Chris Whalen has been telling us where this is headed. Banks are not equipped to be property managers. Some sort of government bailout, or other such ownership vehicle that creates a REIT to handle the millions of foreclosures, is coming.
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With new threats emerging to the housing and mortgage markets, investors have recently gotten jittery about bank stocks. I recently spoke to famed bank analyst Richard Bove to get his take on the mortgage mess.
What's foremost on Bove's mind these days? In a word, putbacks. "The putbacks are the critical issue," he said.
What exactly is a putback? A putback, in its simplest form, is a forced repurchase of a security — typically due to a claim of misrepresentation or fraud. In the domain of the mortgage market, what would an example of a putback look like? Let's take as an example a Government Sponsored Entity (GSE) like Fannie Mae or Freddie Mac.
These GSE's, of course, hold enormous quantities of mortgages on their books. If the GSE discovers that one of the mortgages they own has faulty underlying loan documentation they can demand that the originator repurchase the mortgage.
According to sources within the mortgage industry, there has been an uptick in this type of repurchase over the last several months. (Harry Terris, of American Banker, has written an excellent primer for Investment Dealer's Digest.)
Not surprisingly, analysts speculate that large scale implementation of putback demands between the GSE's and other institutions and the mortgage originators/aggregators could result in a litigation bonanza.
Bove thinks the litigation process is going to be both time consuming and costly. "The lawsuits are going to last 3-5 years," he says.
Bove maps out a three tiered litigation nightmare: The first wave of lawsuits will be to discover the mortgage documents which banks are not currently willing to disclose. The second wave of suits involves mortgages where the documents were fraudulently underwritten, or were fraudulently assigned to the pools. The third wave of litigation would be to decide which mortgages are going to be put back and to whom.
(My colleague John Carney has recently published a counterpoint article, arguing that the putback crisis will not be the apocalypse that has been projected.)
What's the magnitude of the litigation? Assigning a dollar value to the potential liabilities on this sort of case is notoriously difficult business — but Bove believes the potential liabilities may run over $150 billion mark.
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And there's more.
LL: In addition to the foreclosure issue, you have the put-backs. But its a well known fact mortgage loans are notorisly known to have errors in them.
We're seeing Fannie and Freddie put-back some of these loans because of that. Is there a tsunami of put-backs forming?
AS: We could have a tsunami. The loan put-back issue is a mirror to what we are seeing with the foreclosure issue right now. Loans are sold based on reps and warranties. Sometimes there are technical difficulties in these reps and warranties. Sometimes there are substantive deficiencies.
Now these technical deficiencies are being used simply to redistribute the losses on these loans. And there is going to be significant litigation on this for a long period of time. For Fannie and Freddie specifically, these are disputes with their business partners. But this is not the market working it.
Fannie and Freddie are under enormous pressure from their government minders to do these put-backs. So in some sense, its the government seeking to recover from their support of Fannie and Freddie. This put-back issue really needs to be looked at in that specific light.
There is a lot of blame to go around on these loans. Fannie and Freddie and other secondary mortgage players knew what they were buying and the risks associated with it. Everyone in the chain was counting on two things: that interest rates would not go up, and that property values would not go down. Everyone gambled but lost.
LL: You have gone through hundreds of these foreclosure and put-back documents. What trends are you anticipating next?
AS: It is really difficult to predict which way this is going to go. The one thing I would say with some certainly is as this litigation progresses and when everybody starts to get access to the emails and documents on these loans, it will be clear that those who are suing understood what they were getting.
These were sophisticated financial players and everybody knew what a "no documentation loan" meant in terms of risks. We'll see numerous governmental investigations. Some criminal in nature.
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Further reading: