Loan Mod Racketeering?

James Cagney in "Public Enemy"

James Cagney and Mae Clarke in “Public Enemy”

Bloomberg BNA Banking quoted me in BofA Must Face RICO Claims on Loan Modifications (behind paywall). It opens,

Bank of America must face claims that it and another company violated federal anti-racketeering laws by denying loan modifications to eligible borrowers, a federal appeals court said Aug. 15 ( George v. Urban Settlement Svcs., 10th Cir., No. 14-cv-01427, 8/15/16 ).

The ruling by the U.S. Court of Appeals for the Tenth Circuit reinstates purported class claims by Richard George and other borrowers that Bank of America and Urban Settlement Services (“Urban”), a settlement company, feigned compliance with guidelines under the Home Affordable Modification program (HAMP) while modifying as few loans as possible.

A district court dismissed the claims, saying the plaintiffs failed to sufficiently allege the existence of an association-in-fact enterprise under the Racketeer Influenced and Corrupt Organizations Act (RICO), but the Tenth Circuit reversed, saying they made a “facially plausible” claim.

The ruling sends the case back to the district court to consider that and other allegations.

Case Moves Forward

The decision is the latest in connection with HAMP, a 2009 Treasury Department effort aimed at stabilizing the housing market that was closely related to disbursement of government funds to banks under the Troubled Asset Relief Program. Bank of America received $45 billion in TARP funds.

The plaintiffs are represented by Steve Berman, Ari Y. Brown, Kevin K. Green, and Tyler S. Weaver in the Seattle and San Diego offices of Hagens Berman Sobol Shapiro.

“We are more than pleased the court has ruled our complaint has sufficiently alleged that Bank of America’s massive HAMP mortgage-modification program was in fact a RICO enterprise,” Berman, the firm’s managing partner, said in an Aug. 15 statement. “For years, we have tirelessly fought this major Wall Street kingpin to right the wrongs it committed against hundreds of thousands of homeowners and taxpayers who footed the $45 billion government bailout BoA took in, only to have it used to propagate a scheme to squeeze every dollar from BoA customers and wrongfully foreclose thousands of homes in the process.”

Bank of America spokesman Rick Simon said the bank denies the claims, which he said paint a false picture of the bank’s practices and its employees.

“In fact, Bank of America has been an industry leader in HAMP and other beneficial mortgage modifications,” Simon told Bloomberg BNA in an Aug. 15 e-mail. “We are reviewing the Circuit court’s decision and considering our options.”

The lawsuit, which involved loans originally held by Countrywide Home Loans, said Bank of America and Urban were part of a fraudulent scheme to keep borrowers from acquiring permanent HAMP loan modifications, allegedly because defaulted loans were more profitable.

They said Urban functioned as a “black hole” for HAMP-related documents submitted by borrowers, ensuring that trial modifications would not be made permanent.

Tenth Circuit Reverses

In its September 2014 ruling, the district court said the plaintiffs failed to allege, as required by RICO, that Bank of America was distinct from the alleged racketeering enterprise.

The Tenth Circuit reversed in a decision by Judge Nancy Moritz, who wrote for a three-judge panel. The plaintiffs, she said, “don’t contend that either a parent corporation or its subsidiary corporation is the enterprise. Rather, they assert that BOA and Urban—two separate legal entities— joined together, along with several other entities, to form and conduct the affairs of the BOA-Urban association-in-fact enterprise.”

According to the plaintiffs, she said, Bank of America and Urban “performed distinct roles within the enterprise while acting in concert with other entities to further the enterprise’s common goal of wrongfully denying HAMP applications.”

That is enough to “plausibly allege” that Bank of America meets the “enterprise” requirement, she said.

Crisis Cases Continue

Brooklyn Law School Professor David Reiss said the decision shows that financial crisis-era litigation is not over. “This case is an example of litigation that arises from the supposed fixes for the crisis—fixes that were often implemented poorly, as can be seen from a variety of cases and regulatory actions,” Reiss told Bloomberg BNA in an Aug. 15 e-mail.

The lawsuit alleged in part that documents submitted by borrowers were intentionally “scattered” across various computer databases and systems, allegedly with the goal of creating the appearance that borrowers had not completed the paperwork required to convert their trial plans into permanent modifications.

Reiss called it significant that the court accepted, for purposes of a motion to dismiss, the plaintiffs’ theory that the alleged “black hole” treatment of documents could rise to the level of a RICO violation.

“While courts have held against defendants in individual cases with similar facts, the possibility that they could hold against lenders and servicers in a class action raises the stakes quite a bit for defendants,” Reiss said.

Wall Street’s New Toxic Transactions

Toxic Real Estate

The National Consumer Law Center released a report, Toxic Transactions: How Land Installment Contracts Once Again Threaten Communities of Color. It describes land installment contracts as follows:

Land contracts are marketed as an alternative path to homeownership in credit-starved communities. The homebuyers entering into these transactions are disproportionately . . . people of color and living on limited income. Many are from immigrant communities.

These land contracts are built to fail, as sellers make more money by finding a way to cancel the contract so as to churn many successive would-be homeowners through the property. Since sellers have an incentive to churn the properties, their interests are exactly opposite to those of the buyers. This is a significant difference from the mainstream home purchase market, where generally the buyer and the seller both have the incentive to see the transaction succeed.

Reliable data about the prevalence of land contract sales is not readily available. According to the U.S. Census, 3.5 million people were buying a home through a land contract in 2009, the last year for which such data is available. But this number likely understates the prevalence of land contracts, as many contract buyers do not understand the nature of their transaction sufficiently to report it.

Evidence suggests that land contracts are making a resurgence in the wake of the foreclosure crisis. An investigative report by the Star Tribune found that land contract sales in the Twin Cities had increased 50% from 2007 to 2013. Recent reports from The New York Times and Bloomberg reveal growing interest from private equity-backed investors in using land contracts to turn a profit on the glut of foreclosed homes in blighted cities around the country.

Few states have laws addressing the problems with land installment contracts, and the state laws on the books are generally insufficient to protect consumers. The Consumer Financial Protection Bureau (CFPB) has the mandate to regulate and prevent unfair and deceptive practices in the consumer mortgage marketplace, but has not yet used this authority to address the problems with land installment contracts. (1-2, footnotes omitted)

This report shines light on this disturbing development in the housing market and describes the history of predatory land contracts in communities of color since the 1930s. It also shows how their use was abetted by credit discrimination: communities of color were redlined by mainstream lenders who were following policies set by the Federal Housing Administration and other government agencies.

The report describes how these contracts give the illusion of home ownership:

  • They are structured to fail so that the seller can resell the property to another unsuspecting buyer.
  • They shift the burden of major repairs to the buyer, without exposing the seller to claims that the homes breach the warranty of habitability that a landlord could face from a tenant.
  • They often have purchase prices that are far in excess of comparable properties on the regular home purchase market, a fact that is often masked by the way that land contract payments are structured.
  • The properties often have title problems, like unsatisfied mortgages, that would not have passed muster in a traditional sale of a house.
  • They often are structured to avoid consumer protection statutes that had been enacted in response to previous problems with land contracts.

The report identifies Wall Street firms, like Apollo Global Management, that are funding these businesses. It also proposes a variety of regulatory fixes, not least of which is to have the CFPB take an active role in this shadowy corner of the housing market.

This is all to the good, but I really have to wonder if we are stuck just treating the symptoms of income and wealth inequality. Just as it is hard to imagine how we could regulate ourselves out of the problems faced by tenants that were described in Matthew Desmond’s Evicted, it is hard to imagine that we can easily rid low-income communities of bottom feeders who prey on dreams of homeownership with one scheme or another. It is good, of course, that the National Consumer Law Center is working on this issue, but perhaps we all need to reach for bigger solutions at the same time that we try to stamp out this type of abusive behavior.

The Sloppy State of the Mortgage Market

photo by Badagnani

I published a short article in the California Real Property Law Reporter, Sloppy, Sloppy, Sloppy: The State of the Mortgage Market, as part of a broader discussion of Foreclosures Following Problematic Securitizations.  The other contributors were Roger Bernhardt, who organized the discussion,  as well as Dale Whitman, Steven Bender, April Charney and Joseph Forte.  My article opens,

Much of the discussion about the recent California Supreme Court case Yvanova v New Century Mortgage Corp. (2016) 62 C4th 919  has focused on the scope of the Court’s narrow holding, “a borrower who has suffered a nonjudicial foreclosure [in California] does not lack standing to sue for wrongful foreclosure based on an allegedly void assignment merely because he or she was in default on the loan and was not a party to the challenged assignment.” 62 C4th at 924. This is an important question, no doubt, but I want to spend a little time contemplating the types of sloppy behavior at issue in the case and what consequences should result from that behavior.

Sloppy Practices All Over

The lender in Yvanova was the infamous New Century Mortgage Corporation, once the second-largest subprime lender in the nation.  New Century was so infamous that it even had a cameo role in the recently released movie, The Big Short, in which its 2007 bankruptcy filing marked the turning point in the market’s understanding of the fundamentally diseased condition of the subprime market.

New Century was infamous for its “brazen” behavior.  The Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (Jan. 2011) (Report) labeled it so because of its aggressive origination practices.  See Report at page 186. It noted that New Century “ignored early warnings that its own loan quality was deteriorating and stripped power from two risk-control departments that had noted the evidence.” Report at p 157. And it quotes a former New Century fraud specialist as saying, “[t]he definition of a good loan changed from ‘one that pays’ to ‘one that could be sold.”  Report at p 105.

This type of brazen behavior was endemic throughout the mortgage industry during the subprime boom in the early 2000s.  As Brad Borden and I have documented, Wall Street firms flagrantly disregarded the real estate mortgage investment conduit (REMIC) rules and regulations that must be complied with to receive favorable tax treatment for a mortgage-backed security, although the IRS has let them dodge this particular bullet.  Borden & Reiss, REMIC Tax Enforcement as Financial-Market Regulator, 16 U Penn J Bus L 663 (Spring 2014).

The sloppy practices were not limited to the origination of mortgages. They were prevalent in the servicing of them as well. The National Mortgage Settlement entered into in February 2012, by 49 states, the District of Columbia, and the federal government, on the one hand, and the country’s five largest mortgage servicers, on the other, provided for over $50 billion in relief for distressed borrowers and in payments to the government entities. While this settlement was a significant hit for the industry, industry sloppy practices were not ended by it. For information about the Settlement, see Joint State-Federal National Mortgage Servicing Settlements and the State of California Department of Justice, Office of the Attorney General, Mortgage Settlements: Homeowners.

As the subprime crisis devolved into the foreclosure crisis, we have seen those sloppy practices have persisted through the lifecycle of the subprime mortgage, with case after case revealing horrifically awful behavior on the part of lenders and servicers in foreclosure proceedings.  I have written about many of these Kafka-esque cases on REFinBlog.com.  One typical case describes how borrowers have “been through hell” in dealing with their mortgage servicer. U.S. Bank v Sawyer (2014) 95 A3d 608, 612 n5.  Another typical case found that a servicer committed the tort of outrage because its “conduct, if proven, is beyond the bounds of decency and utterly intolerable in our community.” Lucero v Cenlar, FSB (WD Wash 2014) 2014 WL 4925489, *7.  And Yvanova alleges more of the same.

S&L Flexible Porfolio Lending

Bailey BrosDepositAccounts.com quoted me in Types of Institutions in the U.S. Banking System – Savings and Loan Associations. It opens,

When you think of a savings and loan, maybe you think of the Bailey Savings & Loan from the movie It’s a Wonderful Life or remember the savings and loan crisis of the 1980s, when more than 1,000 savings and loans with over $500 billion in assets failed.

But there’s much more to the story. Savings and loan associations originally specialized in home-financing, be it a mortgage, home improvements or construction. According to Encyclopedia Britannica, Savings and loan associations originated with the building societies of Great Britain in the late 1700s. They consisted of groups of workmen who financed the building of their homes by paying fixed sums of money at regular intervals to the societies. When all members had homes, the societies disbanded. The societies began to borrow money from people who did not want to buy homes themselves and became permanent institutions. Building societies spread from Great Britain to other European countries and the United States. They are also found in parts of Central and South America. The Oxford Provident Building Association of Philadelphia, which began operating in 1831 with 40 members, was the first savings and loan association in the United States. By 1890 they had spread to all states and territories.

Today, explains, David Bakke, a financial columnist for MoneyCrashers.com, explains how S&Ls have evolved. “More recently, they have also expanded into areas such as car loans, commercial loans and even mutual fund investing. Currently, there isn’t much difference between them and other types of financial institutions.”

S&Ls are a type of thrift institution. Like all financial institutions they are bound to rules and regulations. They can have a state or federal charter. Those with a federal charter are regulated by the Office of the Comptroller of the Currency (OCC). The Office of Thrift Supervision (OTS) used to be the regulator before it was merged with the OCC in 2011.

Another big change that impacted S&Ls was the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). It abolished the Federal Savings and Loan Insurance Corporation, which had provided deposit insurance to savings and loans since 1934. It created two insurance funds, the Savings Association Insurance Fund (SAIF) and the Bank Insurance Fund (BIF), which were both administered by the FDIC. Those two funds were merged into the Deposit Insurance Fund (DIF) in 2006. In summary, your deposits at S&Ls today are insured by the FDIC.

If you’re wondering how S&Ls work, to put it simply, the money you deposit into your savings account, is used to fund the money the S&L doles out in loans.

Savings and loans have some advantages over other types of institutions. “Many S&Ls keep many of the loans that they originate in their own portfolio instead of selling them off for securitization.  This means that they often have more flexibility in their underwriting criteria than do those lenders that sell off their mortgages to Fannie, Freddie and Wall Street securitizers.  This means that borrowers with atypical profiles or borrowers interested in atypical properties might be more likely to find a lender open to a nontraditional deal in the S&L sector,” says David Reiss, a professor at Brooklyn Law School, that specializes in real estate.

Road to GSE Reform

photo by Antonio Correa

A bevy of housing finance big shots have issued a white paper, A More Promising Road to GSE Reform. The main objective of the proposal

is to migrate those components of today’s system that work well into a system that is no longer impaired by the components that do not, with as little disruption as possible. To do this, our proposal would merge Fannie and Freddie to form a single government corporation, which would handle all of the operations that those two institutions perform today, providing an explicit federal guarantee on mortgage-backed securities while syndicating all noncatastrophic credit risk into the private market. This would facilitate a deep, broad and competitive primary and secondary mortgage market; limit the taxpayer’s risk to where it is absolutely necessary; ensure broad access to the system for borrowers in all communities; and ensure a level playing field for lenders of all sizes.

The government corporation, which here we will call the National Mortgage Reinsurance Corporation, or NMRC, would perform the same functions as do Fannie and Freddie today. The NMRC would purchase conforming single-family and multifamily mortgage loans from originating lenders or aggregators, and issue securities backed by these loans through a single issuing platform that the NMRC owns and operates. It would guarantee the timely payment of principal and interest on the securities and perform master servicing responsibilities on the underlying loans, including setting and enforcing servicing and loan modification policies and practices. It would ensure access to credit in historically underserved communities through compliance with existing affordable-housing goals and duty-to-serve requirements. And it would provide equal footing to all lenders, large and small, by maintaining a “cash window” for mortgage purchases.

The NMRC would differ from Fannie and Freddie, however, in several important respects. It would be required to transfer all noncatastrophic credit risk on the securities that it issues to a broad range of private entities. Its mortgage-backed securities would be backed by the full faith and credit of the U.S. government, for which it would charge an explicit guarantee fee, or g-fee, sufficient to cover any risk that the government takes. And while the NMRC would maintain a modest portfolio with which to manage distressed loans and aggregate single- and multifamily loans for securitization, it cannot use that portfolio for investment purposes. Most importantly, as a government corporation, the NMRC would be motivated neither by profit nor market share, but by a mandate to balance broad access to credit with the safety and soundness of the mortgage market. (2-3, footnotes omitted)

The authors of the white paper are

  • Jim Parrott, former Obama Administration housing policy guru
  • Lewis Ranieri, a Wall Street godfather of the securitized mortgage market
  • Gene Sperling,  Obama Administration National Economic Advisor
  • Mark Zandi, Moody’s Analytics chief economist
  • Barry Zigas, Director of Housing Policy at Consumer Federation of America

While I think the proposal has a lot going for it, I think that the lack of former Republican government officials as co-authors is telling. Members of Congress, such as Chair of the House Financial Services Committee Jeb Hensaerling  (R-TX), have taken extreme positions that leave little room for the level of government involvement contemplated in this white paper. So, I would say that the proposal has a low likelihood of success in the current political environment.

That being said, the proposal is worth considering because we’ll have to take Fannie and Freddie out of their current state of limbo at some point in the future. The proposal builds on on current developments that have been led by Fannie and Freddie’s regulator and conservator, the Federal Housing Finance Agency. The FHFA has required Fannie and Freddie to develop a Common Securitization Platform that is a step in the direction of a merger of the two entities. Moreover, the FHFA’s mandate that Fannie and Freddie’s experiment with risk-sharing is a step in the direction of the proposal’s syndication of “all noncatastrophic credit risk.” Finally, the fact that the two companies have remained in conservatorship for so long can be taken as a sign of their ultimate nationalization.

In some ways, I read this white paper not as a proposal to spur legislative action, but rather as a prediction of where we will end up if Congress does not act and leaves the important decisions in the hands of the FHFA. And it would not be a bad result — better than what existed before the financial crisis and better than what we have now.

Wall Street Naughty List

Damian Gadal

Law360 quoted me in Checks Needed For Naughty List To Improve Wall Street’s Rep. It reads, in part, 

Wall Street banks may back a push to create a central registry of employees who misbehave in a bid to improve internal culture at the country’s biggest banks, but worries about the accuracy of any potential list and other due process concerns have given some observers pause.

Federal Reserve Bank of New York President William F. Dudley has been advocating for the creation of such a central registry that can be used by banks when recruiting new talent as a way to make sure that serial rulebreakers are kept out of the biggest banks. And a readout of a meeting on bank culture with Wall Street bigwigs in November appear to show that the banks are getting behind the idea.

While creating such a central registry could go a long way toward preventing bad actors from engaging in future frauds and improving the internal workings of banks, there are risks that people could be wrongly included on the list and shut out from jobs, or that individuals could be made scapegoats for larger, institutional failures at the big banks.

In order to prevent that from happening, any formal registry of wrongdoers set up by the banks must have strict rules for when a person is added and how they can appeal their placement on the list, said Ellen Zimiles, a managing director at Navigant Consulting.

*     *     *

Still, despite her concerns, Zimiles said that having a registry of bad actors could increase the amount of individual accountability for Wall Street’s misdeeds, something that has been lacking.

But some say it does not go far enough.

The Dodd-Frank Act mandated new compensation rules, and more than five years after the law’s passage, they have still not been completed. Without compensation reforms, including clawbacks for violations, a central registry will not be enough to truly reform Wall Street’s internal culture, said David Reiss, a Brooklyn Law School professor.

“Together, perhaps the registry and clawbacks could have a positive effect on firm behavior if they are implemented thoughtfully and are designed to work together,” he said.

And even with the addition of compensation reforms to the central registry forming a “belt and suspenders” approach to reform bank culture, the fiercest of Wall Street critics say that changes will not come unless bankers are brought before courts for alleged violations and sent to jail if found guilty.

“And, of course, along with the belt and suspenders, there should be prison bars as well,” Bart Naylor of Public Citizen said.

That’s something that critics say was missing after the financial crisis.

The registry, however, could be a start to bringing about much-needed accountability, they said.

What’s Behind Rising Mortgage Bond Issuance?

GlobeSt.com quoted me in What Else Is Behind Rising Mortgage Bond Issuance, Demand?. It opens,

Investor demand for mortgage bonds, both that have agency backing and not, is quite high these days.

Last week Bloomberg reported that issuance of home-loan securities that don’t have government backing reached more than $32 billion this year, compared to $18 billion a year ago, citing data compiled by Bloomberg and Bank of America Corp. These securities include rental-home bonds, a relatively new asset class that developed after the recession.

Agency and GSE securities are also in high demand, as a recent report from the Mortgage Bankers Association indicates. The level of commercial/multifamily mortgage debt outstanding increased by $40.4 billion in the first quarter of 2015 — a 1.5% increase over the fourth quarter of 2014. Said Jamie Woodwell, MBA’s Vice President of Commercial Real Estate Research with the report’s release: “Multifamily mortgages continued to grow even more quickly than the market as a whole, with banks increasing their portfolios by $8 billion and agency and GSE portfolios and MBS increasing their holdings by $10 billion.”

There are a number of economic-based drivers behind the demand for mortgage bonds of course: the fundamentals in the real estate space and the low interest rates that have driven investors to consider all manner of securities to eek out yield.

However, there is another possibility to consider as well and that is that the changing financial regulations are driving both issuance and investment.

On one hand, mortgages and private-label mortgage backed securities are much more regulated per Dodd-Frank and its Qualified Mortgage and Qualified Residential Mortgage rules, according to David Reiss, professor of Law and research director of the Center for Urban Business Entrepreneurship (CUBE) at Brooklyn Law School. On the other, post-crisis rules put in place for mortgage bonds have made these securities far more attractive for banks to hold as various news reports suggest.

For example, new rules have made ratings on mortgage bonds less crucial, allowing US lenders to use an alternative approach to calculating capital requirements, according to another recent article in Bloomberg. In essence, these rules allow lenders to reduce the amount needed for junk-rated mortgage bonds that are trading at discounts.

In addition, banks are finding that “treasury debt and MBS pass-throughs meet regulators’ standards much more easily than other assets”, according to a report by Deutsche Bank analysts Steven Abrahams and Christopher Helwig, per a third recent article in Bloomberg.

Two Opinions

With these facts in mind we turned to two experts to see how much of an impact new regulations are having. As it turned out, they are driving some of the change – but what is actually moving the needle in terms of demand is yet another trend. Read on.

For starters, there are some caveats. It can be misleading to throw the new rental home bonds in the mix in such a comparison, Reiss tells GlobeSt.com. “They are a post-crisis product when Wall Street firms saw that single-family housing prices were so low that they could make money from buying them up in bulk and then renting them out,” he says.

“They are not regulated in the same way as private-label MBS.”

Meanwhile issuers are still navigating Dodd-Frank’s Qualified Mortgage and Qualified Residential Mortgage rules, he says. They “are still trying to figure out how to operate within these rules — and outside of them, with the origination of non-QM mortgages. The market is still in transition with these products.”

As he sees it, the surge in issuance is a reflection of market players trying to understand how to operate in a new regulatory environment. They “are increasing their issuances as they get a better sense of how to do so.”