WASHINGTON — Major U.S. banks are facing a double whammy from the subprime mortgage debacle: They're under siege over their mishandling of home loan foreclosures and confronting mounting investor demands that they repurchase billions of dollars in failed mortgage securities.
Amid revelations of the banks' potentially massive legal problems, Housing and Urban Development Secretary Shaun Donovan said Wednesday that 11 federal agencies are examining aspects of the home foreclosure and financing messes that have stalled the U.S. economy. He said the inquiries would ensure that banks, loan servicers and other institutions follow the law.
If investigators find that people were wrongly evicted from their homes, Donovan said, "We will take actions to ensure that banks make them whole and make sure that their rights have been protected and defended."
Donovan said an initial review of the Federal Housing Administration's five largest loan servicers found that some had breached the agency's foreclosure procedures, but that nationwide reviews so far haven't identified "systemic issues."
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The HUD secretary addressed a White House news briefing after he and Treasury Secretary Timothy Geithner led an inter-agency meeting to address the latest fallout from the subprime mortgage meltdown that sent the economy reeling.
While revelations about loan servicers' use of phony affidavits and failure to transfer loans properly have dominated the headlines, major banks appear to be facing far bigger perils.
Not only could they be blocked from evicting delinquent borrowers, but some also face the possibility they'll be forced to buy back billions of dollars in mortgage bonds that have since sunk in value.
Analysts at J.P. Morgan Chase estimated this week that banks that underwrote more than $3 trillion in risky mortgage bonds will be compelled to repurchase $55 billion to $120 billion in securities over the next few years because the underlying loans are defective.
"Banks are trying to put a good face on this," said James Cox, a Duke University law professor who specializes in securities. However, he said, the dimensions are "potentially catastrophic" from blunders in documenting the chain of custody of the mortgages, and bondholders' demands for repayment appear to have "tremendous value."
Effectively, banks are being punished for their treatment of both the marginally qualified borrowers of their subprime mortgages and the investors who bought securities backed by those loans.
Bondholders are pursuing massive claims against Bank of America and other big banks, alleging that they were sold defective products.
Bank of America owes most of its risks to its purchase of Countrywide Financial, one of the largest issuers of subprime mortgages.
On Monday, bondholders with more than 25 percent of the voting rights on $47 billion in Countrywide mortgage securities notified the Charlotte-based bank that Countrywide's loan servicing had failed to perform, the first step toward declaring a default. The bondholders complained that the underlying loans didn't meet the guidelines that were laid out when they invested.
Among the bondholders: the Federal Reserve Bank of New York, which wound up owning Countrywide-originated mortgage securities as part of the federal rescue of the giant insurer American International Group.
Underscoring the extent of the legal tangle, some government agencies are suing the banks, and some of the bondholders are suing the Federal Deposit Insurance Corp.
Germany's Deutsche Bank, a trustee for pension funds, municipalities and other investors facing huge losses on these bonds, sued the FDIC because it served as receiver for Washington Mutual and IndyMac Federal Bank, two giant lenders that failed in 2008.
Deutsche Bank alleges that the FDIC took the place of the two banks in purchase contracts and agreements with the investors, even though it turned their deposits over to successor institutions.
The FDIC has filed motions to dismiss the two suits in federal district courts in the District of Columbia and Los Angeles.
Some hedge funds, such as Greenwich Financial Services, have begun buying the mortgage bonds at depressed values, in the belief that they can collect huge returns in suits against the big banks. William Frey, Greenwich's chief executive, said his investor group controls $600 billion in mortgage-backed securities.
Cox said he thinks the suits, even those pursuing taxpayers, have strong potential "settlement value," because "there is a lot of uncertainty about the law, as we've never seen anything like this."
As for the bungled paperwork that forced Bank of America and some other banks to halt foreclosure proceedings temporarily, Cox said: "I'm still waiting to get a sense about whether this is just a hiccup in the system or whether this is an embolism."
Donovan, appearing two weeks before the midterm elections, sounded a stern note in describing ongoing reviews by agencies ranging from the Federal Reserve Board to the Federal Trade Commission and state attorneys general.
"Throughout our reviews, as we uncover bad practices, cutting corners or sloppy processes that disregard or ignore the rights and protections of any homeowners, we're committed to forcing institutions to change the way that they conduct business," he said.
Among the agencies involved:
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