Will banks have to buy back bad mortgages they issued?Last week several large investors and the New York Federal Reserve sent a threatening letter to Countrywide, the mortgage giant that is now part of Bank of America. The investors were objecting to the way Countrywide was handling $47 billion in mortgage-backed securities that they owned. (The New York Fed is involved because it owns Bear Stearns and AIG securities as part of the rescue of those firms.) Arguing, among other things, that these mortgages didn't meet Countrywide's purported underwriting standards, the investors want Countrywide to buy them back.
Kathy Patrick, the Gibbs & Bruns lawyer who represents the investors in this case, said in an earlier letter that "our clients will pursue all contractual remedies available to them in these and "¦ many other Countrywide [mortgage-backed-security] deals." The Federal Home Loan Bank system has filed lawsuits seeking to get banks to buy back a combined $25.6 million in mortgage-backed securities, according to Compass Point Research and Trading in Washington, D.C. The foreclosure mess is getting most of the headlines right now, but the related prospect that banks might be forced to repurchase bad mortgages is another reason bank stocks have been sliding during the last few weeks. Chris Gamaitoni of Compass Point estimates that the 11 biggest banks, including JP Morgan, Bank of America, and Goldman Sachs, could end up losing almost $200 billion thanks to mortgage repurchases.
That is a stunning and (given banks' well-publicized misbehavior in creating the housing mess) supremely satisfying number. Forcing mortgage bankers to buy back those bad loans seems like perfect retribution. But investors probably can't make it happen.
The key idea is that the "representations and warranties""”the legal promises that both the originators of the loans and the underwriters of the securities made to buyers about the quality of the loans"”were false. A former Citigroup loan underwriter named Richard Bowen told the Financial Crisis Inquiry Commission last spring that more than 60 percent of the mortgages he looked at that Citi sold violated the reps and warranties. The government-owned mortgage giants, Fannie Mae and Freddie Mac, have with some success been pushing banks to buy back mortgages. In addition, bond insurers like MBIA and Ambac, which insured pools of mortgages against default, have been embroiled in lawsuits with both those who made the mortgages (most notably Countrywide) and the investment banks who packaged up the securities.
But investors in "private-label" securities"”meaning those that didn't pass through Fannie and Freddie"”were mostly quiet until now. One reason is that the recent foreclosure scandal spotlighted just how sloppy the banks' bookkeeping really was. In last week's letter, Gibbs & Bruns' Patrick noted that although there were tens of thousands of mortgages underlying the bonds, Countrywide had never told the investors about the discovery of even one"”not one!"”mortgage that violated the reps and warranties. How could that be possible?
The other thing that changed is that Talcott Franklin, a former equity partner at D.C.'s Patton Boggs, created what he calls an "Investor Clearing House" that banded investor groups together to facilitate lawsuits. Joint action is necessary because the investors need to own 25 percent, and sometimes more, of the bonds in order to force servicers such as Countrywide to take any action. This summer, Franklin announced that he had signed up investors holding 25 percent or more of $500 billion in mortgage-backed securities. "The phone doesn't stop ringing," says Franklin.
Read Full Article »