As if an insolvent Europe was not enough (and everything seemed so good one short month ago), foreclosure expert firm RealtyTrac opines on the issue of fraudclosure and just how big the impact will be on the GSEs, and thus, on the upstream lenders who sold Fannie and Freddie MBS that had material misrepresentations. Add this to the over 240,000 REO properties held by the GSEs, and one can see why Jim Saccacio, CEO of RealtyTrac says: "Not only do the GSEs have an REO problem, they also have a guarantee problem because they promised to make good on the securities they sold to mortgage investors. The potential liability of the GSEs is a matter of debate but there's little doubt that the final total will be enormous.” Oops.
And just how enormous? We have previously summarized various third party estimates, but here it is courtesy of RealtyTrac, all compiled in a tidy little package:
Some of the loss estimates are astronomical.
- The Federal Housing Finance Agency
(FHFA) says Fannie Mae and Freddie Mac have borrowed $148 billion to
date from the Treasury but that additional draws could range “from $221
billion to $363 billion through 2013.”
- Credit Suisse says
Fannie Mae and Freddie Mac could face $321 billion in losses if home
values decline by 10 percent in a year, are flat the next year and rise 3
percent annually thereafter. Of course, if things don't go so well then
the losses could amount to $448 billion.
- Standard & Poor's
says “the ultimate taxpayer cost to resolve Fannie Mae and Freddie Mac
could reach $280 billion, including the $148 billion already invested —
money largely spent to make good on loans gone bad.” Things could get
worse, however. S&P says that $280 billion “could swell to $685
billion, by our estimate, with the establishment of a new entity to
replace Fannie and Freddie that the government would initially
To put these numbers in context consider that in the second quarter of 2010
all of the nation's banks jointly earned $21.6 billion in “profits” —
earnings which were achieved in part because loss reserves were reduced
by $27.1 billion when compared with a year earlier.
As we have been skeptically saying since the loss reserve gimmick started being prevalent in Q2, look for the loss reserve estimates to reverse course. And since these impact EPS not by absolute value but by the change in value, should loss reserves merely retrace the "improvement" from a year ago, look for Wall Street to suddenly go from profitable to losing $6 billion all over again (not that this would impair the payout of record banker bonuses obviously).
As for the question of who ultimately ends up footing the bill, please refer to your nearest mirror: should the GSEs be forced in their pursuit of fiduciary duty to put back hundreds of billions of mortgages to the BofA's of the world (because the GSEs are after all nationalized entities, and any exposed fraud must be investigated, Tim Geithner's protests notwithstanding), the banks will have no choice but to resort to TARP 2 and more rounds of capital raising. After all, the new stress test plan has already been launched - it is the Treasury's hope that BAC and WFC will be able to capitalize on a successful "passage" and raise some equity capital before the entire MBS buyback fiasco goes nuclear some time in H1 2011.
If Fannie Mae and Freddie Mac are facing vast losses on the mortgages they bought then do they have any claims against the lenders who sold such loans? Can they force private-sector lenders to buy back failed mortgages?
Fannie Mae and Freddie Mac were taken over by the federal government in the summer of 2008. They are now operated by the Federal Housing Finance Agency (FHFA), a governmental entity that in July issued 64 subpoenas “to determine whether misrepresentations, breaches of warranties or other acts or omissions” were made by lenders who sold loans to Fannie Mae and Freddie Mac.
And just what documents does the government want? It's “seeking the contents of loan files, which include documents used in the underwriting process, such as loan applications and property appraisals.”
The potential for lender buybacks has not gone unnoticed and it involves not just Fannie Mae and Freddie Mac. The biggest case so far concerns the Maine State Retirement System and other mortgage investors who sued the Bank of America — the successor to Countrywide Financial — claiming that loans worth $352 billion should be bought back at face value. The suit has just been dismissed — but “without prejudice,” meaning it can be re-filed. As a result of the dismissal, says Bank of America, its liability has been reduced to not more than $31 billion — a sum greater than the profits of the entire banking system in the second quarter.
Meanwhile, other claims loom. As examples, the Federal Reserve Bank of New York and several large investors want Bank of America to buy back mortgage-related securities worth $47 billion. On the West coast, the Federal Home Loan Bank of Seattle has sued 11 lenders, seeking buybacks worth $4 billion.
In one suit, the bank alleges that a mortgage seller “made numerous statements to the plaintiff about the certificate and the credit quality of the mortgage loans that backed it. Many of those statements were untrue. Moreover, the defendants omitted to state many material facts that were necessary in order to make their statements not misleading.”
How much, if anything, mortgage investors can get back from loan originators and packagers is unknown. A report from Goldman Sachs says the nation's four largest banks will likely need $26 billion to cover “putback” claims during the next few years — that's $15.5 billion for the Bank of America, $5.3 billion for JPMorgan Chase, $2.2 billion for CitiGroup and $3 billion for Wells Fargo. The number for JPMorgan Chase could grow by an additional $3.5 billion if more loans from its Washington Mutual subsidiary do not work out. Whatever the case, the numbers suggested by Goldman Sachs can be easily absorbed by the larger banks.
But what if mortgage investor claims are more successful? What if settlements and remedies against dozens of lenders and Wall Street firms amount to hundreds of billions of dollars? Or more? Massive losses will need to be written off immediately so it will no longer make sense for lenders to have a foreclosure inventory or to wait for higher prices. Instead — under inevitably new management — the fresh strategy will be to clean up the books, dump REOs, speed short sales, blame old management, regain public confidence and move on.