Tag Archives: MBS

Life Post-Fannie, Post-Freddie

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The Congressional Budget Office has released a report, Transitioning to Alternative Structures for Housing Finance. This report

examines various mechanisms that policymakers could use to attract more private capital to the secondary mortgage market. The report also addresses how those mechanisms could be combined in different ways to help the market make the transition to a new structure during the coming decade. CBO analyzed transition paths to four alternative structures that involve choices about whether the government would continue to guarantee payment on mortgages and MBSs and, if so, what form and prices those guarantees would have. Under those different structures, the government’s activities would range from providing full or partial guarantees for a large share of the mortgage market to playing a minimal role in a largely private market (except perhaps during a financial crisis). Any transition to a new type of secondary market would also require decisions about what to do with the existing operations, guarantee obligations, and investment holdings of Fannie Mae and Freddie Mac. (1, footnotes omitted)

The report has three key findings:

1.  A transition to a new structure for housing finance that emphasized private capital could reduce costs and risks to taxpayers. One drawback to such a transition is that mortgages could become somewhat less available and more expensive to borrowers. Thus, over the longer term, it could also result in a modest shift of the economy’s resources away from housing toward other activities.
2.  Although the transition to a new structure could significantly decrease the number of borrowers who received mortgages backed by Fannie Mae or Freddie Mac, additional private capital would replace most of the lost funding. Borrowers would probably not face significant increases in interest rates because the two GSEs’ current pricing is not too far below market pricing. Consequently, a gradual transition would probably exert only modest downward pressure on house prices.
3.  Because policymakers have already raised the guarantee fees charged by Fannie Mae and Freddie Mac close to those that CBO estimates would be charged by private insurers, the budgetary costs of the two GSEs’ activities over the next 10 years are expected to be small. As a result, the budgetary savings would also be small under any of the transition paths to a more private system that CBO considered. Thus, the choice between the different market structures probably rests primarily on considerations other than budgetary costs. (2)
I have been a long-time advocate for attracting more private capital to the secondary mortgage market, so I welcome this report. Given the public statements of the Obama Administration and the composition of the new Congress, there appears to be an opportunity to move in that direction. A bipartisan reform plan for the housing finance system will need to provide for a lender of last resort; appropriate consumer protection; and assistance for households that are underserved by the private market. There seems to be bipartisan will to reform this system, so we just need to chart a way to achieve it. This report leads us down the right path.

Hockett on NYC Eminent Domain

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Bob Hockett has posted ‘We Don’t Follow, We Lead’: How New York City Will Save Mortgage Loans by Condemning Them to SSRN. The abstract reads,

This brief invited essay lays out in summary form the eminent domain plan for securitized underwater mortgage loans that the author has been advocating and helping to implement for some years now. It does so with particular attention in this case to New York City, which is now actively considering the plan. The essay’s first part addresses the plan’s necessity. Its second part lays out the plan’s basic mechanics. The third part then systematically addresses and dispatches the battery of remarkably weak legal and policy arguments commonly proffered by opponents of the plan.

Hockett has been advocating this plan for some time in the face of concerted opposition from the financial industry. One industry argument that I have found to be over the top is that lenders will refuse to lend in communities that employ eminent domain to address the foreclosure crisis. Hockett writes,

Another policy argument made by some members of the securitization industry is that using eminent domain to purchase loans will dry up the sources of mortgage credit, rendering the American dream of homeownership unattainable. The financial services industry and its legislative supporters have made this kind of claim against regulatory and consumer protection proposals emerging from national, state, or municipal legislatures.

One problem with this argument is that private credit has not flowed to non-wealthy mortgage borrowers since the crash. Federal lenders and guarantors are nearly the only game in town, and they are likely to remain so until the underwater PLS loan logjam is cleared.

Another problem with the credit withdrawal argument is that it characterizes a benefit as a burden. The housing bubble was, like most of the more devastating bubbles through history, the upshot of an over-extension of credit. Lenders extended excess credit through reverse redlining and other predatory lending practices perpetrated or aided and abetted by participants in the securitization industry itself. Hence the securitization industry’s warning that credit might not be overextended in the future is a warning of something that might well be desirable. (142-43, footnotes omitted)

Given that lenders always rush to lend to countries that have recently defaulted on their sovereign debt, I don’t find the credit withdrawal argument to be particularly convincing here. But it may succeed in convincing some local governments not to proceed with their eminent domain strategies. I do hope, however, that at least one locality will follow through during the current foreclosure crisis. That way, we will at least have a proof of concept for the next foreclosure crisis.

 

Romano’s Iron Law of Financial Regulation

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Roberta Romano has posted an essay, Further Assessment of the the Iron Law of Financial Regulation:  A Postscript to Regulating in the Dark, to SSRN. The abstract reads,

In an earlier companion essay, Regulating in the Dark, I contended that there is a systemic pattern in major U.S. financial regulation: (i) enactment is invariably crisis driven, adopted at a time when there is a paucity of information regarding what has transpired, (ii) resulting in off-the-rack solutions often poorly fashioned to the problem at hand, (iii) with inevitable flaws given the dynamic uncertainty of financial markets, (iv) but arduous to revise or repeal because of the stickiness of the status quo in the U.S. political framework of checks and balances. This pattern constitutes an “Iron Law” of U.S. financial regulation. The ensuing one-way regulatory ratchet generated by repeated financial crises has produced not only costly policy mistakes accompanied by unintended consequences but also a regulatory state whose cumulative regulatory impact produces over time an increasingly ineffective regulatory apparatus.

This Postscript analyzes the experience with regulators’ implementation of Dodd-Frank since the publication of the earlier essay. After a discussion of broad issues related to the statute and its implementation, the analysis focuses on two provisions by which Dodd-Frank exemplifies the difficulties that are created by legislative strategies conventionally adopted in crisis-driven legislation, off-the-rack solutions along with open-ended delegation to regulatory agencies as legislators, who perceive a political necessity to act quickly, adopt ready-to-go proposals offered by the policy entrepreneurs to whom they afford access: the Volcker rule, which prohibits banks’ proprietary trading, and the creation of the Consumer Financial Protection Bureau. The analysis bolsters the original essay’s contention regarding the inherent flaws in major financial legislation and the corresponding benefit for improving decision-making that would be obtained from employing, as best practice, the legislative tools of sunsetting and experimentation to financial regulation. The use of those techniques, properly implemented, advances means-ends rationality, by better coupling the two, and improves the quality of decision-making by providing a means for measuring and remedying regulatory errors.

This is a foray into the dark heart of financial regulation. Romano finds much to be unhappy with. I disagree, however, with some of her main points. For instance, I think that her assessment of the role of the CFPB in the broader context of financial regulation misses the mark. She argues that the “absence of a designated consumer-product regulator” did “not contribute to the financial crisis.” (28) In fact, regulating exotic loan terms like Option ARMs and teaser rates would have slowed the expansion of the subprime market. Those exotic terms allowed lenders to keep the party going longer than it would have otherwise. And that would have limited the exposure of financial institutions to subprime mortgage-backed securities.

Notwithstanding my disagreements with this essay, I think that Romano’s “Iron Law” of financial regulation remains, unfortunately, quite strong.

 

Reiss on Catching FIRREA

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Inside ABS & MBS quoted me in Experts: New AG Likely to Continue Aggressive Use of FIRREA Against Industry, Individual Executives Targeted (behind a paywall). It reads in part,

Mortgage industry executives should be aware and expect continued – and perhaps even more muscular – use of a 1989 federal law by government prosecutors to pursue mortgage-related claims. At the direction of Attorney General Eric Holder, the Department of Justice embraced the use of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) in MBS lawsuits. Despite Holder’s announcement late last month that he is stepping down after six years as AG, there is little reason to expect that President Obama’s new attorney general will surrender use of such a “potent statute” that has employed a lower burden of proof and long statute of limitations to exact large tribute from the mortgage industry, according to Marjorie Peerce of the Ballard Spahr law firm.

*     *    *

Brooklyn Law School Professor David Reiss agrees. He added that throughout President Obama’s term, the White House at the highest level has set an agenda for corporate accountability so it’s likely that one of the chief mandates of Holder’s successor will be the continuation of the DOJ’s vigorous use of tools such as FIRREA.

During a speech last month prior to announcing his resignation, Holder called for making the FIRREA statute even stronger, with whistleblower bounties raised to induce more testimony. However, Reiss noted it’s unlikely the White House would be keen to encourage lawmakers to take another look at FIRREA given that Congress next year will likely be in Republican hands.

However, Reiss called attention to a part of Holder’s speech where the AG expressed frustration with the DOJ’s inability to hold financial services executives criminally liable for alleged misconduct. Holder suggested several ways for the DOJ to do so, including extending the “responsible corporate officer doctrine” to the financial services industry.

Under this doctrine, an individual may be prosecuted criminally under the Food, Drug and Cosmetic Act even absent culpable intent or knowledge of wrongdoing if the executive was in a position to prevent the wrongdoing and failed to do so.

“Focusing on individual culpability could be a new charge of the new attorney general,” said Reiss. “Given the events of the last 10 years, [a significant number of] people think that fewer individuals were held accountable for the financial crisis than should have been, so I think the Department of Justice may have heard that message as well.”

Reiss on The FHFA’s Common Securitization Platform

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I have submitted my response to the FHFA’s Request for Input on the Proposed Single Security Structure.  The abstract for my response, The FHFA’s Proposed Single Security Structure, reads,

The Federal Housing Finance Agency (FHFA) has posted a Request for Input on “the proposed structure for a Single Security that would be issued and guaranteed by Fannie Mae or Freddie Mac.”  The FHFA states it is most concerned with achieving “maximum secondary market liquidity” (Request for Input, at 8)

I am skeptical about the reasons for this move to a Single Security and whether it will achieve maximum liquidity. Moreover, it is unclear to me that this move reflects an urgent need for the FHFA, the two companies, originating lenders or borrowers. While I have no doubt that it could slightly increase liquidity and slightly decrease the cost of credit, I do not see this move as having a meaningful effect on either.

This move is consistent, however, with a move toward a new model of government-supported housing finance, one that could contemplate an end to Fannie and Freddie as we know them and the beginning of a more utility-like securitizer.  If, indeed, the FHFA is taking this step, it should be more explicit as to its reasons for doing so.

Reiss on Housing Finance Reform

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Inside MBS and ABS, the trade journal, quoted me in DeMarco Cites ‘Structural Improvements’ in Housing Six Years After GSE Conservatorship, More Needed (behind a paywall). It reads,

Six years after the government takeover of Fannie Mae and Freddie Mac, the former regulator of the government-sponsored enterprises noted that the housing finance system has made “significant progress.” But even as critical structural changes are underway, comprehensive improvement is still several years out.

In a policy paper issued last week, Edward DeMarco–new senior fellow-in-residence for the Milken Institute’s Center for Financial Markets–said that house prices, as measured by the Federal Housing Finance Agency, have recovered more than 50 percent since their decline in 2007.

“While the damage from the housing crisis has been substantial, we are finally seeing a sustained market recovery,” said the former FHFA chief. “The crisis showed that numerous structural improvements were needed in housing–and such improvements have been underway for several years.”

Poor data, misuse of specialty mortgage products, lagging technologies, weak servicing standards and an inadequate securitization infrastructure became evident during the crisis.

“New data standards have emerged…with more on the way,” wrote DeMarco. “These standards should improve risk management while lowering origination costs and barriers to entry.” Development of the new securitization structure, begun more than two years ago, “should be a cornerstone for the future secondary mortgage market,” he added.

DeMarco said the major housing finance reform bills in the House and Senate share key similarities: “winding down Fannie Mae and Freddie Mac, building a common securitization infrastructure and drawing private capital back into the marketplace while reducing taxpayer involvement.”

DeMarco added, “We should build on these similarities, making them the cornerstone features of final legislation.” Prolonging the GSEs’ conservatorship, he warned, “will continue to distort the market and place taxpayers at risk.”

David Reiss, research director of the Center for Urban Business Entrepreneurship at the Brooklyn Law School, lauded the common securitization project. But Reiss worried the former FHFA head is too optimistic about the state of Fannie and Freddie.

“The GSEs have been in a state of limbo for far too long,” said Reiss. “All sorts of operational risks may be cropping up in the entities as employees sit around or walk out the door waiting for Congress to act.”

Reiss on FIRREA Storm

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Law360 quoted me in Bold 10th Circ. Opinion Muddies FIRREA Challenges. The article opens,

The Tenth Circuit last week gave a strong argument as to why a recent U.S. Supreme Court decision has no bearing on one federal agency’s ability to sue over soured mortgage-backed securities, but that won’t stop big banks from trying to convince different courts otherwise, legal experts say.

The appeals court’s opinion said a June high court ruling did not alter its original ruling that the National Credit Union Administration Board’s suit against Nomura Home Equity Loan Inc. and a number of other MBS originators was not time-barred.

The Supreme Court had found that a lawsuit by North Carolina residents under the federal Comprehensive Environmental Response, Compensation and Liability Act was time-barred by the state’s statute of repose

But the regulator of federally chartered credit unions is bringing its claim under the Financial Institutions Reform, Recovery and Enforcement Act, and the appeals court said that law’s so-called extender statute was not subject to the same limitations the Supreme Court had found in the Superfund pollution cleanup law at the heart of CTS Corp. v. Waldburger.

Rather, the language of FIRREA and its legislative history made it clear Congress had intended the law to have its own statute of limitations and not be bound by other statutes of repose, the appeals panel wrote, responding to a Supreme Court order that it take a second look at its earlier decision.

Before the Tenth Circuit issued its decision, defense attorneys had looked to the Supreme Court’s remand as a chance to give banks some relief from the lingering hangover of government lawsuits, many of which have ended with banks coughing up hundreds of millions, if not billions, of dollars in damages.

And it’s clear banks will still fight for that relief. In a motion for summary judgment Friday, attorneys for RBS told a Connecticut district court judge he should toss an FHFA suit brought under the extender statute of the Housing and Economic Recovery Act, in light of the time bar established by the Supreme Court in Waldburger.

In doing so, the attorneys also urged the judge to disregard the Tenth Circuit’s opinion, arguing it was flawed.

“Nomura, of course, is not controlling in this circuit, and the opinion on remand fails to faithfully apply the analytical framework established in Waldburger, instead sidestepping Waldburger by focusing on superficial distinctions between the CERCLA and NCUA extender statutes,” the attorneys wrote.

Experts say such disputes will continue on.

“The debate is not over by any stretch of the imagination,” David Reiss, a professor at Brooklyn Law School, said. “There’s enough at stake for powerful and well-financed institutions that this will be played out to the fullest.”

While legal experts say they can’t predict how other jurisdictions will move on similar questions about timeliness under FIRREA, they say the Tenth Circuit approached the task of reaffirming its earlier opinion in a way that appeared designed to withstand high court scrutiny.

“It is a thorough opinion. I think that other courts will take this opinion very seriously,” Reiss said.