Institutional Investors now suing Bank of America for put backs on MBS

Felix Salmon is right.  This is going to be a big, big problem for the financial institutions.

A group of investors holding $16.5 billion of mortgage bonds took a step toward a possible suit against a Bank of America Corp unit for failing to correctly handle loans that were packaged into bonds.

The investors said that some mortgages should never have been included in the bonds in the first place, and that the Bank of America unit, Countrywide Home Loan Servicing, should force the original lender to buy them back.

The salvo is the latest effort from investors to push losses from mortgage securities back onto banks that made the original loans. Investors say the loans did not meet the standards that bondholders were promised when they bought the securities.

I would venture that this is the issue we should be watching if there is going to be a disorderly outcome in the MBS space. You can assume that the government might protect the banks from  a lot of Fannie and Freddie put backs if they thought it would put banks’ capital at risk. Remember the Obama Administration has banked Obama’s presidency on doing "deeply, deeply unpopular things" that would right the economy. If the big banks are forced into an under-capitalized position, you have a big mess on your hands economically.

Maybe this the kind of thing that kept Jamie Dimon from increasing the dividend after cutting it to five cents from 38 in February 2009.

See Felix comments below:

And, remember when I said Ken Lewis was crazy to take on Countrywide? Well, now you see why.

The CNBC video with the investors’ attorney is below.


Update: Here is another video talking about the impact of the potential lawsuit on BofA and other large banks.  Of note are the comments about the ability to take these earnings hits over a longer period and the banks’ being well capitalized under Basel III standards. Even if the banks get these bonds put back, they could hold them to maturity and don’t have to write them down according to new FASB rules.

The bottom line is that, unless we see more defaults that absolutely require writedowns, the banks are probably going to get through this particular issue without systemic risk. Nevertheless, I think upside for the banking sector is capped, with lower leverage, lower market volume, lower credit growth, so many writedowns still in the pipeline and so many legal issues looming.


Update 2: Below is the letter which the investors’ attorney sent to Bank of America (h/t Deal Book)

Bondholders Letter to BofA Over Country Wide Loans Inc NY Fed

  1. Sam Costanzo says

    Don’t these same investors have a hundred other grounds to sue on, and won’t it take 5 years to reach a settlement, and won’t BofA be able to easily earn through the legal and settlement costs over that period of time? A value investor with a 3 to 5 year time horizon should buy BAC now!

  2. Edward Harrison says

    Cynical, Sam! But, yes you could be right that the banks have enough earnings power to deal with this if they put it off with legal challenges. Anyone looking for the imminent collapse of the banking sector needs to take your comments into account.

  3. Edward Harrison says

    Sam, I have updated the post with a second video making the points you have just done. I don’ think this means the banks have a lot of upside here though.

  4. Ken Smith says

    Not sure if collapse of banking is needed to send the message of TBTF is over. Just one. An ability to earn through it is the premise of taking on risk in the first place. Anyone remember the Pinto calculations Ford made? It was when it came out what Ford did that changed the conversation.

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