By Jeffrey Murphy and Lee Smith of Dentons
The ABI Reform Commission recommended that the safe harbors under Section 555 and 559 of the Code be revised to return to their pre-2005 contours and, specifically, that the safe harbors exclude mortgage warehousing, which is a short-term revolving credit facility extended by a financial institution to the loan originator. We believe that excluding mortgage warehousing transactions from the safe harbors will increase “contagion risk” and also reject the Commission’s assertion that mortgages, in comparison with other safe-harbored asset types, are “illiquid” investments based upon our experience with mortgage loan trading. The largest banks, and ever increasingly, the largest investment funds, are major participants in the mortgage markets as originators, buyers, and market makers (the same cannot be said of, say, municipal bonds), and the financial crisis started with a subset of the mortgage markets: subprime mortgages.
We are not persuaded that repo financing contributed to the excesses of the credit boom of the mid-2000s, nor do we believe that the Bankruptcy Code safe harbors for the liquidation, termination or acceleration of repurchase agreements are to be indicted for causing “runs” on debtors that knowledgeable market actors will not restructure. To the contrary, mortgage repos are a crucial component of healthy housing markets, and fairness requires that debtors relieved of their margin call obligations by a bankruptcy filing not have options to satisfy their obligations while the repo buyers are exposed to all the market risk.
For our full analysis of the ABI recommendation, please see here.