New York Times DealBook:  Why a Tax Crackdown Is Not Needed on Mortgage-Backed Securities, by Victor Fleischer (Colorado):

Capitol Hill is poking around for tax revenue. One sleeping dog to
let lie is the tax treatment of real estate mortgage investment
conduits, or Remics.

These are the tax plumbing that allows the modern mortgage market to
function. Most residential mortgages in the United States are
securitized. This means that, as a method of financing the mortgages
they originate, banks bundle together mortgages and sell them to a
trust. The trust then issues securities to investors. The securities are
backed by the mortgages held by the trust. The Remic rules allow the
trust to be treated as a pass-through entity for tax purposes, avoiding
the corporate tax in the same way that a mutual fund, pension fund or
other investment conduit avoids an extra level of tax.

That is the theory. The collapse of the mortgage-backed securities
market a few years ago exposed systematic failures in the transfer of
title from the originator of the mortgages to the trusts. …

Two professors at Brooklyn Law School, Bradley T. Borden and David J.
Reiss, have argued that many purported Remics may not in fact qualify
as such [Wall Street Rules Applied to REMIC Classification]. In many cases, they explain, mortgage originators failed to
legally transfer mortgages into the trust. Instead, they argue, the
failed Remics were probably taxable mortgage pools or perhaps publicly
traded partnerships. This means that Remic investors would be subject to
additional taxes and penalties.

The IRS began a review
of the tax status of Remics last year, but it is unclear whether
additional enforcement action is forthcoming. Mr. Borden and Mr. Reiss
attribute this apparent nonenforcement to the so-called Wall Street
Rule, part of the lore among tax lawyers that holds that after X million
dollars of securities have been issued (and no one knows exactly what X
is) and enough tax lawyers take the same position, the IRS will not
intervene and blow up the deals.

What should the IRS do? Tax liability would probably fall on
investors, who might then turn around and sue the mortgage originators,
servicers, law firms and other intermediaries, further gumming up the
market for mortgage-backed securities.

The Wall Street Rule is objectionable from a tax policy perspective
when aggressive tax lawyers sanction a deal structure that contravenes
the rules, or one that resides in a gray area but is contrary to what
Congress intended.

I do not think that is the case here. The Remic rules are designed to
prevent operating companies from avoiding the corporate tax. Banks and
other financial institutions that originate mortgages should pay the
corporate tax. Passive conduits should not. The lawyers failed here
because they relied too quickly on a client’s representations about the
status of mortgages in the trust, not because they were overly
aggressive in their interpretation of the Internal Revenue Code.

Instead of going after old, failed Remics, additional IRS
resources would be better put to use in policing the rules going forward
for all types of securitization vehicles.