Are Fannie Mae and Freddie Mac, the enormous Government Sponsored Enterprises (GSEs) that purchased about three quarters of the total single-family mortgages in the United States, about to step into the repurchase litigation fray?
If so, it might be very frightening news indeed for the lenders potentially on the hook to repurchase the securities they sold to the GSE's.
First, a little background.
From the RealtyTrac article, a primer on Fannie May and Freddie Mac:
"They are special corporate concoctions at the heart of the 'secondary' market, an electronic trading post where the GSEs buy loans from local lenders, package the mortgages into securities, and then sell the securities they created to investors. The continued functioning of the secondary market is a big deal because about 75 percent of all single-family mortgage originations are purchased by the GSEs."
The GSEs, Fannie May and Freddie Mac, acquire mortgages from banks that have either originated them or repackaged them for resale. "A lender anywhere in the country can sell qualified mortgages to Fannie Mae and Freddie Mac. Investors from all over the world can buy and sell mortgage-related securities, an expression which can include pass-through securities and mortgage-backed bonds. The money investors pay for such securities enables the GSEs to buy more local loans and so the cycle continues."
Once the GSE's acquire the mortgages from banks, and create new securities composed of them, those new securities then possess the guarantee of the agency issuing them. The article explains:"Along the way the GSEs 'guarantee the timely payment of principal and interest on the mortgage-backed securities they issue' according to Freddie Mac."
As mentioned above, any lender can sell a 'qualified' mortgage to a GSE. And, as the article points out, the word 'qualified' is key:
"The GSEs are willing to buy conventional, FHA and VA loans because such mortgages have precise requirements and standards. A lender who tries to stick the GSEs with an unqualified mortgage can be tossed out of the program. No less important, a lender who sells a tainted loan can be forced to buy back the offending mortgage at face value."
And therein lies the rub.
The RealtyTrac article provides some context for the magnitude of the problem: "By the end of the third quarter the GSEs held massive numbers of foreclosures, properties that could not be unloaded with a short sale or through a foreclosure auction. Freddie Mac held 74,910 REO properties while Fannie Mae had 166,787 homes in its REO inventory." (REO is shorthand for 'real estate owned'. REO properties are properties that banks were not able to successfully sell at auctions, and now reside on the bank's balance sheet.)
But, according to the article, the GSE REOs are only part of the problem. The bigger issue may be the 'astronomical' level of guarantees that the GSEs provide for loans that they purchased. Here is an eye-popping aggregation of several estimates, re-quoted here from the RealtyTrac article:
- The Federal Housing Finance Agency (FHFA) says Fannie Mae and Freddie Mac have borrowed $148 billion to date from the Treasury but that additional draws could range “from $221 billion to $363 billion through 2013.”
- Credit Suisse says Fannie Mae and Freddie Mac could face $321 billion in losses if home values decline by 10 percent in a year, are flat the next year and rise 3 percent annually thereafter. Of course, if things don't go so well then the losses could amount to $448 billion.
- Standard & Poor's says “the ultimate taxpayer cost to resolve Fannie Mae and Freddie Mac could reach $280 billion, including the
$148 billion already invested — money largely spent to make good on loans gone bad.” Things could get worse, however. S&P says that $280 billion “could swell to $685 billion, by our estimate, with the establishment of a new entity to replace Fannie and Freddie that the government would initially capitalize.”
And, as the article points out, those figures don't just appear huge in absolute terms – they represent a massive threat to the balance sheets of the banks which originated or repackage them—particularly in relation to total bank profits: "To put these numbers in context consider that in the second quarter of 2010 all of the nation's banks jointly earned $21.6 billion in 'profits' — earnings which were achieved in part because loss reserves were reduced by $27.1 billion when compared with a year earlier."
Very frightening indeed.
And so the question is raised: "If Fannie Mae and Freddie Mac are facing vast losses on the mortgages they bought then do they have any claims against the lenders who sold such loans? Can they force private-sector lenders to buy back failed mortgages?"
Fannie Mae and Freddie Mac are now operated by the Federal Housing Finance Agency (FHFA), after a government takeover during the summer of 2008. FHFA issued 64 subpoenas this July “'to determine whether misrepresentations, breaches of warranties or other acts or omissions' were made by lenders who sold loans to Fannie Mae and Freddie Mac."
According to the article, FHFA is "seeking the contents of loan files, which include documents used in the underwriting process, such as loan applications and property appraisals."
And that could be very bad news for the banks. Especially when one takes into account all the problems that seem to exist concerning the underlying loan documentation that banks failed to properly transfer along during the securitization process. ( As I wrote earlier this morning, new problems have recently come to light, for example, with the countrywide documentation process. And some of these problems appear to be matters of policy—not simple mistakes. Countrywide is now owned by Bank of America .)
I quote the New York Times Gretchen Morgenson in my article: "If Countrywide’s practice was to hold onto the note [a necessary loan document required for foreclosure], then investors in this pool and others may question whether the security was constructed properly and legally and may be able to require Bank of America to buy back their securities."
If the lawsuits against Bank of America—filed by PIMCO, Blackrock, Freddie Mac, and others, including the Federal Reserve Bank of New York, on behalf of its Maiden Lane LLC's I, II, and III —are any indication of what's to come, things may go from bad to worse.
Especially if the GSEs decide to step into the mix — by engaging in massive litigation against the lenders who issued or repackaged the enormous amount of mortgage debt that Fannie Mae and Freddie Mac currently have exposure to.
Hat tip to ZeroHedge for locating the source article.
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