Econintersect: Fannie and Freddie want their money back, or at least some of it. Bank of America, Goldman Sachs, JPMorgan Chase, Deutsche Bank, Citigroup, Barclays and Morgan Stanley are among the defendants in the suits, brought by the Federal Housing Finance Agency, which oversees Fannie and Freddie. Federal regulators filed suit on Friday against more than a dozen leading banks, seeking billions in compensation for huge losses suffered by Fannie Mae and Freddie Mac on mortgage-backed securities the banks assembled during the housing boom. Click on cartoon for larger image.According to The New York Times:
In the suit filed against Bank of America, the agency alleges that bank sold securities that “contained materially false or misleading statements and omissions.” The company and several individual bankers named as defendants “falsely represented that the underlying mortgage loans complied with certain underwriting guidelines and standards, including representations that significantly overstated the ability of the borrowers to repay their mortgage loans,” the suit says. Fannie Mae and Freddie Mac bought $6 billion in securities from the bank between September 2005 and November 2007.
The legal action opens a broad front in a rapidly growing attempt to force the banks to pay tens of billions of dollars for helping stoke the housing bubble. It was the collapse of the housing market that helped prompt the financial crisis in 2008, and the hangover is still being felt in the housing sector as well as the broader economy.
The amount of money involved for the taxpayers for the failure of Fannie and Freddie has so far totaled $153 billion and it has been estimated that it may cost $210 billion more over the next two years, according to The New York Times.
There have been suits filed against seventeen banks listed in the FHFA press release. They are, in alphabetical order:
- Ally Financial Inc. f/k/a GMAC, LLC
- Bank of America Corporation
- Barclays Bank PLC
- Citigroup, Inc.
- Countrywide Financial Corporation
- Credit Suisse Holdings (USA), Inc.
- Deutsche Bank AG
- First Horizon National Corporation
- General Electric Company
- Goldman Sachs & Co.
- HSBC North America Holdings, Inc.
- JPMorgan Chase & Co.
- Merrill Lynch & Co. / First Franklin Financial Corp.
- Morgan Stanley
- Nomura Holding America Inc.
- The Royal Bank of Scotland Group PLC
- Société Générale
Each of the individual complaints can be reviewed in full at the FHFA web site.
How much is involved in the suit? The Financial Times says that around $200 billion in securities are itemized in the seventeen complaints. A review of a few of the complaints by GEI has found than many of these securities contain no mortgages with 100% LTV (loan to value) ratios. It is the high LTV mortgages (LTV around 100% and higher) that have a higher probability of default. That means that there is residual value in these MBS (mortgage backed securities) and perhaps a small percentage may eventually default.
Thus, it is impossible to make a quick estimate of how much the banks might ultimately be found liable for. It is likely that the amount could be as small as 10% or 20% of the face value of the securities, which would put the exposure for all seventeen banks at a total of $20 billion (or less) up to $40 billion or so.
If any of these cases find complainants able to prove civil fraud, compensatory damages might be awarded which could swell the awards much higher.
Finally, if the finding of the court is that egregious fraud occurred, rescission could be ordered and the securities ordered restored to the originator and the buyers (Fannie and Freddie) refunded their payments of around $200 billion. It is even possible that compensatory damages could be awarded in addition to rescission.
The ability of the banks to withstand the worst case judgments outlined is questionable.
Editor’s note: How ironic that a possible follow-on to the TARP (Troubled Asset Relief Program), which used part of a $700 billion federal rescue program, might possibly be that the fraudulent activities of some of those rescued banks would find them insolvent following judicial action and that they would become state owned enterprises in the settlement. Of course, that was a course of action that many proposed for zombie banks in early 2009.