On June 29 we learned that Bank of America will pay $8.5 billion to settle claims by big investors, including the New York Federal Reserve, that mortgage backed securities sold by Countrywide (which BofA acquired in the heat of the financial crisis) weren't as pristine as they were cracked up to be. That's good news for investors. The settlement may also, down the road, create some good news for homeowners.
BofA's misadventures in mortgages began in early 2008, when the bank's then-CEO, Ken Lewis, agreed to pay $4 billion to acquire Countrywide. It seemed like quite a bargain. The American Banker anointed Lewis "banker of the year," calling him a "critical force for stability in a tumultuous economic time." But the Countrywide acquisition, combined with BofA's purchase of Merrill Lynch in the fall of 2008, made BofA the only major financial institution to buy its way into the financial crisis. Thanks to the terrible quality of the mortgages Countrywide made, the deal quickly turned out to be more expensive than it had originally looked. The first sign of that came in 2008, when BofA paid the estimated equivalent of $8.6 billion in loan modifications to settle a lawsuit brought against Countrywide by 11 state attorneys general.
BofA said it had anticipated that settlement, but another front opened last fall when the big investors, which in addition to the New York Fed included BlackRock and Metlife, sent a letter alleging that Countrywide's "representations and warranties"—the legal promises to buyers about the quality of the mortgages they were buying—weren't true. The initial group of just eight investors who owned mortgage-backed securities that had had an original face value of $104 billion quickly mushroomed to 22 investors holding securities with an original face value of $424 billion.
On Wall Street, talk began to fly that activist hedge funds were buying up sour mortgage-backed securities that were trading at big discounts with the express hope of forcing the banks to buy them back at full price. Chris Gamaitoni, an analyst at Compass Point, estimated that the 10 biggest banks, including Bank of America and Goldman Sachs, could end up losing almost $200 billion thanks to mortgage repurchases. An investor named Ron Beller, who was a former Goldman partner, put out a presentation estimating that BofA alone might have to pay as much as $74 billion to repurchase mortgages, and that its stock could fall to as low as $6. Perhaps not surprisingly, BofA's stock began to fall.
Right around the same time, the news hit that the big servicers, including, of course, BofA, had tried to turn the foreclosure process into a high-volume factory via sleazy practices like "robosigning"—having employees sign off on foreclosures without properly reviewing the documents. A deeper worry emerged: Could it be that the entire process of securitization was flawed? Sloppiness in the way the securities were constructed could mean that investors had been totally defrauded, because they never really owned the mortgages they thought they were buying. That, of course, would mean astronomical liabilities for the banks. By this spring, state attorneys general, some of whom were up in arms about the way homeowners had been treated, began to float the idea that banks would have to pay upward of $20 billion to settle some of this.