June 11, 2014
Reiss on GSE Transfer Taxes
Law360 quoted me in Fannie, Freddie Look Unstoppable In Transfer Tax Fight (behind a paywall). It reads in part,
Class actions against Fannie Mae and Freddie Mac over hundreds of millions of dollars in unpaid transfer taxes in states and cities around the country continue to pile up, but experts say any attempt to challenge the housing giants’ exempt status is likely futile as court after court rules in their favor.
The Eighth Circuit on Friday joined the Third, Fourth, Sixth and Seventh circuits in ruling that Fannie Mae and Freddie Mac are exempt from local transfer taxes when it ruled in favor of the government-sponsored enterprises, or GSEs, after reviewing a suit brought by Swift County, Minnesota.
Swift County, as with a multitude of counties, municipalities and states before it, sought to dispute Fannie and Freddie’s claim that while they must pay property taxes, they are exempt from additional taxes on transfers of assets. But in what some experts say has come to seem like an inevitable answer, the Eighth Circuit found in favor of Fannie and Freddie.
“The federal statutes that set forth the charters of Fannie and Freddie are pretty clear that the two companies have a variety of regulatory privileges that other companies don’t,” David Reiss, a professor at Brooklyn Law School, said. “One of the privileges is an exemption from nearly all state and local taxation.”
The legal onslaught against the GSEs began in 2012 after U.S. District Judge Victoria A. Roberts ruled in March that they should not be considered federal agencies. In a suit filed by Oakland County, Michigan, over millions in unpaid transfer taxes, Judge Roberts rejected the charter exemption argument and, citing a 1988 U.S. Supreme Court ruling in U.S. v. Wells Fargo, found that “all taxation” refers only to direct taxes and not excise taxes like those imposed on asset transfers.
Counties, municipalities and states across the country were emboldened by the decision. Putative class actions soon followed in West Virginia, Illinois, Minnesota, Florida, Rhode Island, Georgia and elsewhere as plaintiffs rushed to see if they could elicit a similar ruling and recoup millions of dollars allegedly lost thanks to the inability to tax Fannie and Freddie’s mortgage foreclosure operations.
But Judge Roberts’ decision was later overturned by the Sixth Circuit, as were other similar orders, though many district judges found in favor of Fannie and Freddie from the start.
* * *
Many cases remain in the lower courts as well, but experts say the outcomes will likely echo those that played out in the Third, Fourth Sixth, Seventh and Eighth circuits, because the defendants’ chartered exemption defense appears waterproof.
“I find the circuit court decisions unsurprising and consistent with the letter and spirit of the law,” Reiss said. “I am guessing that other federal courts will follow this trend.”
June 11, 2014 | Permalink | No Comments
June 10, 2014
Subprime Scriveners
Milan Markovic has posted Subprime Scriveners to SSRN. The abstract reads,
Although mortgage-backed securities (“MBS”) and other financial products that nearly caused the collapse of the global financial system could not have been issued without attorneys, the legal profession’s role in the financial crisis has received relatively little scrutiny.
This Article focuses on lawyers’ preparation of MBS offering documents that misrepresented the lending practices of mortgage loan originators. While attorneys may not have known that many MBS would become toxic, they lacked incentives to inquire into the shoddy lending practices of prominent originators such as Washington Mutual Bank (“WaMu”) when they and their clients were reaping considerable profits from MBS offerings.
The subprime era illustrates that attorneys are unreliable gatekeepers of the financial markets because they will not necessarily acquire sufficient information to assess the legality of the transactions they are facilitating. The Article concludes by proposing that the Securities and Exchange Commission impose heightened investigative duties on attorneys who work on public offerings of securities.
The article addresses an important aspect of an important subject – which professionals could and should be held responsible for the rampant misrepresentation found throughout the MBS industry in the early 2000s. The prevailing wisdom is that no one can be held responsible, because no one did anything that made him or her personally culpable. Markovic argues that lawyers can and should be held responsible for the misrepresentations found in MBS offering documents. While I buy his argument that lawyers have been unreliable gatekeepers, I am not sure that I fully agree with diagnosis of the problem.
Markovic writes,
The large financial institutions that issued MBS presumably understood the implications of incorporating questionable representations from loan originators into MBS offering documents. They also would have been able to consult with their in-house counsel about the risks of securitizing poor quality mortgages. It is not self-evident that ethical rules should compel attorneys to investigate what sophisticated clients advised by in-house counsel do not believe needs investigating. (45)
In fact, sophisticated parties often use reps and warranties to allocate risk. For instance, a provision could require that an originating lender buy back mortgages that failed to comply with reps and warranties. This is not a situation where any of the parties would expect anyone to investigate the “representations from the loan originators.” Rather, the parties assumed (rightly or wrongly) that the originator would stand behind the representation if and when it was proved to be false. And, indeed, solvent originators have had to do so.
As I do not fully agree with Markovic’s diagnosis of the problem, that leads me to have concerns with his proposed solution as well. But the article raises important questions that we have not yet answered even though the events leading to the financial crisis are nearly a decade behind us.
June 10, 2014 | Permalink | No Comments
June 9, 2014
G-Fee Entreaty
The FHFA has issued a Request for Input about Fannie Mae and Freddie Mac Guarantee Fees. The Request both provides a good explanation of g-fees and poses important questions about their appropriate role in the functioning of the housing finance system. The Request opens,
On December 9, 2013, the Federal Housing Finance Agency (FHFA) announced proposed increases to guarantee fees (g-fees) that Fannie Mae and Freddie Mac (the Enterprises) charge lenders. The Enterprises receive these fees in return for providing a credit guarantee to ensure the timely payment of principal and interest to investors in Mortgage Backed Securities (MBS) if the borrower fails to pay. The MBS, in turn, are backed by mortgages that lenders sell to the Enterprises.
The proposed changes included an across-the-board 10 basis point increase, an adjustment of up-front fees charged to borrowers in different risk categories and elimination of the 25 basis point Adverse Market Charge for all but four states. On January 8, 2014, Director Melvin L. Watt suspended implementation of these changes pending further review. (1)
The Request asks for responses to 12 questions. The most important, as far as I am concerned, is the first: “Are there factors other than those described in section III – expected losses, unexpected losses, and general and administrative expenses that FHFA and the Enterprises should consider in setting g-fees? What goals should FHFA further in setting g-fees?” (7)
Setting the g-fee has far-reaching consequences not just for the financial health of the two companies, but also for the health of the overall housing market and the mortgage industry. It will also have predictable effects on the litigation over the conservatorships of the two companies. For instance, a high g-fee will make the two companies appear to be more valuable than a low one. The size of the g-fee may also impact the scope of federal affordable housing initiatives.
While this Request for Input is pretty technical (particularly the parts of it that I didn’t blog about), it touches on some of the most fundamental aspects of our system of housing finance. As such, it invites responses from more than just industry insiders. Input is due by August 4th.
June 9, 2014 | Permalink | No Comments
June 6, 2014
Frannie Effects on Mortgage Terms
The Federal Reserve’s Alex Kaufman has posted The Influence of Fannie and Freddie on Mortgage Loan Terms to SSRN. It is behind a paywall on SSRN, but an earlier draft is available elsewhere on the web. The abstract reads,
This article uses a novel instrumental variables approach to quantify the effect that government‐sponsored enterprise (GSE) purchase eligibility had on equilibrium mortgage loan terms in the period from 2003 to 2007. The technique is designed to eliminate sources of bias that may have affected previous studies. GSE eligibility appears to have lowered interest rates by about ten basis points, encouraged fixed‐rate loans over ARMs and discouraged low documentation and brokered loans. There is no measurable effect on loan performance or on the prevalence of certain types of “exotic” mortgages. The overall picture suggests that GSE purchases had only a modest impact on loan terms during this period.
This is pretty dry reading, but it is actually an important project: “[g]iven the GSEs’ vast scale, the liability they represent to taxpayers, and the decisions that must soon be made about their future, it is crucial to understand how exactly they affect the mortgage markets in which they operate.” (2, earlier draft) The current conventional wisdom is that the two companies will return in something that looks like their pre-conservatorship form.
Given that that is the case, studies such as these are useful for providing some facts about the actual impact that these two companies actually have on the mortgage market. In terms of their impact on loan terms, it appears that the two companies have a modest or even “mixed” effect, at least for the subset of mortgages studied. (22, earlier draft) And there “is no measurable effect on loan performance” at all. (22, earlier draft)
I have argued previously that returning Fannie and Freddie to their pre-conservatorship ways is a bad call. I still think that is the case. And I think studies such as these offer support for that view, in the face of the conventional wisdom.
June 6, 2014 | Permalink | No Comments
June 3, 2014
Discovery War in GSE Litigation
The United States filed a motion for a protective order in the Fairholme Funds case in the Court of Federal Claims (the Fairholme Takings case). You may not be familiar with protective orders. By way of background, Federal Rule of Civil Procedure 26(c) states that “The court may, for good cause, issue an order to protect a party or person from annoyance, embarrassment, oppression, or undue burden or expense . . ..”
The federal government can request a protective order, like any other party. But there may be some unique policies at issue when the federal government makes such a request. For instance, the federal government may assert a variety of privileges to limit discovery. These may include the deliberative process qualified privilege. This privilege is asserted to protect communications about the government’s decisions. Another example would be the qualified government privilege for official information. This privilege would be asserted to maintain the confidentiality of official government records. These are just two examples – there are a whole other range of privileges that the government might assert. A court’s protective order analysis involving the federal government thus might take into account a variety of legitimate objectives that would not apply in a dispute between two private parties.
Here, the United States is seeking to limit discovery requests that “seek documents that relate in their entirety to the future termination of the conservatorships, with no end date” and “documents that relate (in part) to the future profitability of the Enterprises, again with no end date.” (2) The government argues that
Disclosure of these documents is contrary to the strictures of the Housing and Economic Recovery Act of 2008 (HERA), which bars a court from taking “any action to restrain or affect the exercise of powers or functions” of the Federal Housing Finance Agency (FHFA) as conservator. 12 U.S.C. § 4617(f). The declaration of FHFA Director Melvin Watt explains that disclosure would “have extraordinarily deleterious consequences on the Conservator’s conduct of the ongoing and future operations of the conservatorships.” Decisions about when and how to terminate the conservatorships and the future profitability of the Enterprises are at the heart of FHFA’s responsibilities as conservator, and Court-mandated disclosure of information bearing on such matters would jeopardize the stewardship of the Enterprises. (2, footnotes and some citations omitted)
While some of the government’s language in the motion seems hyperbolic, the court should certainly focus on the deliberative process privilege that the government asserts. Defining its scope will have implications far beyond this case, no matter that this case is incredibly important itself.
As to this case itself, it is interesting to see how even procedural disputes in the GSE lawsuits implicate the current operations of the GSEs as well as their post-conservatorship future. There is no question that the plaintiffs are very aware of their effect on the broader debates about the housing finance system as they press their individual claims in court. It is not yet clear to me how much the Court will weigh those considerations in its decision regarding the reach of the deliberative process privilege.
June 3, 2014 | Permalink | No Comments
