February 28, 2014
Appraisals in the Coal Mine
The Federal Housing Finance Agency Office of Inspector General released an Audit Report, FHFA’s Oversight of the Enterprises’ Use of Appraisal Data Before They Buy Single-Family Mortgages. As the IG notes,
Assessing the value of collateral securing mortgage loans is one of the pillars in making sound underwriting decisions. Since September 2008, the Federal Housing Finance Agency (FHFA) has operated Freddie Mac and Fannie Mae (the Enterprises) in conservatorship, due to poor business decisions and risk management that led to enormous losses. While in conservatorship, the Enterprises have relied on Treasury’s financial support to operate in the secondary mortgage market, buying loans in order to provide needed liquidity to lenders. In 2010, FHFA directed the Enterprises to improve single-family residential loan quality and risk management through, among other things, developing a uniform collateral data portal (portal).
Unfortunately, the IG found that
- from January 2013 through June 2013, Fannie Mae spent $13 billion buying over 56,000 loans even though the portal’s analysis of the associated appraisals warned the Enterprise that the appraisals were potentially in violation of its underwriting requirements.
- from June 2013 through September 2013, Freddie Mac spent $6.7 billion buying over 29,000 loans despite the portal warning the Enterprise that either no property value could be provided or the value of the property was in question.
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the Enterprises bought nearly $88 billion in loans when system logic errors in the portal did not allow them to determine if the appraiser was properly licensed to assess the value of the properties, which served as collateral for the loans.
The IG did not characterize these problems as particularly worrisome, but I wonder if they are somewhat symbolic of the limbo state that the Enterprises find themselves in. Like canaries in a coal mine, they alert us to a serious problem.
Neither private companies nor government instrumentalities, the Enterprises must stagger on until the federal government decides what to do with them. Let’s hope that the Enterprises are not silently building up to another crisis, one not driven by the profit-motive as the last one was, but driven by bureaucratic incompetence. “Bureaucratic” in the sense of the “rule of no one,” as Mary McCarthy defined it.
Fannie and Freddie’s current profitability should not be used as an excuse to delay reform further. They are too important to have been left in limbo for so long.
February 28, 2014 | Permalink | No Comments
February 27, 2014
Reiss on Marketplace: Cash Cows to Slaughter
I was interviewed on Marketplace for its story, Fannie and Freddie: Cash Cows Avoid The Slaughter? (sound file) The text of the story reads
We are making money – the tax payer, that is – on Fannie and Freddie Mac.
When Freddie Mac hands the treasury a $10.4 billion dividend next month, tax payers will have received more money in interest than was put in. (Technically the two institutions still owe the principal on the loan that bailed them out, but the interest they’re paying will shortly exceed that amount).
But.
There always is a but with these things.
Making money for the tax payer isn’t good if you ask those who want reform.
Back during the financial crisis, conservatives and liberals disagreed over whether Freddie and Fannie were a victim of or a cause of the housing collapse, but they agreed that the institutions needed reform. The profits are throwing a wrinkle into this debate.
“As long as Fannie and Freddie continue to pay substantial amounts of money to the government, they are looked at by some people in Congress as a great source of revenue that reduces the deficit,” explains Peter Wallison with the American Enterprise Institute. His concern – shared by reformers on both sides of the political spectrum – is that if Fannie and Freddie become cash cows, congress won’t want to touch them.
David Reiss, professor of law at the Brooklyn Law School, agrees. He says the financial crisis wasn’t a one time problem.
“We should think of it as that we dodged a bullet. There’s fundamental problems with the Fannie and Freddie business model which rests on this notion of privatizing profits and socializing losses.”
Freddie and Fannie buy mortgages from lenders, and then bundle them into “mortgage backed securities” that can be sold to investors. It’s useful because it converted illiquid mortgage loans into liquid securities. In plain English, it means a bank or investor who made a mortgage loan to someone didn’t have to wait around for 30 years to be paid back. They could sell their stake in the mortgage to Fannie or Freddie, move along, and go invest in other things. This helped more people get mortgages.
One concern was that Fannie and Freddie were simply too big and too concentrated. Another concern was that the federal government implicitly guaranteed investments in Freddie and Fannie, and that encouraged people to make home loans that were too risky.
Even without the complication of profits, the debate over how to reform Fannie and Freddie is at a stand still.
House Republicans don’t want the government involved at all, they want an efficient market. The Senate wants the government to be involved a little bit, essentially to promote housing.
“What I see,” says David Reiss, “is nothing really happening, and us being a holding pattern for a long time.”
It’s possible that reform-minded politicians will compromise before they lose their chance. Also possible they won’t.
February 27, 2014 | Permalink | No Comments
February 26, 2014
Subprime Mortgage Conundrums
Joseph Singer has posted Foreclosure and the Failures of Formality, or Subprime Mortgage Conundrums and How to Fix Them (also on SSRN). Singer writes,
One of the striking features of the subprime era is that banks acted without adequate regard for state property law. They were intent on serving the national and international financial markets with new and more profitable products, and they treated state property law as an obstacle to get around rather than a foundation on which to build. Rather than sell mortgages to families that could afford them, they hoodwinked the vulnerable by picking their pockets. Rather than honestly disclose the high risks associated with subprime loans, they paid rating agencies to give them AAA ratings, inducing investors to take risks they neither were prepared for nor understood. The banks made huge amounts of money marketing mortgages to people who could not afford to pay them back while offloading the risks of such deals onto hapless third parties. And rather than observe longstanding laws and customs designed to clarify property titles, banks evaded requirements of publicity and formality that traditionally governed real estate transactions. In short, the banks misled both borrowers and investors while undermining property titles. This was both a clever and a profitable way to engage in business, but it was neither honorable nor responsible. (501, footnotes omitted)
Brad Borden and I have made a similar point in our debate with Joshua Stein, but Singer’s article plays it out in far greater depth. The article is a property prof’s cri de coeur over the near death of real property law principles during the early 2000s subprime boom, but it is also a very thorough inquest. The article concludes with a review of tools that are available to respond to failures in the mortgage market. All in all, it provides a nice overview of what led to the crisis as well as potential policy tools that are available to prevent future ones.
February 26, 2014 | Permalink | No Comments
February 25, 2014
FIRREA Does the Hustle
Judge Rakoff has issued another Opinion in U.S. v. Countrywide Fin. Corp. et al., 12 Civ. 1422 (Feb. 17, 2014). Rakoff reconfirms his broad reading of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which covers fraudulent behavior that is self-affecting; that is, where the perpetrator and victim of the fraud are one and the same financial institution. This Opinion goes further, however, based on on developments in the litigation since that earlier opinion.
The Opinion notes that the defendants were found liable at trial and finds that
Based on the charge as given to the jury, the jury, by finding liability, necessarily found that the defendants intentionally induced two government-sponsored entities, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), to purchase from the Bank Defendants thousands of loans that Fannie Mae and Freddie Mac would not otherwise have purchased. The defendants did so, the jury necessarily found, by misrepresenting that the loans they were selling were “investment quality” and that they knew of nothing that might cause investors to regard the mortgages as poor investments, when in fact the defendants knew that their underwriting process, known as the “High Speed Swim Lane,” “HSSL,” or “Hustle,” was calculated to produce loans that were not of investment quality. (3)
The Court had previously found that “the fraud here in question, perpetrated by the Countrywide defendants and Ms. Mairone, had a huge effect on Bank of America defendants, which, as a result of Bank of America’s purchase of Countrywide, paid, directly or through affiliates, billions of dollars to settle repurchase claims brought by Fannie Mae and Freddie Mac.” (4) The opinion concludes that
It is highly improbable that Congress would have intended to place beyond the reach of FIRREA those defendants whose misconduct “affects” federally insured banks that have the great fortune to be fully insured [by their affiliates] for such losses. Even less so can it be imagined that the device of having BAC [the BoA parent holding company] indemnify BANA [the BoA federally insured bank] for losses that otherwise would result from Countrywide’s fraud immunizes Countrywide from liability under FIRREA. Indeed, defendants’ labeling of this theory of liability as the “self-affecting” theory is something of a misnomer; Countrywide’s fraud, which culminated before the merger with BANA, directly affected, not just Countrywide, but its merger partner, BANA, as well. While the effect on Countrywide might be “self-affecting,” the effect on BANA was not. (5)
This Opinion seems to bolster Rakoff’s broad reading of FIRREA. As of now, FIRREA gives the federal government a powerful tool to pursue alleged wrongdoing affecting federally insured financial institutions. The caselaw reads FIRREA broadly and the statute’s ten-year statute of limitations means that additional suits may still be coming down the pike.
February 25, 2014 | Permalink | No Comments
February 24, 2014
Long-Term Homeownership Affordability
Amnon Lehavi has posted Can the Resale Housing Market Be Split to Facilitate Long-Term Affordability? to SSRN. The paper argues that
a comprehensive affordable housing policy requires the formal splitting of the homeownership market into (at least) two distinct segments: one designated for the general public and following a conventional pricing mechanism through free market supply and demand, and the other designated for eligible households and controlling both initial supply and subsequent resale of housing units through regulated affordability-oriented pricing mechanisms.
While regulation of the pricing of affordable housing units during their initial allocation is a standard feature of housing policy–whether such affordable units are produced by a public authority or a private developer–regulation of pricing upon resale to subsequent buyers has received less attention as a matter of both theory and practice, thus leaving a substantial gap in
design mechanisms aimed at promoting a sustainable affordable housing policy.(1)
This is not really a new argument, but the paper takes the position that existing efforts to regulate resales of affordable housing in the homeownership market can be scaled up significantly. The paper does not take on some of the bigger questions that this position implicates — for instance, should scarce homeownership dollars be spent on rental housing instead — but it does develop a concrete proposal:
This paper seeks to enrich policy design options by introducing two alternative cap-on-resale mechanisms for the affordable housing segment: “Mixed Indexed Cap” (MIC) and “Pure Indexed Cap” (PIC). It explains how such models could be utilized to attain a policy goal of promoting long-term social mobility, allowing multiple low- and modest-income households to engage in capital building by sequentially enjoying increments of appreciation of properties in the affordable housing segment.
In so doing, the paper addresses a series of challenges posed by the design of a cap-on-resale mechanism: Could such a mechanism ensure that the homeowner is granted a fair return upon resale, providing the owner with proper incentives to invest efficiently in the property during the tenure, while setting up a resale rate that would make the unit truly affordable for future homebuyers? (1)
New York Ciy has experimented with affordable homeownership and has not come up with an ideal solution to the problem of affordability upon resale. Given the renewed focus on affordable housing policy in NYC, this attention to affordable homeownership policy is most welcome.
February 24, 2014 | Permalink | No Comments
February 22, 2014
The Court of Appeals of Ohio Upholds Foreclosure Judgment Against Homeowner for Failing to Challenge Bank’s Standing During Trial
In October 2013, the Court of Appeals of Ohio in Wells Fargo Bank N.A., v. Arlington affirmed a trial court’s judgment in favor of the plaintiff bank in a foreclosure action because the homeowner did not properly challenge the bank’s standing to start the foreclosure action during the trial.
In 2006, Dean Arlington (“Defendant”) bought a home in Ohio with a mortgage from Taylor, Bean & Whitaker Mortgage Corp (“TBW”) and MERS. In 2007, MERS sold the mortgage to Wells Fargo Bank, N.A (“Plaintiff”) and in January 2008, Plaintiff initiated a foreclosure action against Defendant. In August 2008, Defendant filed an answer to the foreclosure and Plaintiff moved for summary judgment, but the Court denied Plaintiff’s motion. The case was stayed for three years due to bankruptcy notice. After the bankruptcy stay was lifted, Plaintiff filed a second motion for summary judgment on March 24, 2011. The trial court granted the motion for summary judgment in June 2011 and entered the decree of foreclosure. Defendant first filed a notice of appeal in June 2011 and filed an Emergency Motion for Relief from Judgment in October 2011. Defendant later voluntarily dismissed the appeal in November 2011.
In Defendant’s emergency motion, he argued that the trial court should vacate the foreclosure decree because Plaintiff did not have standing to bring the foreclosure action. The trial court denied the motion in October 2011 and Defendant did not appeal the judgment. One year later in October 2012, the Ohio Supreme Court issued Fed. Home Loan Mortg. Corp. v. Schwartzwald, 134 Ohio St.3d 13. In January 2013, Defendant filed a motion to vacate the trial court’s June 2011 judgment, citing the Schwartzwald case to argue that Plaintiff did not have standing when it filed the complaint in foreclosure. The trial court denied the motion to vacate in March 2013 and Defendant appealed claiming two assignments of error: 1) that the trial court abused its discretion for denying Defendant’s motion to vacate, and alternatively 2) whether the jurisdiction is void for lack of jurisdiction.
The Court of Appeals of Ohio overruled both of Defendant’s assignments of error. The Court of Appeals rejected Defendant’s standing argument under Schwartzwald and held that it did not apply to the facts of this case. The Court of Appeals further held that Defendant’s standing argument was barred by res judicata because he had failed to challenge Plaintiff’s standing in the trial court. The Court therefore held that Plaintiff had standing to initiate the foreclosure action, denied Defendant’s motions and affirmed the trial court’s judgment against Defendant.
February 22, 2014 | Permalink | No Comments
Federal District Court of Nevada Dismisses Homeowners’ Lawsuit Against Banks for not Pleading Enough Facts
In October 2013, the Federal District Court of Nevada in Prince v. Loop Capital Markets, LLC held that Plaintiff homeowners had failed to plead enough facts in their complaint against Defendants Wells Fargo Bank, N.A. and Bank of America, N.A. and dismissed Plaintiffs’ complaint with prejudice.
In August 2009, Thomas Prince and, his wife, Sarah Prince (“Plaintiffs”) bought a home in Las Vegas with a mortgage from New Line Mortgage, Div. Republic Mortgage Home Loans, LLC (“New Line”) as the lender on the deed and Equity Title of Nevada (“Equity”) as the deed trustee. MERS was listed as the nominee for New Line. In August 2012, MERS securitized and pooled the mortgage and sold it as a security to Bank of America, N.A.. Bank of America and Wells Fargo Bank, N.A. (“Defendants”), later initiated a foreclosure action against Plaintiffs, and Plaintiffs later sued Defendants. Plaintiffs sued the Defendants for intentional misrepresentation and negligent misrepresentation in the Defendants’ purchase of Plaintiffs’ mortgage, and sought to stop the foreclosure action. In March 2013, Defendants moved to remove the case from state to federal court and made a motion to dismiss the complaint for failure to state a claim upon which relief could be granted.
The District Court granted the Defendants’ motion to dismiss and held that Plaintiffs’ complaint failed to plead intentional and negligent misrepresentation with specificity under Federal Rules of Civil Procedure Rule 9(b). The Court found that the complaint did not identify a false or misleading statement by Defendants or explain why any alleged statements by Defendants were false. The Court also found that Plaintiffs did not identify the “who, what, when, where, or how of the alleged misconduct” and instead referred to a blanket statement that the discovery in the case revealed that the alleged misconduct occurred. The Court also denied Plaintiffs’ request to amend the complaint to change its argument that the securitization of the mortgage in this case inherently changed the existing legal relationship between the parties to the extent that the original parties ceased to occupy the roles that they did at closing. The Court found that case precedent held that “securitization of a loan does not in fact alter or affect the legal beneficiary’s standing to enforce the deed of trust.” The Court therefore denied Plaintiffs’ request to amend the complaint and granted Defendants’ motion to dismiss with prejudice.
February 22, 2014 | Permalink | No Comments
