Monday’s Adjudication Roundup

Hockett on NYC Eminent Domain

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.

 

The Cost of Doing Nothing

Yesterday, I wrote about the Securities Industry and Financial Markets Association (SIFMA)’s FHFA comment letter. Today I write about SIFMA’s comment letter in response to Treasury’s request for input relating to the future of the private-label securities market. Like the FHFA comment letter, this one is written with the concerns of SIFMA’s members in mind, no others, but it identifies many of the structural problems that exist in the housing finance system today.

If I were to identify a theme of the comments, it would be that the federal government has not moved with sufficient speed to establish a well delineated infrastructure for the housing finance market. Some commentators identify benefits of a slow approach — time to get consensus, time to get rules right, time to for trial and error before committing for the long term. Few identify the costs of regulatory uncertainty — failure to get buy-in for capital-intensive ventures, atrophy of existing resources, limited investor interest.

Now, SIFMA’s members want a vibrant private-label MBS market to make money. But a vibrant private-label MBS market is also good for the overall health of the mortgage market as it spreads risk to private MBS investors and reduces the footprints of the gargantuan GSEs and the government’s own FHA. After all, most of us want the private sector taking a lot of the risk, not the taxpayer.

Notwithstanding the strengths of SIFMA’s comment letter to Treasury in critiquing the status quo, I will highlight a few passages from it that hit a false note. The first relates to the role that private-label securities (PLS) have played

in funding mortgage credit where loan size or other terms may differ from those available in the Agency markets, or where economics dictate that PLS execution is superior. The PLS market may also be more innovative and flexible than the Agency markets in adapting to economic conditions or consumer preferences, or to changing capital markets appetite. (3)

This innovation has obviously cut both ways in terms of introducing new products that can help expand access to credit as well as expand access to credit on abusive terms. The latter way seems to have predominated during the most recent boom in PLS MBS.

The second one relates to assignee liability. SIFMA states that

Investors are concerned with the prospect of assignee liability stemming from violations of the ability-to-repay rules contained in Title XIV of Dodd-Frank and embodied in the CFPB’s implementing regulations. SIFMA has raised concerns with assignee liability in many forms over the years based on the fact that mortgage investors are not at the closing table with the lender and borrower, and should not be held liable for defects of which they have no knowledge or ability to prevent. While efforts were made by policymakers to provide some level of certainty through the inclusion of safe-harbor provisions, no safe harbor is entirely safe, and it is important to note that none of these provisions have been tested in court. It will be in litigation where the market learns the exact boundaries of the protections provided by any safe harbor. This potential liability for investors is likely to reduce the availability of higher-priced QM loans and non-QM loans, all else equal, due to higher required yields to compensate for the increased risk. (5-6)

This focus on assignee liability seems to be a red herring, one that SIFMA has floated for years. The risk from assignee liability provisions is not limitless and it can be modeled. Moreover, the notion that investors should face no liability because they are not at the closing table is laughable — without them, there would be no closing table at all. They paid for it, even if they are not in the room when the closing takes place.

The last one relates to the threatened use of eminent domain by some local governments to take underwater mortgages and refinance them to reflect current property valuations:

Investors have significant concerns with, and continuing distrust of the policy environment because of a sense that rules have been and continue to be changed ex-post. The threat by certain municipalities to use eminent domain to seize performing mortgage loans has been a focus of MBS investors for the last two years and would introduce a significant new risk into investing in PLS. These municipalities propose to cherry-pick loans from PLS trusts and compensate holders at levels far below the actual value of the loans. SIFMA’s investor members view such activity as an illegal taking of trust assets, and successful implementation of these plans would severely damage investor confidence in investing in PLS. (6)

This is another red herring as far as I am concerned.  The use of eminent domain is not an ex post legal maneuver. Rather, it is an inherent power of government that precedes the founding of this country. I understand that MBS investors don’t like it, but it is not some kind of newfangled violation of the rule of law as many investor advocates have claimed.

Notwithstanding its flaws, I recommend this letter as a trenchant critique of the housing system we have today.

Housing Finance Abhors A Vacuum

The Securities Industry and Financial Markets Association (SIFMA) released their comment letter to the Federal Housing Finance Agency’s request for input relating to the role of the Fannie and Freddie guarantee fee (g-fee) in the housing finance market. While clearly reflecting the concerns of SIFMA’s members, the letter provides a thoughtful take on the complexities of the housing finance system. SIFMA writes,

Policymakers should not assume that increases in g-fees alone will lead to a significant increase in PLS issuance. Specific decisions on best execution for a given loan vary depending on the terms of the loan being originated. In some instances, a portfolio purchase may offer best execution, and in other instances the GSEs, private label MBS (PLS) or FHA may be optimal. Taken wholly in isolation, we do agree that increases in guarantee fees should cause originators to look toward other avenues to fund loans – in their portfolios, FHA, or in PLS. However, it is not so simple that an across the board increase in guarantee fees will result in a corresponding uptick in private-label securitization. To the extent GSE securitization becomes more expensive for issuers, PLS are one of a number of options, and not necessarily the most attractive in all instances. Today bank portfolios offer a more attractive funding alternative to the GSEs than PLS for most institutions. Of course, the appetite of banks for loans held in portfolio will vary with economic and regulatory conditions, and cannot always be assumed to comprise a certain percentage of the market.

There are also a number of reasons that increases to g-fees will not directly lead to increased PLS issuances that are not precisely quantifiable or directly related to cost. PLS issuers and investors face uncertainty as to the future shape of the mortgage market and questions related to compliance with the future regulatory regime. The re-regulation of the mortgage and securitization markets is not complete, and a number of consequential rulemakings are incomplete. These include but are not limited to risk retention and proposed revisions to the SEC’s Regulation AB. The final form of the definition of QRM and the rest of the risk retention rules will directly impact the economics of securitization. Regulation AB will impact the offering process, disclosure practices, and require fairly massive infrastructure adaptation at many RMBS issuers and sponsors. Of course, given that final rules are not available for any of these items, issuers and sponsors cannot begin this work. In this environment of uncertainty, it is difficult and indeed may be unwise for issuers or investors to expend resources to develop long-term issuing and investment platforms.

*     *     *

For these reasons, we do not believe FHFA or other policymakers should look at increases to GSE g-fees in a vacuum, and must consider them within the broader context of mortgage finance conditions. (6-7, footnotes omitted)

SIFMA is right to emphasize the regulatory uncertainty that its members face.  The federal government has not done enough to address this.  Housing finance, like nature, abhors a vacuum.  More on this tomorrow.