Author Archives: David Reiss

$127 Million LPS Robo-Signing Settlement with 47 A.G.s

Posted on by

The Lender Processing Services, Inc. press release is here.

The $2.5 million Michigan settlement relating to the overall total $127 million settlement can be found here.  In the Michigan settlement, LPS did not admit “any violation of law.” (2)  Nonetheless, there are some interesting admissions, including, that

  • some mortgage loan documents executed by employees of LPS subsidiaries contain “unauthorized signatures, improper notarizations, or attestations of facts not personally known to or verified by the affiant” and some may contain “inaccurate information relating to the identity, location, or legal authority of the signatory, assignee, or beneficiary or to the effective date of the assignment.”  (5)
  • LPS subsidiaries “recorded or caused to be recorded Mortgage Loan Documents with these defects in local land records offices or executed or facilitated execution on behalf of the Servicers knowing some of these Mortgage Loan Documents would be filed in state courts or used to comply with statutory, non-judicial foreclosure processes.”  (5)
  • employees of LPS subsidiaries signed mortgage loan documents in the name of other employees.  (5)

Brad and I discuss the importance of following the letter of the law when dealing with the assignment of mortgage notes in Dirt Lawyers and Dirty REMICs.  It should go without saying that that applies to judicial and non-judicial foreclosure processes as well.  We will be addressing that subject in our forthcoming piece with KeAupini Akina which should be out later this month.

With this latest settlement, only Nevada has an ongoing suit against LPS.

S&P Complaint, Bombshell upon Bombshell!

Posted on by

DoJ’s complaint is chock full of interesting allegations.  Previous critiques of the rating agencies rehashed a handful of embarrassing emails that made their way into an SEC staff report a few years ago (“It could be structured by cows and we would rate it.”).  The complaint has a lot more substantive allegations of conflicts of interest that are rampant in the rating agency industry.

The complaint states that, “In carrying our the scheme to defraud, S&P falsely represented that its credit ratings of RMBS and CDO tranches were objecivie, independent, uninfluenced by any conflicts of interest that might compromise S&P’s analytic judgment, and reflected S&P’s true current opinion regarding the credit risks the rated RMBS and CDO tranches posed to investors.”  (2)

Some highlights from the allegations contained in the complaint:

  • From an S&P strategic plan:  “The primary customers of the CDO group today are the deal arrangers (bankers/intermediaries).  This customer group continues to be responsible for the bast majority of revenue, including all initial deal rating fees paid to S&P.”  (16, emphasis in the original)
  • In response to a new rating process that “required consideration of ‘market insight’ and rating implications and the polling of both ‘3 to 5 investors in the product’ and ‘an appropriate number of issuers and investment bankers for a full 360-market perspective,” an S&P executive wrote,

What do you mean by “market insight” with regard to a proposed criteria change?  What does “rating implication” have to do with the search for truth?  Are you implying that we might actually reject or stifle “superior analytics” for market considerations.?  Inquiring minds need to know.  (40)

  • With echoes of Quattrone’s suggestion to follow his firm’s document retention policy, S&P executives prepared a memorandum that stated that “concerns with the objectivity, integrity, or validity” or rating criteria should not be put in writing unless it was addressed to an S&P attorney which would presumably trigger attorney-client privilege.  (41)
  • An S&P analyst wrote, “We just lost a huge Mizuho RMBS deal to Moody’s due to a huge difference in the required credit support level.”  The analyst continued, “What we found from the arranger was that our support level was at least 10% higher than Moody’s.”  The analyst continued, “Losing one or even several deals due to criteria issues, but this is so significant that it could have an impact on future deals.  There is no way we can get back on this one but we need to address this now in preparation for the future deals.” (44-45)
  • Another analyst wrote, “Remember the dream of being able to defend the model with sound empirical research?  The sort of activity a true quant CoE [the analysts job at the time] should be doing perhaps?  If we are just going to make it up in order to rate deals, then quants are of precious little value.  I still believe that people want the model to be consistent with history, and that the impact of the model will not destroy the business.”  (51)
  • An S&P PowerPoint presentation stated that to come up with Probabilities of Default (PDs) in certain contexts, “we look at our raw data and come up with a statistical best fit.  When this does not meet our business needs, we have to change our parameters ex-post to accommodate.”  The slide continued, “Does this work [for] our rating business?  If it does not, need to tweak PDs.”  (56)

S&P is going to have a tough time harmonizing those statements with the numerous assertions of their objectivity, such as those found in its Code of Practices and Procedures:

  • S&P’s “mission has always remained the same — to provide high-quality, objective, independent, and rigorous analytical information to the marketplace” (28)
  • “Ratings assigned by Ratings Services shall not be affected by an existing or a potential business relationship between Rating Services (or any Non-Ratings Business) and the issuer or any other party, or the non-existence of such relationship.”  (29)

More on this anon.

 

More on CFPB Ability-To-Pay Rule

Posted on by

Attorney Robert Barnett asks whether the CFPB’s new Ability-To-Pay Rule is too rigid.  He says that ‘the insistence on a solid 43 percent debt-to-income ratio will exclude many very solid applications from qualification as a Qualified Mortgage . . ..” (1)  He also argues that LTV and credit scores are more reliable predictors of default and that there is no reason to trump them with a firm debt-to-income limitation.  Barnett cites a study from the Housing Policy Council that indicates that loan volume would drop more than 18 percent when DTIs were reduced from a range of 44 to 46 percent to a range of 40 to 42 percent.  This drop in loan volume was accompanied by a relatively modest drop in the default rate from 1.59 percent to 1.43 percent.

I can’t speak to the merits on this, but it does raise an important question:  what mechanisms are in place at the CFPB to go back and test such rules to ensure that they are appropriately balancing consumer protection with consumer opportunity.

Borden and Reiss on Lawyers and REMICs

Posted on by

Our latest, Dirt Lawyers and Dirty REMICs, is on SSRN and BEPress.

SEC Complaint on Improper Trading of MBS — Much Ado?

Posted on by

Floyd Norris, the only journalist to whom I have written fan mail (sorry Gretchen, you’re next), has another interesting column about a case that the SEC has brought against an MBS trader, Jesse Litvak.  The complaint alleges that

On numerous occasions from 2009 to 2011, Litvak lied to, or otherwise misled, customers about the price at which his firm had bought the MBS and the amount of his firm’s compensation for arranging the trades. On some occasions, Litvak also misled the customer into believing that he was arranging a MBS trade between customers, when Litvak really was selling the MBS out of Jefferies’ inventory. Litvak’s misconduct misled customers about the market price for the MBS, and, thus, about the transaction they were agreeing to. Litvak also misled customers about whether they were getting the best price for their MBS trades and how much money they were paying in compensation. MBS are generally illiquid and discovering a market price for them is difficult. Participants trading in the MBS market must rely on informal sources, including their broker, for this information.(1-2)

Norris is right to highlight what this case can reveal about the lack of transparency in the trading of MBS, a lack of transparency that does not exist in many other major secondary markets for securities.

But I was struck by how little is at stake in this SEC case.  The complaint alleges that the misconduct occurred in 25 (count ’em, 25!) trades from 2009 through 2011 (7) and that Litvak’s behavior “generated over $2.7 million in additional revenue for his firm.”  (2)  Not for him personally, mind you, but for his firm!  He, of course, should be punished if the allegations prove to be true.  And yet . . ..

Time after time, the government brings cases against mid-level players somehow involved in the financial crisis.  Time after time, people wonder why these are the best cases that can be brought.  My earlier thoughts about this can be found here and here.  Is it possible that even the SEC lacks the resources to investigate the massively document intensive cases that would get to the heart of the matter?

 

FDIC Lawsuit against Bank Directors

Posted on by

The FDIC has filed a lawsuit (hat tip LaCroix by way of April Charney) against the officers and directors of a small bank in New Mexico alleging negligence, gross negligence and breaches of fiduciary duties.  The FDIC alleges that the

Defendants, as officers and directors of Charter Bank of Santa Fe, New Mexico (“Charter Bank” or “the Bank”), committed $50 million – 72 percent of the Bank’s core capital of $69 million – to open and operate a highly risky and speculative subprime lending operation in Denver, Colorado in late 2006, when they knew or should have known that there was no secondary market for subprime loans. The Bank funded loans that no reasonable financial institution would have made at any time, much less in 2007 and 2008 when the risks of such lending were well recognized. The Defendants negligently permitted and presided over, and failed to suspend, limit or stop the production of a portfolio of approximately $50 million in risky, subprime residential loans intended for sale into a secondary market that at the time was recognized to be increasingly unstable, unpredictable, and illiquid due to concerns about the credit quality of subprime loans. (1)

While the allegations, if true, would prove that the bank engaged in predatory lending, the complaint is revealing about the behavior of the bank’s regulators too:

Federal regulators repeatedly warned the Director Defendants that the Bank was over-leveraged and needed to raise more capital. The Director Defendants responded that they could operate the Bank with less capital and more borrowed money because they had placed most of their loans in the real estate acquisition, development, and construction loan business. The Director Defendants asserted that, because these loans were shorter in duration, the Bank had less risk – an analysis that failed to anticipate any real downside risk in the real estate development business. (6)

One wonders if the regulators should have done more than “repeatedly warn”  these defendants in the run up to its failure.

The complaint also has some revealing allegations about how far lenders went to skirt the Home Ownership and Equity Protection Act’s regulation of high cost loans by limiting “loans to interest rates of no more than 11.5 to 12 percent. Given the minimum FICO score and maximum debt-to-income ratios for SLG loans based solely on stated income, these artificially capped interest rates were simply insufficient to cover the very high risk of default.” (10)  Clearly, incentives ran amok at this closely held bank.

 

Strategies to Improve the Housing Market

Posted on by

Boston Consulting prepared this Strategies to Improve the Housing Market report on behalf of The Pew Charitable Trusts.  The report focuses “on practical solutions that can readily be implemented by industry, agencies, and regulators working within existing mandates, or by nongovernmental organizations.”  (6)  I highlight three proposals in their report that I find particularly interesting.

1.  Promulgate Consistent Set of Loan Servicing Standards

Mortgage servicing is governed by a number of loan servicing standards—including standards under the DOJ settlement, OCC consent orders, FHFA Servicing Alignment Initiative, CFPB, as well as those of individual states—which vary in scope and individual provisions. A consistent set of loan servicing standards across the servicing life cycle can both ensure a basic standard of service for all homeowners and reduce the operational complexity of complying with multiple, varying standards for servicers.  (8)

This seems to be key to dealing with the misaligned incentives and anticommons problems that have become so apparent during the Subprime Bust.

2.  Streamline The Foreclosure Process in Key States

The long foreclosure process, particularly in judicial states, creates negative impacts on both lenders and communities, particularly when borrowers are “free riding.” While preserving the primacy of states and localities in foreclosure law, experts highlighted the desirability of working with them to develop a “model” foreclosure process based on best practices, to be adopted by states and localities on a voluntary basis. We recommend that an NGO takes the lead on developing such a model, based on best practices across jurisdictions, brings in key states and other relevant stakeholders to build consensus, and advocates for change with state policy makers and legislatures.  (9)

This issue is more complicated than the report (and most other commentators) concedes.  The claim that borrowers are “free riding” is not exactly true.  Lengthy foreclosure periods existed before the mortgages were entered into and were presumably priced into the cost of mortgages.  Indeed, the FHFA is trying to reprice mortgages in jurisdictions with the longest periods.  There are clearly policy choices at issue in the design of a foreclosure process.  For homeowners and lenders alike, the difference between the lengthy judicial process and the relatively rapid non-judicial process is only the most stark example of how process (in this case, length of process) affects substantive rights (that is, post-default occupancy periods).

3.  Rationalize First and Subordinate Lienholder Rights

In the context of continuing demand for home equity loans (second or subordinate liens), there is a need to clarify the rights of first and second lienholders to avoid a repeat of current frictions in the future and to restore investor confidence that first lienholders will have enforceable priority in the event of default. Any new framework put forward should achieve two key objectives:

>  protecting first-lien priority

>  standardizing treatment of seconds in loss mitigation efforts.

Conflicts between first and second lienholders have been a source of controversy and friction since the crisis began. It is unlikely that private investors will want to commit substantial new investment dollars to private securitizations until this issue is resolved. The industry, perhaps through the auspices of one of its trade association, should take the lead on further developing these options, in the first instance, with involvement from the FHFA, Treasury, and FDIC.  (11, emphasis deleted)

This is a very important issue.  I have been struck since the early days of the crisis how non-lawyers in particular (economists are particular offenders!) assume away the legal rights of seconds in their proposals to address the foreclosure epidemic.  Unsurprisingly, the seconds (knowing what happens to those who “ass-u-me”) have successfully asserted their legal rights to protect their financial interests.  Any solution to the problem of misaligned incentives between first and seconds must take the legal rights of these profit-maximizing entities into account.