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Usury and Securitization

posted by Adam Levitin

Most institutional lenders in the United States are not subject to usury laws.  National banks can evade they by basing themselves in states without usury laws and exporting the laxer regulation to other jurisdictions.  State institutions often find themselves exempt because of state banking parity laws.  And usury laws are preempted for many mortgages by federal law (although originally the FHA eligibility rate cap--removed in 1983--served as a de facto federal usury law for many mortgages). 

There's plenty to say (at another date) about whether usury laws are good policy.  I want to raise a related legal question for discussion on the Slips:  are debts held in securitized pools subject to usury laws? 

I've dealt with this previously in an academic article, but want to raise the issue on the Slips.  My belief is that securitized pools are subject to usury laws, unless usury laws are specifically preempted for the type of debt that is held.  Legal title to securitized pools rests with state-law trusts.  These trusts cannot, as far as I know, claim the benefits of federal preemption themselves.  Their best hope is to shelter in the ability of the debtor's originator or the securitization sponsor/depositor's exemption from usury laws. 

I don't think this is a very good shelter, however.  Usury was historically a personal defense, and when a debt is originated as part of an originate-to-distribute business model, letting the securitization trust shelter in the originator's status allows for a type of usury laundering--the specific exemptions to usury law can then cover all takers from exempt entities.  Putting aside the question of whether usury laws themselves are good policy, once they are on the books, surely allowing the usury defense to transfer with the debt cannot be good policy given that it is plain on the face of a debt whether it is usurious.  And more broadly, do federal preemption defenses apply to securitized pools of debts originated by national banks or federal thrifts?  And what about affiliates (not operating subsidiaries) of national banks or federal thrifts, such as some major debt collection companies?

These aren't mere academic questions.  Securitization trusts hold around 60% of mortgage debt and 25% of other consumer debt.  There's no law directly on point, but if I'm correct, then usury could be raised as a viable defense to the collection of a sizable portion of consumer debt.  And states would have pretty broad rein to regulate the collection of debts held by securitization trusts.  Thoughts? 


Go for it.
As an insider, I am aware first-hand of myriad abuses in CMBS and RMBS securitizations and a lack of economic basis (they were a form of chain-letter/ponzi scheme). These structures cannot withstand scrutiny. The fact that the FED and the GSE are collecting them undermines the financial security of the country.

Almost all of the first mortgage debt is going to be under the usury caps - I don't think recent mortgages ever got above 11% or 12%, even the subprimes.

The consumer debt could be over the limits. But, all of the servicers are in South Dakota, Utah, etc. for a reason.... And how would you know if your consumer debts were in a securitized pool to begin with, to even make the argument?

Usury caps aren't likely to do much with securitized mortgage debt. But other state laws might.

As for consumer debts, I don't see why the identity of the servicer matters. The servicer doesn't own the debt (actually, it might have an ownership percentage, but that's beside the point). This is the same as show-me-the-note litigation for mortgages. The servicer should properly be filing a suit or bankruptcy claim on behalf of the trust. It shouldn't be too hard to find out who owns the debts. In bankruptcy the Chapter 13 claims are usually bought up by professional claims buyers. If they're affiliates, not op-subs of national banks, preemption shouldn't be a defense.

I don't know if it will assist with the preemption argument, but FAS 140 (implemented in 2000-the foundation for the bubble) by which the originators account for the off-balance sheet transfer of the loans, and the IRS REMIC rules would both support a contention that securitizations, once launched, are no longer creatures of the originators but have independent lives.

also...write model legislation and use "the moment" to get it passed in the states.

good luck.

read this very interesting post on naked capitalism.
query: wouldn't it depend on who entered into the contract with the consumer that provides for allegedly usurious rates? if it's a person whose place of busines (a la Marquette) is in a state with a nonexistent usury limit, then wouldn't it be irrelevant whether that person sold off the claim to a trust whose place of business is in a restrictive jurisdiction?

But the credit card debtor still has a contract with Citibank (South Dakota), N.A., for example. The fact that there are investors who have bought securities that are created out of the payment stream to Citibank is irrelevant, isn't it?

If it's a REMIC and falls under FAS 140, I say it's a sale to the the trust, with an assignment of the contract by Citi to the trust.

There's a nice theme here: securitization is all about using formal structures to reallocate (or evade) risks. But that same use of formal structures is also a potential legal vulnerability. If there's been a true sale, preemption shouldn't play a role; there's certainly not much of a policy case, as the major reason for preemption is to avoid state/federal legal conflicts. There's no federal regulation of securitization trusts' operations (there is of the securities they issue, but that's different), so if there were preemption, a regulatory vacuum would result.

Psittakos: The account remains with Citibank (South Dakota), N.A., but the receivables have been securitized. The receivables are owned by Citibank Omni Trust, which issues series of collateral certificates to a Citibank Omni Master Trust, which issues tranched series of notes. This strange structure is done to make all of the securities issued in the end to be "notes"--debt--which makes it possible to sell them to ERISA-qualified entities without the Master Trust and everyone with a control role picking up ERISA's fiduciary responsibilities.

Alex: It's a good point, but I think it depends on how one parses Marquette. The issue in Marquette is what usury law applies to a national bank, not what usury law applies to the transaction. Once the national bank is removed, the issue becomes fuzzier. Marquette was predicated on language in the National Bank Act and the policy of making national banks more competitive. But that's different than making securitization trusts more competitive. If the national banks are just a conduit for securitization, there's no reason to favor them. Part of the answer to this might lie in the contractual choice of law provisions.

Wmatthei: REMICs are only for real estate loans, and they are unlikely to violate usury laws (maybe with fees?). Also, FAS 140 has been replaced by FAS 166/167, which changes the test for consolidation. Under FAS 166/167, a lot of credit card securitization trusts will have to be consolidated on the seller/servicer's balance sheet. But remember that is only an accounting treatment. The accounting is different than the actual ownership. I haven't the foggiest idea how FAS 166/167 will be applied to existing trusts, as I don't know what authority the securitization trustee (Bank of NY for Citi) would have to sell the trust's assets back to the originator (Citi).

"If the national banks are just a conduit for securitization, there's no reason to favor them."

I agree, but that horse and innumerable others left the barn a long time ago. Banks don't do much old-fashioned banking anymore.

That said, to argue that the securitization of receivables by a master trust is equivalent to the the assignment of a promissory note seems like a stretch. The investors in the securities don't go to court to get judgments on unpaid credit card debt.

Thanks for clarification...
I do come from CRE/CMBS side and with some exposure to private label RMBS and the GSE's...
The CMBS and RMBS structures were designed for sale treatment in all dimensions-for example, mods are a problem because the originating banks can't take an active role or else be in violation of the REMIC Rules.
I don't know what states are used as homes for these trusts...in fact I will check that out. But the principle holds. If these home mortgage loans are sold into state trusts, why can't the states regulate their conduct by statute?

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