We’ve written at some length about the failure of the IRS to go after what look like slam-dunk violations of the rules governing the tax treatment of mortgage-backed securities. As we said earlier this year:
For those of you who are new to this issue, the 1986 Tax Reform Act created Real Estate Mortgage Conduits, aka REMICs, to allow mortgage securitizations to be pass-through entities, which means their income would not be subject to double taxation. But to get pass through treatment, the REMIC needed to adhere to strict requirements. One of them was it would acquire all its assets within 90 days of its start-up date. If you are at all familiar with chain of title issues in securitizations, you know that appears not to have occurred in 2004 and later securitizations close to universally, and probably happened in a significant number of securitizations between 2002 and 2004. Basically, the securitization industry appears to have decided it couldn’t be bothered to staff up back offices to meet rising origination volumes. And one of the corners they cut was adhering to the carefully designed steps to get the mortgage notes from the originator into the business trust that was supposed to comply with REMIC. That meant everything needed to be done, meaning multiple endorsements on each and every one of a typically 4,000 to 5,000 mortgage notes, by startup date + 90 days. But as the robosigining scandal and the continuing mess in local courts has revealed, in the overwhelming majority of cases, these endorsements (which were to effect transfers through several legal entities to the trust) not only often weren’t done by the cutoff date, and attempt to pretty up the record for the purpose of foreclosure (which is not kosher but is nevertheless common) were often botched.
As far as we can tell, this issue was first raised with the IRS in the summer of 2010, with a senior individual in enforcement who was up on REMIC by virtue of having revised the rules to allow for HAMP mods. She was initially very excited about it. When the attorney who had contacted her had not heard back as promised, he called her and she took the call and said she had been told not to speak to him. She said the question had gone to senior levels in the Treasury and had been referred over to the White House, which said that it did not want to use tax as a tool of policy. Another attorney told me later of securing a meeting at the IRS on the same issue. The staffer (apparently not as senior as the one in the first story) said that the parties intended to do things correctly and that was good enough. The attorney asked if he could call the IRS staffer and have him tell the IRS examiner that intending to do things was good enough the next time the attorney was audited. I’ve since been told by other lawyers that they have also brought up the issue of REMIC violations with the IRS and have been told that the IRS has no intention of pursuing it.
So the IRS refusal to touch this issue seems to be common knowledge in legal circles.
Back to the current post. Apparently the noise has been made about the failure to pursue REMIC violations, the latest by two law professors in a journal article, has roused the IRS from its official somnolence (we posted on the piece when it was made public). I happened to be vastly amused by the pointedness of article by Bradley T. Borden and David J. Reiss. Its synopsis:
Investors in mortgage-backed securities, built on the shoulders of the tax-advantaged Real Estate Mortgage Investment Conduit (“REMIC”), may be facing extraordinary tax losses because of how bankers and lawyers structured these securities. This calamity is compounded by the fact that those professional advisors should have known that the REMICs they created were flawed from the start. If these losses are realized, those professionals will face suits for damages so large that they could put them out of business.
The IRS supposedly started a review of REMICs in April of last year, but the comments we got on its views were in 2010, long before the “review.” That suggests this is merely
an official ass-covering exercise a formality. It must be about to come to fruition, since an article in Dealbook by Victor Fleischer (aha, another tax prof to take issue with the Borden/Reiss position!), which looks awfully consistent with the IRS position, was published today (hat tip AKS).
The article makes no bones about its position: “Why a Tax Crackdown Is Not Needed on Mortgage-Backed Securities.” Gee, if necessity is the standard, the IRS doesn’t need my late fee while I miss a filing deadline. Can I get a free pass too? This piece is priceless. It starts with the usual warning about the importance of the MBS market:
These are the tax plumbing that allows the modern mortgage market to function.
That is narrowly true but misleading. The part of the market where the REMIC rules were violated was in the private label mortgage backed securities market. The MBS guaranteed by Fannie and Freddie had different transfer procedures stipulated and they were adhered to. And that private label market happens to be completely dead because the originators so badly abused investors that they want nothing to do with them until the market is reformed, which the sell side has stymied. I was at a conference recently where Pimco’s head of mortgage and asset-backed securities said he saw no reason for a private label securities market, it had only existed in a meaningful fashion from 2003 onward and had comported itself badly. So this thinly veiled “you enforce REMIC rules, you mess with mortgage finance” is simply untrue in our new normal of mortgage finance on government life support and sell side refusal to agree to needed, pro-investor reforms on private deals.
Then we get the next canard:
The legal process of transferring a mortgage is complex.
No, mortgage transfers are NOT complex. Dirt law is well established. What was complex was how these private label deals were structured. And the mortgage transfers, the part that was botched, was CUMBERSOME, rather than complex. Big difference. These deals set up their own transfer procedures, that the notes be endorsed through multiple parties to get to the final owner, a trust, and that had to take place in a stipulated time frame. And the proof that the Fleischer’s position is bunk is that these procedures were adhered to for the most part in the first decade plus of private label securitizations, from the late 1980s through at least the late 1990s.
The position taken in the article is effectively “The intent was there, so who cares if they screwed up on the execution?” And that is precisely the argument the IRS is making privately, which is why I suspect the Fleisher article is official messaging. Um, so can I tell the IRS I intended to get my taxes in on time when I filed them a day late and not pay any penalty?
The truly offensive part is the way the Wall Street boosters like Fleisher blame the failure of the industry to follow the regulations on the IRS:
Modern financial products do not always mix well with the more arcane aspects of legal process.
These aspects were not arcane, or not so arcane as to be a credible scapegoat. This was a back office breakdown at best but looks to have been a deliberate, system wide change in procedures and no one bothered updating the deal documents to reflect the change in transfer procedures. But the reason they didn’t is investors expected the old process and would have negotiated over changes, and likely would have demanded some changes in the fee structures to reflect the fact that bankers were saving themselves a lot of costs by the changes in procedures. The failing, as we’ve stressed again and again, was not in the law, the deal design, or the contracts, but that the sell side systematically refused to live up to the terms of its own agreements. And those agreements, as we’ve discussed, also happened to be unusually rigid and unforgiving; Adam Levitin and Anna Gelpern have called them “Frankenstein contracts“.
It has been clear for over two years that the IRS won’t touch this issue with a ten foot pole. Even though the violations look clear cut from a tax perspective, the liability would fall on the investors, who would then sue the sponsors and originators to kingdom come. It would put on full view what the Administration has been working overtime to hide, that of the massive legal abuses at the heart of the mortgage crisis. So while the outcome is predictable, articles by shills like Fleischer are an insult to the intelligence of the long-victimized public.
Isn’t there established legal doctrine regarding selective prosecution and equal protection of the law.
“…so can I tell the IRS I intended to get my taxes in on time when I filed them a day late and not pay any penalty?”
It seems that there should be some established case law that gets you off the hook if you claim an equal protection violation.
Does anyone out there know if this works in the real world?
In Ohio, Montgomery County, I brought these issues before the Courts. Not only the issue of a “Post dated Assignmennt” but also the PSA’s requirement of the 90 day transfer (My assignment was 2 years AFTER the Closing date of the Trust, the Robo-Signeding, gave them multiple signatures (none matching) for the Notarty on the Assignment and also gave the “equal established legal doctrine regarding selective prosecution and equal protection of the law.”
So in “real life” I personally have to say… for the most part the Courts just don’t care. In “Real Life” here, you lose your house. Proof and evidence be damned.
From everything I’ve read and seen, your experience has been the norm versus the exception. Few, if any, of the securitized loans were properly transferred. Rarely were homeowners who argued their case on that basis, outside of perhaps FL and NY, and even there it has been uncommon, successful.
Our jurists, for one, lack the courage to make such rulings. One judge in CA remarked in a decision, in Ronald v. BOA, a mass joinder case, his consideration that a ruling in favor of the plaintiff could likely result in a crash of the US banking system, including the Federal Reserve. Would there be many judges, or people, willing to take on that sort of responsibility? Or would they succumb to the temptation to pursue “policy” (as Patrick calls it) as their peers are all doing, rationalize it with language about intent and money being owed (to somebody), and rule in favor of the banks?
LucyLulu, I’d love to know the case reference specifically — I couldn’t spot it in a google search. I want to know the judge and the court.
Sorry. just saw your note. Hopefully you will check back. Had to do a quick google myself. :)
Case: Ronald v. Bank of America
Judge: Hon. Wm. F. Highberger Case: BC 409 444
CA Superior Court, Los Angeles Jan 11, 2011
Quote: “THE ISSUES PRESENTED BY THE MANY PLAINTIFFS
9 IN THIS CASE AS AGAINST THEIR CURRENT MORTGAGE LENDER
10 AND/OR LOAN SERVICER ARE PART OF A LARGER SOCIOECONOMIC
11 PROBLEM THAT CONFRONT OUR SOCIETY IN CALIFORNIA AND ALL
12 OF THE OTHER STATES IN THIS UNION AN ISSUE OF GREAT
13 CONCERN TO THE U.S. CONGRESS, STATE LEGISLATURE, AND THE
14 BANK REGULATORS, GIVEN THAT IN OUR BANKING SYSTEM THE
15 BANKS ARE INSURED BY THE FULL FAITH AND CREDIT OF THE
16 UNITED STATES GOVERNMENT FOR ALL INTENTS AND PURPOSES.
17 SO THE CONTINUED SOLVENCY OF THE BANKING INDUSTRY AS A
18 WHOLE IS A MATTER OF INTENSE INTEREST TO THE U.S.
19 CONGRESS AS WELL AS THE CENTRAL BANK
20 A PRACTICAL QUESTION THAT CONTINUES TO BE
21 IMPORTANT FOR CASE MANAGEMENT AND POSSIBLE CASE
22 RESOLUTION IS WHAT IS REALLY INTENDED BY PLAINTIFFS AND
23 THEIR COUNSEL IN THIS CASE? SOME OF THE CLAIMS AS
24 PRESSED, IF ACTUALLY SUCCESSFUL, AND TRIED TO A JURY
25 WITH A REQUEST FOR PUNITIVE DAMAGES COULD,
26 THEORETICALLY, IF THE PLAINTIFFS GET THINGS TO GO THE
27 WAY THEY SAY THEY WANT THEM TO GO, TO LEAD TO SUCH –
28 CAN POTENTIALLY, I’M NOT BY ANY STRETCH OF THE
1 IMAGINATION GUARANTEEING THIS OR SAYING IT WILL BE THE
2 MORE LIKELY OR REASONABLE OUTCOME, BUT IF PLAINTIFFS GET
3 THIS CASE WHERE THEY THINK THEY WANT TO PUT THIS CASE
4 THEY ARE PRESUMABLY GOING TO GET A JUDGMENT FOR BILLIONS
5 OF DOLLARS AGAINST BANK OF AMERICA, POTENTIALLY CREATING
6 A PROBLEM OF SUCH GRAVITY THAT ACTION BY THE CENTRAL
7 BANK OR A STATE OR FEDERAL LEGISLATIVE BODY MIGHT
8 THEORETICALLY BE NEEDED.”
IRS rule 401 (a) (5) which essentially says “screw the workers.”
Beginning from there, it’s all corrupted.
Just take a close look at the SEC.
“Modern financial products do not always mix well with the more arcane aspects of legal process.”
This seems to me an admission that “modern financial products” break or at least bend current law. Who’s in charge here, anyway?
“These are the tax plumbing that allows the modern mortgage market to function.”
Extending the metaphor, I guess the private label market flows through this tax plumbing.
Who is in charge?
Best I can tell it is the criminals, their minions and henchmen. Or perhaps the criminals, their henchmen and minions. I expect most accurately it is the banks (and other corporate interests), with the “henchminions” of goverment (yep, executive, legislative and judicial) bending over backwards to suck turds from bank/corporate backsides.
Gosh! The tax laws are being enforced unfairly. Who could have imagined it?
The entire income tax ediface is a gigantic pyramid of loopholes, evasions, inconsistencies, fabrications, deceits, etc. The idea is to extract wealth from wage workers, while maximizing opportunity for inheritors, speculators, grafters and connivers. One can exhaust several lifetimes in attempting to understand how this monster actually works. I know because I tried it. Sniffing a few farts around the edges may be amusing, but it is pretty much a waste of time.
Yves, great post.
Now repeat after me, “Mission Accomplished.”
Next, “No one saw it coming.”
Finally, “Badges? We don’t need no stinking badges!”
And no one ever seems to think about the precedents. 10’s of millions of legal precedents saying “if you’ll just forge a document, and you’re huge in size (monetarily… not your waist), then you to will win in Court… see, it’s been already done millions of times!” Which means… Microsoft can forge doc’s and take over Apple, no problemo, GE can forge doc’s and take over just about any Company in the US.. easy peasy, million of precedents, and on and on and on! Are we starting to see the beginnings of the Corporate Wars? Ethics be damned, process is all, right after maintaining Corporate Profits! Kill off the humans… they cost too much!
“Sorry, Dave, I can’t do that,” – Hal
I think it should be “No, Virginia,…”
Bow to the global hegemony of international finance – sovereign governments are mere pawns and their inconvenient rules can be ignored.
The same kinds of abuses would be present no matter what economic or social system we would have ended up with. Civilization tends to lend itself to social stratification and corruption, among other things. Power often corrupts.
It’s not power that corrupts, it’s immunity to consequences – which is why we have a corrupt government and a corrupt court system.
From David Parlett’s verse translation of the Carmina Burana:
Laws are only made for
those by whom they’re paid for:
not a one endorses
men of no resources.
why dont the fraudsters understand, THIS IS NEVER GOING AWAY….
I just wrote a comment of Fleischer’s article cited in this blogpost. I reprint it here.
I worked on these deals as a tax attorney for a wall street firm in the 80s and 90s. I’ve written many articles on tax policy. Fleischer’s arguments are odd, particularly for a professor teaching tax law. But perhaps not, since the professoriate was asleep at the wheel for the past 20 years while the bankers were saying “I can’t believe we are getting away with all this!” Fliescher argues that violations of the tax rules should not be prosecuted because of what he divines to be “policy” of the rule. As an old partner at Shearman & Sterling used to say “when a tax lawyer is arguing policy, you know he’s lost the argument!” He’s arguing “substance/policy over form” to GET OUT of a technical tax requirement. I’ve not seen this before. Because it doesn’t pass the laugh test. As the professor is well aware, pass through’s have a total pass on audits compared to individual taxpayers and the less powerful. And this only because of the corrosive power of the rich and the willingness of “experts” to provide “rationales” (for free apparently!). It’s time professors stop cow towing to the powers that be. Their influence has severely weakened the standards of our profession. The results are obvious. For further more detailed criticism of Fleischer’s position see http://www.nakedcapitalism.com/2012/11/yes-virginia-the-irs-does-not-treat-the-connected-like-the-rest-of-us-remic-edition.html
“pass through’s have a total pass on audits compared to individual taxpayers and the less powerful.”
As I am now finding out first hand. I am currently undergoing an audit triggered solely by taking my daughter as an exemption and declaring a tuition credit two years ago, because my ex once again, as several times before, also illegally claimed her. My ex is bitter and vindictive, still, after 10 years, despite my nothing but amicable responses in return, for the sake of the children. I sent the necessary supporting docs with my return, followed IRS written procedure to the T,(most importantly, divorce agreement specifying my right to exemption, divorce pre-dated 2004 and need for release signed by ex, thank goodness, he’d have refused to sign….. but he tried to take the exemption when I was custodial parent as well), but was told by the auditor they don’t pass other docs along, only a digital copy of the return itself. The kicker…… my AGI was $51,000 and I always pay every dime I owe, not having the stomach to do otherwise. All I can think is, “Don’t they have rich tax cheats they could go after?” And if my ex is doing this repeatedly, knowing he is ineligible to take the exemption, using the IRS as a harassment tool, why don’t they pursue him (maybe lock him up….. I’m pissed!)? His AGI was over $214,000, having claimed $40,000 of largely shady deductions. Isn’t it fraud or something to claim exemptions one isn’t entitled to? In any case, though I’m only required to supply the divorce agreement per IRS regulations, the auditor requested several documents from me, verifying the support I provided to her. I complied and am nervously awaiting the next move, esp. since the auditor seems to erroneously believe that I was even required to provide support, and told me that generally children can no longer be claimed after 18, even though she already knew my daughter was a full time student.
And speaking of pissed, I know that he claimed my daughter in 2011, despite neither of us being eligible to claim her anymore. She’s in a grad program and borrowed $25,000 last year in addition to earning $2500 working (so didn’t file a return). He supplied her a place to live plus paid $3700 of her expenses. He sent me a spreadsheet detailing all he had spent on the children, during discovery, in his successful effort to halve my $2000/mo. alimony in 2011, due to losing his job. I’m severely disabled, cervical spinal cord injury with traumatic brain injury, married 23 years, on SSDI with some ever-diminishing trust income my parents left me, would love to work if somebody would hire me but haven’t found anybody willing since the GFC.) I don’t believe he can claim $2000/mo. for room and board. I discovered I can report him and am seriously reconsidering my position of turning the other cheek, it doesn’t seem to be serving me well, in several arenas. Does anybody know if they pursue reports that result in collection of perhaps only a few thousand dollars? I don’t know even generally how much to say and if I should offer that this is an attempt to harass me on his part, or if I should volunteer nothing.
@Patrick, good response! Not to play language police, and I love the image ‘cow towing’ brings to mind, but allow me to tell you this is usually rendered ‘kowtowing’ (i think it’s from Chinese, definitely not Japanese).
In a kleptocracy, and we live in a kleptocracy, it is always about the looting. REMICs were from the start a financialized product for rentiers, one form of looting. But the people who set up these deals, another group of looters, realized they could loot them by ignoring the black letter law requirements governing REMICs. But as everything leading up to the meltdown and the now four years since has shown, the law only works for the looters and against us.
REMICs are just one part of what are the largest frauds in human history. No one has gone to jail for these, or even been seriously investigated. The perpetrators got trillions in bailouts and have emerged completely unreformed and even bigger and more powerful than before. The law will never be permitted to touch any of this for the very simple reason that the whole of the banking system is a criminal enterprise. The application of the law to it would destroy it. If there is one point to understand in all this, it is that kleptocracy can not be reformed. The rich and elites who run it can not be reformed. Reform requires a functioning legal system, one that works for and applies to all, not just a few. And we have not had one of those in decades. I fully expect events will have to get much worse before most of us realize that the only way to rid ourselves of a kleptocracy is by overthrowing it.
A modest suggestion
Since the White House now accepts petitons (apparently including those that propose secession – Texas et al)
Could we petition the White house to include a tax on high speed computer stock transactions ? say a 75% tax ?
And could we petition that the REMICs be stripped of their tax exemption ?
Both of these would go a long way towards reducing the deficit and would be at least a small step towards leveling the playing field for tax payers.