Tag Archives: FIRREA

Fannie and Freddie Visit the Supreme Court

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Justice Gorsuch

Fannie and Fredddie investors have filed their petition for a writ of certiorari in Perry Capital v. Mnuchin. The question presented is

Whether 12 U.S.C. § 4617(f), which prohibits courts from issuing injunctions that “restrain or affect the exercise of powers or functions of” the Federal Housing Finance Agency (“FHFA”) “as a conservator,” bars judicial review of an action by FHFA and the Department of Treasury to seize for Treasury the net worth of Fannie Mae and Freddie Mac in perpetuity. (i)

What I find interesting about the brief is that relies so heavily on the narrative contained in Judge Brown’s dissent in the Court of Appeals decision. As I had noted previously, I do not find that narrative compelling, but I believe that some members of the court would, particularly Justice Gorsuch. The petition’s statement reads in part,

In August 2012—nearly four years after the Federal Housing Finance Agency (“FHFA”) placed Fannie Mae and Freddie Mac1 in conservatorship during the 2008 financial crisis—FHFA, acting as conservator to the Companies, agreed to surrender each Company’s net worth to the Treasury Department every quarter. This arrangement, referred to as the “Net Worth Sweep,” replaced a fixed-rate dividend to Treasury that was tied to Treasury’s purchase of senior preferred stock in the Companies during the financial crisis. FHFA and Treasury have provided justifications for the Net Worth Sweep that, as the Petition filed by Fairholme Funds, Inc. demonstrates, were pretextual. The Net Worth Sweep has enabled a massive confiscation by the government, allowing Treasury thus far to seize $130 billion more than it was entitled to receive under the pre-2012 financial arrangement—a fact that neither Treasury nor FHFA denies. As was intended, these massive capital outflows have brought the Companies to the edge of insolvency, and all but guaranteed that they will never exit FHFA’s conservatorship.

Petitioners here, investors that own preferred stock in the Companies, challenged the Net Worth Sweep as exceeding both FHFA’s and Treasury’s respective statutory powers. But the court of appeals held that the Net Worth Sweep was within FHFA’s statutory authority, and that keeping Treasury within the boundaries of its statutory mandate would impermissibly intrude on FHFA’s authority as conservator.

The decision of the court of appeals adopts an erroneous view of conservatorship unknown to our legal system. Conservators operate as fiduciaries to care for the interests of the entities or individuals under their supervision. Yet in the decision below, the D.C. Circuit held that FHFA acts within its conservatorship authority so long as it is not actually liquidating the Companies. In dissent, Judge Brown aptly described that holding as “dangerously far-reaching,” Pet.App. 88a, empowering a conservator even “to loot the Companies,” Pet.App. 104a.

The D.C. Circuit’s test for policing the bounds of FHFA’s statutory authority as conservator—if one can call it a test at all—breaks sharply from those of the Eleventh and Ninth Circuits, which have held that FHFA cannot evade judicial review merely by disguising its actions in the cloak of a conservator. And it likewise patently violates centuries of common-law understandings of the meaning of a conservatorship, including views held by the Federal Deposit Insurance Corporation (“FDIC”), whose conservatorship authority under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), served as the template for FHFA’s own conservatorship authority. Judge Brown correctly noted that the decision below thus “establish[es] a dangerous precedent” for FDIC-regulated financial institutions with trillions of dollars in assets. Pet.App. 109a. If the decision below is correct, then the FDIC as conservator could seize depositor funds from one bank and give them away—to another institution as equity, or to Treasury, or even to itself—as long as it is not actually liquidating the bank. The notion that the law permits a regulator appointed as conservator to act in a way so manifestly contrary to the interests of its conservatee is deeply destabilizing to our financial regulatory system. (1-2)

We shall see if this narrative of government overreach finds a sympathetic ear at the Court.

FIRREA Blanks

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photo by Mike Cumpston

The Court of Appeals for the Second Circuit reversed the District Court’s judgment (SDNY, Rakoff, J.) against Bank of America defendants for actions arising from Countrywide’s infamous “Hustle” mortgage origination program. The case has a lot of interesting aspects to it, not the least of which is that it does away with more than one billion dollar in civil penalties levied against the defendants.

The opinion itself answers the narrow question, when “can a breach of contract also support a claim for fraud?” (2) The Court concluded that “the trial evidence fails to demonstrate the contemporaneous fraudulent intent necessary to prove a scheme to defraud through contractual promises.” (3)

I think the most important aspect of the opinion is how it limits the reach of the Financial Institutions Reform, Recover, and Enforcement Act of 1989 (FIRREA). Courts have have been reading FIRREA very broadly to give the federal government immense power to go after financial institutions accused of wrongdoing.

FIRREA provides for civil penalties for violations of federal mail or wire fraud statutes, but the Court found that there was no fraud at all. It made its point with a hypothetical:

Imagine that two parties—A and B—execute a contract, in which A agrees to provide widgets periodically to B during the five-year term of the agreement. A represents that each delivery of widgets, “as of” the date of delivery, complies with a set of standards identified as “widget specifications” in the contract. At the time of contracting, A intends to fulfill the bargain and provide conforming widgets. Later, after several successful and conforming deliveries to B, A’s production process experiences difficulties, and the quality of A’s widgets falls below the specified standards. Despite knowing the widgets are subpar, A decides to ship these nonconforming widgets to B without saying anything about their quality. When these widgets begin to break down, B complains, alleging that A has not only breached its agreement but also has committed a fraud. B’s fraud theory is that A knowingly and intentionally provided substandard widgets in violation of the contractual promise—a promise A made at the time of contract execution about the quality of widgets at the time of future delivery. Is A’s willful but silent noncompliance a fraud—a knowingly false statement, made with intent to defraud—or is it simply an intentional breach of contract? (10)

This case emphasizes that “a representation is fraudulent only if made with the contemporaneous intent to defraud . . .” (14) While this is not really new law, it is a clear statement as to the limits of FIRREA. This will act as a limit on how the government can deploy this powerful tool as new cases crop up. Unless, of course, the Supreme Court were to reverse it on appeal.

S&L Flexible Porfolio Lending

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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.

Smoldering FIRREA

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Jens Buurgaard Nielsen

American Banker quoted me in Banks Take Losses in MBS Case Appeals; Is Supreme Court Next? (behind a paywall) The story reads, in part,

Banks that sold faulty mortgage-backed securities right before the crisis have suffered a string of legal defeats over the timing of government lawsuits, but some experts believe the industry may still have a shot in the Supreme Court.

Since the crisis regulators have brought a slew of actions against big banks for assets they sold to acquirers that ultimately failed. But in some cases, the parties have tussled over whether the government missed the statutory deadline for bringing a claim.

Appeals courts lately have disagreed with banks that plaintiffs missed court filing deadlines imposed by state law and other regimes, which are stricter than deadlines in federal law. Most recently, the U.S. Court of Appeals for the 5th Circuit ruled in favor of the Federal Deposit Insurance Corp. in the agency’s case against RBS Securities and other issuers related to the 2009 failure of Guaranty Bank.

Still, other cases are pending and some say banks may be emboldened after the Supreme Court last year favored state-mandated timelines in an environmental case.

“I would expect that [banks] would continue to try to pursue the issue and get relief from the Supreme Court,” said Paul Rugani, a partner at Orrick, Herrington & Sutcliffe LLP based in Seattle.

The government has sought billions from MBS issuers that officials say misrepresented the quality of securities leading up to the crisis. The FDIC and National Credit Union Administration sued companies that had sold assets to institutions that ultimately failed, and the Federal Housing Finance Agency brought claims over securities sold to Fannie Mae and Freddie Mac.

But many banks have fought the agencies over whether they could bring the suits in the first place. Defendants seemed to gain ground in the lower courts and when the Supreme Court handed down its decision last year in a North Carolina environmental case.

*     *     *

“The Supreme Court generally does not take a case where there isn’t a split among different circuit appeals courts, and the 5th and 10th circuits are in agreement,” said an attorney familiar with the situation.

But other decisions are still pending. Rulings have yet to come from the 9th circuit as well as a separate case still to be decided in the 2nd circuit. Both involve the FDIC’s extender statute related to MBS losses at the failed Colonial Bank.

“I would think that the parties that lost the case would wait for the 2nd and 9th circuits to decide and then hope that either of them disagrees with the 5th circuit before deciding to take the case up to the Supreme Court,” said Sanford “Sandy” Brown, a partner at Bracewell & Giuliani LLP.

Others said the extender statute in the law at issue in the Supreme Court’s environmental decision – the Comprehensive Environmental Response, Compensation, and Liability Act – is different enough from the extender statute in FIRREA that the justices on the high court may want to weigh in.

The 5th circuit decision “is a well-reasoned opinion, but there is no question that such an interpretation could be challenged in an appeal to the Supreme Court,” said David Reiss, a professor at Brooklyn Law School. “While circuit courts have had a consistent interpretation of the FIRREA extender statute, there is enough interpretation going on that the Supreme Court could come up with a reasonable alternative to the courts of appeal that have ruled on this issue.”

New FHA Guidelines No Biggie

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Welcome_to_Levittown_sign

(Original Purchases in Levittown Funded in Large Part by FHA Mortgages)

Law360 quoted me in New Guidelines For Bad FHA Loans Won’t Boost Lending (behind paywall). It opens,

The federal government on Thursday provided lenders with a streamlined framework for how it determines whether the Federal Housing Administration must be paid for a loan gone bad, but experts say the new framework will have limited effect because it failed to alleviate the threat of a Justice Department lawsuit.

The U.S. Department of Housing and Urban Development provided lenders with what it called a “defect taxonomy” that it will use to determine when a lender will have to indemnify the FHA, which essentially provides insurance for mortgages taken out by first-time and low-income borrowers, for bad loans. The new framework whittled down the number of categories the FHA would review when making its decisions on loans and highlighted how it would measure the severity of those defects.

All of this was done in a bid to increase transparency and boost a sagging home loan sector. However, HUD was careful to state that its new default taxonomy does not have any bearing on potential civil or administrative liability a lender may face for making bad loans.

And because of that, lenders will still be skittish about issuing new mortgages, said Jeffrey Naimon, a partner with BuckleySandler LLP.

“What this expressly doesn’t address is what is likely the single most important thing in housing policy right now, which is how the Department of Justice is going to handle these issues,” he said.

The U.S. housing market has been slow to recover since the 2008 financial crisis due to a combination of economics, regulatory changes and, according to the industry, the threat of litigation over questionable loans from the Justice Department, the FHA and the Federal Housing Finance Agency.

In recent years, the Justice Department has reached settlements reaching into the hundreds of millions of dollars with banks and other lenders over bad loans backed by the government using the False Claims Act and the Financial Institutions Reform, Recovery and Enforcement Act.

The most recent settlement came in February when MetLife Inc. agreed to a $123.5 million deal.

In April, Quicken Loans Inc. filed a preemptive suit alleging that the Justice Department and HUD were pressuring the lender to admit to faulty lending practices that they did not commit. The Justice Department sued Quicken soon after.

Policymakers at the Federal Housing Finance Agency, which serves as the conservator for Fannie Mae and Freddie Mac, and HUD have attempted to ease lenders’ fears that they will force lenders to buy back bad loans or otherwise indemnify the programs.

HUD on Thursday said that its new single-family loan quality assessment methodology — the so-called defect taxonomy — would do just that by slimming down the categories it uses to categorize mortgage defects from 99 to nine and establishing a system for categorizing the severity of those defects.

Among the nine categories that will be included in HUD’s review of loans are measures of borrowers’ income, assets and credit histories as well as loan-to-value ratios and maximum mortgage amounts.

Providing greater insight into FHA’s thinking is intended to make lending easier, Edward Golding, HUD’s principal deputy assistant secretary for housing, said in a statement.

“By enhancing our approach, lenders will have more confidence in how they interact with FHA and, we anticipate, will be more willing to lend to future homeowners who are ready to own,” he said.

However, what the new guidelines do not do is address the potential risk for lenders from the Justice Department.

“This taxonomy is not a comprehensive statement on all compliance monitoring or enforcement efforts by FHA or the federal government and does not establish standards for administrative or civil enforcement action, which are set forth in separate law. Nor does it address FHA’s response to patterns and practice of loan-level defects, or FHA’s plans to address fraud or misrepresentation in connection with any FHA-insured loan,” the FHA’s statement said.

And that could blunt the overall benefits of the new guidelines, said David Reiss, a professor at Brooklyn Law School.

“To the extent it helps people make better decisions, it will help them reduce their exposure. But it is not any kind of bulletproof vest,” he said.

FIRREA Wall

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Courts have read the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) very broadly, giving the federal government a powerful weapon in its lawsuits against financial institutions regarding events relating to the financial crisis. Judge Swain (SDNY) has issued a rare Opinion and Order limiting the reach of FIRREA, FDIC v. Bear Stearns Asset Backed Securities I LCC et al. (No. 12CV4000, Mar. 24, 2015), a suit over allegedly rotten residential mortgage-backed securities.

The limitation derives from a pretty technical Supreme Court opinion, CTS Corp. v. Waldburger. In CTS, the Supreme Court held that statutes of repose were not preempted by a statute that has identical language as the FDIC Extender Provision found in FIRREA and at issue in FDIC v. Bear Stearns.

I warned you that this is technical, so here is what is at issue:

Claims brought under Section 11 of the 1933 Act are subject to the two-pronged timing provision of Section 13 of that Act, which is codified as 15 U.S.C. § 77m. The first prong of Section 13 is a statute of limitations, which provides that Section 11 claims must be brought within one year of “the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence.” 15 U.S.C.S. § 77m (LexisNexis 2012). The statute of limitations may be tolled based on equitable considerations, but not beyond three years from the date of the relevant offering, at which point a plaintiff’s claim is extinguished by Section 13’s second prong – a statute of repose – which provides that “[i]n no event shall any such action be brought . . . more than three years after the security was bona fide offered to the public.” Id.

The FDIC asserts that its claims are timely, notwithstanding the three-year Section 13 statute of repose, because the statute of repose is preempted by the FDIC Extender Provision . . .. (6)

Relying on CTS Corp. v. Wadburger, the Judge Swain concludes that “the FDIC Extender Provision does not preempt the statute of repose set forth in Section 13 of the 1933 Act.” (14-15)

The reasoning in FDIC v. Bear Stearns does not apply to all FIRREA claims, but it would apply to some meaningful subset of them. One of the most powerful things about FIRREA is its very long statute of limitations. If other courts follow FDIC v. Stearns, it could have a meaningful impact on the reach of FIRREA.

Reiss on Financial Crisis Litigation

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Law360 quoted me in Feds’ Moody’s Probe Marks Closing Of Financial Crisis Book (behind a paywall). It opens,

A reported investigation into Moody’s Investors Service’s ratings of residential mortgage-backed securities during the housing bubble era could be the beginning of the last chapter in the U.S. Department of Justice’s big financial crisis cases, attorneys say.

Federal prosecutors are reportedly making their way through the ratings agencies for their alleged wrongdoings prior to the financial crisis after wringing out more than $100 billion from banks and mortgage servicers for their roles in inflating the housing bubble. But the passage of time, the waning days of the Obama administration and the few remaining rich targets likely means that the financial industry and prosecutors will soon put financial crisis-era enforcement actions behind them, said Jim Keneally, a partner at Harris O’Brien St. Laurent & Chaudhry LLP.

“I do look at this as sort of the tail end of things,” he said.

With the ink not yet dry on a rumored $1.375 billion settlement between the Justice Department, state attorneys general and Standard & Poor’s Ratings Services, prosecutors have already reportedly turned their attention to the ratings practices at S&P’s largest rival, Moody’s, in the period leading up to the 2008 financial crisis, according to The Wall Street Journal.

The federal government and attorneys general in 19 states and Washington, D.C., had launched several suits since the financial crisis accusing S&P of assigning overly rosy ratings to mortgage-backed securities and other bond deals that ended up imploding amid a wave of defaults, causing a cascade of investor losses that amounted to billions of dollars.

Although S&P originally elected to fight the government, it ultimately elected to settle. The coming $1.375 billion settlement arrives on top of an earlier $77 million settlement with the U.S. Securities and Exchange Commission and the attorneys general of New York and Massachusetts over similar claims.

Moody’s is reportedly next in line, with Justice Department investigators reportedly having had several meetings with officials from the ratings agency that looked into whether the Moody’s Corp. unit had softened its ratings of subprime RMBS in order to win business as the housing bubble inflated.

Both the Justice Department and Moody’s declined to comment for this story.

The pursuit of Moody’s as the S&P case wraps up follows a pattern that the Justice Department set with big bank settlements for the financial crisis.

“You would expect that they would sweep through, so to speak,” said Thomas O. Gorman, a partner with Dorsey & Whitney LLP.

After reaching a $13 billion deal with JPMorgan Chase & Co. in November 2014, the Justice Department quickly turned its attention to Citigroup Inc. and Bank of America Corp., which reached their own multibillion-dollar settlements last summer.

Now prosecutors are in talks with Morgan Stanley about another large settlement, according to multiple reports.

All of those deals follow the $25 billion national mortgage settlement from 2012 that targeted banks’ pre-crisis mortgage servicing practices.

Time may be catching up with the Justice Department more than six years following the height of the crisis, even after the Justice Department began employing novel uses of the Financial Institutions Reform, Recovery and Enforcement Act, a 1989 law passed following the savings and loan crisis, Keneally said.

Using FIRREA extended the statute of limitations on financial crisis-era cases, allowing for prosecutors to develop their cases and take a systematic approach. Even that statute may have run its course, as it pertains to the crisis.

“The passage of time is such that you have evidence that no longer exists,” Keneally said.

Politics may also play a role as the financial crisis recedes from memory and the next holder of the presidency potentially looks to move forward, he said.

“We’re getting to the end of the Obama administration,” Keneally said. “I think it’s going to be hard for any administration to ramp things up again.”

And that has some wondering whether the Obama administration and the Justice Department under Attorney General Eric Holder followed the correct path.

“The Justice Department and the states’ attorneys general collected far more in their penalties and settlements than anyone could have imagined before the financial crisis,” said Brooklyn Law School professor David Reiss.

Those large settlements may give investors and top management pause when it comes to questionable activity. However, because no traders or other top banking personnel went to prison, questions remain about what deterrent effect those settlements will have on individuals.

“Big institutions are now probably deterred from some of this behavior, but are individuals who work on these institutions deterred?” Reiss said.