Environmental superliens and the problem of mortgage-backed securitization
Nash, Jonathan Remy
On January 23, 1980, New Jersey, one ofthe leading state laboratories for environmental regulation,1 enacted a new provision of its environmental laws. That provision allowed the state environmental agency to obtain a lien against environmentally-contaminated property to recover funds that the state expends, under state environmental law, to remediate any contamination.2 This lien, however, was not ordinary; it was, rather, a “superlien,” which is a lien that enjoys priority as to other liens against the contaminated property even if such other liens predate the state’s lien.3 Attracted by the prospect of increasing the likelihood of recovering funds expended on environmental cleanups, a number of states followed New Jersey’s lead and enacted superlien statutes during the 1980s; thus, for a time it seemed that a trend was developing.4
tial mortgages with ties to the federal government, the Federal National Mortgage Association (FNMA or Fannie Mae), also pressured Massachusetts in a similar manner.8
The action taken by Freddie Mac and Fannie Mae resulted in tangible consequences on the housing market in Massachusetts.9 Further, the threat of a more extensive withdrawal from the state by Freddie Mac and Fannie Mae raised the specter of additional adverse consequences for the Massachusetts mortgage and housing industries, as well as for homebuyers. This additional threat convinced the Massachusetts legislature to pass an amendment within a month that exempted “real property the greater part of which is devoted to single or multi-family housing” from the scope of its superlien provision.10
Some states have repealed their superlien statutes,15 and only one state has enacted a superlien statute since the end of 1990.(16)
According to the prevailing wisdom, the mortgage lending industry vigorously opposed state superlien statutes because superlien statutes decreased the return lenders could expect from foreclosures on defaulted mortgage loans and, as a result, would substantially increase the price of borrowed funds. In this Article, I argue that this prevailing wisdom is flawed. I demonstrate the insignificance of the immediate economic impact of superlien statutes on residential mortgage borrowers.” I then explain that the real cost of superlien statutes to lenders is the nonuniformity that they introduce between states in the laws governing lien priority – and the possibility of future extensions of this nonuniformity into other areas of state law governing lien priority.
The fact that the immediate economic impact of a superlien statute on mortgage pricing remains small suggests that securitization promoters may choose simply to price mortgages from different states without regard to the variations in law across the states. For example, the industry responded to nonuniformity in mortgagor protection laws across state lines in this manner.18 However, as evidenced by the experience in Massachusetts,19 residential real estate mortgage securitization promoters disfavored state enactments of superlien statutes.
to that risk, and instead to demand that residential mortgage liens not be subject to superlien legislation, arises from the nature of the nonuniformity in state laws introduced by superlien statutes.20 In particular, state superlien statutes create nonuniformity in the law in an area that has been a cornerstone of the securitization movement – the predictability of lien preference ordering. If the mortgage lending industry permits any nonuniformity in the laws governing lien preference ordering, it risks relinquishing control over the future growth and expansion of such dissimilarities. The relatively recent dramatic rise in the practice of securitizing mortgages makes this kind of nonuniformity a serious concern. Nonuniformity of this type may affect significantly the bundling of mortgages from different states and result in substantial costs for mortgage lenders and promoters. Moreover, to the extent that mortgage pools do not transcend state lines, many of the benefits that society draws from securitization – including lower interest rates, nationalization of real estate capital markets, and increased cash flow into real estate capital markets – dissipate.
My analysis and conclusions are important in at least three respects. First, they explain the actions of promoters of residential mortgage securitizations in opposition to state environmental superlien statutes. I conclude that securitization promoters consider state superlien statutes a substantial threat to their business because mortgage lending practices and law in the residential arena are especially uniform across state lines and securitization of residential mortgages relies substantially on that uniformity. Accordingly, I predict that these promoters will act to ensure that states do not broaden existing statutes or enact new statutes whose scope would extend to residential mortgage lending.
loans than do residential mortgage pools; thus, it is more difficult to dilute price differentials on the commercial side. Moreover, superlien statutes probably impose greater pricing differential in the commercial setting than in the residential setting. In light of this, it seems that opposition to superlien statutes that apply to commercial lending should increase in coming years. In particular, pressure on states to repeal such statutes should grow.
Third, the residential mortgage lending industry’s antipathy toward, and actions taken to thwart the expansion of, state superlien statutes presents an example of conflict between the economic needs of a particular industry’s market and society’s goal of heightened environmental protection and quality. This conflict mirrors the general discord between the desire of the lending industry for more nationally uniform real estate laws and the local interest in real estate laws tailored to the particular desires of residents of different regions. This conflict differs, however, from the paradigmatic setting in which recent academic commentary has examined the question of whether environmental standards should be set at the national or local level. Supporters of federal environmental standards justify federal environmental regulation with the argument that states might engage in a “race to the bottom” if authorized to regulate the environment. In other words, commentators argue that because market forces might sway state governments to reduce environmental regulation, federal intervention proves justified to establish a national floor for environmental regulation. By contrast, in the case of state superlien statutes, states that enact such statutes seek a higher level of environmental quality, and market forces would frustrate that effort by establishing, in effect, a national ceiling for environmental regulation.21
In Part II of this Article, I present an overview of the mortgage lending system, including the substantial changes that the growth of securitization has effected on that system in recent decades. In Part III, I discuss the superlien statute. First, I describe how a superlien statute is supposed to function and the statute’s intended effect. Next, I discuss the various superlien statutes that have been enacted in different states and highlight important differences among them.
1990s. In particular, I consider the likely effects of the enactment of a state superlien statutes on state environmental quality and state budgeting.
In Part V of this Article, I examine the costs and general effects of superlien statutes on residential mortgage lenders. I describe how superlien statutes generally affect the pre-lending practices of lenders and cause some amount of increase in the price of borrowed funds. With that background, I then consider the extent of that increase in the context of residential mortgage lending. First, in subpart A, I examine the conventional wisdom that superlien statutes, standing alone, substantially increase the cost of residential mortgage funds. I consider arguments made by various commentators to this effect. Ultimately, I find these arguments wanting. I then employ a net present value model for residential mortgage cash flow to predict the actual effect that a superlien statute may have on residential mortgage pricing. The use of this model confirms that superlien statutes likely have a minimal impact on residential mortgage pricing.
In subpart B, I consider the impact of superlien statutes on efforts to securitize residential mortgage loans. I argue that the real problem superlien statutes posed to residential mortgage lenders and securitization promoters consisted of a threat to two aspects of the industry that undergird that industry’s function and success: the predictability of mortgage priority laws and the general uniformity of mortgage lending laws. First, residential mortgage lenders generally, and securitization promoters in particular, feared that superlien statutes would prove to be the first chink in the armor of predictability of mortgage priority laws. In other words, the superlien statutes might have been the first step on a slippery slope that ultimately would eviscerate the predictability that undergirds the residential mortgage lending industry. Second, residential mortgage securitization promoters feared that superlien statutes would proliferate, leading to even more variances – and, even more troubling, variances of greater import – in state mortgage laws.
In Part VI, I consider the interplay between superlien statutes and commercial mortgage lending. I observe that because of fundamental differences between the residential and commercial mortgage markets – most notably the absence of a federal government player (such as the FHLMC) – the lessons about lender opposition to superlien statutes in the residential mortgage context do not apply readily to the commercial mortgage setting. I acknowledge a recent contribution to the academic literature suggesting that superlien statutes may not be as promising in the commercial lending context. I then consider whether, assuming that superlien statutes are good public policy in the commercial mortgage lending context, such statutes are, and will remain, viable. I observe that because the commercial mortgage securitization industry has lagged far behind its residential counterpart, pressure to impose more uniformity on the practices and law applicable to commercial mortgage lending has been comparatively less. This explains the persistence of state superlien statutes that can apply to displace commercial mortgage security interests. I then note that the growth of commercial mortgage securitizations, along with the concomitant increased pressure for uniformity, likely will increase pressure to restrict the scope of – and perhaps ultimately to repeal – superlien statutes applying to commercial mortgages. Further, because commercial loans tend to be much larger than residential loans, the burden that variations in local law, caused by superlien statutes, impose on securitization promoters may be more pronounced – and, therefore, opposition to superlien statutes may be greater — in the commercial mortgage lending context.
In Part VII of this Article, I position the battle over state superlien statutes in the ongoing academic debate over uniformity of law. In particular, I focus on academic debate over the uniformity of real estate law and the debate over the proper allocation of environmental regulatory authority between the federal and state governments. I conclude that the superlien dispute squares nicely with the academic debate over uniform real estate laws. However, the superlien dispute provides a counterpoint to the traditional setting in which environmental academics have analyzed uniformity, since that debate has focused on whether a race-to-the-bottom on the part of states justifies federal imposition of a uniform floor for environmental regulation. By contrast, in the superlien context, states endeavor to enact laws that provide comparatively greater environmental protection, while economic pressures advocate a uniform ceiling. I reason that, even though opposition to superlien statutes applicable to commercial real estate may increase beyond opposition to applying statutes to residential real estate, commercial properties remain more likely than residential properties to become environmentally contaminated. That being the case, applying superlien statutes to commercial real estate ensures greater environmental quality, which is the chief benefit the statutes offer. Accordingly, in Part VIII, I conclude that the economic pressures brought to bear by the expansion of securitization ought not preclude states, as a public policy matter, from maintaining and enacting superlien statutes that apply to commercial real estate properties.
II. Overview of Mortgage Lending
A. Background and the Primary Mortgage Market
Most individuals and families that seek to buy real property do not have sufficient funds to finance such a purchase and thus rely on loans. Further, many who might be able to amass the funds choose for other reasons to finance real estate purchases using borrowed funds. Commercial entities and businesses also often borrow money to finance real estate investments. Persons and entities generally borrow money from professional money– lenders such as banks, savings and loan institutions, and mortgage bankers.22 In the terminology of the mortgage industry, the lender is called the “originator” of the mortgage.23
In general, a borrower must repay the lender the full amount of money that he or she borrowed, plus interest thereon. The interest represents, in effect, the “price” of the borrowed money.24 Much like any other price, the market determines the interest rate charged. In this primary mortgage market, prospective borrowers demand loans and lenders supply them. The resultant demand and supply curves determine the interest rates that accompany various loan structures.zs Figure 1 demonstrates this phenomenon, where D represents the demand curve for loans and S represents the lending industry’s supply curve. The Figure predicts that there will be q loans entered into at an interest rate of i.
course,30 foreclosure on the secured property often is the only way that mortgage lenders can recoup any remaining value ftm a loan on which the borrower defaults.
default on their loans. The lender thus spreads the risk of default among all borrowers.
Given the social benefits of loans and the lobbying power of lenders, it is not surprising that the law assists mortgage lenders in mitigating default risk. The law achieves this effect by allowing mortgage lenders to register their security interests and thus generally to assure their liens a certain priority of payment in the event of default.
Mortgage filing procedures and lien priorities generally are matters of state statutory law. Because superlien statutes upset the status quo of lien priority statutes, it is of particular importance that lien priority statutes come in three basic varieties: race, notice, and race-notice statutes.33 Each breed of mortgage filing statute leaves a mortgagee subject to different risks.34 All these versions of lien priority statutes are similar in that these risks are quite limited in time since no additional risk arises once the lender has recorded its interest.35 In the long run, absent some intervening factor (such as the action and effect of a superlien statute), a lender who follows proper procedure in filing its security interest is assured of its priority of payment.
This assuredness benefits lenders and, indirectly, borrowers as well. The virtually absolute predictability enables lenders both to avoid an increased likelihood of loss on default and to estimate the likelihood of loss with great accuracy. This, in turn, allows lenders to price mortgages with greater efficiency and generally to minimize the loss premium that they charge, which inures to the benefit of borrowers.
B. Securitizations and the Advent of the Secondary Mortgage Market
that is, to collect loan payments the obligation as they become due – so that the borrower may not even be aware that the rights to the mortgage obligation into which he or She entered have been sold.41 In reality, however, the originator serves only as a collector of funds and forwards the monies collected to the purchaser of those rights.
Securitization promoters, or “conduits,”42 purchase mortgages in the secondary market. They bundle together large numbers of mortgages that they have purchased and create “securities” based upon the underlying mortgages. They then sell those packaged securities to investors.43
1. Residential Mortgage Lending
Two quasi-governmental corporations – the Federal National Mortgage Association (FNMA or Fannie Mae)47 and the FHLMC48 – and one government agency – the Government National Mortgage Association (GNMA or Ginnie Mae)49 – have played a major role in establishing and maintaining the secondary market for residential mortgages. The federal government established these entities in order to “provide liquidity in the market for residential mortgage loans and to increase the flow of capital to housing.”50 Fannie Mae and Freddie Mac act as conduits for residential mortgage-backed securities.51 In addition, Fannie Mae, Freddie Mac, and Ginnie Mae all provide payment guarantees for certain residential mortgage-backed securities.52
gages. Securitization ameliorates both of these problems. The emergence of a vibrant secondary real estate mortgage market, as well as a market for real estate securitization products, dramatically increased the flow of information relating to securitized products and the real estate mortgages that undergird them.54 Also, investing in securitization products allows investors to diversify their holdings and to avoid the risk of investing in individual mortgages.
Second, the rise of securitization has led to increased nationalization of the real estate capital markets. Prior to the advent of real estate mortgage securitization, real estate mortgage investing was overwhelmingly local in character. A combination of law and circumstance produced this effect. First, federal law traditionally precluded most banking institutions from engaging in interstate banking.55 Second, the mortgage loans tended to originate locally. As such, an investor in Chicago was unlikely to be familiar with the conditions of the real estate market in Miami or with the laws governing mortgage lending in Florida, and time constraints often precluded an investor from making an intelligent decision as to whether to invest in a mortgage originating there.
gave rise to great pressure on real estate practitioners and legislators to begin to eliminate some of the differences in local real estate practice and law that once might have made investors reticent about investing in real estate mortgages in regions of the country with which they were unfamiliar.57 This nationalization of the real estate capital markets allowed capital available for real estate investment to flow from richer to poorer areas of the country.58
These features – the increase in money invested in real estate capital markets and the nationalization of the real estate capital market – reflect a more general phenomenon wrought largely by the growth of securitization: the integration of real estate capital markets with general capital markets. In general, this integration increased the flow of capital into the real estate markets.59 In particular, this integration has reduced home mortgage loan interest rates.60
2. Commercial Mortgage Lending
commercial mortgages.62 Indeed, no governmental or quasi-governmental agency or corporation serves to create and maintain a secondary market for commercial mortgage.63
Second, the terms of commercial mortgages vary far more greatly than do those of residential mortgages.64 The terms of residential mortgages are fairly standard on a national basis and generally vary only as to their terms and prices.65 Commercial mortgages, by contrast, exhibit distinctions that are far more numerous and greater in scope.66 Moreover, the absence of a national corporation with govemment ties has influenced the shape of the secondary market in commercial mortgages and on the underlying commercial mortgages themselves. In particular, there is less pressure to bring uniformity to the terms of commercial mortgages between states or even within regions.67 This lack of pressure to conform terms tends to preserve the broad variations in commercial lending.
Fourth, before the economic downturn ofthe late 1980s and early 1990s, commercial borrowers could readily obtain mortgage loans; they “enjoyed access to a deep capital pool with relaxed underwriting criteria.”70 Until the 1990s, there was simply no strong pressure for the infusion of funds into, and the nationalization of, the commercial real estate market.
Despite these obstacles, a thriving secondary commercial mortgage market has arisen in recent years.71 Still, commercial mortgage securitizations lag far behind securitizations of residential mortgages.72
III. Overview of Environmental Superlien Stantues
A. The Superlien Statute
is determined under traditionally applicable rules of lien priority.75 Thus, a CERCLA lien will be superior to liens held by unsecured creditors and those filed subsequently76 but will remain inferior to pre-existing liens. Many state laws mimic CERCLA in this respect and also confer standard liens to state environmental agencies under analogous circumstances.77
agencies liens that are superior to all (or most) other liens regardless of when the competing liens were obtained or perfected.79
state, under these cir, will probably not recover much, if any, of its expenditures.80
A superlien statute changes this result. It gives a state the highest priority as to the post-cleanup equity in the property. This prioritization scheme greatly increases the chances that a state will recoup its cleanup expenditures.81
Because superlien statutes can give a state’s lien priority over other lenders’ liens even though the state’s lien arose and was perfected later, these statutes are subject to various constitutional challenges.82 First, one can argue that the state procedures for obtaining and exercising a superlien deprives superior lienholders of property without the due process of law that is required by the Fourteenth Amendment.83 Indeed, the United States Court of Appeals for the First Circuit held in 1991 that the EPA had violated the Fifth Amendment’s Due Process Clause when it obtained a CERCLA lien – of conventional priority – without affording the property owners notice of the lien and allowing for a predeprivation hearing.84 In fact, as I discuss below, several state superlien statutes do require the state to provide notice of the new lien to preexisting lienholders.85
taking of property without just compensation.86 Michael Madison, Jeffrey Dwyer, and Steven Bender argue for a distinction between superlien statutes that afford the state’s lien superpriority status only as to liens perfected after the effective date of the statute – such as those in Connecticut and Maine – and those superlien statutes that apply retroactively. They assert that purely prospective applications of superlien statutes would not seem to violate the Constitution, insofar as persons and entities obtaining liens after that date have notice that a subsequent state environmental lien may take priority over their liens.87 Madison, Dwyer, and Bender further argue that even retroactive applications of superlien statutes do not effect an unconstitutional taking without just compensation, because either (i) the cleaned-up property may well have been valueless before the cleanup so that no compensation was due, or (ii) the cleanup of the property adds to its value, and thus constitutes the due compensation.88
Perhaps the most constitutionally challenging superlien statutes are those that allow the state’s lien to take priority over liens that cover pieces of property other than the contaminated property that are held by the same owner.89 However, in Kessler v. Tarrats,90 the only reported court decision analyzing a Takings Clause challenge to a superlien statute, a New Jersey appellate court upheld that state’s superlien statute.91 The court reasoned:
ever diminution in value may have occurred to affect plaintiffs security interest was as the result of the acts of polluting the property. Therefore, whatever property, if any, was “taken” was taken by the dischargers of the hazardous stances and not by the State.92
Last, one can argue that the application of superlien laws violates the Constitution’s Contracts Clause.93 In Kessler, the only reported court decision addressing a Contracts Clause challenge to a state superlien statute, the appellate court rejected this argument against New Jersey’s superlien statute on the ground that the adoption and use of the statute was a valid exercise of the state’s police power.94
B. Variations in State Superlien Statutes
Michigan’s superlien statute is unique in that it creates two superliens and imposes different prerequisites for each. The first hen, in an amount equal to the lesser of (i) the state’s cleanup expenses and (ii) the increased value of the cleaned property,127 acquires superpriority status as soon as the state files, and thus perfects the lien (the Michigan automatic superlien provision).128 For lien amounts in excess of the increase in the property’s value resulting from the cleanup, the state still must file the lien.129 In order to achieve superpriority, however, the state attorney general must petition a court and assert that a lien of ordinary priority would be “insufficient to protect the interest of the state in recovering response costs” (the Michigan discretionary superlien provision).130 A Michigan appellate court has held that the trial court hearing the petition has discretion to grant or deny the attorney general’s request.131
The state superlien statutes of Connecticut and Maine grant state cleanup liens superpriority status only over compering liens recorded after the effective date of the governing statute.132 The remaining six states’ statutes are wholly retroactive; thus, they grant superpriority status as to all other liens.
Third, of the eight extant state superlien statutes, six explicitly do not apply to “residential” properties.133 Only those of Louisiana and Michigan contain no such exemption. For example, Connecticut’s superlien statute does not apply to “real estate which consists exclusively of residential real estate.”134 This limitation apparently results from the lobbying efforts of residential lenders, the FHLMC, and the FNMC.135
ous materials is located and personal property located at the facility on which hazardous waste or hazardous material is located.”136 No other state’s statute affords superpriority status to anything other than the real property that the state has expended funds to clean up.137
Fifth, under both Louisiana’s superlien statute and the Michigan automatic superlien provision, the state’s superlien enjoys superpriority as to any amounts expended by the state that result in an increase in the value of the property beyond the property’s pre-cleanup fair market value.138 In effect, then, both provisions work to preserve the priority status of previously filed and perfected liens to the extent of the fair market value of the underlying property prior to the state’s cleanup. By contrast, all other superlien statutes confer superpriority status on the state’s lien over all liens on the entire property.
market value, but only if the attorney general applies for superpriority and the court approves the application.142
In short, then, only one state superlien statute – Michigan’s – allows a superlien to apply to the pre-cleanup fair market value of a residential property and applies only if the state attorney general seeks and the court grants such relief ” As such, lenders’ rights to the pre-cleanup fair market value of a residential property in which they hold security interests remains essentially unfettered by any state’s superlien statute.
IV. Benefits of a Superlien Statute
In this Part, I discuss the probable benefits of a superlien law. In particular, I focus on the effects on environmental quality and state budgeting. I conclude that a state superlien law is likely to lead both to improved environmental quality in the jurisdiction and to less taxpayer expense for site cleanups. The extent of these benefits varies according to the state’s approach to funding environmental cleanups.
A superlien statute generally increases the likelihood that a state will undertake an environmental cleanup. This makes sense, given the fact that such a statute makes it more likely that the state will recover at least some portion of the funds it expends to conduct the cleanup.144
reducing expenditures by the state and, presumably, the effect of increasing the total number of cleanups. To the extent that the state is more likely to undertake cleanups, the frequencies of cleanups will be greater. This, in turn, will increase the overall environmental quality in the state.
Thus, an increase in the ability and likelihood of the state to obtain reimbursement for environmental cleanup expenditures should increase overall environmental quality in the state. However, the extent to which a superlien statute results in more state cleanups varies with the funding mechanism that the state uses to finance environmental cleanups. The vast majority of U.S. jurisdictions (forty-nine states, as well as Puerto Rico) emulate the model of the federal CERCLA statute146 and provide for a separate state find dedicated to environmental cleanups (referred to as a “dedicated fund”).147 A dedicated fund finances environmental cleanups conducted by the state, and recoveries from private parties as compensation for cleanup expenses financed by the state are paid into the dedicated fund. Only two United States jurisdictions, Nebraska and the District of Columbia, provide for no such dedicated fund (such states are “general environmental find states”).148 Environmental cleanups conducted by the state come from funds subject to annual appropriation by the state legislature.149
A superlien statute will have a different overall effect in a dedicated fund state than it will in a general environmental fund state. A superlien statute increases the likelihood that a state will recover funds it expends to clean up contaminated properties. This means that states having dedicated funds will find them more easily replenished. Because state decision-makers presumably will be aware of this, the state should be able to, and therefore should be more likely to, undertake more environmental cleanups with a superlien statute than without. It follows that one reasonably can expect environmental quality to be higher in a dedicated fund state that has a superlien statute than in a state without one.
might be redirected to fund other environmental (or even non-environmental) priorities or, even more likely, used to justify reducing budget allocations to the state environmental agency. Whether decision-makers deem it appropriate to cut environmental funding or to use the benefits from the superlien statute to fund other initiatives (and thus to justify cutting direct funding of those initiatives), they reasonably can be expected to pass some of the benefits contributed by the superlien statute on to constituents in the form of tax cuts.”‘ Thus, the effect of the passage of a superlien statute on a general environmental fund state is likely to comprise (i) increased environmental quality, though less than in a comparable dedicated fiend state, and (ii) an increase in the finds generally available to the state government.
is beneficial only where there is value in the property after cleanup, whereas a dedicated find has more general applicability.152
The foregoing allows some insight into the likely preferences of environmentalists and budget-constraint advocates as to whether a state should have a dedicated fund, a superlien statute, neither, or both. Table 2 presents these preferences for environmentalists. The columns tell whether or not the state enacts a superlien statute, and the rows represent whether the state is a dedicated fund state or not. The number in each box of the grid is the payoff that is, the relative preference153 _ of environmentalists to each possible combination of row and column.
One can construct, along similar lines, a similar pref:rme grid and ranking for budget-constraint advocates. Tables 4 and 5 present such a grid and ranking.
It should be borne in mind that these Tables provide some information about different peoples’ likely preferences, in the abstract, as to six different environmental regulatory structures. In reality, decisions as to whether or not a state should have a dedicated fund and whether or not a superlien statute should be enacted are not made in tandem. Indeed, the debate over superlien statutes is more recent and generally made against a backdrop that features the presence or absence of a dedicated fund. Given that, it appears that environmentalists will favor (as they always would) enactment of a superlien statute, whether or not the state has a dedicated find, and would favor a standard hen to no lien at all. By contrast, budget-constraint advocates will favor enactment of a superlien statute if the state has no dedicated fund. If the state has a dedicated fund, budget-constraint advocates generally should be ambivalent about enactment of a superlien statute.
V. Costs of a Superlien Statue
The discussion in Part IV explained that superlien statutes offer some combination of two benefits: higher environmental quality and lower net government expenditures on environmental cleanups. Accordingly, it predicted that environmentalists and budget-constraint advocates generally would support, or at least not oppose, superlien legislation.
Superlien statutes also impose costs on society. What are these costs, how much are they, and on whom do they fall? In answering these questions, I advance the thesis that these costs are relatively minor in the residential mortgage lending context absent the market pressures of securitization. However, by putting a premium on uniformity of law across state lines, securitization magnifies the costs in states with superlien statutes. I test this hypothesis by examining the costs associated with superlien statutes on mortgage lending in the absence of, and then in the presence of, the effects of securitization.
In Part V.A, I consider the nature and extent of these costs in the absence of securitization’s influence. This analysis consists of four parts. In Part V.A. 1, I explain that the immediate impact of superlien statutes generally falls on mortgage lenders and borrowers. I describe this impact with a focus on the effects of superlien statutes on residential mortgage pricing (again in the absence of securitization’s influence). In Part V.A.2, I consider the conventional wisdom, proffered by commentators, that superlien statutes will have a substantial impact on mortgage pricing. I posit that these arguments, while perhaps relevant in the commercial mortgage lending arena, are not persuasive in the context of residential mortgage lending. In Part V.A.3, I argue more generally (still in the absence of securitization’s influence) that superlien statutes should have much less of a pricing impact on residential, as opposed to commercial, mortgage lending. Last, in Part V.A.4, I employ a net present value residential mortgage model to estimate the actual cost that a superlien statute imposes on mortgage lenders and borrowers. The model suggests that these costs will not be significant.
In Part V.B, I consider how the expansion of securitization may augment the costs associated with superlien statutes. I argue that superlien statutes increase the cost of lending substantially once securitization is introduced insofar as superlien statutes create nonuniformity in pertinent law across state lines while securitization markets are impaired by nonuniformity. I also argue that the particular nature of legal nonuniformity and unpredictability that superlien statutes introduce as to the priority of security interests in property is particularly problematic for mortgage lenders and securitization promoters because it directly implicates the fundamental underpinnings of the mortgage lending and securitization industries.
A. Costs of Superlien Statutes to Residential Mortgage Lenders and Borrowers, in the Absence of Securitization
1. Superlien Statutes’ Effect on Residential Mortgage Lenders and Borrowers
Even putting the demands and pressures of securitization to the side, there can be little doubt but that a superlien law increases the price of borrowed funds by some amount. As an initial matter, one can note that additional recoveries made by the state through use of a superlien statute – at the expense of secured lenders – are used to fund improvements in environmental quality in dedicated find states, and a mix of environmental quality improvements and tax cuts in other states. Because lenders pass some portion of these costs on to borrowers,154 lenders and borrowers both, in effect, subsidize these societal benefits.
A successfully obtained and exercised superlien likely will result in a situation where a secured lender does not recover on foreclosure funds that it otherwise would have recovered.155 Thus, the threat of a superlien decreases lenders’ likely recovery rate and amount on foreclosure. It is logical that this would have an impact on the practices of, and rates charged by, lenders.156
place on (or even near) the property that might require an environmental cleanup of the property in the fre, thus exposing the lender to the possible entry of a superlien.157
wide supply curve for mortgage-backed funds. This effect is represented in Figure 2, in which D represents the industry-wide demand curve for borrowed mortgage-backed funds, S^sub 1^, represents the industry-wide supply curve before the enactment of a superlien statute, and S^sub 2^ corresponds with the industrywide supply curve after enactment. As the figure reveals, this shift in the supply curve effects (i) an increase in the equilibrium price for mortgagebacked funds, i.e., an increase in the interest rate charged by lenders, from p^sub 1^ to p^sub 2^,159 and (ii) a decrease in the amount of funds borrowed from q^sub 1^ to q^sub 2^, which translates into fewer mortgage loans made.
2. Evaluation of the Conventional Wisdom: Superlien Statutes Directly and Substantially Affect Residential Mortgage Pricing
generally assume that the increase will be large and have offered varying justifications for that conclusion. Retaining the focus on residential mortgage lending, I now turn to an examination of these justifications. I conclude that none are persuasive.
At first blush, one might comprehend the threat that superlien statutes pose to lenders simply as the possibility that lenders’ prior liens might be superseded by subsequently filed superliens. The concept of a subsequent lien taking precedence over a prior lien is hardly novel, however: Many state laws provide that liens for recovery of real estate taxes take precedence over other liens, even where the holders of the prior liens have filed and perfected those liens before the tax lien arises.160 Thus, it seems unlikely that the mere fact that a superlien is a retroactive lien is alone the cause of lenders’ great enmity toward superlien statutes. The problem for lenders with retroactive environmental liens, as opposed to retroactive tax liens, is that the latter are far more predictable, both in terms of occurrence and magnitude. As Grant Nelson and Dale Whitman explain:
Granting automatic senior status to real estate tax liens usually poses no significant problem for the mortgage[s) because they frequently “escrow” for such liabilities and, in any event, can predict with relative certainty the extent of their… future tax burden. On the other hand, . . . finding and predicting environmental problems represents a much less manageable task for the mortgagee …. 161
Robert Bozarth echoes: “[R]eal estate taxes also enjoy a superpriority, but prospective purchasers and lenders can discover current and delinquent tax liabilities in the title examination. In addition, the total tax delinquency rarely exceeds a fraction of the value of a commercial or industrial property.”162′
as sizeable a pricing problem for lenders as one at first might think. Moreover, while Bozarth’s comment on the relative size of tax delinquencies helps explain why superlien statutes might cause large price increases in the cornmercial mortgage context, it suggests that price increases in the residential context would be comparatively minimal.
A more likely cause for an increase in residential mortgage pricing is a superlien statute that allows state liens to trump other liens that were perfected before the effective date of the statute, i.e., liens where the lenders were not on notice of the possible applicability of a superlien statute and thus had no opportunity to charge a premium for that additional risk. Notably, the superlien statutes in Connecticut and Maine avoid this problem because they vest superpriority in state liens only as to liens that were perfected after the respective statute’s effective date.164 Residential lenders in these states nonetheless sought, successfully, residential property exemptions. Moreover, the fact that a state superlien statute may apply to liens that were perfected before the statute’s effective date should not impact the pricing of residential mortgages issued today, i.e., after the statute has gone into effect.
Mark Budnitz and Helen Chaitman disagree that retroactivity is the lender’s central problem with superlien statutes. While conceding that “[t]here is nothing a lender can do to prevent the imposition of a retroactive lien on contaminated property,”165 they assert:
In practice, the imposition of such a lien may be of no consequence to the lender. The lender may not even wish to enforce its security interest on contaminated property, given the risk of the lender’s liability as an owner for the cleanup. Moreover, once the property is cleaned up, the possibility of unfound waste will leave the property undervalued.166
B. Comparison of the Costs Associated with Superlien Statutes in the Residential and Commercial Mortgage Lending Arenas
The foregoing discussion established that commentators’ proffered reasons for heightened mortgage pricing resulting from superlien statutes, while applicable to commercial mortgage lending, are not persuasive in the context of residential mortgage lending. An examination of the risks faced by residential, as opposed to commercial, mortgage lenders confirms this dichotomy.
As an initial matter, the argument that enactment of a superlien statute substantially reduces mortgage lenders’ expected recovery on mortgage default in the case of residential property seems dubious. The chance of a residential site being environmentally contaminated – or even subject to a risk of such contamination – is smaller than the comparable risk for commercial property. Activities carried on at a site that is used for residential purposes are exceedingly unlikely to result in environmental contamination. Thus, contamination of residential properties is far more likely to result from activities conducted at adjacent or nearby properties. It tends to be the case, however – whether for reasons of zanine” and planned development or simply because of consumer preference – that residences are likely to be located near other residences. This further reduces the risk of a residential property becoming environmentally contaminated.
Second, lenders can act to minimize their risk even if some residential properties in which they hold a security interest become contaminated. In spite of the foregoing, risks of contamination at residential properties remain. A residential property may have become contaminated because of activities conducted at the site before its current residential use. That risk, however, is one that a prospective lender should be able to avoid (or at least knowingly undertake) with the help of due diligence. Due diligence should also mitigate the risk that a residential site that is not currently contaminated might become contaminated because of activities at a nearby site.
follow this logical policy, then they presumably would not invoke a superlien statute to deprive an innocent landowner of any of the value of his or her property. Thus, the practical risk to a residential lender is comparatively small.
C. Economic Analysis of the Costs Associated with Superlien Statutes That Apply to Residential Properties
More precise methods of estimating the likely economic effect of a superlien statute on residential mortgage pricing reinforce the conclusion that the costs associated with superlien statutes are, at least in the absence of securitization, insignificant. I employ a net present value model of a mortgage to examine and estimate the precise economic effect of a superlien statute on residential mortgage pricing.173 Let:
V = the initial principal balance of the loan;
T^sub m^ = the term of the loan;
T = the year in which the loan is prepaid;
i = the annual interest rate of the mortgage;
pi = the annual inflation rate;
L^sub t^= the principal balance of the loan in any year t;
C^sub o^ the net cost to the lender of originating the loan;
C^sub t^= the annual cost to the lender of servicing the loan;174
r = the lender’s cost of funds;
M = the annual hmp sum payment by the borrower to the lender;175
d^sub t^ the probability that the borrower will default in any year t;
R^sub t^ = the revenue received by the lender from the foreclosure sale and deficiency judgment;176
This model does not identify variables the presence or absence of which a superlien statute is likely to affect, such as the cost of mortgage origination, C^sub o^; the cost of pursuing a foreclosure action, F^sub 1^; the proportion of the outstanding loan balance that the lender can expect to recover on foreclosure, theta; or the interest rate, i, the value of which depends upon the values of the other variables. The value of C^sub o^ is likely to be somewhat higher in a jurisdiction that has enacted a superlien statute insofar as lenders are more likely to undertake additional due diligence in response to the statute. Still, C^sub o^ is unlikely to be substantially higher both because lenders are likely to pass some of the cost of the additional due diligence to borrowers183 and because federal and state environmental liability schemes generally prompt lenders to undertake due diligence even in the absence of a superlien statute.184 One also would expect F^sub 1^ to be somewhat higher in a state with a superlien statute. However, the true cost of a superlien statute is not that foreclosure of properties becomes more expensive; rather, a lender is less likely to recover as much after a successful foreclosure than the lender would if no superlien statute were in effect. Thus, while a superlien statute may lead to a slight increase in F^sub 1^, it is more likely to cause a substantial decrease in theta.
I chose as the base case the situation where, in line with current residential mortgage data, C^sub o^ = $800,186 F, = $275,” and 0 = 98%01 This base situation produces an interest rate (i) equal to 6.46%. If theta is 88% (as one might result under a superlien statute),”9 then i will increase only by four basis points. Even reducing theta to 78% – which seems overly pessimistic for residential mortgages, if not for all mortgages – will increase the interest rate by only twelve basis points with a corresponding increase of less than five dollars in monthly debt service.190
that the impact of a superlien statute on residential mortl pricing is not significant.191
D. Costs of Superlien Statutes on the Residential Mortgage Securitization Markets
Part V.A established that, at least in the absence of securitization, the costs associated with superlien statutes are comparatively small. Part IV identified some benefits associated with superlien statutes, such as greater environmental quality at less cost to the government. Part IV did not quantify those benefits; nonetheless, it is reasonable to conclude that, given the small size of the accompanying costs and assuming that securitization does not magnify those costs substantially, one should not rule out superlien statutes as beneficial as matters of public policy and efficiency.192 This Section examines whether this assumption is a valid one.
As discussed above, securitization offers many benefits: It increases the flow of capital into real estate markets, leads to greater flow of capital from region to region, and ultimately results in lower interest rates.193 Securitization can function only if its promoters successfully can “bundle together” groups of mortgages in “mortgage pools” that serve as underlying collateral for the securities that the promoters issue. In tun, this bundling can take place only if the terms of the mortgages that are bundled together and the laws that govern them are substantially similar.
(b) price mortgages without regard to whether their state of origin features a superlien statute; or (2) decline to include mortgages originating in states with superlien statutes in mortgage pools. Each of these options has drawbacks.
First, securitization promoters have the capability, at relatively low expense, to include the costs associated with superlien statutes in the formula to determine the price of mortgages in mortgage pools.194 This inclusion would allow conduits to discount the price of mortgages originating in states that feature superlien statutes to reflect the increased risk associated with such statutes.
Two drawbacks exist for this approach. First, even if pricing mortgages differentially because of variations in law is not expensive, myriad variations in numerous laws in multiple states at some point will generate more substantial transaction costs. Moreover, residential mortgage securitization promoters are predominantly corporations with ties to and subject to the regulatory oversight of the federal government.195 Such corporations may decide that they risk inviting congressional oversight and regulation if they price mortgages differently according to the state of origin.196 Indeed, “[f]ederally related secondary mortgage agencies such as FNMA, GNMA and FHLMC do not price mortgage market loans differentially to reflect the expected costs attributable to state mortgage laws.”197
allows states with protective laws to internalize the benefits of such laws while externalizing some of the costs. Equally pricing mortgages from all states acts both as an artificial incentive for states to enact costly, protective laws such as superlien statutes and as a disincentive against enactment of uniform laws that securitization prefers.199 As such, this approach introduces inefficiency both into the securitization markets and into state decision-making processes. Thus, this option will be viable only when the amount of the increased cost, and the number of loans featuring that increased cost, are small.200
mortgage loans from states with laws that create greater risks for lenders may become prohibitive.202
In fact, superlien statutes introduce nonuniformity in state laws that would impair substantially promoters’ ability to include in mortgage pools residential mortgage loans originating from those states that feature such statutes.203 Superlien statutes threaten the cornerstone of residential mortgage lending: predictability of lien priority.
Predictability of lien priority is of paramount importance in real estate lending. A superlien statute substantially damages that predictability. As a New Jersey Superior Court judge concisely explained:
A superlien statute thus upsets the otherwise predictable priority that residential mortgage liens enjoy. Moreover, a superlien statute represents a real threat to residential mortgage lenders and to securitization promoters that it may be only the first of many exceptions to that predictability. To the extent that securitization promoters view superlien statutes in such a light, the statutes present a threat and added cost beyond the actual economic cost that the statutes currently pose.
If securitization promoters determine that they cannot include mortgages from states with laws that create a substantially greater risk to mortgage lenders, such as superlien statutes, then the promoters may decide simply to refuse to purchase mortgages that originate in those jurisdictions. Indeed, that option is exactly what FNMA and FHLMC chose in Massachusetts in the mid– 1980s.205
VI. Commercial Mortgage Lending and Superliens
While in this Article I have generally focused on the effects of superlien statutes on residential mortgage lending, a few words about the impact of such statutes on commercial mortgage lending are in order.
the size of whose claims will not vary if bankruptcy results (such as the state for recoupment of environmental cleanup expenses).208 Second, a firm may offer to secure a debt as an incentive for a creditor to lend money (in particular, for enough money to satisfy the needs of the firm).209
Van ‘t Veld, Rausser, and Simon assert that enactment of a superlien statute decreases the attractiveness of the first reason that firms offer secured debt because as it increases the priority of some non-adjusting claims and thus reduces the ability of firms to minimize non-adjusting claims.210 They argue that this effect may shrink the range of projects that firms will undertake to below the socially-optimal level.211 They further assert that, if the projects that the firms no longer undertake are ones that would have proven to be especially successful, then less money may be available to pay creditors, including the state; thus, the state may find, perversely, that it is “paying more cleanups out of public funds.”212 Van ‘t Veld, Rausser, and Simon recommend, as an alternative to a superlien statute that grants the state’s lien superpriority status over all of a firm’s assets, a statute that gives superpriority to the state only for secured liens that arise in connection with the particular project that gave rise to the environmental contamination.213
exemption, and the remaining two substantially circumscribe the scope of the statutes as to residential property.215 From this common feature, one can infer that opposition to superliens in the commercial lending context has been either (1) far less great, (2) far less successful, or most likely, (3) some combination of both. Several reasons exist for this conclusion.
Second, the existence of greater variations among residential mortgages as compared to commercial mortgages also decreases the pressure for uniformity. In particular, as I argue above, the general existing uniformity among residential mortgages both within states and across state lines greatly heightens the impact of superlien statutes on the ability of promoters to securitize residential loans originating in states with such statutes.219 Compared to residential mortgages, commercial mortgages historically have featured, and continue to feature, much more diversity. Any two commercial mortgages may have significant differences. Those differences, moreover, generally do not arise because of variations in commercial mortgage practices or due to laws across state lines; rather, the particular circumstances of the transaction, mortgagor, and mortgagee will determine the terms of a commercial mortgage.
Second, although the number of residential loans subject to state superlien laws is likely to be small in the context of mortgage pools,” the insignificance of a singe mortgage is not as likely with commercial mortgages. This difference results from the fact that “the number of loans in a commercial mortgage-backed security pool is much smaller and [so] any one loan is likely to have a far greater impact.”225 As a result, loans from states with statutes that veer from the norm – such as superlien statutes – may pose a larger barrier to securitization in the commercial setting than they do in the residential setting. Thus, as Michael Schill concludes, the forces that challenge the continued existence of variable state laws affecting commercial lenders’ rights “are probably stronger today than at any time in our past. “226
In light of this conclusion, one might expect the pressure for national uniformity to grow as the commercial mortgage securitization continues to expand. This pressure, as it builds, should overtake the pressure for uniformity in the context of residential mortgage lending because the structure of commercial mortgage lending allows superlien statutes applicable to commercial property to greater frustrate securitization of loans than their residential counterparts. In particular, the comparatively large size of commercial mortgage loans makes loans with differentiations that much more difficult to isolate in a diversified mortgage pool that generally does not feature such differentiations.
VII. Superliens and the Debate over Uniformity of Laws
and enactments to preempt state law228 and of attempts to induce state legislatures to enact uniform laws.229 Commentators observe that economic forces drive these efforts,230 which have had mixed success.231 In short, the argument for uniform laws “is one of competitive advantage for available capital. “232 Lenders and securitization conduits have called to curtail state laws that afford their residents rights not available to residents of other states in order to reduce the transaction costs and protect the viability of a national market.
debate has centered largely on the validity of one of the primary justifications that supporters of federal environmental regulation offer – that the states, left to their own devices, will embark on a race-to-the-bottom that will result in suboptimal protection of the environment. The superlien debate differs from the paradigm of race-tothe-bottom supporters in that, in the context of the superlien, the states that enact such statutes provide greater environmental protection than other states.
Before I analyze the merits of the argument for uniformity in the context of superlien statues, I note that the taxonomy that Table 7 demonstrates is somewhat problematic for race-to-the-bottom adherents. In particular, the superlien statute debates provide an example where some states have not engaged in such a race, but instead have tried to provide greater environmental protection than their neighbors. Moreover, the pressure for uniformity is not for a uniform floor for environmental protection, but rather for an effective uniform ceiling to cap the states’ effort in this regard. At the same time, race– to-the-bottom adherents could point also to the debate over state superliens and could argue that the success of lenders and securitization conduits in halting the proliferation of superlien statutes is indicative of the same forces that generally drive the race-to–the-bottom.
Turning to the merits of the argument for a uniform law that restricts state superlien statutes, Richard Revesz posits three reasons in favor of a general presumption of decentralization of environmental regulation.234 First, the question of whether a community wishes to invest in increased environmental protection is one of resource allocation. As Revesz explains, “we can generally purchase additional environmental protection at some price, paid in the currency of jobs, wages, shareholders’ profits, tax revenues, and economic growth.”235 Given the large size and diversity of the United States,236 different regions reasonably would have different aggregate preferences as to how much environmental protection to purchase.237 Different regions also may rank other interests higher and therefore think that it is appropriate to devote more resources to those causes. Indeed, this logic is borne out by empirical evidence and supported by political theory.238
Third, the costs of meeting a given environmental standard also vary throughout the country.241 Revesz elucidates as follows:
For example, a source may have a large detrimental impact on ambient air quality if it is directly upwind from a mountain or other topographical barrier. Similarly, a water polluter will have a far larger impact on water quality standards if it disposes its effluents in relatively small bodies of water. Climate might also play a role: certain emission or effluent standards may be easier (and cheaper) to meet in warmer weather.242
Of these factors, the last – the cost of compliance – seems less likely to vary in the case of cleanups of hazardous waste sites than with other forms of pollution. However, the particular topography and chemical makeup of a contaminated site surely can affect the cost of cleanup and accordingly can affect the likelihood that a superlien statute might apply.
The second factor – the benefits of more frequent environmental cleanups – indeed can vary across regions. For example, greater numbers of environmentally-contaminated sites are more likely to concern a more densely populated state. By contrast a sparsely populated state may be more content to allow contaminated sites in uninhabited areas to remain untreated.243
Revesz argues in favor of a presumption that rests environmental regulation with more local governments. Understandable regional variations in the importance of environmental quality, the expense of achieving it,246 and in home ownership underscore the applicability of that presumption in the context, of state superlien regulation. Moreover, two standard justifications for uniform federal environmental regulation – the dangers of a race-to-thebottom situation and of interstate environmental externalities – are absent here.
The question arises whether securitization’s preference for uniformity might justify overcoming this presumption. I describe above how securitization magnifies the costs associated with superlien statutes.247 It appears that states have determined, in the face of pressure from Fannie Mae and Freddie Mac, that these heightened costs outweigh the benefits of superlien statutes in the context of residential mortgage lending.
Pressure to restrict and to eliminate superlien statutes in the context of commercial mortgage lending is likely to increase, perhaps beyond the level of pressure to eliminate them in the residential context, as commercial mortgage securitizations continue to expand.248 However, it is also true that commercial properties are much more likely to become environmentally contaminated and therefore to require environmental cleanup.249 Therefore, application of superlien statutes to the commercial, as opposed to the residential, mortgage lending context is more likely to serve the primary goal underlying superlien statutes – greater environmental quality at less cost to the government. Accordingly, I cannot conclude that the presumption in favor of vesting environmental regulatory authority more in state and local governments necessarily can be overcome in the context of commercial mortgage lending.
fies the costs of these statutes because it places a high premium on uniformity of state law. Superlien statutes introduce a nonuniformity in state law which, in the context of residential mortgage lending, tends to undermine the predictability of lien priority upon which the residential mortgage lending and, by extension, securitization industries rely.
As opposed to superlien statutes applicable to residential properties which are few in number and greatly circumscribed as an apparent result of opposition by lenders and securitization promoters – superlien statutes applicable to commercial properties are more numerous and better established. This difference is due to the relatively slow development of secondary markets in commercial mortgage loans. Now that the commercial mortgage secondary market is expanding at a fast pace, it is reasonable to expect the opposition of lenders and securitization promoters to superlien statutes to increase. That opposition one day might exceed opposition to superlien statutes in the residential context insofar as commercial mortgage loans tend to be much larger than their residential counterparts, making it harder for commercial loan securitization promoters to include commercial loans from states with superlien statutes as small pieces of large, diverse mortgage pools.
Superlien statutes are an example of a type of state law that affords residents of a state greater protection (here, specifically, greater environmental protection) but that goes against the demands of a developing national marketplace. In this sense, the battle over superlien statutes is typical of efforts to make real estate laws more uniform – market pressures seek to impose a national ceiling on state regulation. By contrast, this discussion differs from the typical setting in which academics debate which level of government should promulgate environmental regulation. There, a standard justification for federal environmental regulation is that states, left to their own devices, would respond to economic pressures and engage in a race to the bottom in environmental regulation. Advocates for federal intervention argue that the possibility of such a race makes appropriate the federal government’s setting a national floor on state regulation. The debate over superlien statutes poses an important counterexample to these scholars’ arguments, insofar as states in fact have tried to resist market forces and to set higher environmental standards. I argued here that the economic pressure of the securitization industry is not sufficient justification to preempt states from enacting superlien statutes applicable to commercial properties. State decision-makers rationally might conclude that the benefits of a superlien statute outweigh its costs in their state.
Jonathan Remy Nash*
* Associate Professor of Law, Tulane Law School. LL.M., Harvard Law School; J.D., New York University School of Law, BA., Columbia University. I am grateful to the following individuals for helpful discussions and comments on earlier drafts: Douglas Baird, Vicki Been, Eric Claeys, Lee Fennell, Jack Goldsmith, Ryan Goodman, Eric Iversen, Raymond Jasen, Saul Levmore, James Madigan, and Adam Tempkin. I owe great thanks to Michael Schill for his help and support Special gratitude is due to Richard Revesz for his extensive and insightful comments and overall support. All errors are my own.
This Article was presented at the 2002 annual meeting of the American Law and Economics Association.
Copyright Washington & Lee University, School of Law Winter 2002
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