Banks Could Face New Mortgage Lawsuits As Fresh Losses Emerge For Investors

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If a recent review of several troubled mortgage-backed securities is to be believed, investor woes originated from these securities in the run-up to the economic downturn of 2008, may be far from over. [1] Already having incurred substantial losses on these investments over the years, investors are not going to be too happy with the news that these securities may very well be worth billions less than what is reported. The discrepancy stems from the fact that in hundreds of instances, the individual mortgages which are shown as foreclosed have actually been sold off or paid off quite some time ago. So not only do investors in the securities continue to pay a monthly fee for these ‘foreclosed’ properties, the total value of the securities they hold are unaccounted for any shortfall in price for the property sold or settled.

The revelation is likely to trigger yet another wave of lawsuits against some of the country’s biggest banks as well as mortgage servicing firms, as disgruntled investors look to be compensated for these unwarranted losses. This would represent one step backwards for the progress Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) have made over the recent years, to clear-up their mortgage-related legal overhangs. BNY Mellon (NYSE:BK) will also face the music for failing its duties as the trustee for most of these securities.

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As investors in the booming U.S. housing market realized within months of the bubble burst that mortgage-backed securities were going to be a long term liability for everyone involved in the process. From the lender who originated the (sub-prime) mortgage, to the bank that converted huge chunks of these mortgages into securities, the other bank acting as trustee for these securities and to the servicer of the loan. Not to forget the investor himself. And a good five years later, mortgage-backed securities remain the biggest source of headache for the country’s financial industry.

Among all the financial institutions, Bank of America has had to jostle with mortgage-related issues the most due to unregulated sub-prime lending by Countrywide which it acquired at the peak of the economic downturn. It looks like the bank and its peers will have to brace for more lawsuits in the wake of a report by foreclosure investigator Lisa Epstein, which shows that various mortgage securities are inaccurately reporting the condition of underlying mortgages. As a result, the values of the securities are inflated even as investors continue to incur monthly charges on loans that have often been cleared a couple of years ago.

Epstein’s report is likely to be taken seriously by investors, as she was one of the investigators who helped unearth the robo-signing scandal among the banks in 2009. The country’s biggest banks have settled robo-signing lawsuits against them for millions, and they might just end up with millions more in settlement costs from these recently discovered discrepancies. The impact of this on Bank of America can be understood by making changes to the chart below.

Banks have already responded to the imminent threat by pointing the finger at mortgage servicers like Ocwen, who take care of the day-to-day activities related to each mortgage. The way we see it, the best solution for everyone involved is for the servicers to publish a thorough report on the condition of all mortgages underlying the securities under fire. While no doubt a mammoth task, the sooner this is completed, the quicker banks can make amends with investors and resolve the issue before it escalates.

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Notes:
  1. Losses loom for investors enmeshed in U.S. mortgage chaos, Reuters, Jun 21 2013 []
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