Author Archives: David Reiss

More on DoJ’s S&P Complaint

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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

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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.

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

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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!

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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

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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

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

SEC Complaint on Improper Trading of MBS — Much Ado?

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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?