The Lawsuits Begin …

OK, there are probably other lawsuits already. But now a hedge fund is suing Countrywide (Bank of America), claiming that its loan modification program violates contract law and that if Countrywide wants to modify any mortgages it must buy out the existing investors at face value.

This is one aspect of the “securitization problem” that got a lot of air time on this blog a few weeks ago.

9 thoughts on “The Lawsuits Begin …

  1. From BusinessWeek article, “Investor Sues to Block Mortgage Modifications”:

    The largest subprime-mortgage servicing company, Ocwen, could be in the crosshairs of such lawsuits if its workouts are found to break securitization contracts. Nevertheless, Paul Koches, general counsel for Ocwen, contends that modifications are in the best interest of the borrowers and the market. Moreover, he says servicers are contractually bound to pursue modifications that benefit all parties.

    In an e-mail, Koches claims that “modifications designed to yield greater cash flow to investors…compared to net liquidation proceeds from a foreclosure are not only legally permitted, they are arguably required of the servicer. In a market environment where loss severities on foreclosures exceed 50%, loan modifications are not only a useful tool in protecting investors, but they also keep homeowners in their homes—truly a win/win result.”

    Koches adds that as a loan servicer, he’s obligated to “act in the best interest of the investor.” That standard, he says, should be interpreted as applying to all investors in a securitization in the aggregate—irrespective of the specific impact on any particular class of investors.

    End Quote.

    See http://www.businessweek.com/bwdaily/dnflash/content/dec2008/db2008121_173068.htm?chan=top+news_top+news+index+-+temp_news+%2B+analysis

    I would be surprised if this lawsuit isn’t thrown out in short order.

  2. Interesting question posed by this suit – who should bear the risk of modification? I’m guessing that unless the language of the MBS is very strict, the mods will be allowed.

  3. The complaint (link in the BW article that Tom K cites) includes these passages (direct quotations are from the Pooling and Service Agreements):

    33. “The Master Servicer may agree to a modification of any Mortgage Loan (the ‘Modified Mortgage Loan’) if … CHL [Countrywide Home Loans] purchases the Modified Mortgage Loan from the Trust Fund immediately following the modification…”

    37. The PSAs that govern the CWL and CWALT certificates define the “Purchase Price” at which modified mortgage loans must be repurchased from the trusts as “an amount equal to the sum of (i) 100% of the unpaid principal balance … of the Mortgage Loan as of the date of such purchase, [plus] (ii) accrued interest thereon …”

    Those seem to be the key claims.

  4. I am wondering if this particular securities contract is more definitive on servicer modification of mortgages than most.

    According to Joe Nocera of the NYTs, the FDIC generally sees no problems to loan modification in the securities contracts. See the Nov. 18th Nocera blog, “What Securitization Problem? The FDIC Weighs In.”, http://executivesuite.blogs.nytimes.com/2008/11/18/what-securitization-problem-the-fdic-weighs-in/.

    Even in cases where there is precise language dealing with mortgage modification, I think a strong argument could be presented in support of such modification. The argument would be along these lines.

    The subprime crisis is the root of the current financial crisis and the attendant severe economic downturn. Alleviating the subprime crisis through modification of subprime loans is needed to help end the financial crisis and to significantly improve the housing market in America.

    The interests of a handful of investors should not be allowed to take precedent over the economic interests of all Americans.

    Furthermore, the handful of investors who might receive a smaller return (perhaps a loss) from investments in mortgage securities, contrary to what they expected, accepted various investment risks when they bought the securities. One of the investment risks is that the housing bubble would burst, bringing on a severe financial crisis, and that mortgages would need to be modified to attenuate this financial crisis.

  5. In response to Tom K’s comment that investors “accepted various investment risks when they bought the securities,” it’s important to note that investors were also provided with comfort by provisions in the respective PSA’s requiring lenders to repurchase loans that were originated fraudulently or negligently, or that did not conform to the lender’s reps and warranties regarding the loan characteristics.

    It appears that investors are opposing loan modifications because they are hoping to hold Countrywide responsible for many defective loans by enforcing the lender’s repurchase obligations. It would be unfair for Countrywide to be able to legitimize defective loans by making them the subject of loan modifications pursuant to this settlement.

    For more on these conflicting interests, see the recent discussion on my blog, The Subprime Shakeout: http://subprimeshakeout.blogspot.com/2008/11/investors-cry-foul-at-bofa-settlement.html

  6. Mr. Gradman raises a very good point: the widespread fraud and abuse which took place in generating subprime mortgages. BusinessWeek published an interesting article, “Sex, Lies, and Subprime Mortgagges”, on Nov. 13th, which points out some of the abuse that took place. See http://www.businessweek.com/magazine/content/08_47/b4109070638235.htm.

    It is clear that a great deal of fraud and negligence took place which helped bring about the subprime crisis. I certainly hope that many of the individuals who practiced the fraud and negligence will be made to answer for these abuses.

    My point, however, is that this country desperattely needs to have the housing market stabilized. It is a national need. Contractual obligations, which would normally take precedence, should at this time be subordinated to the overall economic welfare of the country.

    If lawsuits are allowed to stand in the way of settling the subprime mortgage crisis, the country as a whole will fare the worse for it.

  7. WILL LAWSUITS UNDO TARP AND THE BANK RECAPITALIZATION PROCESS?

    There is a tsunami coming. Can you hear its rumble in the distance? That is the sound of a tidal wave of lawsuits heading towards banks and other institutions involved in the home mortgage business. Anybody who has so much as sniffed a mortgage backed bond will be lining up to get their ounce of flesh.

    This post by James refers to the hedge fund lawsuit against Countrywide (Bank of America). Now a group of investors is launching a lawsuit against Citigroup for “employing ‘shamelessly fraudulent schemes’ to disguise the risks it was taking with mortgage debt”. See “Lawsuit Says Citigroup Misled Investors” in Businessweek: http://www.businessweek.com/bwdaily/dnflash/content/dec2008/db2008125_639361.htm?chan=top+news_top+news+index+-+temp_news+%2B+analysis.

    These actions are just ripples compared to what is coming on the litigation front.

    Is this a good thing?

    Clearly investors have a right to be angry. But then so does every person affected by the financial crisis. That makes about 6 billion of us.

    If lawsuits like this are allowed to go forward, then TARP and all the other efforts to thaw out the credit markets and recapitalize the banks are just exercises in futility. We will be struggling to recapitalize banks only to have them decapitlized by lawsuits and awards. We may as well just let all the banks go bankrupt. At least we would save the tax payer some money.

    At some point, Congress is going to have to step in and limit the effect of lawsuits related to fraud and negligence in underwriting and securitizing mortgages. I can’t see any other solution.

    It is unfortunate for those who lose out on mortgage backed bonds. But then there are risks in all investments. Just ask people who invested in Enron, or Worldcom, or municipal bonds offered by the Washington Public Power Supply System (WPPSS, aka WHOOPS!).

  8. I think that from reading the previous comments that there is a certain lack of understanding as to the circumstances that helped us to arrive at our current predicament. The FBI financial crimes oversight board has estimated that 40% of the foreclosures to date in this meltdown have been due to fraud on the part of LENDERS. (not borrowers) Round that up to 50%. Add another 30% for mortgage servicing fraud, and you’ll slowly realize that the reason that the problem isn’t going away is because the treatment is addressing the symptoms, not the problem. A foreclosed property is worth up to 50x as (5000%) more billable fees to a servicer as it is to the lending institution,(most of the fees are fraudulent) MBS,CDO or whatever, regardless of the public statements to the contrary. Just visit the SEC website rules pages regarding servicing agreements and read the 1000 pages, then get back to me. A scam of monumental, earthshattering, mind numbing proportions which will, no doubt, never see the light of day. As less than 5% of US citizens ever consult an attorney, and less than 2% of attorneys have a concise working knowledge of federal and state lending laws, is it any wonder that this continues?

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