Reuters

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U.S. Sues 17 Major Banks Over Subprime Bond Losses

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A U.S. regulator sued more than a dozen major banks on Friday over losses on nearly $200 billion of subprime bonds, which may hamper a broader government settlement of the mortgage mess left over from the housing crisis.

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The lawsuits by the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, came as a surprise to the market and weighed down bank shares.

The lawsuits could add billions of dollars to the banks' potential costs at perhaps the worst possible time for the industry. The litigation reflects how different parties, including investors, banks and different government groups are fighting over who should bear the losses from the housing crisis that tripped the economy into the worst recession in decades in 2008.

The FHFA accused major banks, including Bank of America Corp, its Countrywide and Merrill Lynch units, Barclays Plc, Citigroup Inc and Nomura Holdings Inc of misrepresenting the checks they had done on mortgages before bundling them into mortgages.

The banks also bundled loans into bonds that should have never been sold to investors, because the mortgages did not meet the investors' stated criteria, the lawsuits said.

Most of the banks and finance companies that were sued refused to comment or were not immediately able to comment, but some called the charges unfounded.

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"Fannie Mae and Freddie Mac are the epitome of a sophisticated investor, having issued trillions of dollars of mortgage-backed securities and purchased hundreds of billions of dollars more," said Mayura Hooper, a spokeswoman for Deutsche Bank AG in a an emailed statement.

The biggest banks are already negotiating with the attorneys general of all 50 states to address mortgage abuses. They are looking for a comprehensive settlement that will protect them from future litigation and limit their potential mortgage litigation losses.

"This new litigation could disrupt the AG settlement," said Anthony Sanders, finance professor at George Mason University and a former mortgage bond strategist.

Banks may be more reluctant to agree to a settlement if they know litigation from other government players could still wallop their capital, he said.

Before the FHFA lawsuits had even hit a court docket, financial experts offered blunt expectations for the outcome.

"The lawsuits will be settled. The end result will be a further outflow of cash from the banks and more importantly an additional black eye," said Sean Egan, managing director of Egan-Jones Ratings Co.

FHFA director Edward DeMarco is looking to minimize future losses for Fannie Mae and Freddie Mac, which are owned by the government after failing in September 2008. The FHFA filed the suits before a three year statute of limitations expired. Fannie Mae and Freddie Mac are pillars of U.S. mortgage finance.

The KBW Bank Index closed down 4.5 percent on Friday, nearly doubling the losses of the broader market. Bank of America led the index lower, dropping 8.3 percent.

A TWIST

Bank shares also came under pressure from signs the Federal Reserve could start selling shorter-term debt on its books and buying long-dated bonds to push longer-term yields lower as a stimulus measure.

Such a move, known as "operation twist," would hurt banks whose profit margin is tied to the short-term rates at which they fund and the longer-term rates at which they invest.

Major banks already face potential payouts of tens of billions of dollars to settle regulatory charges of abusive mortgage lending and foreclosure practices, and other investor lawsuits over mortgage debt losses.

Such payouts would reduce earnings and weaken capital levels, perhaps harming the ability of banks to lend money and provide much-needed life to a stalled housing market and weakened economy.

Banks have been walloped by mortgage losses, but so have Fannie Mae and Freddie Mac, which failed after trying to finance too many bad mortgages with too little equity. The two entities guarantee bonds backed by mortgages.

The question of whether to take action for problems related to the mortgage bonds has been under discussion since Fannie Mae and Freddie Mac were placed in conservatorship in 2008, a person familiar with the matter said.

While the ultimate amount FHFA will seek is still unclear, that person said it could top the $20 billion being discussed by the banks and the state attorneys general.

A BLIZZARD

The blizzard of litigation against banks is hurting share prices in the sector because investors feel unable to estimate the ultimate scope of a given bank's legal liabilities.

Bank of America, for example, had intended its proposed $8.5 billion settlement in June with investors in Countrywide mortgage securities to resolve most litigation tied to its disastrous 2008 takeover of that home loan provider.

But many parties are objecting to that settlement and the deal did not stop insurer American International Group Inc from suing Bank of America for $10 billion over its own alleged mortgage securities losses.

Nor did it stop Nevada's attorney general from threatening to withdraw from an $8.4 billion nationwide settlement with the bank. The AG now wants to sue the bank, accusing it of reneging on promises to modify mortgages.

Other banks also face mortgage lawsuits. In May, the U.S. Justice Department sued Deutsche Bank, accusing it of misleading a U.S. housing agency into believing loans it made qualified for federal insurance.

The FHFA's lawsuits follow an initial lawsuit in July against UBS AG seeking to recover $900 million of losses incurred on $4.5 billion of debt.

One legislator praised the expected FHFA lawsuits.

Brad Miller, a Democratic congressman from North Carolina, said: "Not pursuing those claims would be an indirect subsidy for an industry that has gotten too many subsidies already."

FHFA and various investors have alleged banks, while packaging residential home loans into securities sold to investors, failed to conduct adequate due diligence and hid or misstated the quality of the underlying loans and underwriting as well as borrowers' ability to make payments.

A Bank of America spokesman said Fannie Mae and Freddie Mac acknowledged their losses were due to the downturn in the housing market and other economic factors, and they claimed to understand the risk in the securities, but are now trying to hold other parties responsible for their losses.

As more borrowers fell behind or went into foreclosure, the value of securities backed by their loans fell, causing losses for investors.

Losses stemming from the precipitous deterioration in subprime and other mortgages pushed the government to take over Fannie Mae and Freddie Mac on September 7, 2008. Since then, taxpayers have spent more than $140 billion to keep the firms afloat.