Banks Dig In Their Heels on Mortgage Settlement

 | Sep 08, 2011 | 4:30 PM EDT
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I've written a few columns recently about actions being taken by both fiscal and monetary authorities that should be positive for the economy.

The gist of the columns is that the Federal Reserve and the executive branch are trying to get the financial markets and economy past the fallout from the recent financial crisis, with the goal of stabilizing the relationship between the public and private sectors.

That sets the stage for an increase in investor and consumer confidence, which is a prerequisite for the private sector to expand and for the virtuous cycle of consumption and production to become self-validating again.

What I have not discussed, but will now, are the actions being taken by the private sector, principally the money-center banks, in response to the public sector's overtures.  As the old saying goes, it takes two to tango.

But the private sector does not appear to be interested in responding substantively to the actions and proposals being made by the public sector to resolve the residual legal issues that led to the financial crisis of 2008. And this is very troubling. As discussed in those previous columns, the Obama administration and the Federal Reserve have taken positive steps.

In the normal course of relationships, either personal or business, such actions are akin to putting the ball in the other court. In this case, in order to arrive at a resolution, the money centers must respond substantively.

However, as near as we have been able to ascertain, this isn't happening. The money centers do not appear to be interested in entering into real negotiations with the Obama administration concerning a universal settlement to the residual legal and regulatory issues related to the treatment of mortgages.

This has left the administration in the position of having to negotiate with itself. That process can go one of two ways: Either Obama and his team "chase the sale" by offering to accept less in return for a settlement with the banks, or they can play hardball and do the exact opposite.

The administration appears to be choosing to play hardball.

Over the past 10 days:

  • The Federal Housing Finance Agency filed a suit against the banks for mortgage losses they claim were absorbed by Fannie Mae and Freddie Mac.
  • The Department of Justice has begun investigating a report by the Department of Housing and Urban Development that the money centers have been receiving kickbacks from the insurers of their mortgage portfolios.
  • The Federal Reserve has begun an enforcement action against Goldman Sachs (GS) for "a pattern of misconduct and negligence" on mortgage loans.

All of these issues could be wrapped into a settlement with the banks, and perhaps one of the goals in taking these actions now is to compel the banks to work with the administration on crafting such a settlement.

But there is a darker potential outcome as well. It is possible that the banks have already decided that they are going to wait out the administration, in expectation that a new president being inaugurated in January 2013 will be more accommodating to the banks.

If that is indeed the case, it would be an extraordinarily risky move on the part of the banks. It would also a very negative indication of banks' intentions regarding lending over the next 14 months in the run-up to the election.

For investors, if a settlement is not reached, the companies most at risk are the ones with the greatest proportion of residential mortgage debt on their balance sheets, and three names stand out above all of the others: Bank of America (BAC), JPMorgan Chase (JPM) and Wells Fargo (WFC). Bank of America absorbed the Countrywide portfolio, JPMorgan Chase bought Washington Mutual, and Wells Fargo got the Wachovia / Golden West / World Savings portfolio of mortgages.

Of the 17 banks listed in the FHFA lawsuit, First Horizon (FHN) has the largest second trust portfolio and has uniquely negative issues because of it.

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