Author Archives: David Reiss

California’s S&P Suit

Posted on by

The California complaint follow on the heels of the DoJ complaint but it hangs its hat on an aggressive theory — that S&P’s ratings violate California’s False Claims Act.  While I do not yet have an opinion about whether that is a stretch, I do note the allegations in the complaint add to the tragicomic ones that we have seen in the other complaints filed against rating agencies.  Here are some of the more quote-worthy ones:

  • S&P executives “suppressed development of new, more accurate rating models that would have produced fewer AAA ratings -and therefore lower profits and market share. As one senior managing director at S&P later confessed, “I knew it was wrong at the time.” (3)
  • “S&P knew that its rating process and criteria had become so degraded that many of its ratings were, in the words of one S&P analyst, little better than a “coin toss.” During those years, its models were “massaged” using “magic numbers” and “guesses,” in the words of other senior S&P executives.” (3)
  • “it rated notes issued by structured investment vehicles (“SIVs”) another type of security central to this case-without obtaining key data about the assets underlying the SIVs. A reporter later asked the responsible executive about this failing: “If you didn’t have the data, and you’re a data-based credit rating agency, why not walk away” from rating these deals? His response was remarkably candid: “The revenue potential was too large.” (4)

This complaint, like the others, highlights the chasm between S&P’s representations of its own conduct and the alleged behavior set forth in the complaint.  Indeed, the complaint states that representations by employees which were authorized by S&P “about its integrity, competence, and the quality of its ratings were knowingly false.” (19)

If the facts in this complaint prove to be true, some of the statements by employees seem hard to explain away:

  • “As explained by Kai Gilkes, an S&P managing director of quantitative analysis at the time, analysts were encouraged to loosen criteria:  The discussion tends to proceed in this sort of way. “Look, I know you’re not comfortable with such and such assumption, but apparently Moody’s are even lower, and if that’s the only thing that is standing between rating this deal and not rating this deal, are we really hung up on that assumption?” (21)
  • “[w]e just lost a huge … RMBS deal to Moody’s due to a huge difference in the required credit support level … [which] was at least.1 0% higher than Moody’s. . . . I had a discussion with the team leads here and we think that the only way to compete is to have a paradigm shift in thinking.” (21)
  • “S&P’s highest management ordered a credit rating estimate even though S&P lacked vital loan data to perform the necessary analysis. This resulted in the “most amazing memo” Mr. Raiter had “ever received in [his] business career.” When Mr. Raiter requested the necessary loan level data, Richard Gugliada, the head of S&P’s CDO group at the time, rejected the request, stating: “Any request for loan level tapes is TOTALLY UNREASONABLE!!! : .. Furthermore, by executive committee mandate, fees are not to get in the way of providing credit estimates…. It is your responsibility to provide those credit estimates and your responsibility to devise some method for doing so.” (22)

 

Misleading CoreLogic Report on Qualified Mortgage Rules

Posted on by

The Wall Street Journal reported (behind its paywall) uncritically on a recently released CoreLogic report about the supposed impact of the new Qualified Mortgage rules issued last month by the CFPB on the mortgage market.  The report is very flawed.

The report states that “the issuance of final Dodd-Frank related regulations now underway represent a watershed moment that will impact the size of mortgage market [sic] and performance for many years to come.” (3) In particular, it argues that the new CFPB Qualified Mortgage and Qualified Residential Mortgage rules “remove 60  percent of loans.” (4)

The methodology here is superficially sophisticated, employing a

waterfall approach . . . where loans that do not qualify for QM were sequentially removed.  The loan features that do not meet the QM requirements include loans with back-end [Debt To Income] above 43 percent, negative amortizations, interest only, balloons, low or no documentation, and loans with more than a 30 year term. (3)

The report thus implies that the QM regulations will reduce the number of mortgages originated by nearly two thirds.  But the report ignores the obvious dynamics that one would find in a well-functioning market.  Once certain products are banned  (let’s say interest only mortgages), borrowers will have at least three options.  First, they can take the path implied by CoreLogic and exit the mortgage market thereby becoming one of the supposedly 60 percent of loans that are “removed” from the market.  Or, they can seek a mortgage product that complies with the new rules (perhaps an ARM) that will allow them to buy the home of their choice.  Or, they can choose to buy a cheaper house with a mortgage that complies with the rules and is affordable to them.  It is very likely that many borrowers will go with the second or third option, resulting in a different but not severely diminished mortgage market.

Yes, the new rules will change the types of mortgages that are available.  Yes, loans will be more conservatively underwritten to ensure that they are sustainable.  Yes, home prices will need to find a new equilibrium.  But no, CoreLogic, the new rules will not destroy the mortgage market.

 

Robo-Signing as Abuse of Process?

Posted on by

Apparently not.  The Florida Supreme Court issued a narrow ruling in Pino v. Bank of New York that a trial court does not have the authority “to grant relief from a voluntary dismissal where the motion alleges fraud on the court in the proceedings but no affirmative relief on behalf of the plaintiff has been obtained from the court.”  (3)

In Pino,the homeowner defendant had sought to have the trial court strike “a notice of voluntary dismissal of the mortgage foreclosure action” and have “the case reinstated in order for the trial court to then dismiss the action with prejudice as a sanction to the mortgage holder for allegedly filing fraudulent documentation regarding ownership of the mortgage note.” (2)

As the court noted, the question before it was very limited.  It indicates that the “case is not about whether a trial court has the authority in an ongoing civil proceeding to impose sanctions on a party who has filed fraudulent documentation with the court.” (2)  That being said, if the judiciary has an epidemic of fraudulent filings in plain sight — foreclosure filings with facially flawed documentation– could it and should it have done more?  If foreclosure mill law firms (and debt collection law firms) realize that they can file flawed papers and either withdraw or correct them later on, where are  defendants, particularly unrepresented ones, left?

The common law already acknowledges the tort of Abuse of Process which awards damages against a party who maliciously and intentionally perverts judicial process.  And yet, the judiciary has taken very few systemic measures to address what has become a dominant business model for foreclosure and debt collection law firms.  So, the Florida Supreme Court is right that it only addressed a limited question under Florida law.  It could have sought to rule more broadly about the judiciary’s inherent authority to protect the process of litigation. (See 33) But it chose not to.

The Court does acknowledge that there are bigger issues at play, as it asked the Florida Civil Procedure Rules Committee to consider whether additional sanctions should be available to courts to address fraudulent pleadings. (43) But it is also time for the courts to deal with the bigger questions.  How should courts deal in particular with robo-signing practices endemic to the 50 states?  How does the rule of law suffer when officers of the court are not required (i) to do due diligence as to their own filings and (ii) to stand by them when they turn out to be fraudulent or materially flawed?  And how can that state of affairs best be remedied?

More on The DoJ’s S&P Lawsuit

Posted on by

Law360 interviewed me and others about the reliance on FIRREA in the Department of Justice’s complaint (story available here).

CFPB Mortgage Disclosure Forms: Test And Verify

Posted on by

The CFPB is requesting comments relating to the collection of “information as part of quantitative research related to residential mortgage loan disclosures.”  (8113) The purpose “of the quantitative testing will be to examine whether the disclosures aid consumers in understanding the terms of the mortgage loan that is the subject of the disclosure.”  (8814)  It is great that the CFPB is testing its tools to ensure that they work as intended.  Government has put a lot of faith in the power of disclosures to help consumers make good financial decisions.  It is important to test whether that faith is deserved.

More on DoJ’s S&P Complaint

Posted on by

I highlighted some of the juicy bits of the complaint a few days ago.  There has been a lot of discussion of the suit and related issues.  Here is my two cents’ worth.

  • FIRREA, an untested enforcement statute, has gone from zero to hero in sixty seconds.  The federal government has had very little experience using the enforcement provisions of FIRREA but commentators have now identified it as a powerful tool to hold financial companies accountable for their misdeeds in the early 2000s.  Time will tell if courts agree that this expansive interpretation will hold up.
  • It is probably no coincidence that the federal government brought the S&P case in California, which is in the 9th Circuit.  Or rather, I should say, it is probably no coincidence that the government did NOT bring it in the 2nd Circuit.  The 2nd Circuit has ruled in favor of the rating agencies even since the events of the financial crisis had become well known, continuing the trend of treating rating agencies as editorialists, albeit terse ones.  Even though Judge Scheindlin (SDNY) has issued a series of rulings against rating agencies, the 2nd Circuit will ultimately rule on any appeals from the cases she hears.  While the 9th Circuit is more of a wild card than other Circuits, there is no doubt that it will go its own way on rating agency liability.
  • It is hard to say whether the federal government is primarily seeking to reform the rating agency industry by bringing this lawsuit (I would assume that similar suits are in the works for Moody’s and Fitch) or whether it is merely seeking to hold it accountable for its alleged bad acts.
  • It is interesting to see how the states are piling on, with lawsuits and investigations in a number of states, including NY.  The rating agencies’ potential liability from all of these suits combined is quite significant — indeed, going-out-of-business significant.
  • And it is scary to realize that for all of the documented flaws in the rating agency industry, no one has come up with a model for the industry that is clearly superior to what we have now.  There is a lot of work to be done.

First Circuit Hears RI Case Involving Hundreds of Foreclosures

Posted on by

The First Circuit has heard oral argument on February 5th in In Re Mortgage Foreclosure Cases.  In that consolidated case, a Rhode Island District Court judge had stayed over 700 foreclosures until a good faith attempt to settle the cases under the auspices of a special master has run its course.  The court issued a memorandum and order denying a motion for a stay pending appeal.

The homeowners claim that the mortgages being foreclosed upon were improperly assigned, but this appeal does not reach the substance of the dispute.