The Federal Housing Finance Administration (FHFA) is finally calling foul on the likes of Goldman Sachs, Bank of America (BofA) and others who sold toxic mortgage-backed bonds (MBBs) to mortgage titans Fannie Mae and Freddie Mac.
Rather than marshal what is now considered a garden-variety securities claim to recover mortgage investment losses, the FHFA is tapping its vast resources to invoke lesser-known rules from the canon of securities law. As dictated by the Securities Act of 1933, before any security can be initially sold to the public, the seller must file a registration statement and a prospectus that details the risk characteristics of the investment.
According to the well-worked Securities Act, if either of these documents contains any misrepresentation of the security’s profile, the seller is liable for the purchaser’s losses — the FHFA’s silver bullet.
Most securities claims do not rely on this powerful provision from the Securities Act since it only applies to the initial purchase. The preponderance of MBB fraud claims in recent years concern purchases on the secondary market where the virtual game of hot potato results in a continuous evasion of the risk of any loss.
The FHFA, however, is poised for success with their claim since they purchased MBBs in the initial offerings from BofA and others via Freddie Mac and Fannie Mae.
The actual amount of potential losses recoverable is difficult to determine at this point, but the claim is related to a $200 billion acquisition of MBBs. If the FHFA prevails in its claim, it will be entitled to recover the difference between the price paid for the securities at the time of purchase and the fair market value (FMV) at the time the claim was filed, plus interest.
Considering the current valuation of the FHFA’s MBB holdings, this could mean another round of huge losses for mortgage lenders.
first tuesday take: Sometimes the road to retribution is long. first tuesday has been reporting law suits and settlements brought against lenders for years — decades even — none of which have made a difference in their modus operandi. However, the reregulation of late has definitely begun to do so with much more mortgage borrowing (consumer) protection coming from the Federal Reserve (the Fed) and the newfangled Bureau of Consumer Protection.
first tuesday began its reporting on mortgage lender misbehavior with the landmark case Wellenkamp v. Bank of America (1978), a case which eliminated mortgage lender interference with property sales. Wellenkamp was quickly rendered moot by congressional deregulation of mortgage lenders. [For the most recent report on lender settlements, see the July 2011 first tuesday article, Payday cometh. . .for BofA’s investors.]
While the FHFA stands to recover some losses, and BofA may have to cut another check (probably through a settlement rather than costly litigation), their respective balance sheets will most likely remain unchanged. BofA will continue to be profitable (though insolvent) and Fannie Mae and Freddie Mac will by design continue to decline until privatized or overrun by the private mortgage insurance (PMI) sector. [For more information on the endurance of the Big Banks, see the July 2011 first tuesday article, Too big to fail or too rich to fail?]
Many pundits believe that the time for a great wave of MBB-related lawsuits is nigh, bringing with it the promise of vindication for the listless millions of underwater homeowners who fell prey to the predatory lending practices (mostly of the inherently deceptive adjustable rate mortgage (ARM) variety) perpetrated during the Millennium Boom.
For now, brokers and agents waiting to see the mighty banking giants fall at the hands of the GSEs (our government) would do better to focus their gaze on the economic tsunami of this jobless Lesser Depression that will undoubtedly decimate the ranks of those without a robust forward-oriented business plan.
re: “U.S. Takes Hard Line in Suits Over Bad Mortgages” from the New York Times