Author Archives: David Reiss

The Advantages of ARMs

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photo by Kathleen Zarubin

The Wall Street Journal quoted me in Why Home Buyers Should Consider Adjustable-Rate Mortgages (behind paywall). It opens,

With interest rates on the rise, it may be time for home buyers to take a fresh look at some alternatives to the 30-year, fixed-rate mortgage, which has dominated the mortgage market since the financial crisis.

While many out-of-the-mainstream loans got a black eye in the subprime debacle, today’s versions have been shorn of the toxic features—such as negative amortization and prepayment penalties—that tripped up many borrowers during the housing bubble a decade ago.

Plan to move

Experts say today’s adjustable-rate mortgages, or ARMs, as well as interest-only loans, are especially suitable for borrowers who expect to move before any rate increases can wipe out the savings in the early years. They’re also useful for sophisticated borrowers wrestling with uneven income, borrowers who expect their income to rise, or borrowers who are willing to bet they can invest their mortgage savings for a greater return elsewhere.

“Many of the mortgage products that some may have thought slipped into extinction, such as interest-only loans, do still exist today, but in far less volume” than in the heyday of the subprime era, says Bill Handel, vice president of research and product development at Raddon Financial Group, consultant to the financial-services industry.

Adds David Reiss, a law professor and academic program director at the Center for Urban Business Entrepreneurship at Brooklyn Law School: “The benefits of non-30-year, fixed-rate mortgages are legion.”

A sweet spot

Many borrowers can find a sweet spot, for example, in the so-called 7/1 adjustable-rate mortgage, which carries a fixed rate for seven years before starting annual adjustments. With a typical rate of 3.75%, the monthly payment on a $300,000 loan would be $1,389, compared with $1,449 for a 30-year, fixed-rate loan at 4.1%, saving the borrower $5,040 over seven years.

Even if the loan rate then went up, it could take two or three years for higher payments to offset the initial savings, making the mortgage a good choice for a borrower likely to move within 10 years. Once annual adjustments begin, they are generally calculated by adding a fixed margin to a floating rate, such as the London interbank offered rate.

“ARMs are very underutilized,” says Mat Ishbia, president of United Wholesale Mortgage, a lender in Troy, Mich. He expects the 7/1 ARM to account for 15% of new mortgages within the next few years, up from less than 5% today. Historically, ARMs become more popular as interest rates rise, making savings from the loan’s low initial “teaser rate” more attractive, he notes.

Manafort’s Real Estate Deals

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Paul Manafort

WNYC quoted me in Paul Manafort’s Puzzling New York Real Estate Purchases. The story opens,

Paul J. Manafort, the former Trump campaign manager facing multiple investigations for his political and financial ties to Russia, has engaged in a series of puzzling real estate deals in New York City over the past 11 years.

Real estate and law enforcement experts say some of these transactions fit a pattern used in money laundering; together, they raise questions about Manafort’s activities in the New York City property market while he also was consulting for business and political leaders in the former Soviet Union.

Between 2006 and 2013, Manafort bought three homes in New York City, paying the full amount each time, so there was no mortgage.

Then, between April 2015 and January 2017 – a time span that included his service with the Trump campaign – Manafort borrowed about $12 million against those three New York City homes: one in Trump Tower, one in Soho, and one in Carroll Gardens, Brooklyn.

Manafort’s New York City transactions follow a pattern: Using shell companies, he purchased the homes in all-cash deals, then transferred the properties into his own name for no money and then took out hefty mortgages against them, according to property records.

Buying properties using limited liability companies – LLCs – isn’t unusual in New York City, nor is borrowing against a home to extract money. And there’s no indication that Manafort’s New York real estate borrowing spree has come to the attention of investigators. In an emailed statement, Manafort said: “My investments in real estate are personal and all reflect arm’s-length transactions.”

Three Purchases, Lots of Questions

Manafort’s 2006 purchase of a Trump Tower apartment for all cash coincided with his firm’s signing of a $10 million contract with a pro-Putin Russian oligarch, Oleg Deripaska, that was revealed last week in an investigative report by The Associated Press.

For the Carroll Gardens home, a brownstone on Union Street, Manafort recently borrowed nearly $7 million on a house that was purchased four years ago for just $3 million. The loans – dated January 17, three days before President Trump’s inauguration – were made by a Chicago-based bank run by Steve Calk, a Trump fundraiser and economic advisor.

Nine current and former law enforcement and real estate experts told WNYC that Manafort’s deals merit scrutiny. Some said the purchases follow a pattern used by money launderers: buying properties with all cash through shell companies, then using the properties to obtain “clean” money through bank loans. In addition, given that Manafort is already under investigation for his foreign financial and political ties, his New York property transactions should also be reviewed, multiple experts said.

One federal agent not connected with the probes, but with experience in complex financial investigations, said after reviewing the real estate documents that this pattern of purchases was “worth looking into.” The agent did not want to speak for attribution. There are active investigations of Manafort’s Russian entanglements by the FBI, Treasury, and House and Senate Select Committees on Intelligence. Manafort has denied wrongdoing and has called some of the allegations “innuendo.”

Debra LaPrevotte, a former FBI agent, said the purchases could be entirely legitimate if the money used to acquire the properties was “clean” money. But, she added, “If the source of the money to buy properties was derived from criminal conduct, then you could look at the exact same conduct and say, ‘Oh, this could be a means of laundering ill-gotten gains.’”

Last spring, the Obama Treasury Department was so alarmed by the growing flow of hard-to-trace foreign capital being used to purchase real estate through shell companies that it launched a special program to examine the practice within its Financial Crimes Enforcement Network, or FinCen. The General Targeting Order, or GTO, required that limited liability company disclose the identity of the true buyer, or “beneficial owner,” in property transactions.

In February, FinCen reported initial results from its monitoring program: “about 30 percent of the transactions covered by the GTOs involve a beneficial owner or purchaser representative that is also the subject of a previous suspicious activity report,” it said. The Trump Treasury Department said it would continue the monitoring program.

Friends and Business Partners

According to reports, Manafort was first introduced to Donald Trump in the 1970s by Roy Cohn, the former aide to Senator Joseph McCarthy who went on to become a prominent and controversial New York attorney.

Long active in GOP politics, Manafort also worked as a lobbyist for clients who wanted something from the politicians he helped elect. His former firm – Black, Manafort, Stone and Kelly – represented dictators like Ferdinand Marcos of the Philippines and Mobuto Sese Seko of Zaire.

In the 2000s, Manafort created a new firm with partner Rick Davis. According to the recent investigative report by The Associated Press, Manafort and Davis began pursuing work in 2005 with Oleg Deripaska, one of the richest businessmen in Russia. Manafort and Davis pitched a plan to influence U.S. politics and news coverage in a pro-Putin direction, The AP said.

“We are now of the belief that this model can greatly benefit the Putin government if employed at the correct levels with the appropriate commitment to success,” Manafort wrote in a confidential strategy memo obtained by The AP.

In 2006, Manafort and Davis signed a contract to work with Deripaska worth $10 million a year, The AP reported.

Also that year, a shell company called “John Hannah LLC” purchased apartment 43-G in Trump Tower, about 20 stories down from Donald Trump’s own triplex penthouse. Manafort confirmed that “John Hannah” is a combination of Manafort’s and Davis’s respective middle names.

The LLC was set up in Virginia at the same address as Davis Manafort and of a Delaware corporation, LOAV, Ltd., for which there are virtually no public records. It was LOAV that signed the contract with Deripaska – not the “public-facing consulting firm Davis Manafort,” as the AP put it.

A lawyer for John Hannah LLC signed the deed on apartment 43-G for $3.675 million in November of 2006. But Manafort’s name did not become associated formally with the Trump Tower apartment until March of 2015, three months before Trump announced he was entering the presidential race in the lobby 40 stories down. On March 5, John Hannah LLC transferred the apartment for $0 to Manafort. A month later, he borrowed $3 million against the condo, according to New York City public records.

A year later, Manafort was working on Trump’s campaign, first as a delegate wrangler, then as campaign manager. Trump’s friend and neighbor had become a top advisor.

In a text message that was hacked and later obtained by Politico, Manafort’s adult daughter, Jessica Manafort, wrote last April: “Dad and Trump are literally living in the same building and mom says they go up and down all day long hanging and plotting together.”

In August 2016, The New York Times published a lengthy investigation of Manafort, alleging he’d accepted $12.7 million in undisclosed cash payments from a pro-Putin, Ukrainian political party between 2007 and 2012. Manafort resigned as campaign manager, but according to multiple reports, didn’t break off ties with Trump, who remained his upstairs neighbor.

The White House press secretary, Sean Spicer, said last week that Manafort “played a very limited role for a very limited period of time” in the Trump campaign.

Davis did not return WNYC’s calls for comment, but in an email exchange with The AP, he disavowed any connection with the effort to burnish Putin’s image. “My name was on every piece of stationery used by the company and in every memo prior to 2006. It does not mean I had anything to do with the memo described,” Davis said.

Buy. Borrow. Repeat.

Trump Tower 43-G was not Manafort’s only New York property.

In 2012, another shell company linked to Manafort, “MC Soho Holdings LLC,” purchased a fourth floor loft in a former industrial building on Howard Street, on the border of Soho and Chinatown, for $2.85 million. In April 2016, just as he was ascending to become Trump’s campaign manager, Manafort transferred the unit into his own name and borrowed $3.4 million against it, according to publicly available property records.

The following year, yet another Manafort-linked shell company, “MC Brooklyn Holdings,” purchased a townhouse at 377 Union Street in Carroll Gardens for $2,995,000. This transaction followed the same pattern: the home was paid for in full at the time of purchase, with no mortgage. And on February 9, 2016, just after Trump won decisive victories in Michigan and Mississippi, Manafort took out $5.3 million of loans on the property.  (Some of these transactions were first reported by the blog Pardon Me For Asking, and by two citizen journalists at 377union.com.)

Though the deals could ultimately be traced to Manafort, his connection to the shell companies would not likely have emerged had Manafort not become entangled in multiple investigations.

Public records dated just days before Trump was sworn in as President show that Manafort transferred the Carroll Gardens brownstone from MC Brooklyn Holdings to his own name and refinanced the loans with The Federal Savings Bank, in the process taking on more debt. He now has $6.8 million in loans on a building he bought for $3 million, records show.

David Reiss, a professor of real estate law at Brooklyn [Law School], initially expressed bafflement when asked about the transactions. Reiss then looked up the home’s value on Zillow, a popular source for estimating real estate values. The home’s “zestimate” is $4.5 to $5 million.

Reiss said unless there is another source of collateral, it is extremely unusual for a home loan to exceed the value of the property. “I do think that transaction raises yellow flags that are worth investigating,” he said.

Light Bloggin’ Through March

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Judge Gorsuch v. Uncle Sam

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The Hill published my latest column, Where Does Judge Gorsuch Stand on Limiting the Federal Government? It opens,

This week, all eyes are on Judge Gorsuch’s confirmation hearing for a seat on the Supreme Court. While Gorsuch has not explicitly stated that he wants to drown or deconstruct the federal government, there is troubling language in his opinions that indicates that he shares that goal. While this will hearten many a Tea Partyer, moderate Republicans along with Democrats should be wary of someone who does not value the good that the federal government can and does do.

His opinion in Caring Hearts Personal Home Services v. Burwell describes a federal government that has ceased to function rationally: “The number of formal rules [administrative] agencies have issued thanks to their delegated legislative authority has grown so exuberantly it’s hard to keep up. The Code of Federal Regulations now clocks in at over 175,000 pages. And no one seems sure how many more hundreds of thousands (or maybe millions) of pages of less formal or ‘sub-regulatory’ policy manuals, directives, and the like might be found floating around these days.”

He continues, “This case has taken us to a strange world where the government itself — the very ‘expert’ agency responsible for promulgating the ‘law’ no less — seems unable to keep pace with its own frenetic lawmaking. A world Madison worried about long ago, a world in which the laws are ‘so voluminous they cannot be read’ and constitutional norms of due process, fair notice, and even the separation of powers seem very much at stake.”

While this opinion draws a colorful picture of a topsy-turvy government that plays well to the crowd, the fact is that the federal government runs pretty well given its size and complexity. Indeed, employees of large and profitable corporations can often be heard making the same kind of complaints about their employers. All large organizations have their catch-22s, their inconsistencies, their maddening snafus. But the fact remains that large organizations have been remarkably successful at navigating the modern world.

Gorsuch’s lazy originalism, with musings of Madison’s concerns about a legal code so massive that it is unknowable, may have packed a punch at the dawn of the administrative state a hundred years ago. Today it misses its mark. Indeed, the first lesson I teach my law students is that their job is not to know what the law is in advance, but rather to be able to figure it out when a case presents itself. The same could be said of any professional. A doctor need not know all of the medical literature. She just needs to be able to search it in order to diagnose her patient. In fact, the massive code is pretty knowable. Just use Google. It’s all there.

For those of us who work for large organizations, who deal with large amounts of data, who crisscross the world’s borders, who do business over state lines, we know that we can survive and thrive in this complex world. And there simply is no alternative. To deny this is to pander to silly romantics who pine for a time that passed more than a century ago for most people: when you only did business with your neighbors, when your justice of the peace lived down the block and when you walked to your job across town.

President Trump knows this. His businesses are scattered across the globe. Steve Bannon knows this. He worked at Goldman Sachs. And Judge Gorsuch certainly knows this. But they also know that people like to hear that we can go back to a simpler time that never really existed for most Americans.

We do not need that kind of patronizing nostalgia in the Supreme Court. Our ninth justice should be one who can craft solutions to our 21st century legal problems that are based on the values embodied in the Constitution, not the facts of life of a bygone era.

The Economic Implications of the Housing Supply

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Ed Glaeser and Joe Gyourko posted The Economic Implications of the Housing Supply which is forthcoming in The Journal of Economic Perspectives. In it, they

review the basic economics of housing supply and the functioning of U.S. housing markets to better understand the impacts on home prices, household wealth and the spatial distribution of people across markets. Section II documents the state of housing affordability in the U.S., and begins with three core facts about housing supply. First, when building is unrestricted by regulation or geography, housing supply curves seem relatively flat, meaning that we can approximate reality by referring to a single production cost. Second, both geography and regulation severely restrict the ease of building in some parts of the country. These constraints raise building costs both directly, by increasing time delays and reducing the amount of available land, and indirectly, by ensuring the homes are produced more on a one-by-one basis rather than in bulk. Third, the supply of housing is kinked and vertical downwards because housing is durable. (2, citation omitted)

These are themes that Glaeser and Gyourko have touched on before, but this essay does a service by updating them ten years after the financial crisis.

Glaeser and Gyourko have consistently hit on some important points that can garner attention at the national level , but there has been no real action on them as of yet:

  • where supply is regulated, housing costs more;
  • heavy land use regulation in places like NYC and SF reduces the nation’s overall economic output; and
  • existing homeowners tend to oppose new projects, which is consistent with their financial self-interest.

Glaeser and Gyourko do not give up hope that policymakers can craft solutions that deal with the political economy of housing construction. One first step would be to develop a toolkit of carrots and sticks that can be employed at the national and state level to incentivize local governments to take actions that are in the interest of their broader communities and the nation as a whole.

We know we need more housing in highly productive regions. We just need to figure out how to build it.

United States v. CFPB

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photo by AgnosticPreachersKid

United States Court of Appeals for the District of Columbia Circuit, E. Barrett Prettyman Federal Courthouse

The Trump Administration has filed an amicus brief in PHH Corp. v. CFPB. The case is schedule for an en banc hearing in May. The filing is particularly newsworthy because the Trump Administration is siding with PHH, a mortgage lender, against the CFPB, a federal agency. The Trump Administration summarizes its position as follows:

In 2010, Congress created the Consumer Financial Protection Bureau (CFPB) as part of the Dodd-Frank Act, giving the CFPB authority to enforce U.S. consumer-protection laws that had previously been administered by seven different government agencies, as well as new provisions added by Dodd-Frank itself. See 12 U.S.C. § 5581(b). The CFPB is headed by a single Director who is appointed by the President, with the advice and consent of the Senate, for a term of five years, id. § 5491(b), (c)(1), and who may be removed by the President only for “inefficiency, neglect of duty, or malfeasance in office,” id. § 5491(c)(3).

The panel in this case held that this “for cause” removal provision violates the constitutional separation of powers. Op. 9-10. The panel explained—and neither party disputes—that, as a general matter, the President has “Article II authority to supervise, direct, and remove at will subordinate [principal] officers in the Executive Branch” in order to exercise his vested power and duty to faithfully execute the laws. Op. 4. The panel recognized as well that Humphrey’s Executor v. United States, 295 U.S. 602, 629 (1935), established an exception to that rule, holding that Congress may “forbid [the] removal except for cause” of members of the Federal Trade Commission (FTC)—a holding that has been understood to cover members of other multi-member regulatory commissions that share certain features and functions with the FTC. Op. 4.

The principal constitutional question in this case is whether the exception to the President’s removal authority recognized in Humphrey’s Executor should be extended by this Court beyond multi-member regulatory commissions to an agency headed by a single Director. While we do not agree with all of the reasoning in the panel’s opinion, the United States agrees with the panel’s conclusion that single-headed agencies are meaningfully different from the type of multi-member regulatory commission addressed in Humphrey’s Executor.

The Supreme Court’s analysis in Humphrey’s Executor was premised on the nature of the FTC as a continuing deliberative body, composed of several members with staggered terms to maintain institutional expertise and promote a measure of stability that would not be immediately undermined by political vicissitudes. A single-headed agency, of course, lacks those critical structural attributes that have been thought to justify “independent” status for multi-member regulatory commissions. Moreover, because a single agency head is unchecked by the constraints of group decision-making among members appointed by different Presidents, there is a greater risk that an “independent” agency headed by a single person will engage in extreme departures from the President’s executive policy. And as the panel recognized, while multi-member regulatory commissions sharing the characteristics of the FTC discussed in Humphrey’s Executor have existed for over a century, limitations on the President’s authority to remove a single agency head are a recent development to which the Executive Branch has consistently objected.

We therefore urge the Court to decline to extend the exception recognized in Humphrey’s Executor in this case. (1-2)

This is of course an obscure argument about administrative law jurisprudence, but it also has serious real world consequences. I have previously argued that the panel reached the wrong result in this case and I think that the en banc Court will overturn it.

This amicus brief does not add too much to the reasoning in Judge Kavanaugh’s majority opinion in PHH v. CFPB, although it does flesh out one important argument that it made. The brief provides some support for the position that multi-member commissions are better suited to run independent agencies than single directors. But while it makes the case that single director agencies may not be the best choice for agency design, it does not make the case that it is an unconstitutional one.