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Foreclosure-Gate: MERS, REMICs and Sloppy Securitizations

Achieving REMIC (Real Estate Mortgage Investment Conduit) treatment was an important objective in these securitizations. They were created in the 1986 Tax Reform Act. REMICs are pass through entities, meaning the entity (in this case a REMIC trust) is not subject to Federal income taxes; investors are taxed only on the income they receive. The discussion of re-REMICing is a bit scary. Tom Adams weighted in: She is just describing a very arcane aspect of the trust construction: because of various restrictions on “regular” and “residual” interests under REMIC, most MBS actually had two or three layers of REMIC regular and residual interests in them, which was needed to get deal features like interest only certificates, or certain over-collateralization structures. No one, other than tax attorneys, were able to decipher this details, but if you look at the definitions sections of a PSA, you see all of the crazy definitions around the regular and residual interests. All of the mortgage loan assets and any other eligible collateral would go into the REMIC I trust, which would then issue certain interests, which would go into the REMIC II trust, and so on, until the tax attorneys were satisfied the appropriate structure had been created, then the certificates are issued to real certificate The requirements generally were that the REMIC had to hold only certain assets consisting of “qualified mortgages” and “permitted investments” (covering certain cash flow investments, qualified reserves, and foreclosure properties); it had to issue only permitted REMIC interests consisting of “regular interests” that were treated as debt for tax purposes under the tax code and one class of “residual interest” that was treated as the owner of the REMIC under the tax code (special tax rules applied to require the holders of the residual interest to report certain amounts of income with respect to the REMIC on their tax returns ); and it had to satisfy an “arrangements” test to ensure that the residual interest was not held by inappropriate organizations and that appropriate information was provided. Qualified mortgages had to satisfy a loan to value ratio and had to be contributed to the REMIC either at startup or within 90 days under a fixed-price contract OR be substituted for defective loans within 2 years of startup. If a loan were discovered to be defective after that, it would need to be sold out of the REMIC within 90 days, or the REMIC would hold a “bad” asset that could cause the REMIC to lose its qualification as a REMIC. (There is a de minimis rule that lets a REMIC hold an insignificant amount of bad assets, but that generally would not cover a REMIC with lots of mortgages that fail to qualify.) If a REMIC is disqualified, it is almost certainly a “taxable mortgage pool” under section 7701(i) of the Code that is subject to corporate taxation without the ability to be consolidated with other members of the same affiliated group.

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