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Banks Face Two-Front War on Bad Mortgages, Initial Jobless Claims in U.S. Fell 23,000 Last
Week to 452,000 Updated 10 minutes ago

Foreclosures Crude Falls in New York Following Biggest Rally


By John Gittelsohn and Jody Shenn - Oct 20, 2010 11:01 PM CT in More Than Two Months
Updated 15 minutes ago
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Treasury 30-Year Yield Matches Week Low as
More Easing by Fed Questioned
Shoddy mortgage lending has led bankers into a two-front war, Updated 22 minutes ago
pitting them against U.S. homeowners challenging the right to
foreclose and mortgage-bond investors demanding refunds that UPS Profit Tops Analysts' Estimates on Global
Economic Pickup Updated 24 minutes ago
could approach $200 billion.
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While federal regulators and state attorneys general have
Wells Fargo Chief Financial Officer Howard Advertisement
focused on flawed foreclosures, a bigger threat may be the cost
Atkins said, “Our experience continues to be
different than some of our peers in that our to buy back faulty loans that banks bundled into securities.
unresolved repurchase demands outstanding
JPMorgan Chase & Co., Bank of America Corp., Wells Fargo &
are actually down.” Photographer: Jonathan
Alcorn/Bloomberg Co. and Citigroup Inc. have set aside just $10 billion in reserves
to cover future buybacks. Bank of America alone said this week
that pending claims jumped 71 percent from a year ago to $12.9
billion of loans.

Investors such as Bill Gross’s Pacific Investment Management


Co. contend that sellers are obligated to repurchase some
Play Video mortgages because of misrepresentations such as
Oct. 20 (Bloomberg) -- U.S. Housing and overstatements of borrowers’ income or inflated appraisals.
Urban Development Secretary Shaun
Their case may be bolstered by probes in 50 states into whether
Donovan talks about the government's probe
into home foreclosure practices. Donovan banks used documents that were also flawed to conduct
says federal regulators haven't found
foreclosures. Neither dispute is likely to be resolved quickly.
evidence of "systemic issues" in legal
documents at the center of the turmoil over
foreclosure processing. He talks with Mark “It’s going to be trench warfare with years of lawyering,”
Crumpton on Bloomberg Television's
Christopher Whalen, managing director of Institutional Risk
"Bottom Line." (Source: Bloomberg)
Analytics, said in a telephone interview from White Plains, New
York. “The banks can’t afford to lose.”

The biggest risks for banks may be loans packaged into


mortgage-backed securities during the housing bubble, of which
$1.3 trillion remain. The aggrieved bondholders include
government-controlled firms Fannie Mae and Freddie Mac,
Play Video
bond insurers and private investors.
Oct. 21 (Bloomberg) -- Bloomberg's Lizzie
O'Leary reports on the increasing number of
home foreclosures in Florida and the Fannie, Freddie
potential impact on midterm elections.
(Source: Bloomberg)
Fannie Mae and Freddie Mac, the largest mortgage-finance
companies, may be owed as much as $42 billion just on loans
they bought directly from lenders, according to Fitch Ratings. On top of that, investors in private
mortgage bonds, including them, may collect as much as $179.2 billion, Christopher Gamaitoni, Market Snapshot
vice president of research at Compass Point Research & Trading LLC in Washington, said in an U.S. Europe Asia

August report. That brings the total to more than $220 billion. DOW 11108.00 +129.35 (1.18%)

Pimco, BlackRock Inc., MetLife Inc. and the Federal Reserve Bank of New York are seeking to S&P 500 1178.17 +12.27 (1.05%)
force Bank of America to repurchase mortgages packaged into $47 billion of bonds by its NASDAQ 2457.39 +20.44 (0.84%)
Countrywide Financial Corp. unit. In a letter to the bank, the group cited alleged failures by
Stocks on the Move
Countrywide to service the loans properly.
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“It enhances the likelihood of claims coming to fruition,” said Gamaitoni, a former senior
Rare Earth Prices Soar Even as China Pledges
financial analyst at Fannie Mae.
Supply

Repurchase Obligations China's Economic Growth Cools as Inflation


Accelerates
Bank of America, which acquired Countrywide, the biggest U.S. mortgage lender, in 2008, faces
potential repurchase obligations of $74 billion, according to an August report by Branch Hill Stocks, U.S. Index Futures Advance on Earnings,
Economy; Euro Strengthens
Capital, a San Francisco hedge fund, which is betting against the Charlotte, North
Updated 32 minutes ago
Carolina-based company’s shares. Potential claims consist of $21.8 billion to Fannie Mae and
Freddie Mac, $45 billion for investors in mortgage bonds and $7.2 billion for insurance Credit Suisse Posts 74% Profit Drop on Lower
Trading
companies, Branch Hill said.
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Bank of America has $4.4 billion in reserves for claims on $12.9 billion of loans, the company
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reported Oct. 19, and has already resolved claims on more than $14 billion of loans.

The company will “defend our shareholders” by disputing any unjustified demands that it
repurchase mortgages, Chief Executive Officer Brian T. Moynihan said in an interview on
Bloomberg Television. Most claims “don’t have the defects that people allege.”
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million in the previous period. Wells Fargo reduced its repurchase reserves to $1.3 billion, from www.BankofAmerica.com

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“These issues have been somewhat overstated and to a certain extent, misrepresented in the Homes For Sale La Crosse
marketplace,” Wells Fargo Chief Financial Officer Howard Atkins said yesterday on the bank’s Owner Financing For YOU! Call Now (608)
782 - 4848
third-quarter earnings call. “Our experience continues to be different than some of our peers in www.lacrosseownerwillfinance.com

that our unresolved repurchase demands outstanding are actually down.”

So far, most lenders have resisted large-scale settlements, agreeing only to paybacks after defects
are discovered in individual loans. Investors have in some cases been stymied in their efforts to
examine individual loan files by mortgage-bond trustees, which administer the securities.

In July, the Federal Housing Finance Agency, the government conservator of Fannie Mae and
Freddie Mac, issued 64 subpoenas demanding loan files to assess the possibility of breaches in
representations and warranties by securities issuers.

Plaintiff Claims

The most common issues with the mortgages bundled into securities were borrowers who didn’t
occupy the homes and inflated appraisals that distorted the loan-to-value ratio, according to
lawsuits filed by the Federal Home Loan Banks in Seattle and San Francisco. A sampling of
6,533 loans in 12 securitizations by Countrywide found 97 percent failed to conform to
underwriting guidelines, according to a lawsuit filed Sept. 29 by Ambac Assurance Corp. in New
York state Supreme Court.
Richard M. Bowen, former chief underwriter for Citigroup’s consumer-lending group, said he
warned his superiors of concerns that some types of loans in securities didn’t conform with
representations and warranties in 2006 and 2007.

“In mid-2006, I discovered that over 60 percent of these mortgages purchased and sold were
defective,” Bowen testified on April 7 before the Financial Crisis Inquiry Commission created by
Congress. “Defective mortgages increased during 2007 to over 80 percent of production.”

Analysts’ Estimates

Some analysts say that the losses will be manageable by the banks. Last week, Mike Mayo, an
analyst at Credit Agricole Securities USA in New York, estimated a cost of $20 billion for
repurchases. Goldman Sachs Group Inc.’s Richard Ramsden said a worst-case scenario would be
$84 billion.

U.S. Representative Brad Miller, a North Carolina Democrat on the House Financial Services
Committee, says he asked Treasury Secretary Timothy Geithner in a recent hearing whether the
government included mortgage-repurchase losses in the so- called stress tests of banks
conducted last year, because he was expects that they will be growing. Geithner couldn’t
immediately answer, and Miller assumes they weren’t.

“It appears the banks have contractually promised the mortgages met specific requirements, and
also it certainly appears not all of them did,” Miller said. “In all likelihood a great many of them
didn’t.”

The other front in the battle is the potential cost to banks of improper documentation used in
foreclosures. Attorneys general in all 50 states are jointly investigating foreclosure procedures,
including the use of so-called robo-signers who didn’t check the material they were signing.
Litigation costs for such cases may reach $4 billion, while a three-month delay in foreclosures
would add an additional $6 billion to industry expenses, FBR Capital Markets estimated in an
Oct. 19 report.

Document Errors

Foreclosure document errors also can be used to push for repurchases.

The total amount of loans that the four biggest banks may need to buy back because of flawed
paperwork could be “on the order of” about $25 billion, said Paul Jablansky, a senior debt
strategist at Stamford, Connecticut-based RBS Securities Inc. With these demands to investigate
breaches of contracts, “it’s relatively objective, the loan files are either complete or not, and the
missing files are either material and adverse, or not.”

To settle disputes with homeowners about attempts to foreclose, banks may offer borrowers
more generous loan modifications, potentially including principal reductions, said Frank
Pallotta, managing partner of Loan Value Group, a mortgage-consulting firm in Rumson, New
Jersey.

‘Going to Cost Them’

“The potential for owners to challenge lenders on foreclosure improprieties certainly is there,”
Pallotta said. “Even if it turns out that the banks were right in 99 percent of these foreclosures,
the additional diligence on their part, going forward, is going to cost them more money.”

The litigation over buybacks, also known as putbacks, can also pit big banks against each other.
Last month, Deutsche Bank AG, acting as a trustee, refiled a lawsuit over misrepresented
mortgages in $34 billion of Washington Mutual Inc. mortgage securities, with $165 billion in
original balances.
The new suit in the U.S. District Court for the District of Columbia included JPMorgan as a
defendant, after the Federal Deposit Insurance Corp. said that JPMorgan was wrongly claiming
its insurance fund had agreed to cover the liabilities, according to the amended complaint.

JPMorgan Balks

JPMorgan, which bought most of WaMu after it failed in 2008, is balking at turning over loan
files to the trustee, according to the suit. “Based on the limited information available to”
Deutsche Bank, including evidence of WaMu’s shoddy practices found in internal documents
released in a Senate investigation, either JPMorgan or the FDIC owes investors $6 billion to $10
billion, according to the complaint.

About 26 percent of mortgages underlying securities without government backing are at least 60
days late, in foreclosure proceedings or already backed by seized homes, according to data
compiled by Bloomberg. Typical prices for the most-senior bonds tied to so-called Alt-A
mortgages, whose borrowers often failed to document their pay or plan to live in properties, fell
to as low as 33 cents on the dollar in March 2009, before rallying to 64 cents last week,
according to Barclays Capital Inc. data.

Like WaMu, many lenders that originated the mortgages have gone out of business, making
litigation more complex, said Kurt Eggert, professor of law at Chapman University in Orange,
California. And top executives at the surviving companies, such as the CEOs of Bank of America
and Citigroup, have been replaced.

“It’s troubling that the people who caused the problem have walked away and left everybody else
to fight over who gets stuck with the tab,” Eggert said in a telephone interview. “It’s like a
massive game of dine and dash.”

To contact the reporters on this story: John Gittelsohn in New York at johngitt@bloomberg.net;
Jody Shenn in New York at 2380 or jshenn@bloomberg.net

To contact the editor responsible for this story: Kara Wetzel at kwetzel@bloomberg.net.

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