Author Archives: David Reiss

Land Use Controls Caused The Financial Crisis?

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Respected Housng Economist Edwin Mills and co-author B.N. Jansen write in their article, “Distortions Resulting from Residential Land Use Controls in Metropolitan Areas”,

The strong conclusion of this paper is that stringent residential land use controls were a primary cause of the massive house price inflation from about 1992 to 2006 and possibly of the deflation that started in 2007.

Indeed, it is difficult to imagine another plausible cause of the 2008-2009 financial crisis.  Popular accounts simply refer to a speculative housing price bubble.  But productivity growth in housing construction is faster than in the economy as a whole [citation omitted] and the US has an aggressive and competitive housing construction sector.  In the absence of excessive controls, housing construction would quickly deflate a speculative housing price bubble.

A final comment is that there appears to be no interest at any level of government, or among the articulate population, in reducing the stringency of land use controls.  Indeed, recent trends are in the opposite direction. (200)

Jansen and Mills rely heavily on a dataset constructed by Joseph Gyourko and others to analyze local land use control stringency.  I am not in a position to evaluate the dataset or the model that they use, but their findings are consistent with those of Gyourko and Edward Glaeser in Rethinking Federal Homeownership Policy.

It seems to me that Jansen and Mills overstate their case quite a bit — stringent land use controls may have been a necessary condition for the bubble, but I can’t see how their argument demonstrates that it was sufficient unto itself.  That being said, I would agree wholeheartedly that this hypothesis is worthy of serious study.  The relationship between land use and housing policy is way more important than most members of the “articulate population” understand.

Before The Next Crisis: Now’s The Time to Rethink The Martin Act

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The Martin Act, New York State’s far-reaching securities fraud statute, has been a powerful tool for New York law enforcement officials to pursue wrongdoing by financial institutions.  It has a broad definition of fraud and a long statute of limitations. NY Attorneys General like Spitzer, Cuomo and Schneiderman have used it to bring whole industries in line.

The act has faced criticism from the financial sector for being farther reaching than federal securities laws and comparable statutes in other states.  Because it is such a powerful too, various groups have promoted various amendments to increase its potency.  The financial sector has opposed these attempts (and here) over the last few years to expand its reach by, for instance, creating a private right of action.  Manhattan District Attorney Vance has also called for the Martin Act’s statute of limitations (currently six years or two years from when the injured party discovered or could have reasonably discovered fraudulent behavior) to be extended.  The financial sector would not welcome such a move either, of course.

With the six year statute of limitations soon to run out on actions from the Subprime Boom, we should ask ourselves — how broad should the Martin Act be?  On the one hand, New York must treat businesses fairly for fairness’ sake but also to maintain its dominant position as a global capital of capital.  On the other hand, fairness demands that wrongdoers be punished and fraud be deterred by vigorous enforcement.

Now that we are about to have a breather between the last crisis and the next, we should try to come up with a principled balance between those two goals.  That balance should be struck while our cooler heads are prevailing.

 

CFPB Releases Ability-To-Repay and Qualified Mortgage Final Rules

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The CFPB has released the final rules relating to ability-to-repay and Qualified Mortgages.  The CFPB’s Summary is currently available.

The big news is that qualified mortgages do NOT have a minimum down payment requirement.  This was a very big bone of contention during the proposed rulemaking process (which I discussed here and here).

It is also very interesting to see that the CFPB has taken the position that a total debt-to-income ratio of 43% is the maximum that is generally sustainable for homeowners.  This was a bone of contention in the FDIC’s workout of the IndyMac mess during the early years of the crisis, which I had addressed a bit here at page 807.  43% is on the high side of earlier estimates of what is sustainable, so it will be interesting to see if future default data confirms the wisdom of this position.

The rules take effect a year from now.

 

 

S&P Is Optimistic That Residential Mortgage Market Is Rising From Bottom

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S&P’s Outlook Assumptions for the U.S. Residential Mortgage Market

support our view of loss projections on an archetypical mortgage loan pool (see description in section IV). The base-case loss projection of 0.5% for U.S. prime mortgage loan pools, incorporates our current outlook which reflects:

  • Standard & Poor’s current economic outlook, which factors slow growth over the next several years, declining unemployment rates, and a moderate increase in interest rates, as well as our cautiously optimistic view of housing fundamentals, based on price-to-rent and price-to-income ratios.
  • Our view that U.S. housing prices on a national level have seemed to have reached bottom. This view underlies our assumption that only a minor percentage of a prime RMBS pool is susceptible to a market value decline of up to 30% in select local markets experiencing a local economic downturn and accompanying distress sale discounts. (1)

S&P’s archetypal loan is “collateralized by a single-family detached primary residence with a loan-to-value ratio of 75%. For more information on the “archetypical” loan, see paragraph 24 in U.S. RMBS Criteria. Our projections for other types of newly originated products could be lower or higher depending on the characteristics of the loans, relative to the archetypical loan.” (2)

S&P notes that mortgage delinquencies have been flat and even declining.  This outlook may be one more crocus pushing through a frozen but thawing residential market.

Scheindlin Allows More Fraud Claims Against Rating Agencies To Go To Trial

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Judge Scheindlin (SDNY) has ruled that investors can proceed with their fraud claims against the big three rating agencies for giving a top rating to a SIV.  There are no surprises in this opinion as it tracks the reasoning of Judge Scheindlin’s earlier opinion in a related action (Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Inc. (Abu Dhabi I), No. 08 Civ. 7508, WL 3584278 (S.D.N.Y. Aug. 17, 2012).)

loan application fees

I think this quotation from the King County opinion puts the issue nicely:

While ratings are not objectively measurable statements of fact, neither are they mere puffery or unsupportable statements of belief akin to the opinion that one type of cuisine is preferable to another. Ratings should best be understood as fact-based opinions. When a rating agency issues a rating, it is not merely a statement of that agency’s unsupported belief, but rather a statement that the rating agency has analyzed data, conducted an assessment, and reached a fact-based conclusion as to creditworthiness. If a rating agency knowingly issues a rating that is either unsupported by reasoned analysis or without a factual foundation, it is stating a fact-based opinion that it does not believe to be true.41

I subsequently held that the rating agency defendants could “only be liable for fraud if the ratings both misstated the opinions or beliefs held by the Rating Agencies and were false or misleading with respect to the underlying subject matter they address.” To sustain a fraud claim against each rating agency, then, plaintiffs must provide evidence that the rating agency issued a rating that it knew was unsupported by facts or analysis — that the rating agency did the equivalent of issuing a restaurant review despite never having dined at the restaurant. (12-13, footnote omitted)

Judge Scheindlin has now made it clear that rating agencies may face liability for their opinions under certain circumstances.  Time will tell whether the 2nd Circuit (which has favored the rating agencies in other cases) will agree.

I can only find the King County opinion and the Abu Dhabi opinion behind the NYLJ paywall for now.

FIRREA as a Mortgage Lending Enforcement Tool

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William Johnson of the Fried, Frank law firm has an interesting analysis of enforcement cases that invoke the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) which is unfortunately behind the NYLJ paywall.

Johnson discusses the history of FIRREA which arose from the ashes of the S&L Crisis of the 1980s.  He notes that FIRREA extended the statute of limitations to 10 years for mail and wire fraud statutes (18 U.S.C. sections 1341 and 1343) where the crime “affected” a financial institution.

The government is turning to FIRREA at this point because of its ten year  statute of limitations which doubles the statute of limitations that would apply to many other causes of action.  Given that we are now about five years out from the crisis, he says that this development is not surprising.

He identifies five cases where the Department of Justice has brought FIRREA causes of action arising from alleged conduct relating to mortgages:

  • United States v. Buy-a-Home, No. 1:10-cv-09280 (S.D.N.Y.) (PKC) (filed Dec. 13, 2010)
  • United States v. Allied Home Mortgage, No. 1:11-cv-05443 (S.D.N.Y.) (VM)
  • United States v. CitiMortgage, No. 1:11-cv-05473 (S.D.N.Y.) (VM)
  • U.S. v. Wells Fargo Bank, No. 1:12-cv-07527 (S.D.N.Y.) (JMF) (JCF) (filed Oct. 9. 2012)
  • U.S. v. Bank of America, No.1:12-cv 1422 (S.D.N.Y.) (JSR)

He concludes that the government has “turned FIRREA on its head” by stretching its provisions to encompass alleged wrongs against entities such as Fannie and Freddie as well as HUD as well as “financial institutions” as that term is defined in FIRREA.

I don’t know enough to have a position on whether  the government has turned FIRREA on its head, but its ten year statute of limitations must look very tempting to prosecutors and regulators as the events that were at the root of the crisis receded further and further from the present.

SEC Staff Report on Rating Agencies Goes Through The Motions

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The SEC staff report required by Dodd Frank section 939F looks like it is just going through the motions.  It is poorly organized and marred by poor analysis.  It is unclear what it is trying to achieve, other than complying with the requirements of 939F.