It would appear that an important court case may go in favor of BofA (NYSE:BAC) and Bank of NY (NYSE:BK) in a suit brought by AIG’s wholly owned subsidiary United Guaranty Mortgage Indemnity Co. If that is the final outcome it will set a dangerous precedent for the Mortgage Insurance industry. It could destroy what is left of an already broken part of the mortgage market.
This fight is headed for a conclusion in the next few weeks. I think the MI industry has been a significant part of the collapse of the mortgage market, housing market and therefore the US economy. But, in this case I have to side with the MI industry. I have some insight on this that is apparently not in the court’s hands at this time. If and when this information becomes public it could change the outcome of this important case. Some background:
In March of 2009 United Guaranty (UG) sued Countrywide Financial (“CWF”) (BofA now owns CWF). The lawsuit accused CWF of misrepresenting underwriting standards on loans UG insured. Specifically, UG claimed that most mortgages covered by policies for asset-backed securities were either underwritten in violation of Countrywide’s own guidelines or contained defects, such as missing documents, misrepresented credit scores or false social security numbers. The mortgages in question were bundled into junk MBS. The Agent for these securities was Bank of NY. Investors who lost money are suing BONY/CWF-BofA. UG insured the mortgages and is now trying to walk on that promise.
A US District Court issued a ruling on 10/5/09 in favor CWF. While there is still some wiggle room, it looks like UG is going to have to pay. If that is the case it will set a dangerous precedent.
Historically MI companies have paid claims in situations where there has been fraud committed by the borrower. However they do not pay claims where a loan officer, appraiser or real estate agent has committed the fraud. The critical issue is therefore who committed the fraud. If it is the borrower, then UG and the other MI companies are forced to pay. If the fraud is perpetrated by the lender (or their agents) UG can walk on its obligations.
The question that needs to be examined is how many of the defaulted mortgages in question were the result of fraud by the borrower or fraud by the lender. In this regard consider an (as of now) unrelated matter in Illinois. This concerns a Countrywide office in Chicago. That office, under a program called Optimum, originated approximately 1,000 loans. Substantial percentages of these loans have gone into default. An investigation has determined that 90% of the busted loans had the following ‘coincidences’:
- The same loan officer.
- Same RE agent.
- Same appraiser.
All of the loans had credit references from the same sources:
- A boot company.
- A linen shop.
- A restaurant.
The FBI is involved with this case. I will leave it to the reader to conclude if lender fraud was involved or not.
If the Court’s decision in California stands, the MI companies losses will explode. Their ability to survive this is already in doubt. Approximately 20% of the mortgages held by Fannie Mae (FNM) and Freddie Mac (FRE) are insured by the MI industry. Therefore the taxpayer will suffer the losses. If the California court reverses it’s decision (unlikely) then BofA and Bank of NY stand to lose. In this outcome the taxpayers will also suffer.
The President has proposed regulations that would protect consumers from predatory lending tactics. That is sorely needed. What is needed even more are some regulations that protect the taxpayers from footing the bill for everything that goes wrong. There is plenty of evidence that fraud has been committed by all involved. The lenders, the borrowers and Wall Street are all dirty. But it is our grandchildren that will get stuck with this bill.