Friday, July 20, 2012

Mortgage buybacks: the issue that won't go away

In the past, your humble blogger has used mortgage buybacks to illustrate the big difference between the current policy of implementing the Japanese model for handling a bank solvency led financial crisis and the Swedish model.

Under the Japanese model, bank book capital levels and banker bonuses are protected at all costs.  As a result, every effort is made to minimize mortgage buybacks because almost by definition they involve a loss (buyers of the mortgages have the right to request the seller of the mortgage repurchase the mortgage if it violates certains representations and warranties; the mortgages that tend to attract attention are the ones that aren't performing; as a result there is likely to be a loss).

Under the Swedish model, banks are required to protect the real economy and absorb all of the losses on the excesses in the financial system.  As a result, banks honor the mortgage buyback requests without dispute.

As reported by Reuters,
Lenders like Bank of America Corp and Wells Fargo & Co say they are facing mounting pressure to buy back bad mortgages they sold to investors, signaling that banks' home-loan headaches could continue for years.
Investors like Fannie Mae and Freddie Mac have been pressing banks to buy back bad mortgages for years, but in recent months those requests have intensified, the banks have said in recent second-quarter earnings reports. 
These comments from banks provide a fresh reminder of the loose ends that remain from the housing bust that started five years ago. The threat of new expenses and litigation is dampening bank share prices, and the problem could linger for some time, analysts and experts said. 
"This is not done yet," said Paul Miller, analyst with FBR Capital Markets. "There will be continued surprises in the industry."...

When selling the mortgages, banks made promises or "representations and warranties" about the loans. Investors can ask banks to buy back soured mortgages if these promises were evidently broken, for reasons such as poor underwriting, insufficient verification of income or other documentation errors. 
Banks have fought some of these claims, but most lenders still expect to have to buy back many of the mortgages....
 Some?  How about fighting all of these claims?
In addition to a jump in requests from Fannie Mae and Freddie Mac, Bank of America said it is getting more claims from private investors who want to meet statute of limitations requirements. These claimants weren't part of an $8.5 billion settlement the bank reached last year with major institutional investors. 
For the second quarter, Bank of America added $395 million to its repurchase reserves, which was more than the first quarter but way down from the $14 billion it set aside a year ago to cover the $8.5 billion settlement and other repurchase requests....

Bank spokesman Jerry Dubrowksi said the bank's calculations take into account the fact that collateral backs about half of its $22 billion in outstanding claims. In addition, the bank has historically paid out 8 to 12 cents on the dollar for the remaining balance for settlements with private investors, he said.
Strongly suggesting that fighting the claims is good for banks and bad for private or government investors.

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