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Over on Housing Wire, Paul Jackson is crowing that chain-of-title issues in mortgage securitization are overblown because an Alabama state trial court rejected such arguments in a case ironically captioned U.S. Bank v. Congress.
But let’s actually consider whether the opinion matters, what the court actually did and did not say, and whether it was right.
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Last week the US Bankruptcy Court for the District of New Jersey issued an opinion in a case captioned Kemp v. Countrywide Home Loans, Inc. This case looks like the first piece of evidence in what might turn out to be the Securitization Fail or, in homage to Michael Lewis, The Big Fail.
Briefly, Countrywide as servicer filed a proof of claim for a mortgage in a bankruptcy case on behalf of Bank of New York as trustee for a securitization trust. The bankruptcy court denied the claim because there was no evidence that Bank of New York ever owned the mortgage. The mortgage note had never been negotiated or delivered to Bank of New York, despite the requirement to do so in the Pooling and Servicing Agreement (PSA) that governed the securitization of the loan. That meant that Bank of New York as trustee had no interest in the loan, so the proof of claim filed on its behalf was disallowed.
This opinion could turn out to be incredibly important. It provides a critical evidence for the argument that many securitization transactions simply failed to be effective because non-compliance with the terms of the transaction: failure to properly transfer the mortgage meant that the mortgages were never actually securitized. The rest of this post explains the chain of title issue in mortgage securitizations and how Kemp fits into the issue.
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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?
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A few days ago I wrote a long and detailed critique of a Boston Federal Reserve staff study that argued, among other things, that securitization was not a factor in the paucity of loan modifications. The study reached this conclusion based largely on the similar rate of modifications for portfolio and securitized loans. Although the study controls for the effect of the modification in terms of monthly payment, it otherwise assumes all modifications are created equal. But clearly they are not. There is a significant difference in redefault rates for securitized and portfolio loans, and the securitized loan mods perform much worse. This is something the Boston Fed's study cannot explain other than if there is (1) unobserved heterogeneity in the loans or (2) differences in the loan mods.
Finally, the study has a very strange observation that there is a moral hazard problem in principal balance reductions, but apparently not for interest rate reductions: "Balance reductions are appealing to both borrowers in danger of default and those who are not." Therefore, borrowers might default to get principal reductions. Sure, that's right, but everyone would also like a lower interest rate too. I don't see why a principal reduction presents a different level of moral hazard from an interest rate reduction. In terms of net present value, principal and interest rate are interchangeable (yes, there's an interest deduction, and a principal reduction changes the ability to refinance, but that's not the distinction at issue). The bigger factor pushing against principal reductions (other than servicer compensation) is an accounting issue. A principal reduction shows up on the balance sheet immediately. A reduction of interest just reduces future income.
The take-away here is that even if the Boston Fed staff is right that securitization doesn't affect the prevalence of loan modifications, it clearly affects the quality of those modifications, and that is every bit as important, not least because the performance of past modifications is the basis for servicers' calculation of the redefault risk that the Boston Fed staff emphasizes as constraining modifications. If servicers do bad mods and have high redefaults, that will make them more adverse to doing mods in the future because they will think that the mods don't work.
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There's a very interesting new study on mortgage loan modifications out from the Boston Federal Reserve staff. This sort of study is long-overdue and from an academic standpoint, there's a lot I really like about this study. But the study is going to get a lot of policy attention, and I think it's important to point out some of the problems with the study that limit its ability to serve as a policy guide.
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"Bankruptcy remoteness" is the bedrock of asset securitization. Bankruptcy remoteness means both that the assets will not be part of the originator's bankruptcy estate and that the securitization vehicle (SPV) will not itself file for bankruptcy. The former is achieved by a true sale of the assets from the originator to the SPV; the later by ensuring that the board of the SPV will not authorize a bankruptcy petition and that there will not be outside, creditors who might file an involuntary petition.
The bankruptcy filing of General Growth, the second largest mall operator and the largest CMBS sponsor in the US is putting bankruptcy remoteness into question.
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To understand rate-jacking, you have to understand two factors about credit cards: lock-in and the incentive to increase account volatility created by card securitization.
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Last night John McCain presented a “new” plan to deal with the financial crisis. Unlike the bailout rescue bill, it is a bottom-up plan, not a top-down plan, meaning that it focuses on helping homeowners, not financial institutions.
It’s commendable that now in October 2008, over a year into this foreclosure crisis, John McCain has recognized that homeowners need some help and is proposing to do something for them. The trouble is that his proposal won’t help.
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Elizabeth Warren draws our attention to an astonishing example of banking industry chutzpah–claiming preemption protection against state foreclosure laws. Not only has no one ever historically believed that state foreclose law was preempted; the OCC’s preemption reg’s specifically carve out state debt collection law from preemption. There’s no conflict preemption here, and given specific mortgage preemption laws like DIDMCA and AMTPA that preempt state usury limits on some mortgages and limits on exotic mortgage structures, it is hard to see how there is general field preemption or the like.
The preemption argument is even more chutzpadik, though, because banks hold only a small percentage of mortgages. Most mortgages are held by securitization trusts. The last time I checked, they are not federally chartered financial institutions nor are they operating subsidiaries or agents of federally chartered financial institutions. Thus it is utterly beyond me how anyone could claim that preemption applies to mortgages owned by securitization trusts, even if the mortgages were originated by national banks and are serviced by them. The preemption claim here doesn’t even pass the straight-face test. As unbelievable as it is, though, perhaps legislation should clarify this just to, um, foreclose possible preemption arguments.
I’m curious whether the same financial institutions pushing the preemption claim are also the same institutions that are members of the HOPE Now Alliance, who have supposedly committed themselves to working to modify loans rather than foreclose. The preemption agenda is simply inconsistent with a commitment to efforts to avoid foreclosure.