Tag Archives: Brookyn Law School

A Controversial Fix for America’s Housing Market

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Sustainable Economies Law Center

Insider quoted me in A Controversial Fix for America’s Housing Market: More Foreclosures. It opens,

How many people should lose their homes to foreclosure?

In an ideal world, of course, there would be no foreclosures at all. Everyone who buys a home would get one that fits their income and needs, and people would have enough money to make their mortgage payments on time and in full. But in a housing market built on debt, foreclosures are a painful reality. People lose their jobs or fall behind on payments, and lenders repossess the home to recoup their losses.

Too many foreclosures is obviously a bad thing — losing a home is devastating both financially and emotionally — but it’s also a problem to have too few foreclosures. Low rates of foreclosure activity signal that housing lenders aren’t taking enough risk, locking out hopeful buyers who could have kept up with payments on their mortgage if only lenders gave them the chance.

Most residential loans are backed by the government-sponsored enterprises Fannie Mae and Freddie Mac or the Federal Housing Administration. To try to find a happy medium of risk, the GSEs — government-sponsored enterprises — and FHA set a “credit box” to determine who gets a mortgage. The companies base these standards on factors including the borrower’s financial stability and the state of the housing market and economy. When the credit box gets tighter, fewer people get mortgages, and foreclosures generally go down. When it opens up, banks take more risks on people with lower credit scores or worse financial histories, increasing the possibility of foreclosures.

Finding the right size for the credit box is easier said than done. In the years leading up to the Great Recession, banks and private lenders handed out millions of risky loans to homebuyers who had no hope of repaying them. A tidal wave of foreclosures followed, plunging the US housing market — and the global economy — into chaos.

But some experts argue that in the years since the crash, the GSEs, lenders, and regulators overcorrected, shutting loads of potentially reliable buyers out of the housing market. Laurie Goodman, the founder of the Housing Finance Policy Center at the Urban Institute, a nonpartisan think tank, said there’s room today to “open the credit box” and relax lending standards without pushing the housing market into crisis. More foreclosures might come as a result, she said, but that would be “a worthwhile trade-off” if it gave more people the opportunity to build wealth through homeownership.

Opening the credit box isn’t a cure-all for housing, and given the weakening economy, more cautious experts argue that making it easier to get a mortgage is unnecessary or dangerous. But if lenders do it correctly, it could be a major step toward a healthier market. A more stable credit box over time could not only ensure future homebuyers aren’t locked out of getting the home of their dreams, but could also smooth out some of the market’s chaotic nature.

The ‘invisible victims’ of the housing market

In the aftermath of the Great Recession, the victims of the housing free-for-all were clear. An estimated 3.8 million homeowners lost their homes to foreclosure from 2007 to 2010, and plenty more also lost theirs in the following years. But the overly strict lending standards and tighter regulations that followed created a new class of victims: people who were unable to join the ranks of homeowners. David Reiss, a professor at Brooklyn Law School, called these would-be homebuyers “invisible victims” — people who probably could have stayed current on their payments if they’d been approved for a loan but who didn’t get that opportunity.

Reiss on Citigroup Settlement

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Law360 quoted me in Feds Deploy Potent Bank Fraud Law In $7B Citi Pact (behind a paywall). It reads in part:

The U.S. Department of Justice’s $7 billion mortgage bond settlement with Citigroup Inc. on Monday may not have been possible without the help of a once-obscure fraud law that has become a legal magic wand for prosecutors.

Citigroup’s settlement included a $4 billion civil fine under the Financial Institutions Reform Recovery and Enforcement Act, the largest such penalty in history. FIRREA was passed in the wake of the 1980s savings-and-loan crisis but has been dusted off in recent years as prosecutors have targeted major Wall Street banks that packaged and sold toxic residential mortgage-backed securities before the 2008 economic collapse.

The law’s government-friendly provisions are well-documented. FIRREA contains a 10-year statute of limitations, rather than the typical five-year window for fraud suits. That has permitted the government to comfortably sue banks over conduct that occurred in 2006 and 2007, when many of the shoddy loans implicated in the crisis were securitized. Prosecutors can use tolling agreements to keep potential claims alive even longer.

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The sheer size of the government’s FIRREA fines thus far, combined with the lack of case law underpinning the statute, has placed banks and their defense counsel in a difficult negotiating position, according to David Reiss, a professor at Brooklyn Law School.

“The message for people in negotiations is: Expect to pay a lot, or else, the government is going to call your bluff,” Reiss said. “It’s the Wild West for civil penalties.”

Monday’s settlement relates to Citigroup’s due diligence on loans that were packaged into securities and sold to investors for tens of billions of dollars. According to an agreed-upon statement of facts, the bank “received information indicating that, for certain loan pools, significant percentages of the loans reviewed did not conform to the representations provided to investors about the pools of loans to be securitized.”

In one case, a Citigroup trader wrote an internal email questioning the quality of loans in mortgage-backed securities issued in 2007. The trader said that he “went through the diligence reports and think that we should start praying … I would not be surprised if half of these loans went down.”

The bank did not admit to breaking any particular law, and neither it nor any individual employees were criminally charged. At the same time, DOJ officials were quick to point out that the settlement did not release Citigroup or any individuals from potential criminal liability.

Reiss said the threat of criminal prosecution could become a hallmark of FIRREA cases, giving banks another cause for concern.

“That again demonstrates a lot of leverage on the side of the government,” Reiss said. “It’s a powerful tool to keep in your back pocket.”

Reiss in Reuters on Mortgage Investing

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Reuters quoted me in Mortgage Bonds Reward Yield-Sensitive Investors, which addresses the future of Fannie and Freddie. It reads in part,

Investors who buy mortgage-backed securities from Fannie Mae and Freddie Mac and hold those bonds until they mature will get their full investment back; there is no “principal risk.”

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Washington has spent years debating what to do with Fannie Mae and Freddie Mac in the future, and quick change is unlikely.

Even if Fannie and Freddie are privatized, older bonds would be safe, suggests David Reiss, a law professor of real estate finance at Brooklyn Law School.

“The government would not change the rules of the game for securities purchased with the guarantee. Pre-privatization (securities) would retain the guarantees, and future securities would have a different type of guarantee,” he said.