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The GOP Victory Could Make 2011 the Year of the Put-Back

Published: Thursday, 4 Nov 2010 | 10:34 AM ET

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By: John Carney
Senior Editor, CNBC.com

Fannie Mae and Freddie Mac may throw a surprise wrench into the profits of our largest banks next year by demanding sizable repurchases of mortgages contained in flawed pools that underlie mortgage-backed securities.

Jodie Coston | Photodisc | Getty Images

The giant mortgage companies, which have been under government conservatorship since 2008, have historically not demanded that banks repurchase very many mortgages. When I talk to banking executives about their exposure to repurchase demands, they always say that one of the reasons they are confident these will not become overwhelming is that most of the mortgages were sold to Fannie and Freddie. They're confident that these mortgages won't get put-back to them.

But that confidence could be misplaced given the current political climate. As Republicans take control of the House and Democrats feel stung by losses that some attribute to the impression that they've been too easy on banks, Fannie and Freddie could come under political pressure to put-back flawed mortgages.

You don't have to strain very hard to see the refusal of Fannie and Freddie to investigate whether they are entitled to mortgage put-backs and then demand banks repurchased flawed mortgages is a kind of subsidy or backdoor bailout of the banks. The government is spending hundreds of billions of dollars to support Fannie and Freddie—an expenditure of taxpayer dollars that could be greatly reduced if Fannie and Freddie were able to force banks to buy back flawed mortgages.

The current law requires government support of Fannie and Freddie to end in 2012. Replacing taxpayer funding with funds from banks repurchasing loans could help transition the GSEs into their next phase.

Pressuring Fannie and Freddie into making repurchase demands could have the support of both parties. Republicans could support the move as a way of transitioning Fannie and Freddie into wind-down mode without the need for a new government aid program. Democrats might look at the influx of new funds from banks as a way of allowing Fannie and Freddie to keep supporting the housing market without spending as much taxpayer money.

If Fannie and Freddie were to begin demanding that banks repurchase flawed mortgages, banks like Bank of America, JPMorgan Chase and Citigroup could be hit with a huge unexpected costs. Resisting the put-backs could put banks in the awkward position of litigating against arms of the U.S. government.

Right now, banks remain confident that the put-back issue will remain on the back-burner. But these things have a way of changing. And change is once again in the air on Capitol Hill.

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Companies mentioned in this post

Bank of America [BAC Loading... () ]