- Morgan Stanley agrees to pay the DOJ $2.6 billion to end investigation about its mortgage-backed securities deals during the financial crisis.
- MetLife settles with DOJ for $123.5 million for issuing mortgages that did not meet underwriting standards.
- State Farm will refund $352.5 million to customers for overcharging them for homeowners’ insurance.
- New York City apartment owners are suing Lexington Insurance Co. for failing to pay more than a third of its $95.3 million claims from Superstorm Sandy.
- Bank of America moves to dismiss Ambac’s $600 million claim that Countrywide issued faulty residential mortgage-backed securities.
Tag Archives: MBS
Treasury Gives RMBS a Workout
The Treasury has undertaken a Credit Rating Agency Exercise. According to Michael Stegman, Treasury
recognized that the PLS market has been dormant since the financial crisis partly because of a “chicken-and-egg” phenomenon between rating agencies and originator-aggregators. Rating agencies will not rate mortgage pools without loan-level data, yet originator-aggregators will not originate pools of mortgage bonds without an idea of what it would take for the bond to receive a AAA rating.
Using our convening authority, Treasury invited six credit rating agencies to participate in an exercise over the last several months intended to provide market participants with greater transparency into their credit rating methodologies for residential mortgage loans.
By increasing clarity around loss expectations and required subordination levels for more diverse pools of collateral, the credit rating agencies can stimulate a constructive market dialogue around post-crisis underwriting and securitization practices and foster greater confidence in the credit rating process for private label mortgage-backed securities (MBS). The information obtained through this exercise may also give mortgage originators and aggregators greater insight into the potential economics of financing mortgage loans in the private label channel and the consequent implications for borrowing costs.
While this exercise is very technical, it contains some interesting nuggets for a broad range of readers. For instance,
The housing market, regulatory environment, and loan performance have evolved significantly from pre-crisis to present day. Credit rating agency models appear to account for these changes in varying ways. All credit rating agency models incorporate the performance of loans originated prior to, during, and after the crisis to the degree they believe best informs the nature of credit and prepayment risk reflected in the market. Credit rating agency model stress scenarios may be influenced by loans originated at the peak of the housing market, given the macroeconomic stress and home price declines they experienced. The credit rating agencies differ, however, in how their models adjust for the post-crisis regime of improved underwriting practices and operational controls. Some credit rating agencies capture these changes directly in their models, while other credit rating agencies rely on qualitative adjustments outside of their models. (10)
It is important for non-specialists to realize how much subjectivity can be built into rating agency models. Every model will make inferences based on past performance. The exercise highlights how different rating agencies address post-crisis loan performance in significantly different ways. Time will tell which ones got it right.
Monday’s Adjudication Roundup
- Consumer Financial Protection Bureau has sued and settled with Flagship Financial Group for $225,000 for advertising their mortgages as government approved.
- Citigroup, UBS and Goldman Sachs settle for $235 million over Residential Mortgage-Backed Securities that Residential Capital, LLC issued without informing consumers of the risks associated with such securities. New Jersey Carpenters Health Fund et al v. Residential Capital LLC et al, U.S. District Court, Southern District of New York, No. 08-08781.
Monday’s Adjudication Roundup
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A New York bankruptcy judge denied several mortgage originators’ motions to dismiss for Residential Capital LLC’s claims that they sold billions of dollars in defective loans.
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A few weeks after settling with the SEC for $58 million for fraudulent ratings on commercial mortgage-backed securities, Standards & Poor settles with the U.S. Department of Justice for $1.38 billion for the same fraudulent ratings.
- After dismissing a suit against Royal Bank of Scotland, Deutsche Bank and others in 2011 over mortgage-backed securities and the Second Circuit Court of Appeals nixed her dismissal, U.S. District Court Judge Deborah A. Batts has permitted New Jersey Carpenters Health Fund to file a third amended complaint to revive the suit. This could end up costing the banks $7.7 billion if the suit is successful.
- Bank of America has defeated Prudential’s claims that it sold $2 billion of fraudulent residential mortgage-backed securities.
Reiss on Financial Crisis Litigation
Law360 quoted me in Feds’ Moody’s Probe Marks Closing Of Financial Crisis Book (behind a paywall). It opens,
A reported investigation into Moody’s Investors Service’s ratings of residential mortgage-backed securities during the housing bubble era could be the beginning of the last chapter in the U.S. Department of Justice’s big financial crisis cases, attorneys say.
Federal prosecutors are reportedly making their way through the ratings agencies for their alleged wrongdoings prior to the financial crisis after wringing out more than $100 billion from banks and mortgage servicers for their roles in inflating the housing bubble. But the passage of time, the waning days of the Obama administration and the few remaining rich targets likely means that the financial industry and prosecutors will soon put financial crisis-era enforcement actions behind them, said Jim Keneally, a partner at Harris O’Brien St. Laurent & Chaudhry LLP.
“I do look at this as sort of the tail end of things,” he said.
With the ink not yet dry on a rumored $1.375 billion settlement between the Justice Department, state attorneys general and Standard & Poor’s Ratings Services, prosecutors have already reportedly turned their attention to the ratings practices at S&P’s largest rival, Moody’s, in the period leading up to the 2008 financial crisis, according to The Wall Street Journal.
The federal government and attorneys general in 19 states and Washington, D.C., had launched several suits since the financial crisis accusing S&P of assigning overly rosy ratings to mortgage-backed securities and other bond deals that ended up imploding amid a wave of defaults, causing a cascade of investor losses that amounted to billions of dollars.
Although S&P originally elected to fight the government, it ultimately elected to settle. The coming $1.375 billion settlement arrives on top of an earlier $77 million settlement with the U.S. Securities and Exchange Commission and the attorneys general of New York and Massachusetts over similar claims.
Moody’s is reportedly next in line, with Justice Department investigators reportedly having had several meetings with officials from the ratings agency that looked into whether the Moody’s Corp. unit had softened its ratings of subprime RMBS in order to win business as the housing bubble inflated.
Both the Justice Department and Moody’s declined to comment for this story.
The pursuit of Moody’s as the S&P case wraps up follows a pattern that the Justice Department set with big bank settlements for the financial crisis.
“You would expect that they would sweep through, so to speak,” said Thomas O. Gorman, a partner with Dorsey & Whitney LLP.
After reaching a $13 billion deal with JPMorgan Chase & Co. in November 2014, the Justice Department quickly turned its attention to Citigroup Inc. and Bank of America Corp., which reached their own multibillion-dollar settlements last summer.
Now prosecutors are in talks with Morgan Stanley about another large settlement, according to multiple reports.
All of those deals follow the $25 billion national mortgage settlement from 2012 that targeted banks’ pre-crisis mortgage servicing practices.
Time may be catching up with the Justice Department more than six years following the height of the crisis, even after the Justice Department began employing novel uses of the Financial Institutions Reform, Recovery and Enforcement Act, a 1989 law passed following the savings and loan crisis, Keneally said.
Using FIRREA extended the statute of limitations on financial crisis-era cases, allowing for prosecutors to develop their cases and take a systematic approach. Even that statute may have run its course, as it pertains to the crisis.
“The passage of time is such that you have evidence that no longer exists,” Keneally said.
Politics may also play a role as the financial crisis recedes from memory and the next holder of the presidency potentially looks to move forward, he said.
“We’re getting to the end of the Obama administration,” Keneally said. “I think it’s going to be hard for any administration to ramp things up again.”
And that has some wondering whether the Obama administration and the Justice Department under Attorney General Eric Holder followed the correct path.
“The Justice Department and the states’ attorneys general collected far more in their penalties and settlements than anyone could have imagined before the financial crisis,” said Brooklyn Law School professor David Reiss.
Those large settlements may give investors and top management pause when it comes to questionable activity. However, because no traders or other top banking personnel went to prison, questions remain about what deterrent effect those settlements will have on individuals.
“Big institutions are now probably deterred from some of this behavior, but are individuals who work on these institutions deterred?” Reiss said.
Reforming Fannie & Freddie’s Multifamily Business
Mark Willis & Andrew Neidhardt’s article, Reforming the National Housing Finance System: What’s at Risk for the Multifamily Rental Market if Fannie Mae and Freddie Mac Go Away?, was recently published in a special issue of the NYU Journal of Law & Business. Most of the ink spilled about the reform of Fannie and Freddie addresses their single-family lines of business. The single-family business is much bigger, but the multifamily business is also an important part of what they do.
The author’s conclude that
Reform of the nation’s housing finance system needs to be careful not to disrupt unnecessarily the existing multifamily housing market. The near collapse of Fannie and Freddie’s single-family business over five years ago resulted in conservatorship and has spawned calls for their termination. While a general consensus has since emerged that Fannie and Freddie should be phased out over time, no consensus exists as to which, if any, of their functions need to be replaced in order to preserve the affordability and availability of housing in general, and multifamily rentals in particular.
On the multifamily side, Fannie and Freddie have built specialized units using financing models that involve private sector risk-sharing (i.e., DUS lender capital at risk or investors holding subordinate tranches of K-series securities) and that have resulted in low default rates and limited credit losses. These units have benefited from an implicit government guarantee of their corporate debt, which has expanded their access to capital and lowered its cost. As a result of the implicit guarantee, Fannie and Freddie have been able to: 1) offer longer term mortgages than generally available from banks, 2) provide countercyclical support to the rental market by funding new mortgages throughout the recent housing and economic downturn, and 3) ensure that the vast majority of the mortgages they fund offer rents affordable to households earning less than even 80% of area median income.
The potential for moral hazard can be reduced without disrupting the multifamily housing market simply by separating out and nationalizing the government guarantee It would then be possible to: 1) spin off the multifamily businesses of Fannie and Freddie into self-contained entities and 2) create an explicit government guarantee, offered by a government entity, and paid for through premiums on the insured MBS. The first step could happen now with FHFA authorization. These new subsidiaries could also begin to pay their respective holding companies for providing the guarantee on their MBS. The second step requires Congressional legislation. Once the public guarantor is up and running, the guarantee would be purchased from it and these subsidiaries could then be sold to private investors. As for other reforms that would explicitly restrict market access to the government guarantee, the best approach would be to first test the private sector’s appetite for risk on higher-end deals. (539-40)
This article has a lot to offer in terms of analyzing how Fannie and Freddie’s multifamily business is distinct from their single-family business. But I do not think that it fully makes the case that the multifamily sector suffers from some sort of market failure that requires so much government intervention as it advocates. I suspect that private capital could be put into a first loss position for much more of the lending in this sector. The government could continue to support the low- and moderate-income rental market without being on the hook for the rest of the multifamily market.
SEC Update on Rating Agency Industry
The staff of the U.S. Securities and Exchange Commission has issued its Annual Report on Nationally Recognized Statistical Rating Organizations. The report documents some significant problems with the rating agency industry as it is currently structured. The report highlights competition, transparency and conflicts of interest as three important areas of concern.
Competition. There are some of the interesting insights to be culled from the report. It notes that “some of the smaller NRSROs [Nationally Recognized Statistical Rating Organizations] had built significant market share in the asset-backed securities rating category.” (16) That being said, the report also finds that despite “the notable progress made by smaller NRSROs in gaining market share in some of the ratings classes . . . , economic and regulatory barriers to entry continue to exist in the credit ratings industry, making it difficult for the smaller NRSROs to compete with the larger NRSROs.” (21)
Transparency. The report also notes that “there is a trend of NRSROs issuing unsolicited commentaries on solicited ratings issued by other NRSROs, which has increased the level of transparency within the credit ratings industry. The commentaries highlight differences in opinions and ratings criteria among rating agencies regarding certain structured finance transactions, concerning matters such as the sufficiency of the credit enhancement for the transactions. Such commentaries can serve to enhance investors’ understanding of the ratings criteria and differences in ratings approaches used by the different NRSROs.” (23) The report acknowledges that this is no cure-all for what ails the rating industry, it is a positive development.
Conflicts of Interest.Conflicts of interest have been central to the problems in the ratings industry, and were one of the factors that led to the subprime bubble and then bust of the 2000s. The report notes that the “potential for conflicts of interest involving an NRSRO may continue to be particularly acute in structured finance products, where issuers are created and operated by a relatively concentrated group of sponsors, underwriters and managers, and rating fees are particularly lucrative.” (25) There is no easy solution to this problem and it is important to carefully study it on an ongoing basis.
The staff report is valuable because it offers an annual overview of structural changes in the ratings industry. This year’s report continues to highlight that the structure of the industry is far from ideal. As the business cycle heats up, it is important to keep an eye on this critical component of the financial system to ensure that rating agencies are not being driven by short term profits for themselves at the expense of long-term systemic stability for the rest of us.
