This blog post continues our expert analysis of complex investments and their regulation.
A new paper from Alp Simsek of MIT makes an argument that financial innovation always increases market risks. (See the WSJ article on the paper here, and the paper here.) Essentially, the argument boils down to this:
- New financial products create new disagreements about valuations and outcomes;
- These products are new and therefore disagreements are bound to be wide;
- New products amplify speculation on existing disagreements;
- They also allow traders to purify their bets (and speculate on more narrow outcomes) or in economic terms, the traders opportunity set has increased;
- When traders are able to make purer bets, they make larger bets
The traditional argument for financial innovation is that it allows for risk sharing, and that those who don't want to take certain risks can trade them to others who want them. This paper is interesting because it shows that aggregate risks are increased by the endogenous introduction of new financial products (by amplifying old disagreements and introducing new disagreements).
Isaac Gradman, writing in The Big Picture blog, has a very well done long-form piece on RMBS litigation. (TBP) Readers will note that we have covered RMBS litigation extensively, here, here, here, and here.
Of note were some quotes from the ever entertaining Judge Rakoff:
Even more striking was the straightforward manner in which Rakoff cut through the continued efforts of Flagstar to frame the claims in a backward-looking, results-oriented manner based on the borrower’s payment or employment history post-origination. Manal Mehta of Sunesis Capital highlights the following three passages as directly debunking the banks’ logic for their minimal private label putback reserves:
THE COURT: I don’t understand the relevance of what the witness just said at all. At the time the borrower applies to the bank for the loan, there is no way of knowing whether he’s going to be paying for the next three years or not, so you have to assess the risk as it stands at the moment of application, true?
THE COURT: The information that was available at the time was that, in fact, it appeared that he had substantially misrepresented his income, and his income was less, considerably less than he had represented, yes?
THE COURT: But I am still missing the point. It is true, of course, that someone who may have made all sorts of misrepresentations on their loan application may still wind up paying the mortgage for a while. They may have hit the lottery or they may have a relative who helped them out or a hundred other possibilities. But the relevant thing is, in assessing risk, is the risk at the time the loan was approved, yes?
From my perspective, Rakoff has nailed it. The reps and warranties made by originators and issuers were made as of the date the securitization trust closed and the securities were sold to investors. The question is whether a reasonable underwriter using an objective methodology should have found that the borrower was likely to repay the mortgage. Whether the borrower ultimately paid is immaterial – underwriting is all about trying to control the risk at the outset. In other words, even a blind underwriter can sometimes find a bone (a risky borrower who actually does repay the mortgage), but that doesn’t mean it was acceptable for him or her to ignore underwriting guidelines just to push more loans through to closing.
For your RMBS litigation fix, a 106 page exhibit from MBIA's Motion for Summary Judgement against Countrywide. Hat tip Barry Ritholtz.
Henry Raschen of HSBC Securities, has a short piece at FTSEGlobalMarkets.com about the Dodd-Frank Act ("DFA"). (FTSEGM). Some quick take-aways:
- The registration requirement applies to US private advisers and non-US private advisers that advise funds with US investors;
- Many smaller non-US domiciled private advisers may have failed to register correctly;
- All registered private advisers with a least $150 million in private fund assets under management must periodically file a Form PF;
- All private advisers must provide basic information about themselves including: AUM, investment concentration, borrowing, liquidity and performance;
- Large private advisers must provide more detailed reports
One thing is for sure, the regulatory burden for hedge funds and private equity funds has increased significantly under DFA. While there will be an initial adjustment period for those running these funds, the transparency for investors will be a good thing.
Here are some useful links:
- SEC Private Fund Reporting Depository home page. (PFRD)
- SEC Form PF (42 pages with an 8 page glossary). (Form PF)
- Form PF FAQ page. (FAQ)
Private Fund Reporting Depository,
Just when you thought it was safe to say the RMBS suits were behind us, they're back with a vengeance. As always, Lowenstein Sandler has it covered, in their excellent Structured Finance Litigation Blog. Links follow:
- New York AG Sues JP Morgan (SFB)
- FHFA Sues HSBC (SFB)
- HSBC Files Putback Action Against Deutsche Bank (SFB)
- NCUA Sues Barclays (SFB)
- Homeward Residential Files Putback Action Against Sand Canyon (SFB)
Structured Finance Litigation Blog,
New York Attorney General,
This is not breaking news, but I came across this in my research and thought it interesting. Law firm Winston & Strawn formed an RMBS "Rapid Response Team" earlier this year to help firms subject to investigation by President Obama's RMBS Working Group, which was formed to investigate RMBS fraud. A description of the team can be found here.
The Winston & Strawn team is lead by Robb Adkins, who is fresh off a two-year term leading the RMBS Working Group. Why should firms use the team? Because:
Winston & Strawn offers distinctive insight into the course the Working Group is likely to take — and how to navigate the road ahead. Winston partner Robb Adkins recently joined the firm after two years of service as the Executive Director of the Task Force, which is now pursuing the RMBS matters. As the founding leader of the Task Force, Mr. Adkins helped establish its membership and priorities. In his position, he worked with the leaders at DOJ, SEC, HUD, the Attorney General in New York and other states, as well as a wide array of federal and state regulators — the same leaders who are leading the Working Group.
Rapid Response Team,
RMBS Working Group,
Winston & Strawn,
Michelle Conlin reports for Reuters about a Washington State Court ruling that MERS (Mortgage Electronic Registration Systems) did/does not have the legal authority to foreclose on a home. The article can be found here.
The crux of the decision is summarized in this:
The Washington Supreme Court held that MERS' business practices had the "capacity to deceive" a substantial portion of the public because MERS claimed it was the beneficiary of the mortgage when it was not.
This finding means that in actions where a bank used MERS to foreclose, the consumer can sue it for fraud. If the foreclosure can be challenged, MERS' involvement would make repossession more complicated.
On top of that, virtually any foreclosed homeowner in the state in the past 15 years who feels they have been harmed in some way could file a consumer fraud suit.
For those of you not so familiar with MERS, Conlin summarizes nicely:
The company's history dates back to the 1990s, when banks began aggressively bundling home loans into mortgage-backed securities. The banks formed MERS to speed up the handling of all the paperwork associated with recording the filing of a deed and the subsequent inclusion of a mortgage in an entity that issues a mortgage-backed security.
MERS allowed the banks to save time and money because it permitted lenders to bypass the process of filing paperwork with the local recorder of deeds every time a mortgage was sold.
Instead, banks put MERS' name on the deed. And when they bought and sold mortgages, they just recorded the transfer of ownership of the note in the MERS system.
Two items hit the tape today on the RMBS litigation front:
1. There was a win for plaintiffs in attacking the standing argument that has been so effective for defendants. See the AmLaw piece here and the Second Circuit unanimous decision here.
2. The National Credit Union Administration filed against UBS for over $1B in damages arising from two failed credit unions. See the AmLaw piece here and the 148 page complaint here. There's actually a color flowchart of the securitization process and tables and graphs showing the actual v. predicted defaults.
In an RMBS litigation by the City of Ann Arbor Employees' Retirement System as lead plaintiff against Citigroup et al, a settlement has been proposed of $13.20 per $1,000 or 1.32 cents on the dollar. As observers of RMBS settlements will note, this is the mid-range of recent settlements.
Read the memorandum of law, submitted in the Eastern District of New York, here.