Dirt Lawyers and Dirty REMICs: A Debate

Probate Property, 2013

SSRN Electronic Journal, 2000

This paper examines how the severity of moral hazard problems in the securitization process is related to the structure and performance of securitized pools of residential Alt-A mortgages created during the 2003-2007 period. We argue that the severity of moral hazard problems is likely to vary inversely with originator-sponsor and originator-servicer affiliation as well as originator concentration. We refer to the lack of affiliation and originator dispersion as measures of distance from loss. Overall, we find that, after controlling for borrower and deal characteristics, cumulative loss and foreclosure rates are significantly higher for mortgage-backed securities (MBSs) in which originators are not affiliated with the sponsor or servicer and in deals with more originators (i.e., the loss distance is greater). We also find that the losses and foreclosures occur earlier in MBSs with greater distance from loss. While these relations are more prominent for deals structured during the 2006-2007 period, we find that the distance was also related to losses before the peak of the housing market. Consistent with investors recognizing the potential loss exposure from greater distance from loss, we find that the average yields are higher on MBSs with greater distance. We also find that the percentage of securities rated AAA is decreasing in the distance. Finally, deals with greater distance are significantly more likely to employ overcollateralization accounts (that require the sponsor to have greater skin in the game). These results suggest that, while ex post investors might have misestimated their exposure to losses arising from incentive conflicts with the originator, ex ante frictions were reflected in the pricing and the structure of MBSs.

2009

SSRN Electronic Journal, 2008

OMPLEX ECONOMIC TRANSACTIONS, especially those engaging multiple jurisdictions, are creating considerable problems in regulation and management that are taxing states' resources. The result is that alternative support structures are generated to resolve these difficulties and lacunae (Gessner, 2008a, this volume). While states provide some legislative frameworks, the vast majority of the support structures are brought into existence by other sources. Among them are candidates such as lex mercatoria (Konradi, 2008, this volume), real-time contract evaluation (Dietz and Nieswandt, 2008, this volume) and large and medium-sized law firms (Flood and Sosa, 2008). The liquidity crisis originally prompted by the 2007 sub-prime mortgage debacle in the United States is an exemplar of the type of complexity referred to here that has caused chaos in international financial markets. Here, although the individual steps in the creation of the sub-prime market and its extension and amplification through the collateralised debt obligation market were carried out legitimately, the cumulative effect of the steps combined with the lack of necessary regulatory oversight by the authorities produced a series of effects that rippled out worldwide and that most states were unable to manage competently or foresee, or even begin to calculate how to prevent their future re-occurrence. 1 Indeed, the regulatory conundrum was such that whichever way governments acted, they would be accused of participating in the creation of moral hazards by rescuing institutions or failing to insure weak, unprotected investors from the seamy side of market exploitation. 1 By the first quarter of 2008, the 'credit crunch' had caused one major British mortgage bank to threaten bankruptcy and ultimately be nationalised by the government, and at least two German banks to be rescued by state authorities to avoid insolvency. In both cases, their exposure to sub-prime mortgage hazards through their dealings in asset-backed paper was the genesis of their problems.

The Journal of Real Estate Finance and Economics, 1988

In this paper we review the forms of mortgage securitization, analyze the demand for securitization, and demonstrate how securitization meets these demands by reducing intermediation costs. We argue that the increased use of securitization is a response to increased interest rate volatility and represents a contractual innovation that facilitates an efficient allocation of risk-bearing among households and intermediaries.

International Review of Financial Analysis, 2016

This paper provides theoretical results for the design of contracts used in the market for residential household mortgages and mortgage securities. Critical elements in the problem of immunizing systemic risk through efficient contract design are identified. Using an extension of classical immunization theory, this paper demonstrates that systemic risk of long amortization mortgage contracts is reduced when term to maturity of the contract at origination is significantly less than the amortization period. In addition, incorporating prepayment and limited recourse default options into the mortgage contract increases systemic risk when compared with full recourse mortgage contracts having yield maintenance prepayment penalties. The theoretical results are used to evaluate the systemic risk management problems that have plagued the US mortgage funding system.

2010

Social Science Research Network, 2015

This Paper will reintroduce, explore, and expand on the financing arrangement known as a Participation Mortgage. First, this Paper will cover the features, history, and policy purposes behind the mortgage. 3 Second, the Paper will focus on legal mechanics and drafting considerations of Participation Mortgages, so they may later be securitized. 4 Finally, the Paper will explore the possibility and legality of creating Participation Mortgaged Backed Securities to be sold in the secondary market. 5 2 The Participation Mortgage, here, is commonly referred to as a mortgage with an "equity kicker" and should not be confused with "Participating" or "Contributory" Mortgages. AMY MORRIS HESS, GEORGE GLEASON BOGERT & GEORGE TAYLOR BOGERT, THE LAW OF TRUSTS AND TRUSTEES § 675 (2014), available at Westlaw THE LAW OF TRUSTS AND TRUSTEES § 675. A Participation Mortgage is a single mortgage in which interests are sold by the mortgagee to various investors who receive certificates of participation. Id. It should be noted each of these subsections could have been a paper in its own right. However, for the purposes of brevity, not every state and federal, tax, securities, regulatory, or common law issue surrounding Participation Mortgages-for example, tax issues involving Real Estate Mortgage Investment Conduits-could be addressed fully. The sources cited in the notes can provide a fuller discussion. 3 See infra Part I and accompanying notes 6-16. 4 See infra Part II and accompanying notes 17-74. 5 See infra Part III and accompanying notes 75-165. 6 M.

2008

As foreclosure initiations have soared over the past couple of years, many have questioned whether mortgage servicers have the right incentives to work out troubled subprime mortgages so that borrowers can avoid foreclosure and remain in their homes. Some critics claim that because servicers, unlike investors, do not bear the losses associated with foreclosure, they have little incentive to modify troubled loans by reducing interest rates or principal, or by extending the term. Our analysis suggests that while servicers have substantially improved borrower outreach and increased loss mitigation efforts, some foreclosures still occur where both borrower and investor would benefit if such an outcome were avoided. We discuss servicers' incentives and the obstacles to working out delinquent mortgages. We find that loss mitigation is costly for servicers, in large part because servicers currently lack adequate staff and technology; unfortunately, servicers have few financial incentives to expand capacity. Two additional factors appear to be damping workouts of nonprime loans, the group that has seen the largest increase in delinquencies. First, affordable solutions are more difficult to achieve for borrowers with these loans than for those with prime mortgages. Second, these loans are generally funded by private-label mortgage backed securities, for which investors provide little or no guidance to servicers about what modifications are appropriate. More generally, investors are wary that modifications might turn out to be unsuccessful, thus delaying and increasing ultimate losses. Given the significant deadweight losses incorporated in recent quarters' loss rates of 50 percent or more, we present options for further improving servicer performance. We discuss supporting further industry efforts to expand borrower outreach and establish servicing guidelines, educating investors, paying servicers fees for appropriate loan workouts, and improving measures of servicer performance.