There’s little doubt that the economy has been in a recovery mode for the past year and perhaps longer. One good way to show that things are on the mend is to look at housing prices: September values nationwide were up 11.3 percent when compared with 2011 according to the National Association of Realtors.
Meanwhile, the banking sector appears to be doing really well. Second-quarter profits reached $34.5 billion and loan balances increased by $102 billion. The architects of various bank bailouts can argue that the money sent to Wall Street and the continued availability of funds from the Federal Reserve at just about 0 percent interest have restored the financial system.
All of this sounds pretty good but there’s a huge kink in the system: vast foreclosure-related claims against major banks and brokerages remain outstanding. Despite recent good news from the financial sector the fact remains that concerns we reported five years ago have never gone away.
What claims? Those would be what are called “buyback” or “put-back” claims, situations where mortgage investors feel they want faulty loans bought back by those who originated, sold or guaranteed them.
In general terms put-back requests are the result of several events: First, the borrower makes no payments after closing, what is called “universal” default and a sure path to foreclosure. Second, a buyback can be required if the borrower misses one payment during the first 120 days of the loan term.
Buyback requests from missed payments are not much of a liability for banks and brokerages today because the periods when such problems could arise are gone for older loans and rarely occur with new financing. Stronger underwriting requirements created by Wall Street reform mean that foreclosure levels today are one fourth of what they were before the mortgage meltdown.
However, if a loan is alleged to be fraudulent or there are claims of negligence then short time limits do not apply. If proven true the originator, packager or guarantor can be required to buy back the loan.
If a large number of loans default you can bet that mortgage investors such as pension funds and insurance companies — investors with lots of money and lawyers — are going to look at how the loans were originated and the representations and warranties made by operators on Wall Street who packaged the loans to create mortgage-backed securities.
“We usually think of foreclosures in terms of people who lose their homes,” said James Saccacio in April 2007, then Chairman and CEO at RealtyTrac. “But we also have an unknown number of fraudulent loans which will need to be bought back. These loans will keep lenders on the hook for years to come — and bankrupt more than a few.”
How much are we talking about?
- Thomson Reuters reports that buyback claims could involve loans worth as much as $140 billion with a single bank, JP Morgan Chase. Actual damages would likely be far lower.
- Buybacks since 2007 have amounted to at least $84.2 billion according to Bloomberg News.
- Bank of America was sued by the Maine State Retirement System for buybacks worth $352 billion, however a judge reduced the maximum possible award to $31 billion.
How can mortgage investors try to prove fraud or negligence? Here’s one example: Steven Krystofiak, President of the Mortgage Brokers Association for Responsible Lending, testified before the Federal Reserve in 2006 and said that most stated-income loans were overstated by at least 50 percent. How did he know? He checked borrower tax returns — something lenders are supposed to do.
The success of a major buyback suit or group of suits could rock Wall Street — and Krystofiak is not the only one who knows how to audit loan applications.