Tag Archives: mortgage

Manafort Indicted for Real Estate Fraud

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Special Counsel Mueller

Paul Manafort and his protege, Richard Gates III, were indicted on a variety of charges, including conspiracy, failure to file requirement financial reports and the making of false statements. The indictment was signed by Special Counsel Mueller. A number of the allegations involve real estate transactions. Here are the highlights (lowlights?) of the allegations that document how money can be laundered through real estate:

Manafort used his hidden overseas wealth to enjoy a lavish lifestyle in the United States, without paying taxes on that income.  Manafort, without reporting the income to his tax preparer or the United States, spent millions of dollars on luxury goods and services for himself and his extended family through payments wired from offshore nominee accounts to  United States vendors.  Manafort also used these offshore accounts to purchase multi-million dollar properties in the United Sates.  Manafort then borrower millions of dollars in loans using these properties as collateral, thereby obtaining cash in the United States without reporting and paying taxes on the income.  In order to increase the amount of money he could access in the United States, Manafort defrauded the institutions that loaned money on these properties so that they would lend him more money at more favorable rates than he would otherwise be able to obtain. (para 4)

More than $75,000,000 flowed through Manafort and Gate’s 15 offshore accounts. They also had 17 US corporations through which some of these funds flowed as well. In order to avoid paying taxes on this money, Manafort and Gates made millions of dollars in wire transfers to pay “for goods, services and real estate.” (para. 15) Manafort spent more than $12,000,000 on personal items including home improvement services, clothing, cars and housekeeping. He also bought four properties for over $6,000,000.

After Manafort bought these properties, “he took out mortgages on the properties thereby allowing Manafort to have the benefits of liquid income without paying taxes on it. Further, Manafort defrauded the banks that loaned him the money so that he could withdraw more money at a cheaper rate than he otherwise would have been permitted.” (para. 33) He did this by wrongfully claiming on a loan application that an investment property was owner-occupied (banks generally give you a more favorable interest rate if the property is owner-occupied). He was also able to borrow more money by claiming that part of the proceeds of a loan would be used to fund a renovation when in fact he did not intend to use the funds for that purpose.

The allegations in the indictment provide a nice case study of how real estate is used in money laundering.

Mortgage Servicing Since The Financial Crisis

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photo by Dan Brown

Standard & Poors issued a report, A Decade After The Financial Crisis, What’s The New Normal For Residential Mortgage Servicing? It provides a good overview of how this hidden infrastructure of the mortgage market is functioning after it emerged from the crucible of the subprime and foreclosure crises. It reads, in part,

Ten years after the start of the financial crisis, residential mortgage servicing is finally settling into a new sense of normal. Before the crisis, mortgage servicing was a fairly static business. Traditional prime servicers had low delinquency rates, regulatory requirements rarely changed, and servicing systems were focused on core functions such as payment processing, investor accounting, escrow management, and customer service. Subprime was a specific market with specialty servicers, which used high-touch collection practices rather than the low-touch model prime servicers used. Workout options for delinquent borrowers mainly included repayment plans or extensions. And though servicers completed some modifications, short sales, and deeds in lieu of foreclosure, these were exceptions to the normal course of business.

Today, residential mortgage servicing involves complex regulation, increased mandatory workout options, and multiple layers of internal control functions. Over the past 10 years servicers have had to not only modify their processes, but also hire more employees and enhance their technology infrastructure and internal controls to support those new processes. As a result, servicing mortgage loans has become less profitable, which has caused loan servicers to consolidate and has created a barrier to entry for new servicers. While the industry expects reduced regulatory requirements under the Trump administration and delinquency rates to continue to fall, we do not foresee servicers reverting to pre-crisis operational processes. Instead, we expect states to maintain, and in some cases enhance, their regulatory requirements to fill the gap for any lifted or reduced at the federal level. Additionally, most mortgage loan servicers have already invested in new processes and technology, and despite the cost to support these and adapt to any additional requirements, we do not expect them to strip back the controls that have become their new normal. (2/10, citation omitted)

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As The Economy Improves, Delinquency Rates Have Become More Stable

Total delinquency rates have only just begun returning to around pre-crisis levels as the economy–and borrowers’ abilities to make their mortgage payments–has improved (see charts 1 and 2). Lower delinquency rates can also be attributed to delinquent accounts moving through the default management process, either becoming reperforming loans after modifications or through liquidation. New regulatory requirements have also extended workout timelines for delinquent accounts. In 2010, one year after 90-plus delinquency rates hit a high point, the percentage of prime and subprime loans in foreclosure actually surpassed the percentage that were more than 90 days delinquent–a trend that continued until 2013 for prime loans and 2014 for subprime loans. But since the end of 2014, all delinquency buckets have remained fairly stable, with overall delinquency rates for prime loans down to slightly over 4% for 2016 from a peak of just over 8% in 2009. Overall delinquency rates for subprime loans have fluctuated more since the peak at 29% in 2009. (2/10)

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Modifications Now Make Up About Half Of Loan Workout Strategies

Government agencies and government-sponsored enterprises (Fannie Mae and Freddie Mac) developed new formal modification programs beginning in 2008 to address the rising delinquency and foreclosure rates. The largest of these programs was HAMP, launched in March 2009. While HAMP was required for banks accepting funds from the Troubled Asset Relief Program (TARP), all servicers were allowed to participate. These programs required that servicers exhaust all loss mitigation options before completing foreclosure. This requirement, and the fact that servicers started receiving incentives to complete modifications, spurred the increase in modifications. (4/10)

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Foreclosure Timelines Have Become Longer

As the number of loans in foreclosure rose during the financial crisis, the requirements associated with the foreclosure process grew. As a result, the time it took to complete the foreclosure process increased to almost 475 days in 2016 from more than 160 days in 2007–an increase of almost 200%. While this is not a weighted average and therefore not adjusted for states with smaller or larger foreclosure portfolios, which could skew the average, the data show longer timelines across all states. And even though the percentage of loans in foreclosure has decreased in recent years (to 1% and 9% by the end of 2016 for prime and subprime, respectively, from peaks of 3% in 2010 and 13% in 2011) the time it takes to complete a foreclosure has still not lessened (6/10)

Improving the 30-Year Mortgage

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Wayne Passmore and Alexander von Hafften have posted Improving the 30-Year Fixed-Rate Mortgage to SSRN. The abstract reads,

The 30-year fixed-rate fully amortizing mortgage (or “traditional fixed-rate mortgage”) was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With so little equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowner might have better uses for this money. Third, refinancing mortgages is often very costly. We propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or “Fixed-COFI mortgage”), that resolves these three flaws. This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and no down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk wedge between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. Committing to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin, the homeowner uses this wedge to accumulate home equity quickly. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. Fixed-COFI mortgages may help some renters gain access to homeownership. These renters may be, for example, paying rents as high as comparable mortgage payments in high-cost metropolitan areas but do not have enough savings for a down payment. The Fixed-COFI mortgage may help such renters, among others, purchase homes.

The authors acknowledge some drawbacks for Fixed-COFI mortgages that can make them unattractive to some borrowers:

What do homeowners lose by choosing Fixed-COFI mortgages instead of traditional fixed-rate mortgages? First, they cannot freely spend refinancing gains on non-housing items. When mortgage rates fall, homeowners with Fixed-COFI mortgages automatically pay less interest and pay down the mortgage principal more. Second, they can no longer “win the lottery” played with capital markets investors and lock in a substantially lower rate for the remainder of their mortgage. With Fixed-COFI mortgages, homeowners trade the option of prepayment for faster home equity accumulation. We believe that many households may prefer Fixed-COFI mortgages to traditional fixed-rate mortgages. Furthermore, we believe that many renting households without savings for a down payment may prefer Fixed-COFI mortgages to renting. (4)

American households rely too much on the plain vanilla 30-year fixed rate mortgage for their own good. Papers like this give us some reasonable alternatives that might be better suited for many households.

The Next Taxpayer Bailout for the Mortgage Market?

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The HUD Office of the Inspector General issued an audit on Nonbank Oversight by Ginnie Mae. This audit is one of those dry government documents that contain whispers of crises to come. The worrisome sentence is buried at the end of the audit: “If disruption in servicing occurs, Ginnie Mae may need to request additional funds from the U.S. Treasury to pay investors.” (8) To understand what is at stake, it is worth reviewing the background of the audit:

The Housing and Urban Development Act of 1968 created the Government National Mortgage Association (Ginnie Mae), a wholly owned U.S. Government corporation within the U.S. Department of Housing and Urban Development, to pursue the creation of a mortgage-backed security market for government-insured loans. Through its mortgage-backed securities programs, Ginnie Mae guarantees securities backed by pools of mortgages and issued by mortgage lenders approved by Ginnie Mae. Ginnie Mae refers to these mortgage lenders as Ginnie Mae issuers.

Ginnie Mae depends on its issuers to take full responsibility for servicing, remitting, and reporting activities for the mortgages in every pool. If the borrower fails to make a timely payment on its mortgage, the issuer must use its own funds to ensure that the investors receive timely payment. If an issuer cannot ensure the timely payment of principal and interest to investors, Ginnie Mae, in accordance with its guaranty, defaults the issuer, acquires the servicing of the loans, and uses its own funds to manage the portfolio and make any necessary advances to investors. Ginnie Mae’s risk for loss occurs almost entirely at the point of issuer default, when Ginnie Mae must step in and exercise its guaranty. Counterparty risk refers to the risk of issuer default.

Following the financial crisis, the demand for government-insured loans increased, which created an increased demand for Ginnie Mae’s product. Ginnie Mae’s total remaining principal outstanding increased from $427.6 billion in 2007 to $1.7 trillion in 2016. This represents a 300 percent increase. The chart below shows the growth of the outstanding remaining principal balance of Ginnie Mae’s mortgage-backed securities programs from 2007 to 2016.

In addition to an increase in demand for Ginnie Mae’s products, Ginnie Mae’s issuer base had shifted dramatically since the financial crisis. Banks retreated from mortgage lending, causing a shift in Ginnie Mae’s issuer base from banks to nonbanks. For the purpose of this report, a bank refers to an institution licensed to receive deposits and make loans, whereas a nonbank refers to institutions that offer only mortgage-related services. In 2014, Ginnie Mae reported that 6 of its top 10 issuers were nonbanks. The chart below illustrates the shift in Ginnie Mae’s issuer base since 2010.

When banks dominated Ginnie Mae’s issuer base, Ginnie Mae outsourced a significant portion of its risk management to bank regulators, such as the Federal Deposit Insurance Corporation, the Federal Reserve, the Office of the Comptroller of the Currency, and the National Credit Union Association. While the Consumer Financial Protections Bureau regulates nonbanks for consumerrelated issues, nonbanks are not subject to the same safety and soundness regulation as banks. No equivalent regulator exists for nonbanks. Therefore, Ginnie Mae must function as the first line of defense to evaluate nonbank institutions for financial and operational soundness. Ginnie Mae’s Office of Issuer and Portfolio Management is responsible for overseeing Ginnie Mae issuers concerning all matters related to participation in its mortgage-backed security programs, including monitoring issuer participation and executing issuer defaults.

Unlike banking institutions, nonbanks tend to have complex financial and operating structures and frequently use subservicers instead of servicing the loans in their portfolios. Additionally, nonbanks rely on credit lines for funding, which may limit a nonbank’s access to liquidity to meet the financial obligations of being a Ginnie Mae issuer. Banking institutions have standardized corporate ownership and lines of business, substantial liquidity, and the ability to service the loans in their portfolios.

Our audit objective was to determine whether Ginnie Mae responded adequately to changes in its issuer base. (3-4, charts omitted)

Unfortunately, the audit found that Ginnie Mae has come up short in dealing with the risks that it now faces. Time will tell whether it meaningfully responds to these deficiencies.

Rethinking FHA Insurance

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The Congressional Budget Office issued a report on Options to Manage FHA’s Exposure to Risk from Guaranteeing Single-Family Mortgages. FHA insurance stands out from other forms of mortgage insurance because it guarantees all of a lender’s loss, rather than just a portion of it. It is certainly a useful exercise to determine whether the FHA could reduce its exposure to those potential credit losses while also making home loans available to people who would otherwise have difficulty accessing them. This report evaluates the options available to the FHA:

The Federal Housing Administration (FHA) insures the mortgages of people who might otherwise have trouble getting a loan, particularly first-time homebuyers and low-income borrowers seeking to purchase or refinance a home. During and just after the 2007–2009 recession, the share of mortgages insured by FHA grew rapidly as private lenders became more reluctant to provide home loans without an FHA guarantee of repayment. FHA’s expanded role in the mortgage insurance market ensured that borrowers could continue to have access to credit. However, like most other mortgage insurers, FHA experienced a spike in delinquencies and defaults by borrowers.

Recently, mortgage borrowers with good credit scores, large down payments, or low ratios of debt to income have started to see more options in the private market. The Congressional Budget Office estimates that the share of FHA-insured mortgages going to such borrowers is likely to keep shrinking as credit standards in the private market continue to ease. That change would leave FHA with a riskier pool of borrowers, creating risk-management challenges similar to the ones that contributed to the agency’s high levels of insurance claims and losses during the recession.

This report analyzes policy options to reduce FHA’s exposure to risk from its program to guarantee single-family mortgages, including creating a larger role for private lenders and restricting the availability of FHA’s guarantees. The options are designed to let FHA continue to fulfill its primary mission of ensuring access to credit for first-time homebuyers and low-income borrowers.

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What Policy Options Did CBO Analyze?

Many changes have been proposed to reduce the cost of risk to the federal government from FHA’s single-family mortgage guarantees. CBO analyzed illustrative versions of seven policy options, which generally represent the range of approaches that policymakers and others have proposed:

■ Guaranteeing some rather than all of the lender’s losses on a defaulted mortgage;

■ Increasing FHA’s use of risk-based pricing to tailor up-front fees to the riskiness of specific borrowers;

■ Adding a residual-income test to the requirements for an FHA-insured mortgage to better measure borrowers’ ability to repay the loan (as the Department of Veterans Affairs does in its mortgage guarantee program);

■ Reducing the limit on the size of a mortgage that FHA can guarantee;

■ Restricting eligibility for FHA-insured mortgages only to first-time homebuyers and low- to moderate-income borrowers;

■ Requiring some borrowers to receive mortgage counseling to help them better understand their financial obligations; and

■ Providing a grant to help borrowers with their down payment, in exchange for which FHA would receive part of the increase in their home’s value when it was sold.

Although some of those approaches would require action by lawmakers, several of the options could be implemented by FHA without legislation. In addition, certain options could be combined to change the nature of FHA’s risk exposure or the composition of its guarantees. CBO did not examine the results of combining options.

What Effects Would the Policy Options Have?

Making one or more of those policy changes would affect FHA’s financial position, its role in the broader mortgage market, and the federal budget. All of the options would improve the agency’s financial position by reducing its exposure to the risk of losses on the mortgages it insures (see Table 1). The main reason for that reduction would be a decrease in the amount of mortgages guaranteed by FHA. CBO projects that under current law, FHA would insure $220 billion in new single-family mortgages in 2018. The options would lower that amount by anywhere from $15 billion to $77 billion (see Figure 1). Some options would also reduce FHA’s risk exposure by decreasing insurance losses as a percentage of the value of the guaranteed mortgages. (1-2)

Treasury’s Overreach on Securitization Reform

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Treasury Secretary Mnuchin Being Sworn in by Vice President Pence

The Department of the Treasury released its report, A Financial System That Creates Economic Opportunities Capital Markets. I will leave it to others to dissect the broader implications of this important document and will just highlight what it has to say about the future of securitization:

Problems related to certain types of securitized products, primarily those backed by subprime mortgage loans, contributed to the financial crisis that precipitated the Great Recession. As a result, the securitization market has acquired a popular reputation as an inherently high-risk asset class and has been regulated as such through numerous post-crisis statutory and rulemaking changes. Such treatment of this market is counterproductive, as securitization, when undertaken in an appropriate manner, can be a vital financial tool to facilitate growth in our domestic economy. Securitization has the potential to help financial intermediaries better manage risk, enhance access to credit, and lower funding costs for both American businesses and consumers. Rather than restrict securitization through regulations, policymakers and regulators should view this component of our capital markets as a byproduct of, and safeguard to, America’s global financial leadership. (91-92, citations omitted)

This analysis of securitization veers toward the incoherent. It acknowledges that relatively unregulated subprime MBS contributed to the Great Recession but it argues that stripping away the regulations that were implemented in response to the financial crisis will safeguard our global financial leadership. How’s that? A full deregulatory push would return us to the pre-crisis environment where mortgage market players will act in their short-term interests, while exposing counter-parties and consumers to greater risks.

Notwithstanding that overreach, the report has some specific recommendations that could make securitization more attractive. These include aligning U.S. regulations with the Basel recommendations that govern the global securitization market; fine-tuning risk retention requirements; and rationalizing the multi-agency rulemaking process.

But it is disturbing when a government report contains a passage like the following, without evaluating whether it is true or not:  “issuers have stated that the increased cost and compliance burdens, lack of standardized definitions, and sometimes ambiguous regulatory guidance has had a negative impact on the issuance of new public securitizations.” (104) The report segues from these complaints right to a set of recommendations to reduce the disclosure requirements for securitizers. It is incumbent on Treasury to evaluate whether those complaints are valid are not, before making recommendations based upon them.

Securitization is here to stay and can meaningfully lower borrowing costs. But the financial crisis has demonstrated that it must be regulated to protect the financial system and the public. There is certainly room to revise the regulations that govern the securitization sector, but a wholesale push to deregulate would be foolish given the events of the 2000s.