'Mortgage Loan Pools' Latest Thing Looming Over Big Banks

As if the problems in foreclosures weren't enough, another potential problem for the nation's big banks is raising its head today and is the key reason that shares of banks such as Bank of America are down sharply and CDS's (credit default swaps) for some banks are widening.

A home is advertised for sale at a foreclosure auction in Pasadena, California.
Reed Saxon
A home is advertised for sale at a foreclosure auction in Pasadena, California.

The worry centers on the mortgage loan poolscreated by many of the big banks as they fed the seemingly endless desire for mortgage-backed securities and CDO's (collateralized debt obligations) made from them.

It appears the mortgage content of many of those pools—created when the banks were dominating the mortgage securitization market in 2005, 2006 and 2007—may have been misrepresented. For example, an underwriter may have maintained that 80 percent of the mortgages in the pool were for primary residences when in fact far fewer were for that purpose. Or the underwriter stated that only 10 percent of the pool would be made of of "no-doc" loans—those that include less documentation about the borrower—when in fact the percentage was far higher.

That could be fraud, and if so, the creator of the mortgage pool could be liable. Given that the market for private label RMBS (residential mortgage-backed securities) was $1.5 trillion, the potential liability may be considerable. And while most of the originators of these mortgages are long gone, the securitizers are not.

Today a report on this potential liabilityhas made its way around the Internet. Its author, Manal Mehta, whose experience is in distressed debt, declined to appear on our show, but his work on Bank of America and H&R Block is having a significant effect on their stock prices.

While this issue has been bubbling for some time, it has only recently come to attention. Yesterday, JP Morgan's CEO, Jamie Dimon, was asked about it on the firm's conference call and said that he does not expect the liability to be a blow up number.

It seems a certainty that more banks will be questioned on this issue. In fact, a smaller bank holding company, First HorizonNational, is likely to be questioned on the issue when it reports tomorrow and of course the bank with perhaps the largest possible issue, Bank of America, is likely to receive many questions when it reports earnings.

Stay tuned for what will happen next.

This post has been updated on October 14.


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