Author Archives: David Reiss

Untrustworthy?

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John Campbell has posted an abstract (and hopefully soon a draft) of Putting the ‘Trust’ in Trustees: An Examination of the Foreclosure Crisis and Suggestions for Reforming the Role of the Trustee. The draft itself proposes legislation for non-judiical foreclosure jurisdictions “that would make trustees real gatekeepers who require essential proofs, ask basic questions, and when factual disputes arise between the foreclosing party and the homeowner, refer those questions to courts.” (53)  It is valuable to set forth some of the things that Campbell’s proposal would require from trustees:

  1. Proof of the transfer of the original note from the original lender to the current party who seeks to foreclose, including any and all intervening assignments. The foreclosing party should be required to produce a copy of the original note and attest in a sworn affidavit that the original note exists in its original form.
  2. Proof that the party who seeks to foreclose is the party who is recorded in the public records as the secured party, along with all the recordings that show how that party came to be secured.
  3. Detailed financial records that show when default occurred and precisely how much money the homeowner currently owes. (56)

Each of these items reflects a major controversy in the world of foreclosures.  The first would ensconce the “Show Me the Note!” claim made by homeowners during foreclosure and bankruptcy proceedings in the statutory framework of non-judicial foreclosure regimes.  The second would be a frontal assault on the role of MERS, requiring that the foreclosing party record in its own name its interest in the deed of trust.  And the third would require that servicers provide adequate evidence to homeowners of the default.  The proposal would effectively make non-judicial foreclosure a lot more like judicial foreclosure, an objective that I will not weigh in on today.

Reiss on Booming Structured Finance Litigation

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Law360 interviewed me about the boom in structured finance litigation arising from the Financial Crisis (here, behind a paywall):

banks will not be able to let their guard down anytime soon, thanks to the U.S. Department of Justice’s rediscovery of a statute developed in response to the late 1980s savings and loan crisis and the increasing ability of plaintiffs attorneys to expand claims first brought in mortgage cases to other consumer finance products, according to Brooklyn Law School professor David Reiss.

“I would still be worrying if I were the [general counsel] of a large financial institution about the cases that might still be filed,” Reiss said.

Most of the fraud claims available under federal securities law have a statute of limitations that expires after five years. Because most of the securities that failed did so in 2007 and 2008, 2013 looked like the end of the line for many of the government’s claims.

That was until the DOJ sued Standard & Poor’s Financial Services LLC in February, claiming it was rife with conflicts of interest and that it ignored evidence that mortgage-backed securities were stuffed with subprime mortgages that were likely to fail. In bringing its suit, the DOJ dusted off the 1989 Financial Institutions Reform, Recovery and Enforcement Act, a federal response to the savings and loan crisis of the late 1980s that allows the government to bring claims against defendants that adversely affect federally insured financial institutions.

Using that statute was a game-changer, Reiss said.

Among a host of other measures provided in the law, FIRREA extended the statute of limitations on those claims from five to 10 years, giving prosecutors more time to bring claims. It also gave the government the chance to bring civil versions of mail, wire and other fraud claims that normally would be brought in a criminal context, meaning the government will now only have to prove its allegations to a jury by a preponderance of evidence, rather than beyond a reasonable doubt.

“If courts favor DOJ’s expansive reading of FIRREA, all bets are off as to how much financial institutions may still be on the hook for suits arising from the financial crisis brought by the government,” Reiss said.

Prosecutors are also looking to bring more cases as pressure from lawmakers mounts.

After Attorney General Eric Holder admitted Wednesday that some banks were “too big to jail,” the spotlight has been turned anew on whether regulators have been tough enough on banks. Critics say that prosecutors and bank regulators have been too timid in their pursuit of crimes allegedly committed by banks.

That could also push the DOJ and the other regulators to find new theories to bring cases, Reiss said.

“It does seem that there is a bit more of a populist bent to prosecutions now that we are past the worst of the crisis,” he said.

Wrapping up America’s Housing Future

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This is my last post (see here and here for the first two) on the Bipartisan Policy Center’s Housing America’s Future report.  I have one last thought to share — a radical one at that.

The report takes for granted that the federal government should provide a guarantee that wraps mortgage-backed securities and completely covers investors for credit losses. (51-52) Is it too Un-American to contemplate a world where investors bear some (I’m not even saying all!) of the credit risk?  Why is that not on the table at all?  Investors obviously bear credit risk in all sorts of credit markets.

But housing, we are told, is special.  The 30 year fixed rate mortgage would disappear without it.  That is patently not true because the private-label market has issued 30 fixed rate jumbos in the past.  It may be true that the number of 30 year fixed rate mortgages would shrink to an unacceptable level if there was no government wrap, but that leads to a modest proposal.

What if the government offered a range of wraps at different price points?  a 100% wrap.  But also a 75% wrap and a 50% wrap and a 25% wrap.  What if those limited wraps covered either first loss or last loss on different MBS?  What if this menu of options allowed us to better determine a socially optimal level of government guarantee instead of assuming that it has to be total to keep the housing market from melting, melting away?

Should CFPB Be a Nudge?

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Cass Sunstein, until recently the Administrator of the White House Office of Information and Regulatory Affairs, has posted an early draft of  Nudges.gov:  Behavioral Economics and Regulation.  While it touches on real estate finance only indirectly, it provides a nice follow up to yesterday’s post on financial education.  Sunstein writes that it “It is clear that behavioral findings are having a large impact on regulation, law, and public policy all over the world . . ..” (2)  For the purposes of residential mortgage regulation it is worth restating some of the central findings of behavioral research:

  • Default rules often have a large effect on social outcomes. (3)
  • Procrastination can have significant adverse effects. (3)
  • When people are informed of the benefits or risks of engaging in certain actions, they are far more likely to act in accordance  with that information if they are simultaneously provided with clear, explicit information about how to do so. (4)
  • People are influenced by how information is presented or “framed.” (4)
  • Information that is vivid and salient usually has a larger impact on behavior than information that is statistical and abstract. (4)
  • People display loss aversion; they may well dislike losses more than they like corresponding gains. (5)
  • In multiple domains, individual behavior is greatly influenced by the perceived behavior of other people. (5)
  • In many domains, people show unrealistic optimism. (6)
  • People often use heuristics, or mental shortcuts, when assessing risks. (7)
  • People sometimes do not make judgments on the basis of expected value, and they may neglect or disregard the issue of  probability, especially when strong emotions are triggered. (7)

Sunstein tentatively concludes — although I would certainly state it more strongly — “it would be possible to think that at least some behavioral market failures justify more coercive forms of paternalism.” (10)

The Financial (Mis)Education of Lauren Willis

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Lauren Willis has posted Financial Education:  Lessons Not Learned and Lessons Learned.  This is a sobering, even depressing, overview of what we know about the efficacy of financial education.  This is an extremely important topic because the CFPB has identified financial education as a core part of its mission in its Strategic Plan (see Outcome 2.2).

Willis asks, “Does financial education work as hoped?” (125) She answers her own question:  “Empirical evidence does not support the theory. Some (but not all) studies show a positive correlation between financial education and financial knowledge or between financial knowledge and financial outcomes. But no strong empirical evidence validates the theory that financial education leads to household well-being through the pathway of increasing literacy leading to improved behavior.” (125)

Some of her her other important conclusions (based on a thorough review of the literature) include

  • “the only statistically significant effect of mandatory personal financial training on soldiers was that they adopted worse household budgeting behaviors after the training than before it.” (126)
  • “Youth who took a personal finance course in high school do not report better financial behavior several years later than youth who did not take the course.  Adults who attended public schools where they were required to take personal financial courses were found to have no better financial outcomes than adults who were not required to take such courses.” (126, citations omitted)
  • One “reason financial education is unlikely to produce household financial well-being is that consumers’ knowledge, comprehension, skills, and willpower are far too low in comparison with what our society demands.” (128)

Willis’ conclusions should caution against assuming that financial education is a proven method to reduce the impact of predatory practices in the consumer finance sector.  The CFPB has shown a willingness to test the efficacy of its approaches.  Hopefully it will do so with its financial education initiiatives too.

Reiss on Fannie and Freddie Multifamily Contraction

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GlobeSt.com interviewed me (and others) about Federal Housing Finance Agency Acting Director Edward J. DeMarco plans to reduce Fannie and Freddie’s multifamily finance volume by 10% from last year’s levels:

Also consider this, says David Reiss, a professor of Law at Brooklyn Law School who has published papers on the GSEs: “We are living through a very abnormal time when the federal government dominates the market for single family and multifamily mortgages.”

This is neither necessary nor optimal, he tells GlobeSt.com. “It is not necessary because there have been long stretches in the past when the government had a much smaller role in those markets. And other credit markets operate well with no or a much smaller government footprint.”

This is not to say that there is no role for the federal government in the multifamily mortgage market, Reiss continues — just that it is far too large at this point in time. “If the reduction in the GSE footprint is telegraphed over a reasonable time horizon to the other market participants, this change should be taken in stride by the multifamily market,” he predicts.

 

Second Circuit Finds Plausible Claims of Widespread Misconduct in RMBS Offering

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The Second Circuit ruled in New Jersey Carpenters Fund v. The Royal Bank of Scotland Group et al. on a number of issues, but of interest to me are the sections dealing with allegations of misrepresentations.

The Court writes that “numerous courts, including the First Circuit in Nomura, have concluded that misstatements of an underwriter’s guidelines are not ‘so obviously unimportant’ that they are immaterial as a matter of law. Id. at 162; see Nomura, 632 F.3d at 773; J.P. Morgan, 804 F. Supp. 2d at 154; IndyMac, 718 F. Supp. 2d at 510; Tsereteli v. Residential Asset Securitization Trust 2006-A8, 692 F. Supp. 2d 387, 392-93 (S.D.N.Y. 2010). We agree. The Series 2007-2 Trust consisted primarily of a pool of mortgage loans and interests in the properties that secured those loans. Investors would profit from their interests in the Series 2007-2 Trust only if the trust could recoup a sufficient portion of the balance of those loans. Thus, a ‘substantial likelihood’ exists that a reasonable investor would want to know whether those underwriting the loans had adhered to the procedures in place for evaluating ‘the capacity and willingness of the borrower[s] to repay the loan[s] and the adequacy of the collateral securing the loan[s].’ J. App’x at 370. Given the apparent importance of this information, we conclude that, at this stage of the proceedings, the alleged misstatements and omissions are not immaterial as a
matter of law.” (25-26)

The Court further writes that “knowledge that the borrowers had low credit scores and that many of the mortgages had high loan-to-value ratios would make a reasonable investor more, rather than less, interested in whether NMI [one of the Novastar defendants] had adhered to its processes for evaluating ‘the capacity and willingness of the borrower[s] to repay.’ J. App’x at 370. Accordingly, for the reasons described above, we conclude that the alleged misstatements and omissions are not immaterial as a matter of law.” (28)

The cumulative effect of the cases (see here for another example) arising from the Subprime Crisis is that broad carve-outs from representations will not protect parties from claims of misrepresentation.  This seems to be an example of schoolyard law — in the good sense.  Just because you crossed your fingers, it doesn’t mean that you weren’t lying.