A.I.G. and Countrywide Go Head-to-Head Over Mortgage Insurance Coverage

Posted on March 23, 2009 by Isaac Gradman

The battle of the titans has begun. As reported by Reuters on Friday, both A.I.G. and Countrywide have now sued one another over who will bear the losses on a $1 billion pool of subprime mortgage loans.

Countrywide fired the opening salvo on Wednesday when it sued A.I.G.’s United Guaranty Mortgage Indemnity Co. in Los Angeles County Court, alleging that the insurer was refusing to honor its mortgage insurance obligations. One day later, United Guaranty responded by suing Countrywide in federal court in Los Angeles, alleging that Countrywide had misrepresented the risks tied to the pool of mortgage loans and had failed to follow its own underwriting guidelines.
Based on the arguments asserted by both sides in their complaints, this clash of mortgage giants features two familiar but wildly disparate perspectives on the causes of this crisis. On one hand, Countrywide argues that United Guaranty profited for years from the premiums it received to insure loans against borrower default, but now that it is “fac[ing] the reality of steep financial losses because of a significant economic downturn,” United Guaranty is trying to escape its obligations.

On the other hand, United Guaranty argues that Countrywide took advantage of its long-standing relationship with the insurer to induce United Guaranty to insure loans that never should have been approved. According to another article in Bloomberg, United Guaranty’s review of loan files from 11 separate policies for asset-backed securities revealed that most either violated Countrywide’s own underwriting standards or had material defects such as misrepresented credit scores or fake social security numbers.

United Guaranty will likely have a mountain of salacious evidence on its side to demonstrate Countrywide’s improper and irresponsible lending, as other lawsuits against the former lending giant have revealed a shocking abandonment of underwriting standards and practices. Yet, United Guaranty will have several hurdles to overcome. First, according to its Complaint, United Guaranty has already paid out over $30 million in insurance claims on these loans. This is sure to raise arguments of waiver or estoppel by Countrywide and questions of whether the insurer should have known about the quality of loans when it placed insurance coverage or, at the very least, when it paid claims. Second, United Guaranty will have to counter Countrywide’s argument that these losses were caused by the broader economic downturn, and show that they were caused, in fact, by Countrywide’s abusive and irresponsible lending practices. United Guaranty might be able to do this by demonstrating that this pool of mortgage loans is significantly worse than comparable pools and/or by showing that Countrywide’s underwriting deficiencies directly caused the loans to fail. The latter approach will likely prove much tougher than the former, as we have already seen litigants struggle to make out the loss causation claim in prior mortgage crisis litigation.
Regardless, this heavyweight legal matchup will be closely watched by the industry and is certain to have a significant impact on future lawsuits stemming from the broader financial crisis.
Posted in AIG, allocation of loss, causes of the crisis, Countrywide, lawsuits, lenders, litigation, loss causation, misrespresentation, mortgage insurers, underwriting practices, United Guaranty | 1 Comment

Senate to Consider Bill That Threatens to Obliterate Mortgage Bondholders’ Contract Rights

Posted on March 16, 2009 by Isaac Gradman

On March 5, 2009, the U.S. House of Representatives passed H.R. 1106, also known as the “Helping Families Save Their Homes Act of 2009,” which threatens to override the contract rights of bondholders who invested in mortgage-backed securities (MBS). A version of the bill has been referred to the Senate Committee on Banking, Housing and Urban Affairs, but the Senate has not yet voted on the legislation. You can follow the progress of this bill here at govtrack.us or here at thomas.loc.gov.

In its current form, H.R. 1106 contains several provisions that would undermine investors’ contract rights and could result in a significant shifting of economic losses to bondholders. First, the bill will allow judicial modification of primary residential mortgages in borrowers’ bankruptcy proceedings (also known as “bankruptcy cramdowns”). This means that judges can now forgive principal on the debtor’s primary residential mortgage, just as they already could for other types of debt. This change in the bankruptcy codes, part of President Obama’s economic plan, has been anticipated for some time, especially since banks began relaxing their opposition to this idea (see prior posting regarding Citigroup here).

However, the troubling aspect of H.R. 1106 for investors is Section 124, which renders unenforceable, as against public policy, any provisions of investment contracts between servicers and securitization vehicles that require excess bankruptcy losses over a certain dollar amount to be borne by all classes of certificates on a pro rata basis. What that means is that instead of having bankruptcy losses hit every bond in the capital structure proportionately, the losses from bankruptcy cramdowns will now “trickle up” from the most junior bonds before hitting senior bonds (the traditional way losses are treated).
Yet, such pro-rata loss provisions in securitization contracts were put in place specifically to attract investors for the junior classes of securities and assuage their concerns that they would be disproportionately exposed to excess bankruptcy losses. Currently, many of the senior classes of bonds in these securitizations are held by major lending institutions who fear that downgrades will put significant pressure on the amount of capital they’re required to hold by law. The practical impact of Section 124 is thus to shift the the loss burden from banks to bondholders. I’ll discuss the constitutionality concerns raised by such a shift in a later posting, but query whether, from a purely equitable standpoint, the risk that borrowers would not be able to make their mortgage payments should be born by banks that often underwrote and issued these loans, or by the outside investors who specifically contracted against bearing that risk.
The second provision raising equitable concerns is the so-called “Servicer Safe Harbor.” This provision will have a direct impact on who will bear the losses for loan modifications, another important issue for the financial well-being of banks, and one that has been discussed at length in prior postings on this blog. Again, many contracts governing securitizations contained provisions mandating that servicers bear the costs of any loans they modify, such as by lowering a borrower’s interest rate, extending the duration of the loan, or reducing the borrower’s principal balance. This is the precise issue being litigated in a suit by Greenwich Financial Services against Countrywide (see prior postings here).
The Servicer Safe Harbor provision of H.R. 1106 threatens to cause a sea change in the loan modification landscape. Pursuant to this provision, servicers will not be obligated to repurchase loans or make payments to the securitization vehicle because of loan modifications or other loss mitigation plans, so long as the loans subject to modification are in default or default is reasonable foreseeable (which is the case for most loans eligible for modification). As if this shift in liability wasn’t dramatic enough, the bill also provides cash incentives ($1000 per loan) for servicers to modify loans, in an attempt to help defray origination costs. Keep in mind that these will apply more often than not to the same servicers who originated the loans and were often grossly negligent in underwriting the loans to determine if the borrower actually had the ability to repay. Not only would this bill let such servicers off the hook for their irresponsible lending practices (see, e.g., prior postings here and here on Countrywide passing off the costs of its settlement with Attorneys General), but servicers will now get handouts from the Government for correcting their mistakes! With the current political climate so supportive of “Helping Families Save Their Homes” and easing the rates of foreclosure, it seems that the goal of allocating losses fairly to the parties who contributed most to this mess has been utterly forgotten.
Check back soon for an analysis of the potential constitutional challenges to H.R. 1106 if, as expected, the bill is passed by the Senate in the coming weeks…
Posted in allocation of loss, bankruptcy, bankruptcy cramdown, Countrywide, Greenwich Financial Services, Helping Families Save Homes, legislation, litigation, loan modifications, Servicer Safe Harbor | 1 Comment

Protesters Converge on Front Lawn of Greenwich CEO’s Home

Posted on February 14, 2009 by Isaac Gradman

In another unexpected twist in the fight over the cost of loan modifications, the Stamford Times and the Greenwich Time have reported that protesters converged outside the home of Greenwich Financial Services CEO William Frey on February 8 to protest Frey’s lawsuit against Countrywide and Bank of America. The protest, part of three-day homeowners’ workshop sponsored by the Neighborhood Assistance Corporation of America (NACA), involved anywhere from 350 to 400 people wearing bright yellow hats and T-shirts with pictures of sharks and the words “Stop Loan Sharks” emblazoned on the front (see picture at right).

In one of the most bizarre facets of this story, the protesters, according to the Stamford Times article, placed furniture on Frey’s front lawn to “symbolize the dislocation felt by people who have had their homes foreclosed upon and been evicted, their belongings tossed outside by state marshals.” The article went on to describe how, according to NACA CEO Bruce Marks, this protest was part of an aggressive and confrontational “Predators Tour” aimed at several top executives of companies that refuse to allow NACA to renegotiate the terms of the loans on behalf of its members. According to the Greenwich Time article, the nonprofit’s accountability campaign targets company executives who they believe contributed to the subprime mortgage crisis to encourage them to support the refinancing of these loans.

While I can understand the anger felt by many homeowners at the greed displayed by banking executives such as Merrill Lynch CEO John Thain and others who profited handsomely during the housing bubble, it seems to me that NACA’s protests aimed at Frey are entirely misguided. For those familiar with Greenwich Financial’s lawsuit against Countrywide (discussed in prior postings here), it should be clear that while Frey is intervening in Countrywide’s settlement with dozens of Attorneys General, it’s not because he opposes loan modifications in principle. Instead, Frey seeks to have the costs of these modifications borne by the party primarily responsible for issuing deceptive or unreasonable loans.

The Attorneys General brought charges of predatory and unreasonable lending practices against Countrywide that the company clearly felt were substantial enough to settle for upwards of $8 billion. However, recent evidence has emerged that these costs are not actually coming out of Countrywide’s pockets, but instead being passed down to the ultimate bondholders, who did not directly engage in predatory lending.

Of course, it’s true that investors exhibited a voracious appetite for subprime mortgage-backed securities during the boom, but most of the pooling and servicing agreements for such bonds contained exhaustive representations and warranties by the lenders that the loans were not originated in a predatory or unprincipled manner. For Frey to attempt to hold Countrywide to its representations and force the company to bear the costs of its practices seems perfectly reasonable, even if fundamentally self-interested.

Most would agree that loan modification and foreclosure avoidance will be integral to any comprehensive financial stimulus. But, in the rush to secure loan modifications, it appears that the consequences and costs were not carefully thought through, resulting in the liability being fixed on parties other than those primarily responsible for these problems. Instead, shouldn’t NACA and other homeowner advocacy groups be focusing their anger and political pressure on lenders who ignored any semblance of quality control measures or reasonable lending practices to push greater and greater volumes of loans through the door? What about protesting outside the homes of the Attorneys General who boasted of achieving comprehensive homeowner relief while letting those responsible almost entirely off the hook? It seems these parties are much more deserving of finding couches and armchairs strewn across their front lawns than is William Frey.

Even more radical, it seems, is the idea that instead of pointing fingers at large companies for their problems, troubled homeowners should start by taking a good hard look in the mirror and deciding whether they were being realistic when they took out such hefty loans. If they were being honest, many would have to admit that they expected to be able to refinance into perpetuity to afford mortgage payments beyond their means. While there was certainly a significant volume of predatory lending occurring during the last ten years, I believe, as I’ve discussed in the past, that we all have to hold ourselves accountable to some degree for the borrow-and-spend culture that led to this inevitable credit crunch.

Posted in Attorneys General, causes of the crisis, costs of the crisis, Countrywide, Greenwich Financial Services, John Thain, loan modifications, NACA, pooling agreements, responsibility, William Frey | 3 Comments

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