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The Subprime Issues, the Global Economic Crisis and Sources of Law

Marianne M. Jennings. The Subprime Issues, the Global Economic Crisis and Sources of Law. Building an Understanding From the Roots Up. The Mortgages The Foreclosures The Bankruptcies The Conflicts Galore The Crimes Corporate Governance The Litigation Constitutional Issues.

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The Subprime Issues, the Global Economic Crisis and Sources of Law

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  1. Marianne M. Jennings The Subprime Issues, the Global Economic Crisis and Sources of Law

  2. Building an Understanding From the Roots Up • The Mortgages • The Foreclosures • The Bankruptcies • The Conflicts Galore • The Crimes • Corporate Governance • The Litigation • Constitutional Issues

  3. The Mortgages: From the Bottom: The Basics of Residential Mortgages

  4. State Laws: “Mortgage” Laws • Mortgages are liens • Deeds-of-trust also covered by state law, but folks still refer to it as “My mortgage” • Overall concept is the same: The mortgagee/lender has the property as security for repayment and therefore has the right to get the property back in a special type of process: Foreclosure

  5. Types of Mortgages:Federal and state laws affect all • Conventional mortgages • FHA and VA mortgages (guaranteed by Fannie and Freddie) • Fixed-rate mortgages: 40, 30, and 15 years • ARMs • Balloons • Jumbo loans – mortgages above a certain amount carried higher interest rates • Title loans • Pay-day loans

  6. Lending/Credit Laws • State laws on interest: usury • State laws on subprime: • Disclosures • Waiting periods • Classes • Federal laws: Truth in Lending • APR • Payments • Variable rate loans • Federal laws: Who gets loans? • Equal Credit Opportunity Act • Redlining prohibited • Federal regulations on both applications and lending • Federal laws: Collections • Techniques for collection • Contact with debtors

  7. Contract law • Misrepresentation on credit worthiness: State • Federal crimes on FHA and VA loans in attesting to income • The Flippers: misleading lender on intentions about property • Fraudulent appraisals

  8. The UCC and HDCs • A holder in due course is someone who purchases a negotiable instrument (i.e., a mortgage note) for value in good faith without notice that it is dishonored or overdue • A holder in due course is not subject to formation defenses (i.e., misrepresentation and silent misrepresentation) • Holder in due course takes free of lender’s defense that mortgagor misrepresented income or use of property • HDC does take subject to insolvency; there is never a guarantee that an instrument will always be paid; HDC is still subject to risk of debtor’s insolvency

  9. The Markets How did Wall Street get intertwined with Main Street?

  10. The CDOs: Selling Securities • You have 10 mortgages that borrowers/mortgagors will pay off over 15-30 years • You’d like the cash up front! • Investment firm Bear agrees to buy those 10 mortgages, present value of $3,000,000 over the 15-30 years • To get the $3,000,000 cash, Bear sells mortgage-backed securities (collateralized debt obligations) to folks looking for a safe long-term investment

  11. Some Other Laws That Made It Possible • The Supply of Mortgages: Public Policy of More Home Ownership • The Community Reinvestment Act of 1977 • Boston Federal Reserve Bank Study of 1992 on lender discrimination: Federal regulation • Civil Rights Act enforcement • Fannie Mae and its ability to package guaranteed mortgages

  12. Foreclosure When Mortgagors Fall Behind: Back to Main Street, Again

  13. Foreclosure (Right of Sale) • All state laws • Default • Notice • Required waiting periods • Sale (auctions) • Buyer is given certificate of sale • Right of redemption (mortgagor has the right to pay up full amount and expenses and redeem the property • Deficiency judgments

  14. Deficiency Judgments • Courts handle judgments: local laws • Difference between the amount due and the amount the sale brought • Not available in non-recourse states • In an upside down market (underwater mortgages), there are deficiencies in almost every foreclosure • Deficiency means you must have sold the property – this crisis has found the inventory mounting • Second mortgage lenders – Nothing!

  15. When Mortgagors Fall Behind: Self-Help Remedies and State, Local and Constitutional Law • Walking away: Credit Reports and federal law • Deed in lieu of foreclosure: State law and credit reports • Stripping the property: State law; criminal law • The problem of blight in neighborhoods with high rates of foreclosure: Zoning; local law • Eminent domain by cities of properties lenders have taken back but cannot sell, rent, or repair: constitutional law

  16. When Mortgagors Fall Behind: Work-Outs • Lender programs: Private law • Reduce payments (Citi is reducing payments to $500 per month for 3 months for folks who have lost their jobs): Contract law • Federal funding for mortgage refinancing • New loan terms • Lower interest rates: contract law, private law • Permanent interest rates • Longer loan periods • The proposal to allow bankruptcy judges to restructure the mortgage loans: federal law

  17. Federal Assistance Program: March 2009 • Loan modification: Federal law preempts state contract and real property law • Have payments that total 31% or more of monthly income • Single-family home • Primary residence • Loan amount is $729,750 or less • Mortgage originated on or before Jan. 1, 2009

  18. The Ethical Issues in Mortgages • Would you accept an approved mortgage loan that you knew was stretching your budget? • What are the moral hazards of mortgage bail-outs? Re-default rates are 55% six months after restructuring • What are the risks of bankruptcy court restructuring? • Review the notion of consideration on all of these restructures. • What is the difference between a refinancing and a loan modification? • What are the risks in highly leveraged personal finance? • Who are the stakeholders in mortgages?

  19. The Bankruptcies Federal law and federal court system

  20. Wall Street Firms: Securities Law, Contracts Law, Antitrust Law • Bear Stearns (purchased by JP Morgan Chase) • Lehman (bankruptcy)(role of trustee and calls for officer compensation to be returned) • Countrywide (purchased by Bank of America) • Merrill (purchased by Bank of America) (intentional interference with contracts) • Citigroup (struggling)

  21. The Crimes Prosecutions?

  22. Did the CDOs violate the law? • Firms were operating in a largely unregulated area with little oversight • There was compliance with the disclosure requirements under the 1933 Securities Act: Federal - USC

  23. The Secondary Crimes • Sales of securities by officers of companies before announcements of subprime losses and effects • 10B and insider trading by insiders: USC and CFR • Overly optimistic information released by company constitutes a corporate violation of 10b: USC and CFR

  24. The Crimes That Come in Market Bubbles: Selling Air • Bernie Madoff and his $50-billion Ponzi scheme • Former chairman and co-founder of NASDAQ • Well know for his philanthropy and generosity • Consistent 12% return over the years • Warnings to the SEC were ignored • That confirmation of facts syndrome • Just plain securities fraud: USC and CFR

  25. Corporate Governance That “Tone at the Top” Thing: State Laws on Corporations

  26. Thain, former CEO of Merrill • Area Rug $87,784 • Mahogany Pedestal Table $25,713 • 19th Century Credenza $68,179 • Pendant Light Furniture $19,751 • 4 Pairs of Curtains $28,091 • Pair of Guest Chairs $87,784 • George IV Chair $18,468 • 6 Wall Sconces $2,741 • Parchment Waste Can $1,405 • Roman Shade Fabric $10,967 • Roman Shades $7,315 • Coffee Table $5,852 • Commode on Legs $35,115

  27. The Laws on Tone • Corporate governance: Who establishes pay? State law on corporations • SOX and the compensation committee; USC and CFR • Shareholder rights: state law on corporations • Proxy season 2009 and the proposals for shareholder approval of compensation packages as well as halt to all off-site meetings: state law and SEC regulations on proxy solicitation

  28. The Litigation Who’s Suing Whom for What?

  29. Richard Fuld, CEO, LehmanSept. 10, 2008 “We are on the right track to put these last two quarters behind us.”

  30. Shareholders vs. Officers and Directors for Misleading Them • Countrywide shareholders vs. Mozilo • Merrill shareholders vs. O’Neal and Board • Bank of America and misleading shareholders about merger • State and federal law

  31. Constitutional Issues State vs. Federal vs. Property Owners

  32. Preemption • Federal restructuring plan • Bankruptcy judges • State contract law • State property law

  33. Foreclosure Blight • Maintenance ordinances and statutes for lenders on abandoned property • Eminent domain on foreclosed, vacant properties • Public health, safety, and welfare • The crime rates

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