the startup day for the Trust. The closing date/startup day is significant because all assets of the Trust were to be transferred to the Trust on or before the closing date to ensure that the Trust received its REMIC status. The IRC provides in pertinent part that:

“Except as provided in section 860G(d)(2), ‘if any  amount is contributed to a REMIC after the startup day, there is hereby imposed a tax for the taxable year of the REMIC in which the contribution is received equal to 100 percent of the amount of such contribution.”

26 U.S.C. § 860G(d)(1).

A trust’s ability to transact is restricted to the  actions authorized by its trust documents. The Saldivars allege that here, the Trust documents permit only one specific method of transfer to the Trust, set forth in § 2.01 of the PSA. Section 2.01 requires the Depositor to provide the Trustee with the original Mortgage Note, endorsed in blank or endorsed with the following: “Pay to the order of Deutsche Bank, as Trustee under the applicable agreement, without recourse.” All prior and intervening endorsements must show a complete chain of endorsement from the originator to the Trustee.

Under New York Estates Powers and Trusts Law § 7-2.1(c), property must be registered in the name of the trustee for a particular trust in order for transfer to the trustee to be effective. Trust property cannot be held with incomplete endorsements and assignments that do not indicate that the property is held in trust  by a trustee for a specific beneficiary trust.

The Saldivars allege that the Note was not transferred to the Trust until 2011, resulting in an invalid assignment of the Note to the Trust. The Saldivars allege that this defect means that Deutsche Bank and Chase are not valid Note Holders.

(2-4, footnotes and citations omitted) The Court agreed, at least while “accepting all well-pleaded facts as true.” (5)

(HT April Charney)

The Mortgage Interest Deduction: A Taxing Expenditure

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The Congressional Budget Office has issued a report, The Distribution of Major Tax Expenditures in the Individual Income Tax System,  which evaluates the mortgage interest deduction and the state and local tax deduction among other tax expenditures.  It finds (consistent with all previous findings) that they accrue disproportionately — grossly so — to the wealthy.  The mortgage interest deduction has a budgetary effect of $70 billion and the state and local tax deduction has a budgetary effect of $77 billion. (6, Table 1) (to be clear, budgetary effect is not the same as lost revenue; read the report for an explanation of the difference)

Itemized deductions such as these “provide the largest benefits — in both absolute dollars and relative to income — to the highest-income taxpayers.  Those tax expenditures benefit only the roughly one-third of taxpayers who itemize their deductions, and lower-income taxpayers are much less likely than higher-income taxpayers to do so.” (17)  The CBO “estimates that the top quintile will receive almost three-quarters of the benefit of the deduction in 2013, including 15 percent accruing to the top percentile.” (18)

I and many, many others have argued that this is not a good state of affairs but the real estate industry are very well organized around this issue.  Real estate brokers are particularly focused on this because a reduction in these deductions would likely lead to a significant and permanent reduction in their income.  Smaller deductions would make owning a home less financially attractive and thereby push down prices.  Brokers typically get paid by a percentage commission of the sales price.  So they would suffer not just during a transition period (as sellers in the transition period would) but for all time.

So there is no reason to believe that we will see reform around these regressive tax expenditures in the near future, but it should always be kept on the table as part of a tax reform package, particularly if it is implemented in some incremental way (for example, capping the value of the deductions individually or as part of a basket of deductions).

Effect of Qualified Mortgages on Credit Availability: Little to None

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The Congressional Research Service has issued a somewhat opaque report, The Ability-to-Repay Rule: Possible Effects of the Qualified Mortgage Definition on Credit Availability and Other Selected Issues, that summarizes the Ability-to-Repay Rule.  More importantly, it offers a bit of an evaluation of the impact of the new regulatory regime for mortgages on the availability of credit.

According to the CFPB, “close to 100% of the 2011 mortgage market would have been in compliance with the” Ability-to-Repay Rule. (9) The CFPB thus believes that the rule will “have a minimal effect on access to credit.”  (9) The report reviews two alternative estimates, one by CoreLogic and another by Amherst Securities, that offer a less optimistic forecast.

CoreLogic uses 2010 data for its analysis. The CRS appears to agree with me that the CoreLogic report is misleading, but it does report that CoreLogic believes that nearly half of all mortgages will not meet the Qualified Mortgage rules once temporary compliance options for the rule expire.  I do not credit the CoreLogic report and would discount its findings for the reasons that I have given previously and for the additional reasons contained in the CRS report.

Amherst takes a look at jumbo mortgages in 2012 and finds that a significant portion of them would not comply with the rule. I have not seen the Amherst report, so I can only respond to what I read about it in the CRS report.  The bottom line appears that about eight percent of jumbos are likely not to comply with the rule.  Given that jumbos make up about 10% of the mortgage market (at least according to CoreLogic), we are talking about one percent of the total residential mortgage market.  Many of those non-complying mortgages do not comply because of limitations on debt-to-income ratio.  Thus, it would appear that the affected borrowers could get mortgages for smaller amounts that would comply with the rule.

I think it is safe to say that based on what we know now, the rule will have an extremely modest effect on credit availability.