A Heavy Crown

 | Oct 24, 2013 | 5:00 PM EDT
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In my recent column, "Revitalizing Housing," I said Wells Fargo's (WFC) stock should rise by at least 10% over the next 12 months. I stand by that recommendation, but you should be aware of a couple of specific issues concerning Wells Fargo -- detailed below -- as they could spur negative consequences for the bank at almost any time.

The first issue concerns the increasing plausibility that the Justice Department will bring an antitrust lawsuit against Wells Fargo regarding the bank's dominance of the U.S. residential mortgage finance market. It's becoming increasingly easy to make a prima facie case that Wells Fargo now has, or is quickly approaching, monopolistic power over this market.

Wells currently finances about 35% of all residential mortgages in the U.S, meaning it now dominates that market to an extent never before experienced in this country. The bank has also essentially displaced firms that used to perform most related services. For instance, it's now engaged in mortgage-origination, which used to be the domain of Fannie Mae and Freddie Mac. It's also packaging mortgages for sale to investors as mortgage backed securities -- an area that, in the past, had been dominated by the now-subsumed Bear Stearns and the long-defunct Lehman Brothers.

Wells Fargo is also now the prime supplier of wholesale mortgage capital to correspondent lenders and, as a result, it dictates underwriting requirements to much of the mortgage industry. What this means is, whether you get your mortgage from Wells Fargo directly or from any other lender, there is a high probability that its underwriting rules have been dictated by Wells Fargo.

At a recent mortgage banker's conference in Washington, one of the speakers said Wells Fargo has become a regulatory compliance company that does mortgages on the side. I don't cite this as a criticism of Wells Fargo, but it is pretty well true.

At any rate, this presents a situation ripe for an attorney at the Justice Department, or a state attorney general, to latch onto as a career-making antitrust-violation pursuit. It's important for investors to be mindful of this, because President Barack Obama is almost halfway through his second term with no chance of retaining his office. By extension, that means that the current U.S. Attorney General, Eric Holder, is also now a "short-timer." The closer an appointed official comes to the termination of their tenure, and thus control over the career bureaucrats they manage, the less pressure can be exerted upon them.

It is logical to conclude, then, that an attorney at the Justice Department will begin to pursue an antitrust-violation cause against Wells Fargo within the next few years -- but probably after the 2014 elections.

Let's now move on to the second pertinent issue when it comes to Wells Fargo: Eventually, and inevitably, one of the other three remaining money centers will decide to aggressively reenter the residential-mortgage business.

The most likely candidate at this time is JPMorgan Chase (JPM), which thus far hasn't been focusing on the domestic residential mortgage market. Instead the bank, under Jamie Dimon's leadership, has been expending most of its energy on displacing fellow money center Citigroup (C) -- crippled during the 2008 crisis -- as the primary U.S.-based international bank. JPMorgan has also been busy resolving its legacy mortgage issues, though these efforts are now approaching conclusion.

As for Bank of America (BAC), at some point it will also have to return its attention to U.S. residential mortgages. But, currently, most of management's time is being consumed by BofA's ongoing legacy issues emanating from the financial crisis and the absorption of Countrywide.

One of the old sayings in journalism is that everyone wants to be the first to be the second. In other words, it's safer to be the first to follow up on a story; nobody wants to break a story that turns out to be wrong. In the corporate world, this manifests itself in companies' wish to refrain from being too distinct from the competition, or too dominant in their market.

Wells Fargo, however, inherited its dominance of the mortgage market by default. All of the other money centers and large mortgage lenders had been absorbed by the remaining four: JPMorgan, Wells, BofA and Citi.

Wells Fargo was lucky enough to have absorbed Wachovia and the problem loans that that bank had inherited from World Savings. Unlike the mortgage loans at Countrywide and Washington Mutual, which were sold into mortgage-backed securities and are now causing regulatory and legal issues for BofA and JPMorgan, the World Savings mortgages were all held in portfolio and not sold into MBS. That afforded Wells Fargo the opportunity to quietly and internally clean up the problem loans.

But this has also resulted in a lack of competition in the mortgage industry, and it has afforded Wells Fargo the opportunity to create a leviathan internal regulatory and compliance scheme and bureaucracy that is arguably rivaled only by the federal government. Now that JPMorgan is wrapping up its legacy mortgage issues, investors should be watchful for it to potentially move more aggressively in the domestic banking market, and especially in mortgages.

If that were to happen, Wells Fargo would find itself facing its own existential crisis within a few years.     

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