Author Archives: David Reiss

Reiss on Qualified Mortgages and Fair Housing

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Law360 ran Banks Fear CFPB Rule Could Spur Fair Lending Fights (behind a paywall) which asked for my thoughts:

banks may be getting a bit ahead of themselves when it comes to worrying about how the fair lending law will work in the qualified mortgage context, said David Reiss, a professor at Brooklyn Law School.

Any mortgage that is purchased by Fannie Mae, Freddie Mac and — key for low-income borrowers — the Federal Housing Administration for seven years after the rules take effect in January will be deemed qualified mortgages. The FHA currently backs around $1.1 trillion worth of mortgages.

Unless the FHA drastically reduces its presence in the market that should cover many of the loans that have banks worried, he said.

The banks are not wrong to flag potential problems that may arise in the future, and the issue of fair lending law bumping up against decisions regarding extending only qualified mortgages is a legitimate potential problem, Reiss said.

It’s simply a bit premature with the federal government’s heavy role in the housing finance market.

“They are predicting a scenario, but there’s a lot that’s going to happen between now and that scenario ever being actualized,” Reiss said.

Reiss on Federal Housing Policy

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Law360 ran a story on President Obama’s vision for America’s housing policy and asked for my reaction:

For a piece of mortgage-related legislation to have any chance of passing, it has to require that a borrower pay some kind of down payment so as to remain responsible for at least a small amount of risk, said David Reiss, a professor of real estate and consumer financial services law at Brooklyn Law School.

“What we’ve seen fail pretty consistently is [legislation in which] the homeowner has no skin in the game at all,” and is allowed to obtain a loan — often backed by the government — without putting down a cent, he said.

While this type of policy may help more Americans become homeowners, it does little to fix the housing finance system, which needs a major overhaul, according to Reiss.

“This is the time to reset the market in a rational way, where private lenders make responsible loans because they are doing responsible underwriting,” he said. “Setting up the framework for that should be happening now, even though right now government lending in the residential sector is really the dominant form of lending.”

The rest of the story is here (behind a paywall).

Reiss on Pino Robo-Signing Case

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I had blogged about the case here.  Law360 interviewed me about the broader significance of the case:

Despite its application to just Florida, real estate and foreclosure attorneys around the country have been keeping tabs on the case, according to Brooklyn Law School professor David Reiss. The ruling highlights a trend around the country of foreclosure mills and debt collection firms “making thousands of filings and paying very little attention to whether the filings are accurate,” he said.

Reiss said the court could have taken broader action by stating clearly that fraudulent filings undercut the rule of law.

“You could easily imagine a court saying that the kind of behavior alleged here does impugn the litigation process and [that] the court can take actions to remedy it,” Reiss said. “I’m not saying they made a mistake, but if you are aware of behavior that is taking advantage of the judicial system, I think I can imagine another set of judges saying, ‘We have the inherent authority to handle that.'”

The rest of the story is here (behind a paywall, alas).

Asset Quality Misrepresentation in RMBS Market

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Piskorski, Seru & Witkin have posted Asset Quality Misrepresentation by Financial Intermediaries:  Evidence from RMBS Market, in which they “identify misrepresentations by comparing the characteristics of mortgages in the pool that were disclosed to the investors at the time of sale with actual characteristics of these loans at the same time and show that such misrepresentations constitute a significant proportion of the loans.” (2) In particular, they

identify two, relatively easy-to-quantify, dimensions of asset quality misrepresentation by intermediaries during the sale of mortgages. The first misrepresentation concerns loans that are reported as being collateralized by owner-occupied properties when in fact these properties were owned by borrowers with a different primary residence (e.g., a property acquired as an investment or as a second home). The second form of misrepresentation concerns loans that are reported as having no other lien when in fact the properties backing the first (senior) mortgage were also financed with a simultaneously originated closed-end second (junior) mortgage. (3)

The paper has some extraordinary findings:

  • there “are instances where, in the process of contractual disclosure by the sellers, buyers received false information on the characteristics of assets.” (2)
  • “loans with misrepresented borrower occupancy status have about a 9.4% higher likelihood of default (90 days past due on payments during the first two years since origination), compared with loans with similar characteristics and where the property was truthfully reported as being the primary residence of the borrower.” (3-4)
  • “loans with a misrepresented higher lien . . . have about a 10.1% higher likelihood of default . . ..” (4)
  • lenders were “aware of the presence of second liens, and hence their misreporting likely occurs later in the supply chain.” (5)

The conclude that these “results suggest that RMBS investors had to bear a higher risk than they might have perceived based on the contractual disclosure.” (4)

1st Circuit Holds that MA Borrowers Can Challenge Mortgage Assignments

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A First Circuit panel (including Justice Souter) ruled that under Massachusetts law, “a mortgagor has standing to challenge a mortgage assignment as invalid, ineffective, or void (if, say, the assignor had nothing to assign or had no authority to make an assignment to a particular assignee).”  (14)  The court concisely sets forth what is at issue in the case:

The fact pattern here is emblematic: the mortgagor’s note was delivered to one party (the lender) and then transferred; the mortgage itself was granted to a different entity, Mortgage Electronic Registration Systems, Inc., and later assigned to the foreclosing entity. We are asked, as a matter of first impression for this court, to pass upon not only the legality and
effect of this arrangement but also the mortgagor’s right to challenge it. The substantive law of Massachusetts controls our inquiry.  (2-3, footnotes omitted)

There are some important dicta in the case.  The court states that “there is no reason to doubt the legitimacy of the common arrangement whereby MERS holds bare legal title as mortgagee of record and the noteholder alone enjoys the beneficial interest in the loan.” (16)

California’s S&P Suit

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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

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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.