Tag Archives: MBS

Open Season on Homeowners

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A case coming out of California, Peng v. Chase Home Finance LLC et al., No. B245436 (California Courts of Appeal Second App. Dist., Div. 8, April 8th, 2014, has attracted a lot of attention in the blogosphere. This is particularly notable because this case is not to be published in the official reports and thus has no precedential value. Judge Rubin’s dissent has attracted much of the attention. It opens,

The promissory note signed by appellants Jeffry and Grace Peng obligated them to repay their home loan. In August 2007, Freddie Mac acquired the promissory note from Chase. Based on Freddie Mac owning the note, appellants seek to amend their complaint to allege Chase did not have authority to enforce the promissory note or to foreclose on their home, but the majority rejects appellants’ proposed amendment. Relying on case law rebuffing a homeowner’s challenge to a creditor-beneficiary’s authority to foreclose, the majority notes that courts have traditionally reasoned that the homeowner’s challenge is futile because, even if successful, the homeowner “merely substitute[s] one creditor for another, without changing [the homeowner’s] obligations under the note.” (Fontenot v. Wells Fargo Bank, N.A. (2011) 198 Cal.App.4th 256, 271.) The only party prejudiced by an illegitimate creditor-beneficiary’s enforcement of the homeowner’s debt, courts have reasoned, is the bona fide creditor-beneficiary, not the homeowner.

Such reasoning troubles me. I wonder whether the law would apply the same reasoning if we were dealing with debtors other than homeowners. I wonder how most of us would react if, for example, a third-party purporting to act for one’s credit card company knocked on one’s door, demanding we pay our credit card’s monthly statement to the third party. Could we insist that the third party prove it owned our credit card debt? By the reasoning of Fontenot and similar cases, we could not because, after all, we owe the debt to someone, and the only truly aggrieved party if we paid the wrong party would, according to those cases, be our credit card company. I doubt anyone would stand for such a thing. (Dissent, 1)

The dissent’s concern is justified. As Professor Whitman has recently noted on the Dirt Listserv and elsewhere, it is a “bizarre notion that anyone can foreclose a mortgage without showing that they have the right to enforce the note.” He also notes that the majority (and even the dissent) in Peng confuse ownership of the note with the right to enforce it. Until courts fully understand how the UCC governs the enforcement of notes, one should worry that some state court judges might declare an open season on homeowners as the majority does here in Peng.

Inside Johnson-Crapo

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Enterprise Community Partners, Inc. has posted Inside Johnson-Crapo: What the Senate Housing Finance Reform Bill Could Mean for Low- and Moderate-income Communities. Parsing the various Congressional proposals for housing finance reform is hard enough for an expert, let alone for an interested observer. This policy brief provides a helpful overview of the proposal that is setting the terms for the debate today, with a focus on low- and moderate-income homeownership. Its key findings include:

  • The bill, called the Housing Finance Reform and Taxpayer Protection Act of 2014 or S. 1217, lays a clear and thoughtful path forward for the nation’s housing finance system, including the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.
  • A new federal agency, modeled after the Federal Deposit Insurance Corporation, would oversee the entire secondary mortgage market and establish a new system of government-insured mortgage-backed securities (MBS). In exchange for a fee, the agency would provide limited insurance against catastrophic losses on qualifying securities issued by private companies. Investors in the private companies would need to incur significant losses before the insurance pays out to holders of the MBS. The bill also winds down Fannie Mae and Freddie Mac, the mortgage companies that were placed under government conservatorship in 2008.
  • The bill includes several provisions to ensure that the new system adequately serves low- and moderate-income communities. First, it requires any issuer of government-insured securities to serve all eligible single-family and multifamily mortgages. Second, it preserves the GSEs’ current businesses for financing rental housing, while ensuring that those businesses continue to support apartments that are affordable to low-income families. Third, it requires issuers to contribute funding to programs that support the creation and preservation of affordable housing. Finally, it creates new market-based incentives to serve traditionally underserved segments of the housing market.
  • Enterprise strongly supports the direction laid out in this bill and appreciates the inclusion of important multifamily provisions. At the same time, we suggest several proposals to further strengthen the bill. Among other things, we recommend that lawmakers promote a level playing field among eligible risk-sharing models; authorize the federal regulator to enforce the bill’s “equitable access” rule; expand the scope of the affordable housing fee; simplify the incentives for supporting underserved market segments; and establish separate insurance funds for single-family and multifamily securities. (1)

The left has criticized Johnson-Crapo for not doing enough for low- and moderate-income homeownership. The right has criticized it for leaving too much risk with the taxpayer. But it seems that a broad center finds that the outline provided by the bill provides a way forward from the zombie-state housing finance finds itself in, with a Fannie and Freddie neither fully alive nor fully dead. Nobody seems to think that a bill will pass this year. But hopefully Congress will keep attending to this issue and we can soon see a resurrected housing finance system, one that can take us through much of the 21st Century just as Fannie and Freddie got us through the 20th.

 

Reiss on BoA-FHFA Settlement

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Inside The GSEs quoted me in BofA MBS Lawsuit Settlement Shrinks List of FHFA Defendants (behind a paywall). It reads,

It’s only a matter of time before the remaining big bank defendants settle lawsuits filed by the Federal Housing Finance Agency over billions in non-agency mortgage-backed securities sold to Fannie Mae and Freddie Mac in the years leading up to the housing crisis, predicts a legal expert.

Last week, Bank of America agreed to a $9.3 billion settlement that covers its own dealings as well as those of Countrywide Financial and Merrill Lynch, which it acquired in 2008. The agreement covers some $57 billion of MBS issued or underwritten by these firms.

BofA did not admit liability or wrongdoing but it will pay $5.8 billion in cash to Fannie and Freddie and repurchase about $3.5 billion in residential MBS at market value. In return, FHFA’s lawsuits against the bank will be dismissed with prejudice.

The FHFA said it is working to resolve the remaining lawsuits regarding non-agency MBS purchased by the GSEs between 2005 and 2007. The suits involve alleged violations of federal and state securities laws and allegations of common law fraud. One week earlier, the Finance Agency announced that Credit Suisse Group had agreed to pay $885 million to settle a similar lawsuit.

Under the terms of that agreement, Credit Suisse will pay approximately $234 million to Fannie and approximately $651 million to Freddie. In exchange, certain claims against Credit Suisse related to the securities involved will be released.

So far, the FHFA’s lawsuits have recovered $19.5 billion in total payments. Expect more where that came from, said David Reiss, a professor at Brooklyn Law School.

“Every case is different and each institution has a different risk profile in terms of litigation strategy,” said Reiss. “The BofA settlement is so high profile because it’s Countrywide. It gives a lodestar when trying to figure out how low [defendants] can go in a settlement offer.”

Prior to the BofA deal, the FHFA had collected $8.9 billion in prior settlements. The Morgan Stanley settlement is the fourth largest of those settlements, behind Deutsche Bank, which agreed to pay $1.93 billion in December, and JPMorgan Chase, which reached a $4 billion settlement in October.

The bank defendants have repeatedly tried and failed to dismiss the FHFA suits on procedural grounds, including a claim that the cases were no longer timely.

In October, the U.S. Supreme Court declined to hear an appeal from the banks, prompting the expectation in legal circles that few, if any, of the remaining cases will ever go to trial.

“I don’t think that if you are a [big bank] defendant, that you see a particularly favorable judiciary,” said Reiss. “You see that the government is able to reach deals with companies in front of you and I think you’re thinking about settling.”

Entities that have yet to settle non-agency MBS claims with the FHFA include Barclays Bank, First Horizon National Corp., Goldman Sachs, HSBC, Nomura Holding America and the Royal Bank of Scotland.

Visualizing The Residential Mortgage Market

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Compass Point Research & Trading, LLC has a nice graph, The Mortgage Market Overview, that helps to make sense of the massive U.S. residential mortgage market. It breaks down the $20 trillion dollar U.S. residential housing market into debt and equity and then further breaks down debt into the various available types, by market share: GSE; portfolio; private-label MBS; etc.  A picture can be worth twenty trillion words . . ..

Reiss on Marketplace: Cash Cows to Slaughter

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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.

Reiss in Bloomberg on CS Lawsuit

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Bloomberg quoted me in Credit Suisse Waits for $11 Billion Answer in N.Y. Fraud Suit.  It reads in part,

As Credit Suisse Group AG (CSGN) sees it, time has run out on New York Attorney General Eric Schneiderman’s pursuit of Wall Street banks for mortgage fraud that helped trigger the financial crisis.

Schneiderman sued Credit Suisse in 2012 as part of a wide-ranging probe into mortgage bonds. He claimed Switzerland’s second-largest bank misrepresented the risks associated with $93.8 billion in mortgage-backed securities issued in 2006 and 2007.

Credit Suisse asked a Manhattan judge in December to dismiss Schneiderman’s case, as well as his demand for as much as $11.2 billion in damages. The bank argued that New York, by waiting so long to file the lawsuit, missed a three-year legal deadline for suing. The state countered that it had six years to file its complaint.

If the bank wins, Schneiderman will face a new roadblock as he considers similar multibillion-dollar claims against a dozen other Wall Street firms. The judge in New York State Supreme Court could rule at any time.

“It would obviously tilt everything in the favor of Credit Suisse and similarly situated financial institutions,” said David Reiss, a professor at Brooklyn Law School, hindering New York’s remaining efforts to hold banks accountable for mistakes that spurred a recession.

*     *     *

Since the latest bonds cited in Schneiderman’s suit originated in 2006 and 2007, if the judge chooses the bank’s argument, the lawsuit may be dismissed. If the judge takes Schneiderman’s more expansive view, most or all of the suspect bonds may still be covered by the litigation.

“The entire case is time-barred,” Richard Clary, a lawyer for the bank, told Friedman at the December hearing. Lawyers for the state argued that such limits weren’t intended to apply to the attorney general.

“We’ve successfully resolved cases filed within six years,” Deputy Attorney General Virginia Chavez Romano said, citing last year’s JPMorgan accord. “It has been our decades-long practice.”

So far, New York’s courts have broadly interpreted the statute in finding a six-year period, Brooklyn Law School’s Reiss said. That may be changing as legal scholars and financial industry lawyers question its propriety.

“Having these incredibly long and ambiguous statutes of limitations is not particularly fair,” he said.

*     *     *

Friedman’s ruling in the Credit Suisse case may be crucial to Schneiderman’s probe of close to a dozen other banks, and whether he can sue them successfully.

New York agreed with the firms in October 2012 that any legal deadline for bringing fraud claims against them would be suspended while he continues his investigation, a person familiar with the matter said.

Such tolling agreements stopped the clock on any statute of limitations and ensured Schneiderman can bring fraud claims against banks for conduct going as far back as 2006, said the person.

Brooklyn Law School’s Reiss said the banks may have agreed to the delay to avoid forcing Schneiderman to file a “kitchen sink complaint with every possible allegation in it” just to beat the clock. Doing so also builds good will with regulators and may also facilitate a favorable settlement.

The agreements don’t necessarily mean that suits will be filed, the person said. If Schneiderman sues any of the banks, they may then assert the statute of limitations is three years, and not six, just as Credit Suisse has done.

*     *     *

This may be a more potent argument if Friedman rules for the Swiss bank in the pending case.

A three-year statute-of-limitations would mean they can’t be held responsible for transactions before 2009, while a six-year deadline would allow Schneiderman to reach back to 2006.

There’s “great uncertainty” about whether Schneiderman can move forward with the Credit Suisse case in light of the statute of limitations arguments, said James Cox, a corporate law professor at Duke University in Durham, North Carolina.

Reiss said that any ruling would probably be challenged all the way to the Court of Appeals in Albany, the state’s highest court.

Mortgage REITs and Other Frights

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The Office of Financial Research in the Department of the Treasury has released its 2013 Annual Report. It describes a number of things that should scare you as you put your head on your pillow at night and dream of the financial markets. It also describes some important steps that OFR is taking to get a handle on these potential nightmares.

One of the nightmares, relevant to readers of this blog, are Mortgage REITs. Mortgage Real Estate Investment Trusts (REITs) are “leveraged investment vehicles that borrow shorter-term funds in the repo market and invest in longer-term agency mortgage-backed securities (MBS).” (16) OFR identifies serious problems in this subsector:

Mortgage REITs have grown nearly fourfold since 2008 and now own about $350 billion of MBS, or 5 percent of the agency MBS market. Two firms dominate the sector, collectively holding two-thirds of assets. By leveraging investor funds about eight times, mortgage REITs returned annual dividend yields of about 15 percent to their investors over the past four years, when most fixed-income investments earned far less.Mortgage REITs obtain nearly all of their leverage in the repo market, secured by MBS collateral.

Lenders typically require that borrowers pledge 5 percent more collateral than the value of the loan,which implies that a mortgage REIT that is leveraged eight times must pledge more than 90 percent of its MBS portfolio to secure repo financing, leaving few unencumbered assets on its balance sheet. If repo lenders demand significantly more collateral or refuse to extend credit in adverse circumstances, mortgage REITs may be forced to sell MBS holdings. Timely asset liquidation and settlement may not be feasible in some cases, since a large portion of agency MBS trades occurs in a market that settles only once a month . . ..

Although their MBS holdings account for a relatively small share of the market, distress among mortgage REITs could have impacts on the broader repo market because agency MBS accounts for roughly one-third of the collateral in the triparty repo market. Mortgage REITs also embody interest rate and convexity risks, concentration risk, and leverage. For these reasons, forced-asset sales by mortgage REITs could amplify price declines and volatility in the MBS market and  broader funding markets, particularly in an already stressed market. (17)

Sounds like systemic risk to me.

Happily, the report also contains policy proposals to address some of these systemic risk concerns. First and foremost, it proposes the adoption of a Financial Stability Monitor tool to track financial threats. The OFR also proposes mortgage-specific tools. Reiterating the findings in a recent OFR white paper, the report calls for the creation of a universal mortgage identifier so that regulators and researchers can more quickly identify patterns in the mortgage market. Predicting financial crises is still more of an art than a science but it is a good development that OFR is trying to improve the quality of the data that regulators and researchers have about the financial market.