David Dayen: FHFA Will Secure Up to $28 Billion From Banks in Its MBS Lawsuit

By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen

An analysis at Bloomberg Law puts some numbers down that I hadn’t seen all in one place previously. The headline effort is to pin down what other banks being sued by the FHFA over mortgage-backed securities passed to Fannie and Freddie with poor underwriting will have to pay, given the standard set by the JPMorgan Chase settlement for $4 billion. The report, by Nela Richardson, actually botches that job by adding the $1.1 billion that FHFA simultaneously received from JPMorgan through reps and warranties on raw mortgages, and doing the calculations based on a $5.1 billion award. Only the $4 billion has anything to do with the lawsuit, which was about $33 billion in Fannie and Freddie purchases of MBS. In other words, FHFA netted about 12 cents on the dollar from JPMorgan. Redoing Richardson’s work, you can calculate how much that means other banks would be expected to pay FHFA in any settlement if they paid 12 cents on the dollar:

Bank of America: $6.97 billion
Royal Bank of Scotland: $3.68 billion
Deutsche Bank: $1.72 billion
Credit Suisse: $1.71 billion
Goldman Sachs: $1.35 billion
Morgan Stanley: $1.28 billion
HSBC: $750 million
Ally: $727 million
Barclays: $593 million
Nomura: $234 million
SocGen: $152 million
First Horizon National: $104 million

GE Capital, Citi, Wells Fargo and UBS have already settled with FHFA in this case. The UBS deal was made public; it was $885 million, slightly above the JPMorgan benchmark (about 14 cents on the dollar). Wells disclosed in a regulatory filing that they paid $335 million. We can safely assume the Citi and GE settlements are in the ballpark of 12-14 cents on the dollar. The Wall Street Journal calculated the numbers based on a 13-cent expectation a few weeks ago. Overall, these numbers feel pretty accurate, as early leaks of the proposed Bank of America settlement are in line with the 12-cent figure. Adding everything up, you find that FHFA can expect to recoup anywhere between $24.5 billion and $28 billion from the 17 banks. That’s in cash, not some fake headline number with a significantly diminished value.

It’s hard to say whether this is a “good” haul or a bad haul, i.e. a punishment that fit the crime. That’s mainly because of the way in which Fannie and Freddie purchased MBS from these various banks. From MBS Guy:

Most of the earlier settlements and proposed settlements that we tracked were for rep and warranty breaches. In those cases, the alleged breaches are for the entire balance of the loans, plus accrued interest. As a result, a direct, one-for-one comparison can be made between the losses incurred on the pools and the balance of the loans with breaches (or the balance of the original mortgage pools).

In the FHFA cases, Fannie and Freddie were buying bonds, mostly at the A (probably only a small portion), AA and AAA levels. That means they were all slivers of the total deal, with credit enhancement below them that absorbed losses. In some cases the bonds owned by Fan/Fred may have been wiped out due to loan losses, in others they may have only been written down by a portion. It’s possible that some didn’t incur credit losses, or haven’t yet, but suffered significant market value losses. In all likelihood, all of these underlying deals have, or will, incur losses of around 20-25% of the original loan pool balances. How that translates into losses on the bonds will vary by deal and by bond.

In other words, the losses incurred by the bonds held by Fan/Fred don’t give a clear picture of what losses were experienced by the underlying mortgage loans or those passed along to the deal in aggregate.

Not a very satisfying answer. It would have been nice to see the complaint or where the FHFA tried to calculate the amount of total losses, but I don’t believe that was ever disclosed.

So now we have something the various Banking Committees in Congress could ask FHFA for; show us the calculation of total losses, so we can determine whether the conservator recouped fair value in these settlements.

But there are several more things to say here:

1) The second half of the Bloomberg Law analysis looks at the remarkable consistency across banks with respect to the poor quality of the underwriting on the securities passed to Fannie and Freddie. This is from the report:

The alleged fraudulent reporting centered on two important mortgage characteristics: occupancy status and the loan-to-value (LTV) ratio. Owner-occupants are less likely to default on their mortgages than second-home buyers and investors. Also, the lower the LTV ratio, the less likely it is that the borrower will default.

Bloomberg Government’s evaluation of data in the FHFA filings reveals that for the 103 securities that Fannie bought between 2005 and 2008, JPMorgan claimed that an average of 16 percent of the underlying mortgages were for investor or second homes. In reality, 25 percent of the securities were backed by loans that were not related to a primary residence.

JPMorgan also stated that, on average, just 38 percent of the mortgages had loan-to-value ratios exceeding 80 percent, and that there were no mortgages in its pool that had a LTV ratio of 100 percent or more. Regulators estimated that the true LTV average for mortgages sold to Fannie and Freddie was closer to 60 percent, and found that 18 percent of the securities JPMorgan sold to Fannie and Freddie had zero or negative equity […]

JPMorgan was not alone in misrepresenting the quality of its securities. Bloomberg Government calculated the average underwriting characteristics of disputed mortgage securities for the 10 largest banks that are still operating independently since the financial crisis. The analysis reveals that these banks also appear to have consistently inflated the percentage of owner-occupied mortgage loans and lowballed the percentage of mortgages with high LTVs.

See the link for a chart of this. The discrepancies are almost identical: with rare exceptions, every bank claimed between 10-18% of second homes in the loan portfolios, when in reality the number was between 21-18%; similarly, the banks claimed between 28-38% of the loans had LTVs above 80%, when the numbers were between 53-63%. So this is further proof that the breakdown in lending standards and the level of duplicity was not only widespread, but very precisely widespread.

2) Bank of America is in a good deal of trouble. The bank noted in its third quarter 10-Q that they could be on the hook for payouts up to $5.1 billion in excess of what they’ve reserved for litigation expenses. That was before the government won the Countrywide “Hustle” case, and demanded $864 million in compensation. And it was before BofA entered talks to settle non-Countrywide repurchases with Freddie Mac for another $1.4 billion. So add those two to the likely settlement of the FHFA lawsuit, and you have $9.2 billion right there. That’s before any outstanding or even new private litigation. And that’s over $1 billion more than the bank has earned this entire year. Should somebody start the death watch again?

3) While I think we need those calculations from FHFA, I’m willing to say that they have captured a pretty decent haul from the banks who wronged them. In fact, it looks to be the largest penalty banks have had to pay out to any government entities in this entire crisis. And that’s just for MBS, I’m not even counting the tens of billions more in repurchases of sour mortgages.

I’ve recently come across an interesting explanation of why FHFA ended up so aggressive. Sure, the actions fit their model of conserving funds for taxpayers. But it didn’t start out very promising. In a new report released today by the Roosevelt Institute about financial reform, former Congressman Brad Miller explains the seeds of this turnaround:

Reformers, including members of Congress, gave FHFA strong encouragement to take a tough stance, and effectively created pressure on FHFA to countervail pressure from financial industry.

At the end of 2010, FHFA approved a settlement with Bank of America for $1.35 billion for mortgages sold by Bank of America to Freddie Mac. The contract between Bank of America and Freddie Mac gave Freddie Mac the right to require Bank of America to repurchase mortgages that did not satisfy Bank of America’s representations and warranties. On January 17, 2011, four Democratic members of the House Financial Services Committee (including the author) wrote the inspector general of FHFA to question the adequacy of the settlement, and to ask for more details. The Office of the Inspector General questioned employees of FHFA and Freddie Mac involved in the settlement. Two employees independently expressed concerns about the settlement and provided the Office of the Inspector General information that supported their concerns. The Office of the Inspector General expanded the inquiry.

On September 2, 2011, FHFA filed lawsuits against 17 banks and other financial institutions for mortgage-backed securities that Freddie Mac and Fannie Mae purchased that did not satisfy the representations and warranties that the banks made about the securities. Industry spokesmen were scathingly critical, called the lawsuits “meritless” and said that the lawsuits were an attempt to shift blame from the two government sponsored enterprises’ own failings.

On September 27, 2011, the FHFA Office of the Inspector General issued a critical evaluation of Freddie Mac’s settlement with Bank of America, an evaluation conducted as FHFA made final decisions about the lawsuits based on mortgage- backed securities. The Office of the Inspector General determined that Freddie Mac performed an inadequate review of foreclosed mortgages, which could cause Freddie Mac to lose “billions of dollars” in claims that would mitigate taxpayer losses from the conservatorship. Moreover, Freddie Mac’s senior managers feared that a “more aggressive approach to repurchase claims would adversely affect Freddie’s business relationship with Bank of America and other large lenders,” especially “capital markets” business such as issuing Freddie Mac’s mortgage-backed securities and corporate debt.

There is no way to know what influence the FHFA Office of the Inspector General and reformers in Congress had on the relative vigor of FHFA’s pursuit of the lawsuits. FHFA’s leaders knew, however, that a cheap settlement would undoubtedly result in another inquiry from members of Congress to the Office of the Inspector General, the agency would have to explain the settlement, and a settlement that FHFA could not credibly defend would result in even harsher public criticism.

How fitting that BofA and Freddie Mac are settling a second mortgage dispute right now!

This is all very plausible to me. FHFA tried to lowball the Freddie Mac/Countrywide settlement, got caught, and chose a path of less resistance by upping their accountability request. Miller did a ton of work on this front. It shows that Congress can make a difference here – and they could again, by demanding the calculations on the MBS losses.

Ultimately, these are still just payouts – nobody is going to jail. But it’s what FHFA was designed to do, and they fact that they could respond to Congressional inquiry by actually fulfilling their mission puts them head and shoulders above the rest of the regulatory and law enforcement space on these matters. But they’re headed by history’s greatest monster, Bush appointee Ed DeMarco, so they couldn’t possibly be a model agency in terms of seeking punishment from Wall Street. Except they are. And DeMarco’s still waiting for that apology.

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About David Dayen

David is a contributing writer to Salon.com. He has been writing about politics since 2004. He spent three years writing for the FireDogLake News Desk; he’s also written for The New Republic, The American Prospect, The Guardian (UK), The Huffington Post, The Washington Monthly, Alternet, Democracy Journal and Pacific Standard, as well as multiple well-trafficked progressive blogs and websites. His has been a guest on MSNBC, CNN, Aljazeera, Russia Today, NPR, Pacifica Radio and Air America Radio. He has contributed to two anthology books, one about the Wisconsin labor uprising and another on the fight against the Stop Online Piracy Act in Congress. Prior to writing about politics he worked for two decades as a television producer and editor. You can follow him on Twitter at @ddayen.

5 comments

  1. HotFlash

    So, even at 14 cents on the dollar, that is less than capital gains tax. Not too shabby, kudos to the tax planning dept. Does a penny go to the people who lost their homes, jobs, pensions, etc. in these bank ‘shenanigans’? I thought not.

    This isn’t law enforcement, this is just a protection racket, and one that operates in the open. Plus taxpayers are paying the salaries of the thugs. Who we gonna call?

  2. leapfrog

    The list of institutions that received the most money from the Federal Reserve can be found on page 131 of the GAO Audit and are as follows..

    Citigroup: $2.5 trillion ($2,500,000,000,000)
    Morgan Stanley: $2.04 trillion ($2,040,000,000,000)
    Merrill Lynch: $1.949 trillion ($1,949,000,000,000)
    Bank of America: $1.344 trillion ($1,344,000,000,000)
    Barclays PLC (United Kingdom): $868 billion ($868,000,000,000)
    Bear Sterns: $853 billion ($853,000,000,000)
    Goldman Sachs: $814 billion ($814,000,000,000)
    Royal Bank of Scotland (UK): $541 billion ($541,000,000,000)
    JP Morgan Chase: $391 billion ($391,000,000,000)
    Deutsche Bank (Germany): $354 billion ($354,000,000,000)
    UBS (Switzerland): $287 billion ($287,000,000,000)
    Credit Suisse (Switzerland): $262 billion ($262,000,000,000)
    Lehman Brothers: $183 billion ($183,000,000,000)
    Bank of Scotland (United Kingdom): $181 billion ($181,000,000,000)
    BNP Paribas (France): $175 billion ($175,000,000,000)
    and many many more including banks in Belgium of all places

    View the 266-page GAO audit of the Federal Reserve(July 21st, 2011): http://www.scribd.com/doc/60553686/GAO-Fed-Investigation

    Don’t know what I’m trying to say here, but when I saw the list of slap-on-the-wrist fines, I thought of the GAO audit recipients and the “coincidence” – lol.

  3. alex morfesis

    oh yeah…demarco is doing his best guy caballero/count floyd

    scary scary booooo

    run jimmy deamon

    run Lord Blanketfail

    run Johny stuffyourpockets

    run Unsure Jayne

    run before the big bad boogie monster
    forces you to pay
    15 cents on the dollar

    with the money handed to you by congress

    so beware…

    one would never want to be caught in a dark
    alley with ninja master demarco…

    scary scary boo boo

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