Tag Archives: freddie

AIG’s “Victory” and the GSE Litigation

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AIG_Headquarters_New_York_City

Court of Federal Claims Judge Wheeler issued an Opinion and Order in Starr International Company, Inc. v. United States, No. 11-779C (June 15, 2015), the case that Hank Greenberg brought against the government over the terms of the bailout of AIG during the financial crisis. The judge found that the government exceeded its authority in taking an equity interest in AIG, but did not award the plaintiffs any damages.  Many will read the tea leaves of this opinion to see what they tell us about the litigation brought against the federal government by shareholders in Fannie and Freddie arising from the bailout of those two companies. I think it offers little guidance as to liability but lots as to damages.

My most important takeaway from the opinion (which seems well-reasoned to me) is that the holding is based on a close reading of the Federal Reserve Act.  The Act enumerates the powers and limitations of the Fed.  The Court held that the Act does not authorize the Fed to take equity in a company as part of a bailout.

Fannie and Freddie are regulated by the Federal Housing Finance Administration (FHFA). The FHFA’s powers and limitations, in contrast, derive from the Housing and Economic Recovery Act of 2008 (HERA), passed during the financial crisis itself.  HERA explicitly granted the FHFA broad powers as conservator.  Section 1117 of HERA authorized the Secretary of the Treasury to make unlimited equity and debt investments in the two companies’ securities through December 31, 2009.  (There is a disagreement as to whether the the Third Amendment to the Preferred Stock Purchase Agreement, discussed here, created new securities after that date, but the more general point is that HERA authorized equity investments in a way that the Federal Reserve Act did not.)

In sum, I would not read too much into the GSE litigation from the AIG litigation as it relates to the government’s ability to take equity in Fannie and Freddie.  The two cases arise under two completely different statutes.

As to the damages component of the opinion, there are many cases when a court finds for a plaintiff but only awards nominal damages.  Thus, the Court’s opinion is not particularly out of the ordinary in this regard.  Here, the Court relied on the reasoning of the Court of Appeals for the Federal Circuit in a TARP case, A&D Auto Sales, Inc. v. United States, 748 F.3d 1142 (Fed. Cir. 2014).  In that case, the Federal Circuit found that absent allegations that “GM and Chrysler would have avoided bankruptcy but for the Government’s intervention and that the franchises would have had value in that scenario,” there was no basis to argue that the government caused “a net negative economic impact” on the plaintiffs (Starr at 66, quoting A&D at 1158).

It would appear that to prove damages, the GSE litigation plaintiffs will need to overcome that bar too, even if they were to succeed in proving that the government had acted improperly in bailing out Fannie and Freddie.

Be Careful What You Wish For GSEs

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Genie Lamp

Jim Parrott and Mark Zandi have released a report, Privatizing Fannie and Freddie: Be Careful What You Ask For. The authors go through a very useful exercise in which they break down the cost of reprivatizing. The report opens,

Few are happy with the current housing finance system that has Fannie Mae and Freddie Mac in conservatorship and taxpayers backing most of the nation’s residential mortgage loans. Yet legislative efforts to replace the system have largely faltered, raising concern that we may not have the political will or competence to replace it any time soon.

This has created an opening for those who contend that we should not replace the system at all, but simply recapitalize the government-sponsored enterprises and release them from conservatorship. Fannie and Freddie were remarkably profitable prior to the financial crisis, after all, and have been consistently in the black recently. Why embark on the laborious, risky and now stalled process of fundamental reform when we can simply return to a model that we know can provide steady access to affordable, long-term fixed-rate lending?

While we both have serious concerns with the wisdom of releasing the duopoly back into the market, we thought it useful to set those concerns aside for the moment to explore the economics of the move. The discussion often takes for granted that this path would take us back to the world precrisis, but economic conditions and the regulatory environment have changed in ways that would significantly affect how Fannie and Freddie would function as reprivatized institutions. (2)

Parrott and Zandi conclude that

The debate over whether to recapitalize and release the GSEs into the private market is often framed as a choice of whether or not to return to a prior period in lending. For all its shortcomings, the argument goes, at least we know what to expect in the cost and availability of mortgage credit. But this is a misconception. In releasing the GSEs into the private market again, we would release them into a very different regulatory and economic environment, and they would respond, not surprisingly, by charging very different mortgage rates. (4)

I really have no argument with Parrott and Zandi’s paper, but I would note that their conclusions don’t differ so much from the pre-crisis academic papers that attempted to quantify the increase in mortgage rates that would result from privatizing the two companies — fifty basis points, give or take (see, for example, The GSE Implicit Subsidy and Value of Government Ambiguity).

I value Parrott and Zandi’s paper because it reminds us to keep pushing forward with real housing finance reform even though Congress has not yet made any progress on that front.

FHFA’s $500MM Win

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Bloomberg quoted me in Nomura, RBS Defective-Bond Suit Loss Seen Spurring Deals. It reads, in part,

Nomura Holdings Inc. and Royal Bank of Scotland Group Plc may face $500 million in damages for what a judge called an “enormous” deception in the sale of defective mortgage-backed securities, a ruling that may spur other banks to settle similar claims tied to the 2008 financial crisis.

Nomura and RBS were excoriated in a 361-page opinion by U.S. District Judge Denise Cote in Manhattan, whose ruling followed the first trial of claims that banks sold flawed securities to government-owned mortgage companies. After a three-week trial, Cote said they misled Fannie Mae and Freddie Mac and set a damages formula that may result in the government winning about half its original claim of $1 billion.

“The offering documents did not correctly describe the mortgage loans,” Cote, who heard the case without a jury, wrote Monday. “The magnitude of falsity, conservatively measured, is enormous.”

Before the trial, FHFA had reached $17.9 billion in settlements with other banks, including Bank of America Corp., JPMorgan Chase & Co. and Goldman Sachs Group Inc. The ruling against Nomura and RBS may encourage other banks to settle mortgage-related suits brought by regulators and private investors rather than face the bad publicity and cost of an adverse judgment, said Robert C. Hockett, a professor at Cornell Law School.

“They look pretty bad,” Hockett said in an interview. “They look like the strategy has blown up in their faces.”

Cote ordered the Federal Housing Finance Agency, which filed the case, to propose how much the banks should pay as a result of her ruling.

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Cote rejected the banks’ claim that the housing crash, and not defects in the loans, was responsible for the collapse of the mortgage-backed securities.

David Reiss, a professor at Brooklyn Law School, called Cote’s ruling “incredibly thorough.” The judge included detailed factual rulings that may make it difficult for Nomura and RBS to win on appeal, he said.

Fannie & Freddie and Multifamily

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The Urban Institute has posted a Housing Finance Policy Center Brief, The GSEs’ Shrinking Role in the Multifamily Market. It opens,

Though the two government-sponsored enterprises (GSEs)—Fannie Mae and Freddie Mac—are best known for their dominant role in the single-family mortgage market, they have also been major providers of multifamily housing financing for more than 25 years. Their role in the multifamily market, however, has declined substantially since the housing crisis and has reverted to more normalized levels. In addition, even as the GSEs continue to meet or exceed their multifamily affordable housing goals, their financing for certain underserved segments of the market has fallen steeply in recent years.

Given recent declines, policymakers and regulators should consider maintaining or increasing the GSEs’ footprint in the multifamily market, especially in underserved segments. The scorecard cap increases and exemptions recently employed by the Federal Housing Finance Agency (FHFA) to slow the decline in GSE multifamily volume have been somewhat effective, but they may not be enough to prevent the GSEs’ role from shrinking further. (1)

The policy brief’s main takeaway is that “policymakers and regulators should consider maintaining or increasing GSEs’ role in the multifamily market.” (8) I was struck by the fact that this policy brief pretty much took for granted that it is good for the GSEs to have such a big (and increasing) role in the multifamily market:

Though the multifamily market continues to remain strong and private financing is readily available today, it is also poised to grow significantly because of rising property prices and higher future demand. This raises the question of whether the GSEs should continue to shrink their multifamily footprint even further below the level of early 2000s, a period of relatively stable housing market. (8)

Government intervention in markets is usually called for when there is a market failure. The policy brief indicates the opposite — “private financing is readily available today.” The brief does argue that financing “backed by pure private capital is likely to be concentrated within the more profitable mid-to-high end of the market.” (9) That does not indicate that there is a market failure, just that borrowing costs should be cheaper for such projects. If the federal government is going to effectively subsidize a functioning credit market through the GSEs, it should make sure that it is getting something concrete in return, like affordable housing. Just supporting a credit market generally because it tends to support affordable housing is an inefficient way to achieve public goods like affordable housing. It also is a recipe for special interest capture and a future housing finance crisis. To the extent that this private credit market can function on its own, the government should limit its role to safety and soundness regulation and affordable housing creation.

Monday’s Adjudication Roundup

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Reiss on Mortgage Lingo

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MainStreet.com quoted me in 10 Terms of Mortgage Industry Lingo for Potential Homeowners to Learn. It reads, in part,

The mortgage industry is no different from the rest of the financial or tech world and is fraught with odd terminology, tons of acronyms and other confusing jargon.

While it appears to be a great deal of inaccessible blather, learning what these terms really mean can save homeowners thousands of dollars as they are negotiating the terms of their mortgage.

Unpacking the lingo is the first step as you sink your hard-earned money into a house for the next 30 years. Pretty soon you can banter about points and closings just like the rest of the experts.

Here are ten terms that we demystify as you prepare you as you embark on one of the largest commitments in your lifetime.

Freddie Mac, Fannie Mae and Ginnie Mae – Is There a Family Connection?

Just who exactly are Freddie Mac and Fannie Mae? What about Ginnie Mae? This trio was created by the federal government to support a national market for mortgage credit, said David Reiss, a law professor at Brooklyn Law School in New York. None of these entities interacts directly with homebuyers. Instead, all have the goal to make it easier for mortgage lenders to sell mortgages to investors by promising “those in mortgage-backed securities that they will receive their payments of interest and principal in a timely manner in case borrowers default on their payments,” he said.

After a wave of foreclosures following the Great Depression, Ginnie Mae was created by the government to support affordable housing in the U.S. Now it provides funding for all government-insured or government-guaranteed mortgage loans.

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Points

Real estate brokers and mortgage lenders discuss points quite often, especially as you get closer to finalizing the terms of your mortgage, since they are negotiable. This refers to the percentage points of the loan amount that a lender charges to a borrower for a loan, Reiss said. For instance, if a lender charges 1 point on a $200,000 loan, the borrower will owe an additional $2,000 to the lender at the time the loan is closed.

The Future of Fannie and Freddie: The Definitive Panel!

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The  NYU Journal of Law & Business has published The Future of Fannie and Freddie (also on SSRN):

This is a transcript of a panel discussion titled, “The Future of Fannie and Freddie.” The panelists were Dr. Mark Calabria from the Cato Institute; Professor David Reiss from Brooklyn Law School; Professor Lawrence White from NYU Stern School of Business; Dr. Mark Willis from NYU’s Furman Center for Real Estate and Urban Policy. The panel was moderated by Professor Michael Levine from NYU School of Law. Panelists looked at economic policy and future prospects for Fannie and Freddie. My remarks focused on the goals of housing finance policy.

The actual panel occurred some time ago, but it remains current given the limbo in which housing finance reform finds itself.