Fannie/Freddie Suit Brings More Gloom to Mortgage Industry

Last week’s announcement by the Federal Home Finance Agency (“FHFA“) that they would sue 17 major banks on behalf of FNMA and FHLMC throws more cold water on the stalled recovery of the US residential mortgage market.  Not that the filing was a complete surprise, given the trail of developments over the last few years regarding shoddy underwriting standards by some of the most aggressive mortgage originators but there is a legitimate school of thought that suggests that such action probably doesn’t solve anything and the only pockets that will wind up being lined here will be those of the lawyers working on behalf of both sides in this dispute.

The evidence seems mighty clear at this point that the 17 organizations named in the suit (see list below)  may have been among the many lenders that were much less than “on the ball” in underwriting thousands of mortgages that eventually found their way into the Government programs.  The rub is that the banks are very likely to make the case that “if anyone should have understood what they were getting with these mortgages, it was the GSE’s”, including FNMA and FHLMC

The banks will undoubtedly argue that the GSE’s, perhaps more so than any other “sophisticated investor” in the market, knew exactly what they were buying from these banks.  Keep in mind that this was not some type of shotgun wedding.  These “trades” took place over several years so, even if one wants to argue that the banks snuck some bad mortgages into the Government programs, how can one seriously believe that the mortgage agencies should not have been conducting their own due diligence on the underlying quality of the product? 

If you ask us, we think this argument has some legs and is probably why several in the industry are suggesting that neither side likely has much motivation to settle this case early.  On that basis, probably too bad for the mortgage industry, as this will undoubtedly put another wet blanket on the industry’s recovery.

Another related development this past week was Bank of America’s decision to exit its correspondent mortgage business and the rumors that an exit of their wholesale business is not far behind.  Clearly the notion of having to take responsibility for the actions of a large network of correspondent mortgage originators sounds less and less appealing to BoA, particularly when banks, which have acted as very useful “clearing houses” for the US mortgage market, begin to feel like they have been left “holding the bag”.

Here are the 17 banks named in the FHFA suit:

Ally Financial (ex-GMAC), $6 billion
Bank of America Corp., $6 billion
Barclays Bank, $4.9 billion
Citigroup, $3.5 billion
Countrywide, $26.6 billion
Credit Suisse Holdings USA, $14.1 billion
Deutsche Bank, $14.2 billion
First Horizon National, $883 million
General Electric, $549 million
Goldman Sachs, $11.1 billion
HSBC North America, $6.2 billion
J.P. Morgan Chase, $33 billion
Merrill Lynch/First Franklin Financial, $24.853 billion
Morgan Stanley, $10.58 billion
Nomura Holding America Inc., $2 billion
Royal Bank of Scotland Group, $30.4 billion
Societe Generale, $1.3 billion

About markferraris
Managing Principal Orchard Street Partners LLC

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