Tag Archives: MBS

Dirty REMICs: A Debate

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Brad, Joshua Stein and I have posted Dirt Lawyers and Dirty REMICs: A Debate to SSRN (also on BePress). Brad and I had posted our side of the debate at various points, but the entire back and forth is contained in this one handy download. The abstract reads:

In mid-2013, Professors Bradley T. Borden and David J. Reiss published an article in the American Bar Association’s PROBATE & PROPERTY journal (May/June 2013, at 13), about the disconnect between the securitization process and the mechanics of mortgage assignments. The Borden/Reiss article discussed potential legal and tax issues caused by sloppiness in mortgage assignments.

Joshua Stein responded to the Borden/Reiss article, arguing that the technicalities of mortgage assignments serve no real purpose and should be eliminated. That article appeared in the November/December 2013 issue of the same publication, at 6.

Stein’s response was accompanied by a commentary from Professors Borden and Reiss, which also appeared in the November/December 2013 issue, at 8.

Rating Agency 1st Amendment Defense Weakened, Again

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Federal District Judge O’Toole (D. Mass.) issued an Opinion and Order in Federal Home Loan Bank of Boston v. Ally Financial Inc. et al., No. 11-10952 (Sept. 30, 2013)  relating to the potential liability of S&P and Moody’s (the Rating Agency Defendants) for their ratings. The case “arises from the purchase of private label mortgage-backed securities” (PLMBS) by the plaintiff, FHLB Boston. (1)  FHLB Boston alleges that the rating agency defendants knew that their ratings “were inaccurate and based on flawed models, and that their conduct gives rise to” a claim for fraud as well as other causes of action. (1) The Rating Agency Defendants sought to have the claims dismissed for failure to state a claim. The Court rejected this as to the fraud claim:

The Rating Agency Defendants’ argument that their ratings are non-actionable opinions is unconvincing. As discussed in Abu Dhabi I, “[a]n opinion may still be actionable if the speaker does not genuinely and reasonably believe it or if it is without basis in fact.” 651 F. Supp. 2d at 176 (internal citations omitted). Here the Bank has pled with sufficient particularity that the Rating Agency Defendants issued ratings that they did not genuinely or reasonably believe. For example, the Amended Complaint alleges that the Rating Agency Defendants diluted their own standards and carried out their ratings procedures in an intentionally lax manner as to PLMBS while maintaining higher standards in other contexts. The Bank has also sufficiently pled scienter, alleging that the Rating Agency Defendants competed for business by artificially inflating ratings, as they were only paid if they provided high ratings. (4)

Rating agencies were able to avoid liability for decades, claiming that their ratings were like min-editorials that were protected by the First Amendment. A number of recent cases reject that defense in a variety of contexts (See here, here and here for instance). It is unclear what will happen when these cases are appealed, but for now it appears that a number of courts have identified situations where an opinion can be more than an opinion — it can amount to actionable fraud.

Borden & Reiss on REMIC Failure, in a Big Way

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Brad and I posted REMIC Tax Enforcement as Financial-Market Regulator to SSRN (as well as to BePress). The article is forthcoming in the University of Pennsylvania Journal of Law and Business and it provides our extended analysis of how the organizers of purported Real Estate Mortgage Investment Conduits (REMICs) failed to abide by the requirements necessary to obtain the favorable REMIC tax status. We had addressed this topic in shorter articles here, here, and here, but this is our most comprehensive take on the subject. We look forward to hearing reactions to it.

The abstract reads:

Lawmakers, prosecutors, homeowners, policymakers, investors, news media, scholars and other commentators have examined, litigated, and reported on numerous aspects of the 2008 Financial Crisis and the role that residential mortgage-backed securities (RMBS) played in that crisis. Big banks create RMBS by pooling mortgage notes into trusts and selling interests in those trusts as RMBS. Absent from prior work related to RMBS securitization is the tax treatment of RMBS mortgage-note pools and the critical role tax enforcement should play in ensuring the integrity of mortgage-note securitization.

This Article is the first to examine federal tax aspects of RMBS mortgage-note pools formed in the years leading up to the Financial Crisis. Tax law provides favorable tax treatment to real estate mortgage investment conduits (REMICs), a type of RMBS pool. To qualify for the favorable REMIC tax treatment, an RMBS pool must meet several requirements relating to the ownership and quality of mortgage notes. The practices of loan originators and RMBS organizers in the years leading up to the Financial Crisis jeopardize the tax classification of a significant portion of the RMBS pools. Nonetheless, the IRS appears to believe that there is no legal or policy basis for challenging REMIC classification of even the worst RMBS pools. This Article takes issue with the IRS’s inaction and presents both the legal and policy grounds for enforcing tax law by challenging the REMIC classification of at least the worst types of RMBS pools. The Article urges the IRS to take action, recognizing that its failure to police these arrangements prior to the Financial Crisis is partly to blame for the economic meltdown in 2008. The IRS’s continued failure to police RMBS arrangements provides latitude to industry participants, which facilitates future economic catastrophes. Even without the IRS taking action, private parties can rely upon the blueprint set forth in the Article to bring qui tam or whistleblower claims to accomplish the purposes of the REMIC rules and obtain the beneficial results that would occur if the IRS enforced the REMIC rules.

Borden and Reiss on High-Stakes MBS Litigation

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Brad and I posted Goliath Versus Goliath in High-Stakes MBS Litigation on SSRN (and BePress).  The abstract reads,

The loan-origination and mortgage-securitization practices between 2000 and 2007 created the housing and mortgage-backed securities bubble that precipitated the 2008 economic crisis and ensuing recession. The mess that the loan-origination and mortgage-securitization practices caused is now playing out in courts around the world. MBS investors are suing banks, MBS sponsors and underwriters for misrepresenting the quality of loans purportedly held in MBS pools and failing to properly transfer loan documents and mortgages to the pools, as required by the MBS pooling and servicing agreements. State and federal prosecutors have also filed claims against banks, underwriters and sponsors for the roles they played in creating defective MBS and for misrepresenting the quality of the assets purportedly held in MBS pools. This commentary focuses on the state of this upstream litigation. It reviews claims of several complaints and discusses some decisions on motions for summary judgment in several of the cases. The commentary is not a comprehensive review of all the activity in this area, but it does provide an overview of the issues at stake in this litigation. The litigation in this area is still relatively new, but with hundreds of billions of dollars at stake, it will likely last for years to come and should reshape the MBS landscape.

Replacing Rating Agencies

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Although rating agencies have been the subject of much criticism, including much from yours truly, (here for instance) there is no clearly superior replacement for the existing business model.  Even worse, there is not even much theoretical work on alternatives. Thus, it is exciting to see that Becker and Opp have posted a new paper, Replacing Ratings, that at least considers a plausible alternative.

Their paper examines “a unique change in how capital requirements are assigned to insurance holdings of mortgage-backed securities. The change replaced credit ratings with regulator-paid risk assessments by Pimco and BlackRock.” (1) But their analysis did not “find evidence for more accurate inputs to regulation.” (3, emphasis removed) Indeed, their “empirical analysis reveals that the old system was better able to discriminate between risks. As a result, the old system based on ratings not only provided higher levels of capital, but also ensured that capital was more appropriately related to risks.” (3-4)

By the end of their analysis, they believe that “the new system only recognizes current (expected) losses, but does not provide any buffer against possible future losses. Our results are consistent with regulatory changes being largely driven by industry interests.” (21)

They find the new system is worse than the old system and that the new system benefits the industry.  So why should we care about this research at all?  For at least three reasons:

  1. it identified a change in the insurance industry that has implications way beyond that industry;
  2. it compared how two different MBS evaluation systems performed; and
  3. it identified the drawbacks of the new system.

This is how we begin to build a body of knowledge about “viable alternatives to ratings.” (2) But, of course, there is much more work to be done.

 

Dirty REMICs, Revisited

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Brad and I have posted, Dirty REMICs, Revisited (also on BePress).  The abstract reads:

We review the differences between two visions for the residential mortgage markets, one driven by the goal of efficiency and the other driven by the goals of efficiency and consumer protection. Both visions advocate for structural reform, but one advocates for industry-led change and the other advocates for input from a wider array of stakeholders. Broader input is not only important to ensure that a broad range of interests are represented but also to ensure the long-term legitimacy of the new system. This is a response to Joshua Stein, Dirt Lawyers Versus Wall Street: A Different View, Probate and Property (2013 Forthcoming), which in turn is a response to Bradley T. Borden & David J. Reiss, Dirt Lawyers and Dirty REMICs, Probate and Property 12 (May/June 2013).

The Potentially Far Reaching Affects of The Ibanez Holding on Foreclosure Proceedings

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The holding in U.S. Bank National Ass’n v. Ibanez, 458 Mass. 637, 941 N.E.2d 40 (2011) potentially may have far reaching affects on foreclosure litigation outcomes across the nation.

Although a state case, Ibanez has national implications for several reasons; the Massachusetts Supreme Court is one of the most respected state supreme courts in the country, a majority of states have laws similar to Massachusetts, and the questions in the case stemming from irregularities in the residential securitized mortgage industry are wide spread.

In Ibanez the Massachusetts Supreme Court was faced with the issue of the validity of foreclosures when the mortgages are part of securitized mortgage lending pools. It is typical practice for mortgages to be bundled and dealt to Wall Street investors. The ownership of mortgage loans are then divided and transferred numerous times with little to no restrictions. However, the mortgage loan transfers’ recordation and documentation often times lag far behind.

The mortgage assignment in the case of Ibanez was executed “in blank” and was not actually recorded until over a year after the foreclosure process had begun. The court’s major problem with the banks was that they did not possess – and could not establish evidence of – a legally effective mortgage assignment showing that they actually held the mortgage. The banks did not posses the mortgage note, thus they lacked standing to sue. Additionally, the banks put the endorsement in blank, without naming the entity to which they were assigning the mortgage. This was a violation of Massachusetts’s law.

Accordingly, the court found that the plaintiff banks – who were not the original mortgagees – failed to make the required showing that they were the holders of the mortgages at the time of foreclosure. As a result their requests for a declaration of clear title were denied.

The court explicitly held that there must be evidence of a valid assignment of the mortgage at the time the foreclosure process commences. However, the court did not specify exactly what type of evidence would suffice to establish what evidence satisfies this requirement.This holding, if applied in its broadest sense, has the potential to ban most securitized mortgages in the country from being foreclosed upon.