Loan Modifications: BofA Gets Taken to Court

Here is a tale of what lies ahead for the mortgage and banking industries. The issue of litigation over the modification of loans is going to clog the courts for some time. Substantial damages could accrue to the lenders and the issue may well come to rival the asbestos litigation chronicles as a gold mine for the bar.

A brief history. When Countrywide was in its death throes, a number of attorneys general around the country smelled blood and attacked. Their claim was generally that Countrywide was engaged in “predatory lending” and they would therefore seek billions in damages. Wounded beast that it was, Countrywide fought back hardly at all and of course fell into the arms of Bank of America.

Once under its wing, BofA (BAC) moved swiftly to settle with the circling carrion. Too many other fish were frying and Countrywide which had seemed like such a big deal at the time was now small potatoes when compared to every other wave crashing onto the shores in landlocked Charlotte. So with little more than a couple of blinks, the bank agreed to modify 400,000 mortgages at a cost of as much as $8.4 billion. The attorneys general all agreed that this was good and would work well during the next election cycle.

Left out in the cold were the people who actually owned these mortgages that BofA agreed to modify since Countrywide/BofA didn’t really own them. In fact they had securitized them and sold them to investors. Oh, by the way, they gave the buyers of these securities a little security blanket. They told them that if they ever modified loans, they would buy them back at par from the investors. At the time they only anticipated modifying them if someone decided to refinance, not if modification were required to preserve the asset, but they didn’t qualify the buyback provision.

So one of those investors, Greenwich Financial, filed a class action lawsuit asking that BofA honor the terms of the contract that Countrywide signed. Since then all hell has broken lose. Various members of Congress and the administration have issued not so veiled threats wrapping themselves in the duty of these investors to in effect take one for the team. To their credit, the investors seem, so far, unintimidated and prepared to seek satisfaction in the courts.

And that’s where we stand. The validity and sanctity of contracts is something that is pretty clearly going to be adjudicated. It’s a very tangled web that gets woven as we try to extricate ourselves from this mess. Let’s hope in doing so we don’t throw overboard the legal framework that made this whole economy work for such a long time.

Comments

[jtmortgageb...:]

Do you or anyone reading this know if the same requirement (buying the loan back at face value) applies to "short sales"? In this context, BAC may negotiate with the homeowner to reduce the principal of the mortgage if the homeowner sells the house. This is getting more common as the seller wants to get out but cannot pay off the full amount of the loan since the house is worth less than what they owe.

It seems lillogical for a lender to let a house go into foreclosure rather than accept a short sale but if this is the explanation, it would be economically rational.

2008 Dec 05 01:36 PM

[prudentinve...:]

Unfortunate that the legal underpinnings, necessary for a stable system, are becoming stressed, and in some cases by government agencies.

For example, I am not sure I understand what happened to WaMu bonds. I was under the impression that senior debt takes precedence when a company fails. However, a government agency (FDIC/FED) seized and sold off WaMu's useful assets to JPM, and ignored the senior bond holders. Not being a lawyer, I am not confident enough in my understanding of the facts, but it sure seems like laws were broken.

It will be sad if the present events turns us into a system where laws are enforced selectively, and based on convenience.

2008 Dec 05 01:55 PM

[Tom Lindmark:]

In the case of WAMU, the FDIC became the receiver of the bank after is was judged to be insolvent. The FDIC's job in this case is to find the least costly way to unwind the bank. Senior debt holders along with holders of other securities and uninsured depositors are entitled to 50% of whatever money is left after the institution is wound down.

Thus senior debt holders of WAMU may be in line for some recovery of principal.

2008 Dec 05 03:01 PM