Tag Archives: mortgage-backed securities

Reiss on Dimming of FIRREA

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Inside MBS & ABS quoted me in Judge Recommends Dismissal of DOJ’s Fraud Case Against BofA, But It May Not End FIRREA Claims (behind paywall). It reads,

A North Carolina federal magistrate has recommended that a Justice Department fraud case against Bank of America be dismissed, but he also said a separate Securities and Exchange Commission lawsuit against the bank based on a different federal law should proceed.

The DOJ last August filed suit against BofA under the Financial Institutions Reform, Recovery and Enforcement Act, accusing the bank of defrauding investors in the sale of $855 million of nonagency MBS. Last week, U.S. Magistrate David Cayer of the U.S. District Court for the Western District of North Carolina found that the government failed to prove the bank made “material” false statements to the former Federal Housing Finance Board.

The DOJ claimed that BofA “willfully” misled investors, including the Federal Home Loan Bank of San Francisco and Wachovia Corp. – now owned by Wells Fargo – about the risks in the 2008 offering by failing to fully disclose the risk of 1,191 jumbo adjustable-rate mortgages backing the deal.

FIRREA allows the government to seek civil penalties equal to losses suffered by federally insured financial institutions, with a maximum of $1.1 million per violation. The 1989 law was a little used relic of the savings and loan aftermath until government lawyers began recently to invoke it widely in addition to other charges.

The law gives agency lawyers the ability to tap grand jury material and to subpoena documents. FIRREA also has a 10-year statute of limitations, longer than the typical five years for fraud cases, allowing government lawyers more time to pursue cases related to the 2007-2008 financial crisis.

The magistrate rejected the government’s claim that BofA’s statements were in violation of FIRREA because the FHLBank of San Francisco was within the jurisdiction of the FHFB. Cayer found that policing such statements did not fall within the agency’s purview and there was no indication that either the FHFB or the FHLBank ever complained about the MBS.

The magistrate recommended the DOJ’s case be dismissed without prejudice, although District Judge Max Cogburn will have the final word. Cayer allowed a parallel complaint filed by the SEC to move forward.

David Reiss, a professor at Brooklyn Law School, noted that U.S. district judges often give deference to reports from magistrate judges. But even if Cogburn opts to dismiss the DOJ’s case, it’s less an indictment against the use of FIRREA and more an indication that the government filed its case incorrectly, he said.

“Is it a harbinger that all other judges are going to change their minds about the broad reading of FIRREA? I don’t see that at all,” Reiss told Inside MBS & ABS. “I see judges in New York and in other jurisdictions continuing to allow the government to broadly interpret FIRREA based on its plain language. They are reading the text of the statute and saying the government can act.”

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.

Nevada Court Dismisses Show-me-the-Note Action Brought Against Chase and MERS

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The court in Leong v. JPMorgan Chase, 2013 U.S. Dist. LEXIS 144678 (D. Nev. Oct. 7, 2013) granted defendants’ motion to dismiss.

This action arose out of the foreclosure proceedings initiated against the property of pro se Plaintiff Teresa Leong. Pending before the court was a motion to dismiss filed by defendants JPMorgan Chase Bank, N.A. (“Chase”) and Mortgage Electronic Registration Systems, Inc. (“MERS”) (collectively, “Defendants”). Plaintiff continued to request “to see my original documents Note and Deed.”

Plaintiff insisted that defendant failed to provide the original note. The court found that the only possibly relevant Nevada statute requiring the presentation of the original note or a certified copy is at a Foreclosure Mediation. Nev. Rev. Stat. § 107.086(4). Moreover, the court noted that it treats copies in the same way as it treats originals: “a duplicate is admissible to the same extent as an original.” Nev. Rev. Stat. § 52.245.

The court noted that the defendants correctly point out that plaintiff failed to cite to any authority that requires defendants to produce the original note, and defendants additionally provided non-binding legal authority to the contrary. As such, the court dismissed this cause of action with prejudice.

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.

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.