A federal housing regulator’s lawsuits against large financial institutions seeking billions of damages in mortgage investments that led to losses for Fannie Mae and Freddie Mac has sparked a debate over whether regulators are now too zealously attacking banks.
The 17 lawsuits, which are seeking unspecified damages on $196 billion in mortgage-backed securities that Fannie and Freddie bought during the housing bubble, illustrate the tension facing regulators over their response to the financial crisis.
On the one hand, regulators have tried to restore lending in order to get the economy moving. But they are also charged with protecting taxpayers and recouping recoverable losses that have stemmed from the massive bailouts of 2008. The central tension, it seems, is this: Should potential misdeeds by banks and other firms be excused because the banking sector is too important to the broader economy, or because Fannie and Freddie knew what they were doing?
A number of analysts made that point on Tuesday. Fannie, Freddie and their regulator “are acting in their own self interest as opposed to that of the broader U.S. economy,” wrote FBR Capital Markets analyst Paul Miller in a note to clients Tuesday. A hefty settlement for any damages will pull away capital from the banking system and cause banks “to overly tighten credit standards, which pushes potential homebuyers onto the sidelines,” Miller said.
The FHFA fired back in a statement on Tuesday: "The nation’s financial system cannot function if sellers of securities fail to fulfill a legal responsibility to accurately represent the characteristics of certain investments."
It continued:
Some have claimed that these suits will disrupt economic recovery, or endanger the targeted banks, or increase their cost of capital. While everyone is concerned with these important issues, the long-term stability and resilience of the nation’s financial system depends on investors being able to trust that the securities sold in this country adhere to applicable laws.
Though banks have argued that Fannie and Freddie were large and sophisticated buyers of mortgage securities, the FHFA noted that “the actual mortgages backing many of the securities had characteristics that differed in a material way from what had been represented in securities filings.”
In a conference call with reporters on Tuesday, Rep. Brad Miller (D., N.C.) argued that 'not pursuing lawsuits against the financial industry for issuing shady mortgage securities would be tantamount to another bailout.'
- “I do not want them to look the other way and let taxpayers, once again, subsidize that industry,” he said. “Not pursuing a legitimate claim would be a subsidy.”
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From the FHFA release, comes more color on the size of the final settlement:
- At this time, it would be premature and potentially misleading to estimate the size of any potential recoveries. However, press reports that FHFA is seeking nearly $200 billion in damages or recoveries are excessive; such numbers reflect the original amount of such securities purchased, not the losses incurred or the potential recoveries at the end of this process. In particular, use of original unpaid principal balance as a measure of potential recoveries is incorrect as it does not equate with the losses incurred and it does not reflect the repayments of principal that have already occurred or the remaining value of the securities.