When it rains, it pours. The fallout from the artificially generated housing bubble and the attendant financial crisis is really starting to take hold against the various major players in the banking industry. It seems everyone with any stake in the mortgage meltdown, from individual home owners to purchasers of mortgage-backed securities, are seeking their pound of flesh from the likes of Bank of America, JP Morgan Chase, CitiBank, Ally Financial, Wells Fargo, UBS, Goldman Sachs, Deutsche Bank, and others.
The New York Times broke the story yesterday that the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, the failed government agencies relegated to taxpayer-backed conservatorship three years ago, is set to file lawsuits against twelve of the major banks. The suits will argue the banks, which assembled the mortgages and marketed them as securities to investors, failed to perform the due diligence required under the nation's securities laws and missed evidence that borrowers' incomes were inflated or falsified.
The FHFA issued sixty-four subpoenas last year to issuers and servicers of mortgage-backed securities - one of the largest investigations to date of alleged securities fraud stemming from the housing bust. The FHFA, with subpoena power, has a huge advantage over private investors, which have had a harder time gaining access to the loan files, critical to filing lawsuits against the banksters. The suits are likely to be filed now because regulators are concerned that it will be much harder to make claims after a three-year statute of limitations soon expires.
In the heyday of loan originations and sales into the secondary market, Fannie and Freddie couldn't purchase those loans directly, but they were allowed to invest in slices of "private-label securities" that were backed by subprime and other risky loans, but were rated as safe AAA investments by the ratings agencies. Indeed, Fannie and Freddie were among the largest investors in those securities. Freddie and Fannie began increasing their purchases of private-label securities early last decade in order to boost profits while satisfying government mandates to support affordable housing. By law, Fannie and Freddie were required to back loans to low-to-moderate income borrowers, and the private-label securities were counted toward those goals. In 2005 alone, Freddie Mac purchased $180 billion in private-label securities, up from $24 billion four years earlier.
In the the lead up to the financial crisis, “the market was so frothy then it was hard to find good quality loans to securitize and hold in your portfolio,” said David Felt, a lawyer who served as deputy general counsel for FHFA until January 2010. Moreover, the private-label securities carried higher yields at a time when the two mortgage giants could buy them using money borrowed at rock-bottom rates, thanks to the implicit federal guarantee they enjoyed. According to Felt, “Fannie and Freddie thought they were taking AAA tranches, and like so many investors, they were surprised when they didn’t turn out to be such quality investments." This despite the fact that Freddie was warned by regulators in 2006 that its purchases of subprime securities had outpaced its risk management abilities, but the company continued to load up on debt that ultimately soured.
Fannie and Freddie still hold billions of dollars in mortgage securities backed by more shaky home loans like subprime mortgages, Option ARM and Alt-A loans. Sadly for the American taxpayer, these securities have been among the poorest performing mortgages. The U.S. government has spent $141 billion to keep Fannie and Freddie afloat. Freddie Mac allegedly estimates its total gross losses stand at roughly $19 billion, while Fannie Mae allegedly estimates its losses at nearly $14 billion.
While the FHFA has been making noise about pursuing the banks for some time, as Naked Capitalism has reported, "the overarching story remains the same: the more rocks you turn over in mortgage land, the more creepy-crawlies emerge." In Arizona, when you turn over rocks in the desert, you often find scorpions. They creep and crawl and they pack a mean sting. It remains to be seen just how many stingers the Too Big To Fail camp have.