Credit Slips is delighted to welcome first-time guest blogger, Professor Gary Neustadter. A renowned innovative teacher, Professor Neustadter specializes in debtor-creditor law, contracts, consumer protection, and legal practice. His classic work, When Lawyer and Client Meet: Observations of Interviewing and Counseling Behavior in the Consumer Bankruptcy Law Office, is a must-read, particularly worth revisiting as the nature of legal practice changes in the last decade driven by BAPCPA and the technology.
His new article, Randomly Distributed Trial Court Justice: A Case Study and Siren from the Consumer Bankruptcy World, is one of the most exciting pieces of scholarship that I've had the pleasure of reading. Gary offers all those interested in civil justice and economic rights a rare window directly into the justice system. While the picture that he portrays is far from pretty, his article approaches the effect of great art: it challenges us to question our assumptions and our perspectives.
Welcome, Gary, to Credit Slips. We look forward to your insights.
Sharing news of this post-election civil rights conference on December 2, 2016 that, notably for Credit Slips, features pathbreaking research by Professors Mechele Dickerson and Bob Lawless (in collaboration with Dov Cohen and the late Jean Braucher) on the intersection of race with debt and bankruptcy and an exploration of how this research informs policymaking and advocacy going forward. Time permitting, I will address a different intersection between race and debt: collecting judgments arising from police misconduct when cities file for bankruptcy. Thanks to Professor Ted Shaw and the Center for Civil Rights for recognizing the role debtor-creditor research can play in the quest for equality.
Register using this link.
The headlines look pretty bad: the DC Circuit Court of Appeals held the CFPB's structure to be unconstitutional in a case call PHH v. CFPB, which deals with kickbacks in captive private mortgage reinsurance arrangements allegedly in violation of the Real Estate Settlement Procedures Act. In fact, however, the ruling is a blessing in disguise for the CFPB. While the 110 page decision is filled with inflammatory rhetoric, it gives the CFPB's detractors very little succor in the end. The CFPB lost on the decision's rhetoric, but won on the practical implications. Although the CFPB’s current structure was declared unconstitutional, the court also immediately remedied the flaw by declaring that the CFPB Director is now removable by the President at will, rather than only "for cause" as provided for by the Dodd-Frank Act. There are four critical implications from this ruling:
A new paper by Franceso D'Acunto and Albert Rossi, both at the University of Maryland's Department of Finance, contends that the Dodd-Frank Act resulted in "a substantial redistribution of credit from middle-class households to wealthy households", as lenders reacted to regulations by reducing credit to middle-class households and increasing it to wealthy households. This conclusion is based on a regression analysis of loan and ZIP-code level HMDA data. The redistribution point is a serious charge to be leveled at the Dodd-Frank Act, and you can bet that this paper is going to be repeatedly cited by Congressional Republicans in their attempts to repeal Dodd-Frank.
Unfortunately, the paper is founded on a pair of mistaken factual claims about the legal landscape that are so staggering that I am puzzled how they could have been made in good faith. Once these mistakes are corrected, it becomes apparent that the paper's analysis cannot actually support its claims because it is testing the wrong thing. The paper is observing changes in the mortgage market that pre-date the implementation of Dodd-Frank. By definition, then, these changes cannot have been caused by Dodd-Frank. What the paper shows (without realizing it) is that there has been a redistribution of credit from middle class households to wealthy ones, but that it wasn't caused by Dodd-Frank. Whoops.
Over on Twitter, Michael Barr noticed that there's an eerie similarity between Wells Fargo employees team members being incentivized to open up unauthorized deposit and credit card accounts for consumers and another practice that got Wells in trouble in 2011, falsifying borrower income and employment information in order to sell debt consolidation, cash-out refinance mortgage loans at sub-prime rates (often to prime borrowers). Wells entered into an $85 million consent order with the Federal Reserve Board in July 2011 over these practices. (See summary here.) The consent order noted that it was Wells incentive-based compensation and minimum sales quotas that drove the employee fraud:
B. Under Financial's sales performance standards and incentive compensation programs, Financial sales personnel, called "team members," were expected to sell (a) a minimum dollar amount of loans to avoid performance improvement plans that could result in loss of their positions with Financial, and (b) a minimum dollar amount of loans to receive incentive compensation payments above their base salary.
This rather expensive consent order should have been a giant red flag for Wells Fargo's compliance department, for Wells Fargo's board of directors, and for John Stumpf, Wells Fargo's Chairman/CEO. It should have caused Wells Fargo to reexamine its loan officer compensation structures throughout the bank. One assumes that the consent order did not come out of the blue in July 2011, but was likely the result of months if not years of investigation and negotiation. That suggests that Wells should have been aware of problems with its compensation system substantially before it began firing employees in 2011 over the unauthorized account openings. As ugly as things already look for Wells, we might learn that things were in fact worse.
A new CMBS issuance is set to test whether regulators will treat the 5% retained credit risk under Dodd-Frank as loans or bonds. The difference matters because there are different capital charges for loans and bonds. If regulators treat the retained credit risk as bonds (which matches the technical form of the retained interest), then the risk retention requirement will be much more onerous. If they treat the retained credit risk as loans, it is just as if the bank securitized only 95% of the loans, rather than 100%.
The Federal Housing Finance Agency has finally announced a program to reduce principal balances of distressed home mortgages held by Fannie Mae and Freddie Mac, eight years into the foreclosure crisis. Too little, too late would be an understatement to describe this initiative. According to the agency’s announcement, they expect about 33,000 homeowners to be eligible to have their mortgage debt reduced to the value of their homes. According to the Zillow negative equity report, more than 6 million homeowners have mortgage debt exceeding their home value, and almost a third of all homeowners are effectively underwater, meaning that their equity is less than 20% of the home value, making it difficult to sell or refinance.
Aggregate value of homes in the US rose from $10.9 trillion in 1998 to $28.3 trillion in 2006, then declined to $19.5 by the beginning of 2012, recovering somewhat in the past three years. This one-third decline in home values was not accompanied by a one-third decline in mortgage debt. Residential mortgage debt peaked at 10.6 trillion in 2006, and then declined to 9.5 trillion by the end of 2012, just a 10% easing. The overhang of home mortgage debt remains a huge impediment to consumer spending, wealth accumulation and the closing of the racial wealth gap in the United States. It is regrettable that the FHFA continues to take such a narrow view of its role as the regulator of our secondary mortgage market utilities and fails to pursue the social values that our taxpayer-backed housing finance system ought to advance.
Tara Twomey is just a keen observer of the consumer finance world, and she recently alerted me to a trend. Reverse mortgages are being aggressively hawked as a valuable financial planning tool, and the media is picking up the story. Even the reverse mortgage industry rag is excited at its publicity rash. While I'm all for consumer finance journalism, these articles often report on studies that bear little resemblance to most Americans' situations.
First a quick definition of reverse mortgages: a loan secured by a home that pays the homeowner money based on accumulated home equity with loan repaid in the future. In its most straightforward form, the homeowner gets a lump sum of cash and must repay the loan when she dies (presumably out of the proceeds of the house that is sold upon her death.) Reverse mortgages are a complex product marketed specifically to older Americans. (If you doubt the complexity, read Tara's great article that ponders how a reverse mortgage should be treated in a homeowner's bankruptcy.) Precisely for this reason, FHA requires counseling for its reverse mortgage, called a Home Equity Conversion Mortgage (HECM).
While we can hope that homeowners receive adequate information and make fully-informed decisions, the chatter about reverse mortgages is starting out their inquiry into reverse mortgages with some questionable math. The problem isn't the math itself, of course, but the assumptions. In a typical example featured in these stories, the couple owns a $400,000 home and has retirement savings of $1 million. Yeah, you read that right--tax-deferred, non-social security retirement savings of a cool mil'. Reality: about one-third of Americans have no retirement savings/pension at all. Even among those in the 55-64 year age bracket, one in five has zero dollars in retirement savings. Zero--to state the obvious--is a long way from $1 million. Even after excluding those with no savings, the typical account balance of near-retirement households was only $104,000. Again, a long way from $1 million.
Long ago, when Elizabeth Warren was building support for the CFPB, she argued there needed to be a dedicated "cop on the beat" for consumers. Check out the press release, CFPB Study Finds Reverse Mortgage Advertisements Can Create False Impressions, for evidence that the CFPB is hard at work in educating consumers. While its study identified more fundamental confusion about reverse mortgages, those attracted to the financial promises in reverse mortgage research or ads should check the math against their own means.
As California Monitor, my staff and I fielded tens of thousands, probably hundreds of thousands, questions from homeowners. The hardest conversations were the easiest from a legal perspective. If someone's home was foreclosed in California, we advised there was little, if any, likely recourse. The California Homeowner Bill of Rights created a new remedy for consumers, but for homeowners before its January 2013 effective date, the options were nearly nil.
The California Supreme Court, in a decision that surprised many, staked out a clear right for homeowners to contest in court whether the foreclosing party had proper rights in the mortgage to allow it to foreclose. In Yvanova v. New Century Mortgage Corp, the court reversed the Court of Appeals and remanded to allow the plaintiff to present her action alleging wrongful foreclosure. The court was careful to stay away from the merits, making no ruling on whether the plaintiff could prove the assignment was void. But, I this the court engaged in a bit of chicanery in declaring that its "ruling in this case is a narrow one." Yvanova is a big change from the developing body of lower court cases in California denying a borrower standing to file a claim based on violations of the the terms of a pooling and servicing agreement.
The LA Times story identifies a number of open questions that must be answered to know if any homeowners will actually win damages in wrongful foreclosure cases based on pre-Homeowner Bill of Rights' actions. For one thing, the statute of limitations for wrongful foreclosure is uncertain in California--partly because the state has had so few cases. While I think the court is correct on the law in Yvanova, the wheels of justice may have turned too slowly to help people. As a case study, the opinion may best be used as evidence of the importance of faster, legislative remedies for consumers such as the Homeowner Bill of Rights over developing the common law. The opinion is well-done, however, and merits a read, particularly for its quotation from the Miller opinion: "Banks are neither private attorneys general nor bounty hunters, armed with a roving commission to seek out defaulting homeowners and take away their homes in satisfaction of some other bank's deed of trust."
With a fiasco as big as the financial crisis, one of the only positive outcomes is there are a lot of lessons for the future. As Credit Slips thinks about how the administration might influence the resolution of Puerto Rico's bond problems, I think there are a few points from the financial crisis to consider.
First, and foremost, is the importance of explaining the issue. Particularly in times of crisis, the explanation/education end of things tends to be pushed to the back of policymakers. "Action" is favored over explanation, but ultimately if the public does not understand what is at stake and the administration's goals, the White House and others quickly have to waste time on the defensive or retreat into silence. Neither strategy helps the problem. One need only look at all the calls to audit or disband the Federal Reserve Board in the wake of the crisis actions around Bear Stearns to see the long-term problems that come from policy without a good public relations campaign. If you need another example, read this great and short piece by William Sage, called Brand New Law! The Need to Market Health Care Reform.
Second, lawyers are fairly lousy at administration. They negotiate hard but the practicability of getting relief is not their strength. We can take a lot of blame for this as law school professors, in that we should teach skills in organizational behavior, project management, etc, especially for those interested in policy. With the financial crisis, the problem was not that the HAMP loan modification term was too stingy or bad on its substance. The problem was severe delays and tangles in rolling out the relief. Jean Braucher has an excellent piece--the title, Humpty Dumpty and the Foreclosure Crisis, gives away the punchline. Whatever is done with respect to Puerto Rico needs to be efficiently administered. In this regard, I think the involvement of seasoned chapter 11 bankruptcy lawyers is a great development. These lawyers are used to being keenly focused on administrative costs in an insolvency situation, and provide a much needed counter-perspective to traditional Washington policymakers. I think if more consumer bankruptcy lawyers had been consulted during the design of HAMP and similar Making Homes Affordable programs, those programs could have been more consumer-friendly, using where people stumble in bankruptcy to identify likely obstacles in obtaining a loan modification (such as submitting paperwork and describing one's own financial situation accurately).
Third, and finally I think the financial crisis reminds us not to get lost in the billions of dollars at stake and the high finance concepts. Behind every bond, there are real people--investors, Puerto Rican residents, taxpayers, and others. The quality of a solution to Puerto Rico's financial problems is not a Wall Street issue; it is a Main Street issue.
I just read a terrific new paper by Gary Neustadter of Santa Clara University Law School, called "Randomly Distributed Trial Court Justice: A Case Study and Siren from the Consumer Bankruptcy World." It presents a monumental empirical study of a debt buyer's litigation campaign to pursue essentially identical contract and fraud claims against hundreds of secondary mortgagors in state courts, federal District Courts, and federal Bankruptcy Courts. The paths and outcomes of these materially identical cases are so different in so many surprising (and often disturbing) ways, the paper offers a really stunning look behind the curtain of our often arbitrary trial-level justice system. And Neustadter's telling of the story is gripping--I read the paper and most of its footnotes from beginning to end in one sitting, unable to put it down. The revelations in this paper are a gold mine for civil proceduralists generally and bankruptcy practitioners in particular. It offers a cautionary tale and useful playbook for lawyers (and perhaps judges) in how to make many aspects of our system more effective. Get it while it's hot!
My ears perk up whenever I hear the musical words "synthetic collateralized debt offering". (Bill Bratton and I did write the paper on history of these crazy things, after all....) So, it was with interest that I read a Wall Street Journal editorial decrying Fannie Mae and Freddie Mac's use of synthetic CDOs to transfer credit risk on mortgages to the private market through the STACR and Connecticut Avenue programs. Unfortunately, the WSJ piece does not accurately describe what Fannie and Freddie are doing and fails entirely to understand why unfiltered private capital is a recipe for financial instability in housing markets.
There’s an interesting new article out on the celebrated Massachusetts U.S. Bank v. Ibanez case that suggests that the defendant, Antonio Ibanez, was at the center of a property fraud ring. It's not clear to me that there was anything illegal about Ibanez's activities, but even if there were, I don't think it much matters.
Here's an opportunity to supervise a consumer financial protection clinic that has done some great work - information on the position and how to apply here.
The Supreme Court made a noteworthy contribution to the crescendo in our national conversation about race in its recent Texas v. ICP Fair Housing Act decision.
The Court affirmed that the Fair Housing Act prohibits not only explicit racial discrimination, but also policies and practices that have the effect of excluding or harming racial minorities.
In marked contrast to its Voting Rights Act and other decisions, the Supreme Court (5-vote majority) in this case did not declare that racism has nearly ended, nor that the time for corrective laws is coming to an end. Justice Kennedy, the perennial swing voter, grounded the continuing vitality of disparate impact analysis in the sad legacy of various policies, including redlining, steering, and restrictive covenants, a legacy that insures the persistence of geographic segregation of races in the United States, and perpetuates our vast opportunity and wealth gaps. In his opinion, he harkens back to the Kerner Commission's conclusion that the uprisings of the 1960s arose in no small measure from the ghettoization and racial apartheid of American cities.
As a matter of legal doctrine the issue was straightforward. The Fair Housing Act has been interpreted consistently for more than forty years by all lower federal courts to prohibit housing and housing finance practices that exclude or discriminate against racial minorities in their effects. For example, a town's zoning plan that completely prohibits multifamily housing construction violates the Fair Housing Act when the result is to perpetuate the virtual exclusion of black families from the town. In the housing finance sphere, a bank's refusal to make mortgage loans in certain zip codes, or below a certain dollar amount, will violate the FHA if it has an unjustified disparate impact on minority homebuyers. Congress has re-enacted and amended the FHA without ever disapproving the application of disparate impact analysis.
Often, the difference between disparate impact and disparate treatment is a matter of proof, not of underlying facts. For example, in the exclusionary zoning cases, there is often evidence of racial animus at least among some members of the excluding suburb's governing bodies, but perhaps not enough to link a particular zoning vote to that racism. Some disparate impact cases are about racism by subterfuge. Others are about implicit bias, or even thoughtless discrimination. Disparate impact analysis, per Justice Kennedy, "permits plaintiffs to counteract unconscious prejudices and disguised animus that escape easy classification as disparate treatment."
One undoubted consequence of disparate impact analysis is that banks are under an affirmative obligation not to perpetuate the legacy of racism and the racial wealth divide with home lending practices and policies that have no business justification. No doubt, in the aftermath of the decision banks will protest that they must now enact racial quotas or make risky mortgage loans to unqualified borrowers. Housing lenders depend on an vast array of explicit and implicit state subsidies. The Fair Housing Act does not require making loans that won't be repaid. It does impose an affirmative public duty to make home loans in a way that closes rather than widens our nation's racial divide.
The Supreme Court ruled unanimously in favor of Bank of America in Caulkett v. Bank of America. Basically the Court found itself bound by its previous decision in Dewsnup and didn't think that any of the distinctions presented (by yours truly among others) between Dewsnup and Caulkett were compelling. I continue to disagree, not least because the Court never explains why the distinctions weren't compelling, or even state what those distinctions were. Given the lengthy opinions that the Court usually issues, I'd like to think that it could have taken the time to explain itself in this regard, if only to help guide future litigants.
What all this means is that that I owe Bob Lawless a dinner: I had been much more optimistic about the outcome of the case following oral argument.
Over the last few years, the US Department of Justice has reached settlements with nearly every major lender with regard to the lending procedures for FHA (Federal Housing Administration) loans. The legal basis for the settlements were alleged violations of the False Claims Act. The total recovery is about $3 billion dollars.
In the wake of lengthy and expensive investigations and negotiations, lenders have basically . . . whined. Jamie Dimon said the company was "thoroughly confused" by the FHA's investigations and said he was going to "figure out what to do." That task might be a whole lot easier due to Chase's competitor, Quicken Loans. On Friday, Quicken sued the Department of Justice and the Department of Housing and Urban Development, asking the court for a declaratory judgment and injunction that would halt the government's efforts to bring Quicken to settle its alleged FHA liability. I love this lawsuit!!!
Clearly, the biggest surprise in consumer borrowing since the crash has been the explosive expansion of student loan debt. It has surpassed both auto lending and credit card lending. And, since it ties with Payday Lending and pre-crash sub-prime mortgage lending for the thinnest underwriting there are defaults aplenty.
Consumer advocates are rightly urging the Department of Education to provide simpler and clearer paths forward for consumers with student loans in default but many people still need a helper. As defaults in mortgage loans and on credit card loans have fallen, providers who live on the profits of counseling people who default on those loans have turned their attention and their advertising and marketing to consumers who are in trouble on their student
The New York Times carried an important story about the risky investment moves of life insurance companies. There's a lot of good stuff in the story, but it missed an important angle, namely the consumer harm that has already resulted from bank affiliation with captive reinsurers in the private mortgage insurance space, namely inflated and unecessary private mortgage insurance premiums because of illegal kickback arrangements.
At the onset of the current foreclosure crisis, banks bemoaned their inability to get homeowners in default to respond to their generous offers of loan modifications and other foreclosure alternatives. Homeowners, it seemed, were like ostriches with their heads in the sand. Outreach efforts were launched to bring the homeowners in from the cold. Foreclosure sales, banks told us, were the worst possible outcome, and everything should be done to avoid them.
Fast forward a few years, and we no longer hear about those unresponsive homeowners. In fact, the mortgage servicing industry, starting around 2009, was rapidly overwhelmed with homeowners seeking loan modifications and other workouts. Soon homeowners were the ones complaining about getting no responses from servicers. Diligent homeowner attorneys uncovered the robosigning scandal, courts and regulators demanded that servicers clean up their act, and foreclosure cases languished while servicers gave homeowners applying for loan modifications and short sales the runaround. Today the banking industry complains of spending too much time talking to homeowners, claiming that long foreclosure delays resulting from homeowners massively coming in from the cold are just wasting everyone’s time and money.
Is the foreclosure crisis over? Yes and no. Since 2007, about six million homes have been sold at foreclosure sales (Foreclosures Public Data Summary Jan 2015). Today, about one million homes are still somewhere in the foreclosure process. Homeowners behind in their payments have declined from 15% at the 2010 peak of the crisis to less than 8% now (MBAA delinquent plus in foreclosure at 12/31/14). Most of the still-troubled loans were originated before 2007. The best news is that new foreclosure starts are now down to pre-crisis levels, at less than one-half of one percent of all mortgages, if we take 2006 to be the pre-crisis level.
So new home loans, those made since 2008, are doing very well, and what remains is the legacy of those bad loans that triggered the crisis, right? Not exactly.
The first problem is to define what we mean by pre-crisis levels. Subprime mortgages expanded rapidly from 2000 to 2007, accounting for an ever-increasing share of all mortgages, and skewing delinquency rates upwards. So for a real pre-crisis baseline, we need to go back to earlier times, or to look at mortgage default rates for prime and FHA loans only. Today in 2015 there are virtually no subprime mortgages being originated. As the inventory of old subprime loans winds down, we should expect to see default rates well below those for the early 2000s, and we are not there yet.
The second problem is negative equity. At the end of 2014, 16.9% of residential mortgages were underwater, i.e. the debt exceeded the current home value. Home price appreciation is not projected to solve this problem any time soon. This situation is historically unprecedented, and leaves millions of homeowners at continuing risk of default should the economy falter.
The third problem is the fragile inventory of nontraditional and modified loans that remain from the subprime bubble. There are perhaps 3 to 4 million active mortgages that were modified to avoid foreclosure in the past seven years. Some of these have temporarily low rates, as low as 2%, that will adjust upwards soon. Others have large balloon payments or payment terms than extend for 40 years, making repayment or refinancing difficult. And of course there are still plenty of homeowners stuck in non-amortizing mortgages or ARMs that are vulnerable to coming interest rate hikes.
At this point, we can begin to identify some lessons from the long and painful process of deleveraging America's homeowners. In future posts I hope to look at some available data showing what worked and what didn't, as we consider various policy measures to reform housing finance and mortgage foreclosure.
I'm testifying before the House Financial Services Committee on Wednesday at a hearing entitled "Preserving Consumer Choice and Financial Independence." I'm the only non-industry witness (no surprise there). For those interested, my testimony is linked here. Here's the highlight:
Community banks face a serious structural impediment to being able to compete in the consumer finance marketplace because they lack the size necessary to leverage economies of scale. The CFPB has repeatedly acted to ease regulatory burdens on community banks in an attempt to offset this structural disadvantage. While community banks continue to face serious problems with their business model, their profits were up nearly 28% in the last quarter of 2014 over the preceding year, which strongly indicates that they are not being subjected to stifling regulatory burdens.
Ultimately, if Congress wants to help community banks, the answer is not to tinker with the details of CFPB regulations... Instead, if Congress cares about community banks it needs to take action to break up the too-big-to-fail banks that receive an implicit government guarantee and pose a serious threat to global financial stability. Until and unless Congress acts to break up the too-big-to-fail banks, community banks will never be able to compete on a level playing field.
With my attention drawn to other matters, my personal blogging has been light for the past month. One of the things that had my attention was the Caulkett case currently pending before the Supreme Court. The issue in Caulkett is whether a wholly underwater second mortgage can be avoided in a chapter 7 bankruptcy. Without any value to reach, a wholly underwater second would not seem to be an allowed secured claim within the meaning of section 506.
Along with fellow Credit Slips blogger, John Pottow, and Professor Bruce Markell, I filed an amicus brief in Caulkett supporting the debtor. One of our points is that Long v. Bullard, which supposedly stands for the proposition that "liens ride through bankruptcy," involved other issues entirely. I'll try to expand on that point in another blog post. But, we were not alone in representing Credit Slips in the case. Blogger Adam Levitin filed his own superb amicus brief supporting the debtor that provides an in-depth look at the facts, evidence, and policy around second mortgages. All of the briefs in the case can be found at SCOTUSBlog.
I am so pleased to offer the following post by Carolina Reid, a premier housing researcher at UC Berkeley, about her excellent study of how mortgage servicers matter in creating home-saving opportunities. Welcome Carolina to Credit Slips.
By now we’re all familiar with a plethora of Wall Street financial acronyms, from ABSs to CDOs and CDSs. But what about MSRs (mortgage servicing rights)? Until a year ago, I had never heard of MSRs, so I was surprised to find out that the rights to collect my mortgage payment are traded on Wall Street, much in the same way mortgage backed securities are traded. And, as a borrower, I have very little control over who purchases the servicing rights to my mortgage, despite the fact that it is usually the servicer who decides whether to offer a loan modification or start the foreclosure process if I become delinquent. Borrowers can’t “shop around” for the best servicer – you get who you get (but maybe you should get upset).
MBS investors suffered a serious legal blow a couple of months back when the Second Circuit held that the Trust Indenture Act of 1939 doesn't apply to MBS.
The Second Circuit's decision hinges on treating a "mortgage" as a "security." That's rather counterintuitive. The Trust Indenture Act doesn't define "security," but refers to the Securities Act's definitions. The Securities Act defines "security" to include "any note" but the definition bears the caveat "unless the context otherwise requires." I'd think that the context would have pretty easily counseled for reading "note" not to include residential mortgages. What the Securities Act is trying to pick up are issuances of corporate notes.
Frankly, I think the Second Circuit's reading (and the resulting decision) are absurd. First, it is hard to see any context in which "note" should be read to include "residential mortgage" (especially in light of all of the other things that constitute a "security" under the Securities Act, when Congress could easily have included a "mortgage" in the definition). Second, the Second Circuit's reading arrives at an absurd policy result. It excludes from the Trust Indenture Act the very sort of securities (proto-MBS) that were the driving force behind the creation of the Trust Indenture Act of 1939 (and the NY state Trust Indenture Act of 1935 before that). The groundwork for the federal Trust Indenture Act was a 1936 SEC report authored by William O. Douglas, Jerome Frank, and Abe Fortas (among others) that documented in incredible detail the abusive role of trustees in mortgage bond reorganizations. (While bankruptcy scholars have tended to focus on the railroad reorganizations chapter of the report, the real estate chapter is just as important, and goes a long way to understanding why Douglas was such a champion of the absolute priority rule.)
The point here isn't to belabor a questionable decision by the Second Circuit (which did not mention the policy issues in its decision, but I don't know if they were argued), but to underscore the ruling's consequence. At least in the 2d Circuit, it's now clear that MBS investors are not protected by the Trust Indenture Act, and that's a bad thing. This decision means that there's very little (if anything) protecting investors from wrongdoing by MBS trustees, whether acts of omission (e.g., failing to police servicers) or commission (e.g., entering into sweetheart settlements of rep and warranty liability). This is exactly what the Trust Indenture Act was supposed to prevent. If Congress cares about investor protection, it's time to devise a 21st century Trust Indenture Act.
[Update: A state securities regulator emailed me to draw my attention to the Supreme Court's 1990 decision in Reves v. Ernst & Young. That decision expressly adopted an older 2d Circuit case's test regarding what is a security. That case excluded residential mortgage loans from the definition of "security" in the context of a securities fraud action. The 2d Circuit cited to its older decision (but not the Supreme Court's subsequent adoption of its test), but said that the context was different. Unfortunately, the 2d Circuit didn't think it was necessary to explain what about that context was sufficiently different to merit a different result. I can't see any plausible contextual distinction. There's really no context in which loans made for personal, family, or household purposes should ever be considered securities. They are subject to entirely different regulatory regimes, they are part of different markets, and no one would ever think to refer to such loans as securities. Except, apparently the 2d Circuit. It's one thing to arrive at the wrong conclusion after a serious analysis, but I am troubled that the 2d Circuit didn't bother to explain itself in this context.]
Empirical economic analysis is a powerful tool. It can elucidate correlations and sometimes even get us to causual explanations. But it has a serious weak-spot: its value is entirely dependent upon the integrity of the data analyzed. To put the problem succinctly: sh*t in, sh*t out.
This brings us to analyses of the housing bubble. There's a sizeable academic literature on the housing bubble (and relatedly also expert witness reports on loss causation in MBS litigation) that rely on loan-level data. The problem is that a lot of that loan-level data is suspect. That should hardly be a surprise: the industry even referred to some products as "liar loans". And there were also FBI Mortgage Fraud reports indicating an uptick in mortgage fraud. But it was easy for economists to ignore the data integrity problem as long as the problems were merely anecdotal (e.g., the mariachi musician with the six-figure income), and could be blissfully assumed to only affect a small number of loans.
No longer. It's hard to show mortgage fraud empirically, but there's a growing empirical literature about mortgage fraud. There are now a couple of academic studies demonstrating significant inflation of borrower income on loan applications (here and here and here and here and here). (To be clear, this does not mean that the income was inflated by the borrowers. It could be inflated by either borrowers or lenders, including loan brokers.) There's also a Fitch Ratings report from late 2007 that shows questionable stated income, employment, FICO scores, property occupancy status, and appraisals on a large percentage of a small sample of subprime loans.
I want to emphasize that this literature does not undermine all empirical work on the housing market during the bubble years. But it should give us pause when considering any analysis that relies on either loan-level or pool-level loan characteristics such as income, DTI, FICO, occupancy status, and LTV/CLTV. I suspect that the empirical mortgage fraud literature will not deter many economists from plowing ahead whenever their data produces a regression with statistical significance. And the studies might well be right in the end. But it should tell the rest of us to consume the studies with a grain of salt.
While I'm on the subject of dead markets, what about HOEPA loans? HOEPA loans are super-high-cost loans that qualify for special consumer protections under the Home Owners Equity Protection Act of 1994. (Yes, that's the one that directed that the Fed "shall" implement a rule on abusive lending, which the Fed understood to be discretionary until 2008.)
HMDA data has previously been a bit of a pain to manipulate to get summary statistics--big data sets and annoying variable labels. No longer. The CFPB has an amazing on-line HMDA data tool that is a lot of fun to explore. The CFPB's created the Rolls-Royce LoPucki-BRD of HMDA data. It's a real public service. My only complaint is that the CFPB only has data going back to 2007. Hopefully the Bureau will add in 2005-2006, at least (there was a reporting change in 2004). The Urban Institute also has a nice HMDA data page, but it's really more for power users.
OK. So what's gone on with HOEPA loans? HOEPA status was always a kiss of death, but in 2005, there were 35,980 HOEPA loans made. In 2013 (still under the same definitions), there were just 1,873. That's a 95% decline in HOEPA lending. Now it might well be that lenders are making lots of loans just under the HOEPA reporting thresholds. But there's little reason to think that they suddenly started doing that in 2013--that trick's been around for a while. Instead, what we're seeing is that high-cost mortgage lending has simply disappeared in the United States, much more so than lending has contracted in general.
Pretty darn dead. In 2014, there were all of 22 private-label RMBS deals. These deals provided $5.67 billion in financing for 7,342 mortgages. Let that sink in for a second. The private-label market financed fewer home mortgages than were made in the District of Columbia last year.
Perhaps the private-label market's defenders will finally accept that it is a seriously broken market and that fixing it isn't just a matter of interest rates moving a few basis points. This is a market that needs to take major steps to restore investor confidence, and that means, among other things, a total redesign of servicing/trustee compensation structures and roles and a major standardization of deal documentation so that investors won't have to worry about what language got snuck in on page 73 of a 120 page indenture.
Susan Wachter and I have a new (short!) paper up on SSRN. It's called Second-Liens and the Leverage Option, and is about the curious absence of negative pledge clauses in US home mortgages, which enabled enormous amounts of second-lien leverage (much more than anyone realized) during the housing bubble. We have a very simple, narrowly tailored legislative fix that should make additional mortgage leverage via junior liens a bargained-for matter between the borrower and the senior lienholder(s), rather than an absolute right of the borrower.
Abstract is below the break:
Last month mortgage servicer Ocwen (that's NewCo backwards) was mauled by the NY State Department of Financial Services. Now the California Department of Corporations is seeking to revoke Ocwen's license to do business in that state.
Here's the thing that is often forgotten: this ain't the first time! Ocwen used to be a federal thrift. In 2005, however, Ocwen "voluntarily" surrendered its thrift charter in the face of predatory lending/servicing investigation. And here we are, a decade later. What's changed? By the NY and California allegations, not much. In other words, we're looking at a potential case of corporate recidivism. I'll refrain from commenting on the merits of the allegations, but there should be zero tolerance for corporate recidivism.
Richard Cordray, the director of the Consumer Financial Protection Bureau, gave a short speech today at the Brookings Institution. In his speech, he outlined several steps the CFPB is taking to help fix the mortgage market. In his view, one of the chief problems with the mortgage market is that consumers do not shop around for mortgages the same way they shop for other products, including houses. According to a recent CFPB study, "almost half of all borrowers seriously consider only a single lender or broker before deciding where to apply."
The CFPB's aims to solve this problem with some new tools. More after the break.
First some easy ones you all know:
1. The stock market will drop, perhaps precipitously, making now great time to rebalance retirement portfolios.
2. The price of gas will inch up and in the meantime, more states will add a little gas tax here and there to quietly fill empty coffers.
On Mortgage Lending:
3. There will be more low rate, “no closing costs” home refinancings available to good credit risks, as lenders try to figure out what to do with themselves. Not much of a spoiler here, since this is already happening.
4. More lenders will be answering the phones when borrowers want to settle up their mortgages. Lenders will be cutting the red tape that is costing them a fortune. Also, more lenders will be settling pending home foreclosure litigation. Something is better than nothing, some might be thinking.
5. Cases that don’t settle will result in more large judgments against lenders, in part because lenders did not do some of the things mentioned above all along.
On High -Cost Lending:
6. The CFPB will announce its long-awaited payday lending rules, which will apply to all high-cost loans, including payday loans, title loans, and high-cost installment loans. These new rules will go a long way (though perhaps not all the way) to curbing high-cost lending abuses and protecting consumers from the debt trap. After all, the bureau is called the Consumer Financial Protection Bureau. Lenders will not like the rules much and may even sue over them but they won’t have a high-cost leg to stand on.
Apparently some mortgage lenders feel they can make this change unilaterally. Big changes are afoot in the process of granting a home mortgage, which could have a significant impact on a homeowner’s ability to fight foreclosure. In many states in the Unites States (including but not limited to Connecticut, Delaware, Florida, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Vermont and Wisconsin), a lender must go to court and give the borrower a certain amount of notice before foreclosing on his or her home. Now the mortgage industry is quickly and quietly trying to change this, hoping no one will notice. The goal seems to be to avoid those annoying court processes and go right for the home without foreclosure procedures. This change is being attempted by some lenders simply by asking borrowers to sign deeds of trust rather than mortgages from now on.
A lot of the mortgage servicing litigation over the past seven years has faltered on standing issues. Does the borrower have standing to sue the servicer? This has been a problem for RESPA and HAMP suits, where there are questions about whether there is a private right of action, as well as for plain old breach of contract actions. The point I make in this post is that borrowers almost always have standing to sue the servicer for a breach of contract action arising out of the mortgage loan contract itself because the servicer is an assignee of part of the mortgage note. This was an issue that lurked in the background of a case I recently testified in, and I think it's worth highlighting for the Slips readers.
A lot of courts have misunderstood the nature of the servicing relationship vis-a-vis the borrower and assumed that because the servicer is not expressly a party to the note and security agreement that there is no privity between the borrower and servicer and hence the borrower cannot maintain a breach of contract suit. That's wrong. The servicer is not on the note or the security agreement, but the servicer is an assignee of the note, just like the securitization trust, and that provides all the privity needed for a breach of contract suit.
First, Sweden is proposing a particularly aggressive approach to reducing the weight of mortgage debt on consumers' balance sheets. The new accelerated amortization rules really struck me from a comparative US perspective: Swedes borrowing more than 70% of the value of their homes would have to pay the loan down by 2% a year (that's 2% of the principal) until the LTV falls to 70%, then 1% of the principal of the loan each year until LTV reaches 50%, the desired level. Wow. In the 15 years that I've been wrestling with a variety of home mortgages, I don't think I've ever paid 2% of the principal (given the back-loaded amortization schedule of most standard US home mortgage loans). To make matters worse (better?), the Swedish central bank is also considering grabbing onto the third rail of US tax reform--reducing tax deductions for mortgage interest. These are pretty aggressive moves to cool off the mortgage market and bring down consumer leverage, and they stand in stark contrast to efforts in the US and the other country in today's news ...
There are three major new regulations shaping the housing finance market: QM (qualified mortgage), QRM (qualified residential mortgage) and Reg X. QM is a safe harbor from the statutory ability-to-repay requirement that applies to all mortgages. QRM is a safe harbor from the statutory risk retention requirement that applies to mortgage securitization. And Reg X are the new mortgage servicing regulations. It's important to understand how these three regulations interact and how they're going to affect the housing finance market. (There's also new TILA/RESPA disclosure stuff, but I don't think that's particularly impactful, in part because I don't think disclosure regulation is especially effective in most real world circumstances.)
The CFPB entered into a Consent Order with Flagstar Bank regarding its default mortgage servicing practices. This order is really important. It's the first enforcement action of the CFPB's new servicing rules, and its "benching" remedy that prevents Flagstar from most default servicing until it demonstrates compliance shows that the Bureau is serious about cleaning out the Augean stables of servicing. (The Ocwen order had a much larger dollar figure attached, but was about pre-2014 conduct).
The details given in the consent order tell an all-too-common picture about mortgage servicing.
In 2011, Flagstar had 13,000 active loss mitigation applications but only assigned 25 full-time employees and a third-party vendor in India to review them. For a time, it took the staff up to nine months to review a single application. In Flagstar’s loss mitigation call center, the average call wait time was 25 minutes and the average call abandonment rate was almost 50 percent. And Flagstar’s loss mitigation application backlog numbered well over a thousand.
And we wonder why loss mitigation hasn't been more effective?
A long long time ago in this same galaxy, I wrote what may be Credit Slips' most popular post: What do bankruptcy mortgage servicing and phone sex in common? Today, I bring you a new comparison: bankruptcy mortgage servicing and ebola. At the outset, let me be very clear that ebola is a tragic health care crisis. I do not mean to minimize those deaths and illnesses with a comparison to mortgage servicing--although to be sure, poor mortgage servicing has tragic financial consequences.
Here is the basic analogy. Ebola has a high kill rate. Similarly, screwed up mortgage servicing can be the death knell for homeownership. Ebola is currently epidemic in West Africa, just as the foreclosure crisis made mortgage servicing a top-line policy problem. And despite the publicity, both ebola and foreclosure--as epidemiological matters--are rare. This is one of the reasons that investment and research on both problems has lagged behind more common occurrences such as, respectively, malaria and mobile banking. We have known about the risks of ebola for years, yet the global community is still struggling to find fixes. Again, in parallel, it has been twelve years since Hank Hildebrand wrote "The Sad State of Mortgage Service Providers," and six years after Tara Twomey's and my research on mortgage servicing errors in bankruptcy hit the front pages of newspapers. While improved, bankruptcy mortgage servicing is still a threat to a healthy bankruptcy system.
My favorite recent case in point: In re Williams, in which a couple filed a second bankruptcy solely to save their home--the exact reason for their first bankruptcy. (At least you can only get ebola once!) The Williams alleged that Ocwen had not properly serviced their mortgage during their first bankruptcy. Ocwen pursued a foreclosure after the debtors had completed their chapter 13 plan and refused to accept debtors' payments. Its proof of claim alleged 28 missed payments and an arrearage of $43,388.82. U.S. Bankruptcy Judge Brendan Shannon (Bankr. Del.) ultimately found the debtors owed only $16,164.24 (12 payments) and ordered Ocwen to pay the costs and fees of the debtors' second bankruptcy filing and litigation with Ocwen. In describing the situation, Judge Shannon, said that the bankruptcy servicing created an "ensuing mess [that] is "dispiritingly predictable." The system was bogged down with a second case, the debtors threatened and stressed by a second foreclosure, and Ocwen spent its resources on a second round of litigation (instead of helping homeowners get loan modifications.)
One of the post-bubble conventional wisdom stories that has gotten a lot of traction is that housing is a bad investment and that consumers would do better to rent and invest in the stock market. The problem is that it's wrong.
The prooftext for the idea that housing is a bad investment is a straightfoward comparison of the returns on stock market indices with those on housing market indices. If one compares the return on the S&P500 index vs. the S&P/Case-Shiller Composite 10 index from the beginning of the Case-Shiller data (1987) to present, one sees that the S&P500 went up 630%, while the Case-Shiller went up only 197%. Even if one uses an average return (averaging the monthly index values, relative to the starting value), S&P500 is 244%, while Case-Shiller is 98%. Ergo housing is a bad investment compared to the stock market, right?
That's certainly what a bunch of smart people have argued. (I won't link or name names, but Google isn't coy.) There are two problems with this line of argument.
First, it fails to account for the leveraged nature of housing investment. Most homes are purchased on leverage, and housing is the only leveraged investment broadly available to the middle class. When one factors in leverage, housing massively outperforms stock market mutual funds, making it a pretty sensible investment in most cases.
Second, the simple return comparison fails to account for the indirect benefits of housing, such as school districts, commuting time, quality of life etc. I'm not going to try to quantify the indirect benefits, although some of them definitely translate into pecuniary terms (schooling, for example).
If you'll indulge me with some number play below the break, you'll see that the leverage point alone blows the "housing is a bad investment" argument out of the water. Leverage is not without its complications, though.
Mark Fogarty has a nice write-up in National Mortgage News of a book chapter about duties to serve in housing finance that I wrote with Jannecke Ratcliffe for a volume entitled Homeownership Built to Last (Brookings/Joint Center on Housing Studies 2014). It's a real pleasure to realize that someone has actually read our chapter!
Larry Summers has a very interesting book review of Atif Mian and Amir Sufi's book House of Debt in the Financial Times. What's particularly interesting about the book review is not so much what Summers has to say about Mian and Sufi, as his attempt to rewrite history. Summers is trying to cast himself as having been on the right (but losing) side of the cramdown debate. His prooftext is a February 2008 op-ed he wrote in the Financial Times in his role as a private citizen.
The FT op-ed was, admittedly, supportive of cramdown. But that's not the whole story. If anything, the FT op-ed was the outlier, because whatever Larry Summers was writing in the FT, it wasn't what he was doing in DC once he was in the Obama Administration.
Let's make no bones about it. Larry Summers was not a proponent of cramdown. At best, he was not an active opponent, but cramdown was not something Summers pushed for. Maybe we can say that "Larry Summers was for cramdown before he was against it."
I just read Jennifer Taub's outstanding book Other People's Houses, which is a history of mortgage deregulation and the financial crisis. The book makes a nice compliment to Kathleen Engel and Patricia McCoy's fantasticThe Subprime Virus. Both books tell the story of deregulation of the mortgage (and banking) market and the results, but in very different styles. What particularly amazed me about Taub's book was that she structured it around the story of the Nobelmans and American Savings Bank.
The Nobelmans? American Savings Bank? Who on earth are they? They're the named parties in the 1993 Supreme Court case of Nobelman v. American Savings Bank, which is the decision that prohibited cramdown in Chapter 13 bankruptcy. Taub uses the Nobelmans and American Savings Banks' stories to structure a history of financial deregulation in the 1980s and how it produced (or really deepened) the S&L crisis and laid the groundwork for the housing bubble in the 2000s.
Credit Slips readers, please note the publication of a new book edited by Marion Crain and Michael Sherraden. The New America Foundation is hosting an event on the book tomorrow, Wednesday, May 28, 2014 at 12:15 EST. Not in Washington, D.C.? The event will be webcast live.
The book project developed out of a stimulating multi-disciplinary conference at Washington University in St. Louis. Participants had great interest in considering how bankruptcy scholarship fits within the larger universe of research on financial insecurity and inequality. My chapter with Mirya Holman synthesizes the literature on medical problems among bankruptcy filers and presents new results from the 2007 Consumer Bankruptcy Project on coping mechanisms for medical bills, looking more closely at the one in four respondents who reported accepting a payment plan from a medical provider. Not surprisingly, these filers are far more likely than most others to bring identifiable medical debt, and therefore their medical providers, into their bankruptcy cases. We examine how payment plan users employ strategies - including but not limited to fringe and informal borrowing - to manage financial distress before resorting to bankruptcy, and (quite briefly) speculate on the future of medical-related financial distress in an Affordable Care Act world.
Paul Krugman has a column today about the blind, fundamentalist faith in efficient markets. This is a phenomenon that Stephen Lubben and I have been discussing recently (did Krugman just preempt our paper idea?), as we've both encountered it in the financial regulatory policy debate:
So here's the inconvenient paradox of market fundamentalism: the idea that the free market can be directed. Either the market is free or it will follow direction, but it's not going to do both. Markets do what markets want.
Thanks to all who commented on my earlier post on the interaction of §§ 544(a)(3) and 551 and homeownership in bankruptcy; as hoped, CreditSlip readers helped me frame the questions that I continue to have about Traverse and the larger policy questions it raises. Some readers emphasized the importance of variations in state mortgage law to the trustee’s strong-arm powers; others questioned whether these distinctions should affect the trustee’s power to sell the residence (or the avoided lien) following avoidance.
Clearly, the trustee had the power to avoid the unrecorded mortgage in Traverse; let’s assume for purposes of argument that he also had the power to sell full title to the debtor’s home after avoidance. For me the more interesting question is whether the trustee should have exercised these powers, and also whether the exercise might be viewed as an abuse of discretion.
Another way to think about this question is from an even broader angle: What position should a trustee play in a individual borrower’s chapter 7 case? Is a trustee’s role to maximize distributions to unsecured creditors, full stop? Or might the trustee’s fiduciary obligations to the estate sometimes sit in tension with an interest in maximizing creditors’ interests?
The U.S. Supreme Court has denied a petition for writ of certiorari in Bank of America v. Sinkfield, an 11th Circuit case raising the issue whether a junior lien wholly unsupported by collateral value can be stripped off in chapter 7.
The high court's denial of certiorari yesterday (March 31) is a victory not only for the debtor who prevailed in the case below but also for the National Association of Consumer Bankruptcy Attorneys, represented by the National Consumer Bankruptcy Rights Center, which argued in an amicus brief against Supreme Court review on the ground that the case had not been fully litigated below and thus was a poor one for the Supreme Court to take up.
The creditor in Sinkfield stipulated to the result that strip off was permitted in the case, based on an Eleventh Circuit opinion so holding in another case, In re McNeal, 735 F.3d 1263 (11th Cir. 2012), one in which en banc rehearing has been sought.
The Supreme Court's decision not to review Sinkfield avoids for now the possibility of disturbing the solid precedent for lien strip off in chapter 13. McNeal is the first circuit court case to allow lien strip off in chapter 7; two other circuits have extended Dewsnup v. Timm, 502 U.S. 410 (1992), to come to the opposite conclusion. See here for background. Lien strip off in chapter 13 has been one of the few ways for debtors in bankruptcy to hold on to homes on which they are underwater while making them more affordable by removing junior liens unsupported by collateral value. Extending that sort of relief to chapter 7 cases would be helpful, but Supreme Court review also poses a serious downside risk of making bankruptcy less promising for consumer debtors.
Can’t get a mortgage? Turns out it’s my fault. As in mine, personally. Yup. That’s the claim in a Housing Wire written by right-wing banking analyst R. Christopher Whalen. Here is Whalen’s argument in a nutshell:
Servicing regulations make banks really reluctant to deal with anyone but very good credit borrowers because it takes so long to foreclose on anyone anymore. Servicing regulations are so onerous because of an article Tara Twomey and I wrote on mortgage servicing that said that servicers were doing bad things. The problem (in Whalen's view) is that Tara and I had it totally wrong.
I'm flattered that Whalen credits the article with having inspired all of the subsequent foreclosure regulation, but it would be nice if Whalen would accurately characterize the article. (Has he even read it?) It would also be nice if Whalen would acknowledge that servicers have done an awful lot of bad things over the past several years, which might just possibily have something to do with the current regulatory enviornment for servicing. But such an admission that might get in the way of Whalen grinding his political axe (two legs good, regulation ba-a-a-d).
Conventional wisdom views bankruptcy as a place that protects homeowners and homeownership. One of the primary reasons Chapter 13 allows debtors to retain all property of the estate, whether exempt or not, is to allow debtors to hang on to their personal residences even though applicable exemption law would not otherwise allow this. OK Chapter 13 doesn’t permit modification of residential mortgages, but it does allow debtors to decelerate and cure mortgages in default, providing some consumer debtors some protection from foreclosure. Chapter 7 is traditionally viewed as less protective of the homestead – that is, it protects residences only to the extent of applicable homestead exemption law, but it has been widely accepted that debtors might protect their homes in chapter 7 by combining a discharge from unsecured debts with reaffirmation of a residential mortgage.
The recent financial crisis has strained both the state court foreclosure process and the federal bankruptcy system, raising questions about the continuing accuracy of the notion that bankruptcy provides a safe place for homeowners. Whether bankruptcy does or even should protect homeownership is a very big question, one undoubtedly best answered in combination with careful analysis of data, and I won’t presume to tackle that question in a blog. But I do want to use this format as a safe place for thinking about these issues.
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