Reps and warrants prompt call to rehaul securitization contracts
The language and structure of mortgage securitization contracts made the financial crisis more painful and confusing for all parties involved, Federal Reserve Board Governor Sarah Bloom Raskin suggested in a speech Tuesday. While speaking to the Maryland State Bar Association, Raskin said securitization contracts are not working, and fixing them remains a "massive challenge for lawyers who practice in the field of mortgage finance." She added, "Your country needs you to tackle it with the same vigor and energy that you have brought to other legal challenges in this housing crisis." Raskin specifically highlighted issues over representations and warranties contained within pooling and servicing agreements. Reps and warranties outline the incentives of originators and issuers as well as those of investors when a loan is sold for the purposes of securitization. It's this part of the contract that identifies underwriting standards for the parties involved in the transactions. The rep and warranties agreement also stipulates that an originator is required to buy back loans that violate terms of the representation and warranty agreements. Despite these agreements existing in all securitization contracts, Raskin believes many of the legal issues stemming from the financial crisis over loan buyback disputes are related to rep and warranty agreements that are not clear enough to allocate responsibility. "[C]ontracts in private-label mortgage securitizations varied considerably from deal to deal, and there was no consistent language or standard for representations and warranties," Raskin said. "Therefore, a poorly underwritten mortgage loan could breach the representations and warranties of one deal's contract but not be a violation of representations and warranties in another very similar deal; this discrepancy would only be apparent following a careful reading and nuanced comparison of the differences in drafting between the two contracts." Raskin also warned a lack of standardization when drafting reps and warranties leaves more room for parties to argue later on over who is responsible for the nonperforming loan. Raskin said comprehensive disclosures also should be made about mortgage loans that are securitized to ensure investors are able to conduct their own due diligence prior to investing in mortgage-backed securities. Write to Kerri Panchuk.