Opinion

Felix Salmon

BofA’s legal predicament

By Felix Salmon
October 20, 2010

Nelson Schwartz links the big lawsuit against BofA/Countrywide directly to the mortgage bond scandal I’ve been banging on about:

The legal battle turns on the question of whether the banks properly represented the loans they put together into mortgage-backed securities when they sold them to investors. If the banks ignored evidence that the underlying mortgages did not conform to underwriting standards or they lacked the proper paperwork, the banks could be obligated to buy the troubled mortgages back.

Schwartz also reports that this legal trade is attractive enough that vultures are circling:

Hedge funds like York Capital and Moore Capital have been jumping into the game recently, buying up bad debt in the hopes it will eventually be bought back…

“Any hedge fund with a distressed desk is contemplating this trade,” said one analyst.

There’s a whole bunch of different things going on here, but the key development is that bondholders have managed to get organized, and they’re taking the battle not only to otiose trustees, but also to loan servicers.

The key number here comes right at the top of the letter sent to BofA/Countrywide:

The undersigned are the Holders of not less than 25% of the Voting Rights in Certificates issued by the Trusts listed on the enclosed Exhibit A.

Once that 25% level is reached, bondholders have all manner of rights, which are now being put to good use. For one thing, they’re allowed to file exactly this letter: a notice of nonperformance, telling the servicer in pretty strong language to buck up and start doing its job, or face a massive legal action.

Isaac Gradman says there might be a problem here:

These efforts may well fail for an additional reason that was cited as a basis for Bank of New York’s refusal to comply with Patrick’s earlier request – the failure to provide evidence of a specific breach.

But I’ve also heard that the 25% number is crucial on this front, too. If you own 25% of a securitized issue, I’m told, you can force the custodian to hand over the underlying, individual loan documents — exactly the same documents that Clayton and other due diligence companies examined before the bonds were issued. At that point, it becomes a lot easier to find specific breaches and to make BofA’s life a legal nightmare.

The position of BofA here is hilariously complex and conflicted. BofA owns 34% of BlackRock, which is a lead plaintiff in this case. (BlackRock manages the mortgage bonds which the Federal Reserve inherited as part of the Bear Stearns bailout.) BlackRock, in turn, is suing Countrywide (owned by BofA), the loan servicer which has clearly not been doing its job:

Although there are tens of thousands of loans in the RMBS pools that secure the Certificates, the Trustee has advised the Holders that the Master Servicer has never notified it of the discovery of even one mortgage that violated applicable representations and warranties at the time it was purchased by the Trusts.

In other words, Countrywide has an obligation to tell the bond trustee whenever a loan turns out to be in violation of the bond’s representations and warranties. But Countrywide has never done that. Why? The answer is obvious: the minute that it did so, the trustee would force the servicer to put the loan in question back to the originator. And the originator is — you guessed it. Countrywide.

Essentially, BofA is suing BofA so that BofA can be forced to put bad mortgage loans back to BofA.

Yves Smith reckons that the winner here is likely to be BofA — that the lawsuits (which, remember, haven’t even been filed yet, and won’t be for at least 60 days) will probably be settled for a relatively modest sum. But I’m less sanguine.

For one thing, Smith says that the plaintiffs will only be able to collect on loans which have gone bad and where they can show damages. But the bondholders might want to force BofA to buy back even performing loans, if they got thrown into the pool without conforming to the relevant standards. Calculating BofA’s loss on such things won’t be easy: after all, if those loans continue to perform, then BofA would ultimately make a profit on them. But given the ongoing foreclosuregate mess, there’s a very real chance that even performing loans will end up in strategic default.

The big picture I think is that a lot of the risk embedded in mortgage bonds could shift from bondholders back to the investment banks which underwrote them. In a just world, the bond trustees would be leading this charge, but they’re not, so the cause has been taken up by the bondholders themselves, who are only now beginning to organize and to become familiar with all the legal avenues that the various players can explore.

It’s entirely possible, of course, that obstructionist lawyers for BofA and the trustees will manage to block these suits and keep all those toxic bonds in the hands of bondholders. But mortgage-bond owners are becoming increasingly aggressive and activist, and they’re comparing notes with bond insurers who are also in a very similar situation. The investment banks, BofA foremost among them, might win. But the fight is going to be long and hard and expensive, and is going to make them look very bad indeed. They might well find it more attractive, all things considered, to negotiate a settlement, write a ten-figure check, and move on.

Comments
16 comments so far | RSS Comments RSS

Essentially, BofA is suing BofA so that BofA can be forced to put bad mortgage loans back to BofA.

Woohoo! Financial circle jerk!

Posted by TWAndrews | Report as abusive
 

I may be missing something here, but I don’t see how bad paperwork on a loan is going to be found material, in a legal sense, unless the loan is actually not what it’s supposed to be.

Posted by Jboy609 | Report as abusive
 

there’s one more conflict, Felix – if/when the NY Fed puts all this crap back to BAC, and bankrupts them, they’ll need to bail BAC out again!

Posted by KidDynamite | Report as abusive
 

I’d like to see a trending graph of the increase in salary and need for litigation lawyers as we ramped up into this recession.

I think that is in big part a reason why the USA is going down the toilet. Any and all regulations can be proven circumvented and liable when chased by good litigation lawyers.

Who in their right mind would want to setup a business in the USA – unless you had the inside track or very deep pockets to cover insurance and/or litigation.

Where is all the insurance for these toxic loans that where picked up by bond holders.

Posted by Butch_from_PA | Report as abusive
 

The problem that you identify is also pervasive in many CMBS bonds. For example, the Examiner that was appointed by the Court in the DBSI Bankruptcy found serious irregularities in many of the appraisals that were purchased in association with the securitization of the DBSI loans. Those appraisals almost certainly didn’t comply with USPAP, a condition that was required for inclusion in the mortgage pools that were ultimately sold to investors by Bank of America. Most of those loans ultimately defaulted, yet we are unaware of any instance in which B of A was required to repurchase.

Posted by DBSI_Victim | Report as abusive
 

In the fine spirit of The Daily Show which has been in front of the MSM on this issue, I think that the best past examples of these issues are Monty Python’s Dead Parrot and Cheese Shop sketches.

I am still trying to figure out how all of the folks on all sides of this issue have been able to make the case that they should be the highest paid people in America.

Posted by ErnieD | Report as abusive
 

i am guessing that wall street banks (and others) will fight this long enough that it won’t matter. but the MBS market will died long before then. which will make F&F even more important as they will be the only remaining buyers of loans.

Posted by willid3 | Report as abusive
 

Technically, I don’t think Bank of America NA (the bank) or Bank of America Corp (the ultimate parent company) have ever guaranteed or stood behind Countrywide Inc. (ie the entity they bought from the tan man).

It was Countrywide, not BofA, that was the aggressive packager and reseller of subprime mortgages (BofA wasn’t good at this which is why why they bought countrywide). And it is Countrywide that would have the repurchase obligation on the loans, not Bank of America. And since BofA doesn’t guarantee Countrywide if countrywide can’t pay you can’t claim on BofA.

In short I’m sure BofA’s lawyers are more focussed on makeing sure the claims don’t come back to BofA and they would allow Countrywide to be cut off like the gangrene infection it is.

Posted by scotta | Report as abusive
 

Smith as usual is wrong. You can put back any non-compliant loan. Of course if you are planning to **sue** for damages thats a different question.

That said, why would bondowners want performing loans bought out? Now is exactly the wrong time for that. Those loans are paying interest at a far higher rate than what the bondholders are likely to be able to reinvest at. Thats before you get into the costs of forcing a bank who is not bending over to buy back.

As for winners, as usual they are the lawyers with a sprinkling of media.

Posted by Danny_Black | Report as abusive
 

@Danny_Black:

I think what Yves Smith was pointing out is that the non-compliant loans would need to be identified on a loan-by-loan basis with proof on why it is non-compliant which is an expensive and time-consuming proposition.

It would be interesting to see if they can identify a means to simply be able to prove that large batches of loans were non-compliant, possibly if there was some form of “robo-signing” going on at the origination where it was clear that the originator was not doing the required due diligence for that type of loan.

Posted by ErnieD | Report as abusive
 

ErnieD, ok well that was not how it was reported here. It may be time consuming which is presumably why they didn’t bother in the first place. Of course, someone should be suing Freddie and Fannie for not doing proper due diligence which they were paid for….

My money is still on it being a storm in a teacup. Remember the Clayton data that got Mr Salmon excited showed a grand total of 5% of loans with documentation deficiencies consistently over 2006 and 2007 origination – which was the very height of the bubble.

Posted by Danny_Black | Report as abusive
 

Danny, if the SEC found only 5% of the sampling had documentation problems, then what were the other 24% of anomalies that didn’t meet standards or are they not looking at the same samples?

It also doesn’t say what percentage of sampling the SEC looked at … it says 5% of the sampling. Is that 5% of the 5% sampling that Clayton said they did the majority of the time?? (remembering they only sampled of 5% to 10% of each bundle)

Donovan was clearly making statements to appease the press/market. It seems that the Government actually is trying to call this a paper glitch, promising to make the few homeowners who can afford a good lawyer whole.

And by making servicers pinkie-swear they are doing every thing possible to keep homeowners in their homes and give the opportunity to use Hamp and to play fair from now on … wait, wasn’t that the purpose of HAMP in the first place? Doesn’t misuse of Government funds mean huge fines?

Nah that might have a bad effect upon the market or the banks. Meanwhile there will be high fives and bonuses at the banks for another job well done…

(but there will be civil suits and damages to pay. There just isn’t any incentive to stop it from happening again.

My money is there being so much more to this and soon the lid will be lifted and all it will take is that little teacup tempest to blow the house of cards down.

Posted by hsvkitty | Report as abusive
 

Sorry hswkitty, I don’t speak fluent gibberish so you might need to translate for me:

1) When did the SEC come up with any data on documentation issues with mortgages?
2) Where did you get the 29% figure from? Or do you mean 24%? Or do you mean anything in between?
3) You know what a sample is right? You have a clue about what sampling means? No? Didn’t think so.
4) Which servicers are getting bonuses for not letting people pay their mortgages? Do you actually know what a servicer does and how they get renumerated? No again?? I am shocked.

Do yourself a favour, get a passing understanding about what you are writing about.

Posted by Danny_Black | Report as abusive
 

Couple of interesting Fed papers indirectly via alea:

The Incentives of Mortgage Servicers: Myths and Realities
http://www.federalreserve.gov/pubs/feds/ 2008/200846/revision/200846pap.pdf

Where’s the Smoking Gun? A Study of Underwriting
Standards for US Subprime Mortgages
http://research.stlouisfed.org/wp/2008/2 008-036.pdf

Would be nice to see if these guys have any data on the percentage of documentation issues on securitised mortgages. I also remember reading a study that claimed that securitisation did contribute to a relaxation of standards but by a relatively small amount. Can’t remember the guy who wrote it unfortunately

Posted by Danny_Black | Report as abusive
 

Enough is enough! First the mortgage industry completely fails at performing due diligence 101 in processing mortgage applications. Then we learn they failed to perform proper legal procedure in transferring ownership title to the trusts that supposedly hold the mortgage for benefit of the bondholders. We also learn, that the same parties who were originating the loans, along with those packaging them into pools and selling them, were actually placing side bets that the pooled securities would fail. Then we learn the companies charged with executing the foreclosure process fraudulently create legal documents to support their claims in court.

Meanwhile, our economy is dying and the markets are on life support provided by the fed and the taxpayer, with future generations of Americans on the hook for hundreds of billions if not trillions of dollars of debt to cover the mortgage and investment banking industry’s butt.

Does the government see a pattern of corruption here or are they just stupid, blind or are they an active partner in the crimes committed against the American public?

As far as I am concerned, we can take all of the garbage mortgages purchased by freddie and fannie, return them to the big investment banks and let the bondholders and banks that profited so handsomely through the incompetence, greed and fraud go belly up. After all they accepted the risk when they made these investments.

Posted by garrisongold | Report as abusive
 

BOA’s questionable business ethics go back for at least several years, when they began issuing credit cards to people in this country illegally as a way to tap into new markets. As a NC native, it’s sad to see a once reputable regional business fall into the Wall Street mentality that making money at any cost is okay. It’s largely up to individuals to walk away from such businesses since we can no longer rely on Washington to protect us. Boycotts were common in the 70′s and need to be used again today.

Posted by actnow | Report as abusive
 

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