Yesterday, just as the stock market was closing for a long holiday weekend, the US Federal Housing Finance Agency (FHFA) filed lawsuits against 17 financial institutions, alleging the banks misrepresented the quality of the mortgage securities that they sliced, diced, assembled and sold. Specifically, the lawsuits charge the country’s biggest banks sold securitized mortgages they knew were exceptionally high risk to the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) to the tune of almost US$200 billion.
Before the lawsuits were even filed, Nelson D. Schwartz, writing for the New York Times, cited anonymous “bank officials” as saying that “further legal attacks on them will only delay the recovery in the housing market, which remains moribund, hurting the broader economy.” A day later Schwartz and Kevin Roose, writing for the New York Times, cited Mike Mayo, an analyst with Credit Agricole: “Banks should pay for what they did wrong, but at the same time they shouldn’t be treated as a big pinata that has the effect of delaying the housing recovery. If banks have to pay for loans they made five years ago, are they going to make new ones?”
Here’s the position the US federal government (and states attorney generals) should take with the banks: Write new loans to qualified borrowers, with proper documentation, or face nationalization. Begin legitimate underwater mortgage restructuring in earnest immediately, or face nationalization. Begin legitimate refinancing for those mortgagees not underwater at reasonable rates—under US$1,000 total—immediately, or face nationalization. Period.
While the banks have mostly paid back the US$700 billion bailout from 2008, Schwartz and Roose note that “the rescue of the mortgage giants Fannie and Freddie has already cost taxpayers US$153 billion, and the federal government estimates the effort could cost US$363 billion through 2013.”
The banks, responding within minutes to the actual lawsuit filings, maintain that Fannie Mae and Freddie Mac were sophisticated investors that knew or should have known the risk-level of the securities they purchased. A large part of the problem, and one that has yet to be addressed, is that the US ratings agencies blessed these securitized mortgages—investment vehicles that they knew were extremely risky—with their highest AAA grade.
“Buried in the filings themselves, however, is a damning portrait of the excesses of the housing bubble, when borrowers were able to obtain home loans without basic proof of income or creditworthiness, and banks appeared only too happy to mine profits taking the risky loans and assembling them into securities that could be sold to investors,” write Schwartz and Roose. The Times writers cite a passage from the filing against Goldman Sachs as an example: “‘Goldman was not content to simply let poor loans pass into its securitizations.’ In addition, the giant investment bank ‘took the fraud further, affirmatively seeking to profit from this knowledge.’” When an external analytics firm flagged problems in the underlying mortgages making up the securities, the suit alleges “Goldman simply ignored and did not disclose the red flags revealed by Clayton’s review.”
My wife and I have carried a mortgage—at a whopping interest rate of 8.375 percent—on our home since 1996. We had an excellent credit rating at the time, and put more than 33 percent down, but being self-employed (with a 17 year history at the time) that was the only deal we could get back when you actually had to qualify for a mortgage. Since then, whenever the interest rates fall, we look into refinancing. When interest rates are high, refinancing fees are low; when interest rates are low, refinancing fees are outrageously high.
That’s precisely why the solution suggested by Cringely—a temporary elimination of the appraisal requirement for federally insured mortgages—is dead on arrival. As Cringely’s own previous column acknowledges, the banks will always try to find a way around anything that’s going to put those fat interest rates at risk. The banks will simply pile on other fees to replace the revenue from the appraisal. A serious threat of nationalization will, like a 2x4 to the forehead, at least get the banks’ attention.
Update: Saturday 3 September 8:04PM CDT: Apparently the US ratings agencies haven’t yet gotten the memo. Zeke Faux and Jody Shenn, writing for Bloomberg, reported a few days ago, “Standard & Poor’s is giving a higher rating to securities backed by subprime home loans, the same type of investments that led to the worst financial crisis since the Great Depression, than it assigns the US government.” (h/t to Dan Gillmor for the link.)
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