Financial stocks just caught fire. Someone must be getting bailed out, right?
Why yes, say critics of the giant banks. They charge that Monday’s rally-stoking mortgage-putback deal between Bank of America (BAC) and Fannie Mae and Freddie Mac is nothing more than a backdoor bailout of the nation’s largest lender. It comes courtesy, they say, of an administration struggling to find a fix for the housing market while quaking at the prospect of another housing-fueled banking meltdown.
Monday’s arrangement, according to this view, will keep the banks standing — but leave taxpayers on the hook for an even bigger tab should a weak economic recovery falter. Sound familiar?
“The administration is trying to weave a path between two bad alternatives,” said Edward Pinto, a resident scholar at the American Enterprise Institute. “They want to bail out the big banks without doing apparent damage” to the sagging U.S. budget position.
Pinto says truly holding BofA responsible for all the mortgage mayhem tied to its 2008 purchase of subprime lender Countrywide would likely drive it into the arms of the Federal Deposit Insurance Corp., which has enough problems to deal with. Though BofA would surely dispute that analysis, it’s easy enough to see where the feds don’t want that outcome.
But BofA’s many problems aren’t the only reason for taking Monday’s deal with a grain or two of salt. Critics also question the timing of the settlement, which comes on the heels of a court setback for the banks and a new legal challenge from a big investor. They wonder, given the huge sums being spent to prop up Fannie and Freddie, why the companies didn’t get better terms.
And you don’t need to be a conspiracy theorist to see that austerity talk in Congress means no more upfront support for financial firms. At a time of double-dipping house prices and nearly 10% unemployment, you can see where some people might find themselves devising new ways to prop up BofA and its housing-exposed rivals JPMorgan Chase (JPM), Wells Fargo (WFC) and Citi (C).
“This looks to me like a gift from Tim Geithner,” said Chris Whalen of Institutional Risk Analytics. “There’s politics all over this.”
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Fannie, Freddie and BofA sadly shake their heads at that one. BofA finance chief Chuck Noski spent a Monday conference call describing negotiations over the putbacks as “vigorous.” Fannie and Freddie say resolving the mortgage putback issues has been a priority for months, and present BofA’s $2.8 billion payment as one that is fair to taxpayers.
Freddie chief Charles Haldeman even says his company, recipient of $64 billion in federal aid over the past two-plus years, “has focused sharply on being a responsible steward of taxpayer funds.”
But how sharp is Freddie if all it can do is squeeze a $1.28 billion payment out of a giant customer in exchange for relinquishing fraud claims on $117 billion worth of outstanding loans? The very best its million-dollar executives can do is claw back a penny on each bubbly subprime dollar?
That seems pretty weak even given that this is Congress’ favorite subsidy dispenser we’re talking about.
“How Freddie can justify this decision to settle ‘all outstanding and potential’ claims before any of the private-label putback lawsuits have been resolved is beyond comprehension,” says Rebel Cole, a real estate and finance professor at DePaul University in Chicago. “This smells to high heaven and they should be called out.”
Freddie declined to comment beyond its public statements and filings, and its regulator, the Federal Housing Finance Agency, didn’t comment beyond its celebratory statement.
As for the scope of BofA’s problems, the bank stressed in its comments Monday that the settlement with Fannie and Freddie should be viewed separately from the two other mortgage-putback categories: suits filed by the monoline insurance companies that backed many of the questionable loans, and disputes with investors in so-called private label securities, those packaged by Wall Street and sold to investors such as insurers and pension funds.
The $6 billion or so BofA has now paid to settle claims with Fannie and Freddie dwarfs its reserves in the other two channels. But that could change, thanks to recent developments in monoline and private label litigation.
In mid-December, a judge ruled that the insurer MBIA (MBI) can use statistical samples drawn from 6,000 case files to show BofA breached contractual representations and warranties on loans, rather than plowing through each of the 386,000 case files involved in the suit.
The finding, wrote an analyst at Gerson Lehrman Group, “dealt a blow to banks trying to defend themselves against mortgage putback liability,” by shortening the path to a trial and reducing plaintiffs’ court costs.
Then, building on that ruling, insurer Allstate (ALL) last week sued BofA, alleging that offering paperwork filed during the bubble years by Countrywide misrepresented the condition of loans that backed the bonds Allstate bought.
The insurer claimed offering documents indicated, for instance, that none of the underlying mortgages were secured by houses that were worth less than the loan. But Allstate’s analysis found in various cases that between 3% and 15% of underlying houses were worth less than their outstanding mortgages.
“That suit is just a slam dunk against BofA,” said Cole. “Some of the stuff Countrywide was doing, you gotta be kidding me.”
Of course, BofA may yet well win both those cases, or tie them up in court for years, or settle at advantageous terms. Such is the majesty of the taxpayer-backed megabank plying the byways of our legal system.
But even as most of Wall Street calls BofA a buy, some contend the market is vastly underestimating the intensity of the mortgage putback pain ahead. Analysts at Iridian Asset Management, for instance, estimated in October that BofA could face between $50 billion and $100 billion of putback-related losses over coming years.
Even without a huge putback tab, the banks could be in for tough times. Falling house prices could lead to rising defaults as more homeowners find themselves owing more than their house is worth. Rising defaults would hit bank capital at a time when many bank business lines, ranging from trading to credit cards, are looking distinctly less profitable.
And of course, no one is going to sign up for another round of the Troubled Asset Relief Program, no matter how strenuously the government claims it is turning a profit. Thus the appeal of a policy that would eliminate any need to go before Congress.
“They’re sending a signal to the banks that now is the time to do a deal and put this stuff behind you,” said Pinto.
