Greenwich CEO William Frey Primed to Become the Lorax For Investors Without a Voice?

Posted on February 11, 2009 by Isaac Gradman

One of the most interesting stories we’ve been following in the world of mortgage crisis litigation has been the lawsuit filed by Greenwich Financial Services CEO William Frey against Countrywide Financial Corp., Countrywide Home Loans, Inc. and Countrywide Home Loans Servicing LP (all now part of BofA). As discussed in several prior postings, Frey has sued Countrywide on behalf of investors in subprime mortgage-backed securities for violating its securitization agreements when it agreed to large-scale loan modifications as part of its $8 billion settlement with Attorney Generals from dozens of states.

In going back and reading news coverage on this story, I came upon a story in the Wall Street Journal from December 1, 2008 that I had missed. The article, entitled “Mortgage-Bond Holders Get Voice: Greenwich Financial’s William Frey Challenges Loan Servicers Like Bank of America“, contains several quotes from Frey that reveal broad aspirations beyond this first lawsuit against Countrywide (thanks to msfraud.org for posting this article). According to the article:

Mr. Frey says he may negotiate with mortgage servicers on behalf of bond investors or file lawsuits against other mortgage-servicing companies. “This is an opening salvo,” he says.

The story instantly recalled images from my childhood of Dr. Seuss’ timeless masterpiece, “The Lorax.” For those who are not familiar with eponymous hero of the Dr. Seuss story, the Lorax was a diminutive but wise character who spoke for the trees because the trees had no voices to speak for themselves (you can find the text of the story here, but like most Dr. Seuss stories, the illustrations are indispensable). The story has been hailed as an “environmentalist classic,” but it could just as easily be considered an allegory about the consequences of unchecked greed and unsustainable growth, two familiar culprits of our current financial calamity. Amidst this modern tale of disaster, it would appear that Frey views himself as the Lorax, speaking for mortgage bondholders who had no voice in the Countrywide settlement. And the WSJ article reveals Countrywide may be just the beginning, as Frey intends to represent additional bondholders in disputes with mortgage servicers.
In Dr. Seuss’ tale, the Once-ler family of loggers ignores the warnings of the Lorax, who lacks any power to affect their actions, and the Once-lers continue cutting down trees until they have all disappeared. Whether the result will be the same for Frey and mortgage bondholders depends in large part on whether they have any power under the terms of their Pooling and Servicing Agreements with Countrywide to require repurchases of modified loans. But this raises an interesting question: how did Frey gain the authority to become the spokesperson for mortgage bondholders in the first place? Surprisingly, the WSJ story suggests that Frey may not have even had standing to contest Countrywide’s settlement until he began acquiring affected securities:

Mr. Frey didn’t initially hold any of the Countrywide bonds that are the subject of the settlement. But in the past month he set up a distressed-bond fund that, he says, contains “substantial holdings” in Countrywide bonds. These bonds were transferred into the fund by one investor who wanted to challenge the company’s actions while staying out of the spotlight. “This is a vehicle designed to put me in charge of resolving these pools,” Mr. Frey says. Mr. Frey and his attorney, David Grais, decline to name the investor or provide information about the size of the fund or whether Mr. Frey himself had invested any money in it.

So, let me get this straight: Frey is actually the spokesperson for a wealthy investor, who in turn has transferred bonds that were the subject of the Countrywide settlement to Frey so that he could have standing to represent a larger class of aggrieved bondholders. Hmmm… not only is it clear that Frey is no Lorax, but this mysterious investor behind the Greenwich lawsuit may not be driven by a higher moral calling, either. After all, if Greenwich is able to prevail and force Countrywide to repurchase the subject loans at face value, this clandestine investor would receive a financial benefit compared to the current depressed value of the bonds (or perhaps this investor actively purchased these bonds hoping that he’d realize a profit as a result of a successful outcome to the Greenwich litigation). Thus, it appears the mantra repeated by the Once-lers to justify exploiting the environment and by mortgage originators and banks to justify massive expansion of their lending programs, may be the same mantra underlying Greenwich’s challenge to the Countrywide settlement: “business is business, and business must grow.”

Posted in Attorneys General, BofA, causes of the crisis, Countrywide, Greenwich Financial Services, lenders, loan modifications, repurchase, William Frey | 4 Comments

Pennsylvania Joins Countrywide Settlement, But Where Is the Money Coming From?

Posted on January 31, 2009 by Isaac Gradman

Pennsylvania Attorney General Tom Corbett, whose office spent several months investigating deceptive mortgage practices alleged against Countrywide and its affiliates, has announced that Pennsylvania has joined the $8 billion settlement announced in October with Attorneys General from now over thirty states.

In exchange for extinguishing the state’s claims against Countrywide, the settlement will allegedly make over $150 million available to help keep borrowers with subprime and pay-option mortgages in their homes.
As discussed in several previous posts (collected here), the primary question engendered by this news is who will really bear the cost of these loan modifications? Though a surface-level reading of the news makes it appear that Countrywide (or BofA) will actually pay $150 million to the state of Pennsylvania to help keep borrowers in their homes, the truth is that Countrywide, which no longer owns most of these loans, will work to modify the terms of the loans to allow borrowers to keep making payments. Though the ultimate loss in revenue generated by the loans may be around $150 million, investors such as hedge fund Greenwich Financial Services have claimed that this loss is actually born by the investors who currently hold an interest in the loans (see, e.g. prior posting here), rather than by Countrywide, which is acting simply as servicer. According to a suit recently filed by Greenwich against Countrywide, this result is contrary to the terms of Countrywide’s Stipulated Judgment with the Attorneys General.
Why this fundamental issue has not been identified by the Attorneys’ General, let alone satisfactorily explained, is anyone’s guess. However, it doesn’t take a rocket scientist to realize that when BofA purchases Countrywide for $4 billion and then quickly settles claims against the entity for $8 billion, something doesn’t add up.
Posted in Attorneys General, BofA, Countrywide, Greenwich Financial Services, investors, lawsuits, loan modifications, pay option ARMs, settlements, stipulated judgments, subprime | 1 Comment

Subprime Shakeout Discussed in Volokh Conspiracy Post On Formation of Aggregator Bank

Posted on January 26, 2009 by Isaac Gradman

On January 19, 2009, Eric Posner from the Volokh Conspiracy cited to the Subprime Shakeout in his article entitled “Why should the government buy toxic assets?” The post addressed the idea of an “Aggregator Bank” that would acquire the mortgage-backed securities that banks can’t or won’t sell–the original and much-debated purpose of TARP (the original government bailout plan).

In discussing the benefits and potential drawbacks of an Aggregator Bank, the article asked:

What is gained by this exercise? Not increased certainty or the discovery of the “real” value of the MBS’s. It would have to be—if the intervention were to make sense at all—that the MBS’s are worth more aggregated in the hands of the Aggregator than they are in the hands of banks and other investors scattered around the world. How could this be the case?

To see how, consider some of the litigation that has erupted as a consequence of the subprime crisis. This excellent blog, by Isaac Gradman, provides some examples. Debtors and attorneys general are suing loan originators like Countrywide for predatory lending practices, and winning settlements. Under the terms of these settlements, the mortgage loans are modified, with principal and interest reduced. The problem is that Countrywide is now the loan servicer for these loans, so if it agrees to lower payments, as it has, the holders of MBS’s, not Countrywide, incur the loss. Can it do this? A definite maybe! Everything depends on the terms of the contracts between the loan servicer and the MBS holders.

Posner is correct that in the particular case of Countrywide, which settled with the Attorneys General of over a dozen states for upwards of $8 billion in what was widely-hailed as the largest predatory lending settlement in U.S. history (see prior post here), the question of who bears the cost of loan modifications comes down to the terms of the contracts between Countrywide and the investors. The settlement itself does not appear to provide for Countrywide to bear the cost of modifications, but does require some consultation with investors. If the contracts likewise do not provide for Countrywide to bear these costs, the great victory claimed by the Attorneys General for engineering this settlement would be rendered ethereal, as investors would bear the entire cost of the poor underwriting and predatory lending practices that led to the suits against Countrywide in the first place. Indeed, how could this be called the largest predatory lending settlement in U.S. history and a “model for other lenders” if the alleged predatory lender was able to shift the cost burden of its modifications onto investors?

The mere fact that this important issue of cost was not addressed by the terms of the settlement agreement is either a horrendous oversight on the part of the Attorneys General, or reveals that the settlement was mere political window-dressing that was never intended to actually punish Countrywide, but only to make it appear that the company was being chastised. This lends even more credence to the lawsuit brought by Greenwich Financial CEO William Frey against Countrywide, discussed in previous posts gathered here.

Loan modifications are ordinarily structured such that the expected value to investors from modifying the loan (in net present value terms) is greater than the expected return from immediate foreclosure. For example, by lowering a borrower’s interest rate to something he or she can afford, but extending the term of the loan or increasing the principal balance, a borrower may be able to continue making payments that will benefit investors in the long run compared to an immediate foreclosure (which, as Posner points out, typically results in a fifty percent drop in the value of the home). However, when loan modifications are being conducted, not for the benefit of the investor, but because the loan was originated in a predatory or otherwise improper manner, the cost of such a modification should obviously be borne by the party responsible for such negligent or predatory practices. Instead, when the $8 billion plus expected loss is born under the terms of the settlement agreement by largely innocent investors, it should be no surprise when massive litigation follows. Thank you to the Volokh Conspiracy for continuing to highlight this important issue.

Posted in Aggregator Bank, Attorneys General, Countrywide, Government bailout, Greenwich Financial Services, investors, loan modifications, predatory lending, securities, settlements, TARP, Volokh Conspiracy | Leave a comment

New Class Action Targets Former AIG CEO Cassano

Posted on January 16, 2009 by Isaac Gradman

Courthouse News Service reports that a new shareholders derivative complaint has been filed in the Chancery Court in Delaware against former American International Group Financial Products (AIG-FG) CEO and president Joseph Cassano for allegedly driving AIG to ruin by losing $33 billion in the subprime credit market.

The double derivative lawsuit, filed by the law firm Chimicles & Tikellis on behalf of shareholders of AIG-FG, who themselves are suing on behalf of nominal defendant AIG-FG, seeks to recover damages and obtain disgorgement of unjust profits from Cassano for breaches of his duty of loyalty to AIG-FP. The suit quotes New York Attorney General Andrew Cuomo as saying that AIG-FP was “largely responsible for AIG’s collapse” and U.S. Rep. John Sarbanes, who said during a hearing of the House Committee on Oversight and Governance Reform that “it appears to me that [Cassano] single-handedly brought AIG to its knees.” The suit further alleges that despite Cassano’s poor management and questionable business practices, the AIG board permitted Cassano to retire with a lucrative compensation package worth upwards of $43 million.
It will be interesting to see how well such derivative shareholder class actions fare in pinning responsibility for large financial crisis-related losses on the executive of major financial institutions (see prior article on loss causation issues). Given the scope of this crisis, it is difficult to believe that any individual “single-handedly” brought a company that in 2007 insured $500 billion in debt instruments to its knees. And proving such massive loss causation in a court of law would be even harder.
While we would love to hold those at the top, who certainly made many questionable decisions and exercised poor judgment during the last several years, responsible for their actions, and while it rankles our sense of justice to see these individuals walk away with millions, it was the financial climate (fueled and supported by everyone from national governments to individual borrowers) that made such massive abuses possible. I’m not suggesting that people like Cassano, if it can be proven that they acted negligently or criminally, should not be held responsible. But, it is far too easy to blame this on a few high-powered individuals, rather than taking a hard look at the circumstances and the society that engendered and encouraged yet another financial bubble to mutate unsustainably.
Whenever too much money chases too few good investments, it creates a climate ripe for another meltdown; and until the incentives change, the villains may be different, but the results will stay the same.
Posted in AIG, causes of the crisis, class actions, derivative lawsuits, incentives, litigation, loss causation, public perceptions, shareholder lawsuits, subprime | Leave a comment

Citigroup Becomes First Lender to Cave to Mortgage Principal Reductions by Bankruptcy Judges

Posted on January 10, 2009 by Isaac Gradman

It’s official: the first domino has fallen.

The L.A. Times has reported that Citigroup Inc. has agreed that bankruptcy courts should be allowed to change the terms of mortgages, including ordering reductions in the principal amount of loans, as part of court-ordered debt restructuring for troubled borrowers. In doing so, Citigroup becomes the first major mortgage lender to buck the industry’s fierce opposition to this change in the nation’s bankruptcy laws, currently being proposed in the U.S. Congress.

Though legislators and consumer lobbying groups have been calling for this change for years, and this chorus of calls grew markedly louder during 2008, the unified opposition of the industry and Republican lawmakers (as well as a few Democrats) have thus far combined to defeat this change–even as part of the $700 billion TARP bailout bill in the fall. Their argument? That giving bankruptcy judges this power would increase the cost to future homeowners and reduce available credit. In the climate of the previous ten years, a reduction in credit to potential homeowners was considered a very bad thing.

But now the U.S. economy has experienced a reduction in credit across the board and with foreclosures skyrocketing, the focus has clearly shifted away from preserving cheap credit to providing aid to existing homeowners struggling to make their monthly payments.

Lawmakers believe that Citigroup’s acquiescence will encourage other major banks and mortgage lenders to follow suit, bringing about a logical expansion to the powers of bankruptcy judges. Indeed, Chapter 13 already allows judges to to reduce the principal balances of auto, credit card and other loans, but have been completely restricted from doing so in the mortgage context.

So why the turnabout? No, Citigroup did not suddenly find a soft spot for troubled borrowers. Instead, the current economic climate and the new administration appear to be the primarily drivers of this change in course. The Obama administration has made this reform a central part of its economic package, and legislators are eager to provide aid to its constituents clamoring for relief in the face of a housing crisis and a deepening economic downturn. Citigroup sees the writing on the wall, and likely believes its best approach is to achieve what concessions it can now, before the tide turns completely against it and its holdout becomes irrelevant. It probably doesn’t hurt that Citigroup also fears that the nice stream of income coming in from the government’s $700 billion bailout fund could dry up quickly if it continues to hold out.

The concessions Citigroup has demanded actually form the most intriguing aspect of this shift. As reported in the L.A. Times article:

Citigroup said it would support [Senator Richard] Durbin’s legislation provided that it applied only to mortgages in effect before passage of the act. To be eligible, borrowers would have to contact their lenders and try to work things out before filing for bankruptcy.The company also said it would support the proposal only if a provision was eased that would void the mortgage if the lender was found to have violated consumer protection laws.The exception would be if the lender violated specific sections of the Truth in Lending Act that already carried such rescissions of mortgages as penalties

What does this all mean? Most obviously, Citigroup wants this change in the law to be a temporary measure, available now to provide relief, but not available to any new homeowners going forward. But what about the second part–easing provisions that would void the mortgage if Citigroup was found to violate consumer protection laws? Something tells me Citigroup is aware of widespread violations of these laws on its part and is afraid that homeowners will band together to obtain rescissions of their mortgages en masse. As discussed in a prior posting here, the Seventh Circuit has recently ruled that Truth-in-Lending-Act (TILA) violations could not form the basis for class action complaints. But, that’s just one court’s take on an issue that is still open for the debate. And in this current economic and political climate, as Citigroup’s capitulation demonstrates, the tides can turn in the blink of an eye.

Posted in bailout, bankruptcy, Barack Obama, cheap money, Citigroup, class actions, contract rights, homeowner relief, legislation, loan modifications, recession, Seventh Circuit, TARP, TILA, workouts | 2 Comments