“It appears as though many loans and other mortgage-related assets have been double and even triple-pledged to various constituencies.”-- Bank of America court filing, June 2010
A court filing made by Bank of America (NYSE:BAC) back in June is adding another twist to the foreclosure document crisis, a problem that could mushroom into more writedowns for the banking industry, and headaches for Fannie Mae, Freddie Mac, and the New York Federal Reserve, which now owns $1.25 trillion in mortgage-backed securities guaranteed by Freddie Mac, Fannie Mae and Ginnie Mae.
Attorneys general in 50 states are now investigating allegations of falsified foreclosure documents, where banks allegedly have not proved they own the underlying mortgage and in turn have the right to seize a home when a borrower defaults.
But now the question is not just who owns the property -- the mortgages -- but whether Wall Street and the mortgage industry pumped out too many mortgage-backed securities built on these loans?
Specifically, the question is how many mortgages were overpromised and overpledged -- sometimes two, three maybe five times, maybe umpteen times -- to back securities? How many fraudulent mortgage-backed securities now sit on Fannie and Freddie’s books? At the New York Fed? Who will be on the hook for those securities?
And instead of another round of quantitative easing from the Federal Reserve, will the US Treasury have to step up to support the banks in clearing out this possible mountain of fake securities?
A New York Fed official tells me that because Fannie and Freddie back its $1.25 trillion mortgage-backed securities portfolio, it won’t face any losses for rotten securities. Fannie and Freddie officials tell me that while they do have that unlimited pipeline into the US Treasury, they are going to turn around and make the banks swallow the losses for the bad securities they built on loans.
Wall Street analysts concur. That is called a put-back. But if the banks cannot, then taxpayers will because the US Treasury is backing up the balance sheets at Fannie and Freddie.
The estimates for the size of the problem are coming in. JPMorgan Chase (NYSE:JPM) analysts Ed Reardon and John Sim calculate bank industry wide put-back risk from Fannie and Freddie at $23 billion to $35 billion from mortgage-backed securities, $40 billion to $80 billion in non-agency mortgages, and $20 billion to $30 billion for second liens and home equity lines of credit.
Reardon and Sim figure the true cost may be less than the total above, perhaps on the order of $55 billion for the entire industry. Worst case scenario could be $120 billion. And the put-backs may be spread over many years, at about $10 billion to $25 billion annually for the entire industry.
But Wall Street fears that numbers could be much larger.
Branch Hill, a San Francisco hedge fund, says Bank of America faces larger numbers for putbacks, suggesting upwards of $59 billion in losses on put-backs. BofA officials say those numbers are exaggerated and are an overstatement.
The Taylor, Bean & Whitaker case illustrates the problem. The BofA court filing indicates that mortgages were falsely pledged to numerous investors, perhaps double- and triple-pledging.
The Bank of America court filing has to do with the Chapter 11 bankruptcy filing by Taylor, Bean & Whitaker Mortgage Corp. [TBW] run by Lee Farkas, a Florida businessman who built Taylor Bean from a tiny mortgage company into the nation’s largest mortgage lender not owned by a bank. The case ropes in Bank of America and Freddie Mac, as well.
Federal prosecutors claim Taylor Bean’s Farkas engaged in a seven-year, multibillion-dollar fraud by double- and triple-pledging Taylor Bean’s mortgage loans to investors and improperly transferring loans and securities between the company’s bank accounts. Farkas now awaits trial.
Prosecutors also say Taylor Bean’s Farkas and others engaged in a scheme to misappropriate more than $1.9 billion in funds to hide operating losses at Taylor Bean, which in turn helped hasten the collapse of Colonial Bank, the company’s main lender.
The fight boils down to this: Deutsche Bank (NYSE:DB) and BNP Paribas in late 2007 created an off-balance sheet vehicle called Ocala Funding that bought $2.1 billion in commercial mortgage loans.
Ocala pumped out asset-backed commercial paper, which then funded the purchase of mortgage loans from Taylor, Bean & Whitaker. Those notes were then sold to Freddie Mac. LaSalle Bank acted as the collateral agent and trustee; Bank of America eventually bought LaSalle Bank, so it then acted as the trustee and managed the collateral for Ocala, helping to oversee the roughly $1 billion in securities Ocala put on its conveyor belt each month.
When Taylor, Bean collapsed in late summer 2009, its lender, Colonial Bank, went under as well, and so did Ocala, after the Federal Housing Administration forced it to pull the plug.
All this triggered lawsuits between Deutsche Bank, BNP Paribas and BofA. Which brings the fight to Freddie Mac. Bank of America has made a court filing essentially demanding to review Freddie Mac’s asset records, to make sure Freddie did not get assets it is not due and owing. BofA also wants to know who is the rightful owner of these mortgages and securities, and that the proper ownership paper trail is in place.
Specifically, its filing says: “On numerous occasions, the Debtor (in this case, TBW) has informed the Court and other parties in interest that one of the biggest challenges in this case will be sorting out the competing claims to cash and other assets that flowed through the Debtor’s accounts prior to the bankruptcy filing.
“Indeed, it appears as though many loans and other mortgage-related assets have been double- and even triple-pledged to various constituencies. According to the Debtor, the largest single source of disputed funds — more than $548 million according to Debtor’s Second Interim Reconciliation Report — relates to Freddie Mac.
“Indeed, BofA believes that there were improper diversions of Ocala loans and assets from TBW to Freddie Mac, and Ocala may have valid ownership claims with respect to a substantial portion of assets that relate to Freddie Mac.
“Accordingly, there can be little doubt that BofA, in its representative capacities with respect to Ocala, has a valid and pressing need for information regarding Freddie Mac’s extensive need for information regarding Freddie Mac’s extensive relationship with the Debtor which is directly relevant and necessary to evaluate the Debtor’s property, liabilities and financial condition.”
So here you have it. That drunken paper daisy chain of mortgages I told you about three years ago is now draped around the neck of the New York Fed. It’s crumbling into a mountain of paper, the refuse of a crazy bubble, that taxpayers will be morosely staring at for years to come.
Loans willy nilly spliced and diced and double and triple, maybe even quintuple counted, into an array of off-balance sheet vehicles, trusts, you name it, means this foreclosure mess won’t be sorted out for a decade or more. It means trying to foreclose on defaulters will be difficult because numerous parties can come forward claiming ownership.
Street analysts expect the Federal Reserve will start to sell its mortgage-backed securities in order to buy Treasury notes and bonds, in a bid to keep long term rates down. This is additional round of quantitative easing the markets expect the Fed to enact shortly, anywhere from $500 billion to $1 trillion total, with purchases ranging from $50 billion to $100 billion a month, as needed.