You'd think a meteor called TRID had hit the secondary mortgage market.
Liquidity has dried up since the Consumer Financial Protection Bureau's disclosure rule took effect in October. With the exception of a few deals backed by loans issued before the financial crisis, private-label securitization has ground to a halt.
The conventional explanation is that the rule has vastly expanded the range of potentially erroneous information that the purchaser of a whole loan or loan securitization could be liable for. No one wants to buy trouble. But this may not be the whole story.
There's a general agreement among mortgage market participants that the liability created by TRID (also known as the "Know Before You Owe" rule) is limited and quantifiable. Statutory damages are not available to borrowers for all violations, and are capped at $4,000, plus attorney's fees. Several credit rating agencies have stated that they are comfortable rating bonds backed by loans with violations.
Given those assurances, why aren't deals getting done? According to Laurence Platt, a partner in Mayer Brown's consumer financial services group, part of the blame lies with third-party firms hired to review the credit quality of loans backing mortgage bonds. He says they are labeling too many violations as "material," leaving too few loans available for securitization.
"It's up to investors to determine what they want to buy and what to pay for it," Platt said. "It's fine for a third-party reviewer to identify errors, but my position is that it's not the job of third-party reviewers to determine materiality."
Platt isn't pulling any punches. He says he made this point at a Mortgage Bankers Association conference last week — on a panel that included John Levonick, the head of compliance at Clayton, the leading third-party loan reviewer. Representatives from rating agencies and mortgage investment firms were in attendance as well.
"There's a debate as to whether TRID is being treated in an unduly important way," Platt said in an interview this week. "The answer I heard at the seminar is that that, because we can measure for it, it matters. There might be other types of deficiencies or violations, but they [due diligence providers] don't measure for it. You can't always find [defects or violations] on the face of loan file."
Even when statutory damages are available to the borrower and the assignee is liable, a borrower will only assert a claim on a property that has been foreclosed on, Platt said. Generally speaking this will only happen in the 22 states where the foreclosure process goes through the courts.
In theory, a borrower could hire a lawyer to seek actual damages, which are calculated according to the degree of harm to the plaintiff rather than stipulated in a statute. "But it is virtually impossible to prove actual damages based on a nondisclosure violation," Platt said.
"I think we'd all agree the bona fide legal risk is really narrow," he said. "It's not like [$4,000] doesn't matter, but it really is chump change. It's unlikely that in many cases a borrower would be able to retain counsel to bring in $4,000."
Levonick, also reached this week, defended Clayton's practice of labeling a wide range of violations as material.
Even before TRID, "there was a clear delineation of assignee liability: Investors wouldn't buy loans with assignee liability because of the significant loss severity, for example HOEPA violations," he said, referring to the Home Ownership and Equity Protection Act of 1994. "Now, with TRID, there exists a world of assignee liability as it applies to statutory damages where the loss can be quantified due to the cap on damages per occurrence."
The likelihood of a consumer making a successful claim for actual damages, when they must prove detrimental reliance and can only recoup $4,000 due to an applicable TRID error, is so low that it could should be considered nonmaterial, Lenovick acknowledged. "But a consumer does not have to prove they were harmed to collect statutory damages, because of the strict liability aspects of certain TRID requirements."
While it might be hard for a single borrower to retain counsel to recover $4,000, there is fertile ground for a class action.
"I can only imagine that the plaintiff's bar is ready, willing and able to start testing the law through litigation," Levonick said. "We can absolutely expect TRID-related litigation in the future."
Depending on an investor's exit strategy, the mere possibility of a lawsuit could make purchasing such a loan with a nonmaterial TRID error unattractive.
"A securitization trust is not structured to handle litigation," Levonick said. "An investor or underwriter may not want to put loans with potential for litigation into this structure."
Platt dismissed the threat of class action lawsuits as "not realistic," citing a cap under the Truth in Lending Act on statutory damages for class actions to $1 million or the holder's net worth, whichever is less. (TRID is the kind of name only a Washington bureaucrat could come up with: an acronym that contains two other acronyms. It stands for TILA-RESPA Integrated Disclosures, and consolidates requirements from the 1968 truth-in-lending law and the Real Estate Settlement Procedures Act of 1974.)
He acknowledged that, since the financial crisis, mortgage investors have been very skittish about buying any paper, or security, tied to loans where there is known compliance violation. "But we all know that residential mortgage loans are not free of manufacturing defects," he said.
A loan, Platt continued, "is a hard sausage to make. Regulations are so prescriptive, there are so many detailed, micro requirements, that it's not uncommon for there to be little errors.
"If you are looking for error-free loans, there are not a lot out there. But the attitude should be, 'no harm, no foul,' if the error doesn't impact a consumer or lead to material liability."