High & Low Finance: Bank of America and MBIA Revisit the Mortgage Debacle

The battle being fought on the most fronts is between Bank of America — the bank that made the critical mistake of acquiring Countrywide Financial, once the country’s largest mortgage lender — and MBIA, the troubled monoline insurer that now warns it may not be able to keep paying claims on structured finance securities unless the bank pays it billions for the sins of Countrywide.

The insurance claims that could well tilt MBIA into bankruptcy are likely to be made by Merrill Lynch, which Bank of America acquired during the financial crisis, not long after it bought Countrywide. Kenneth D. Lewis, the bank’s chief executive then, will go down in history as the Ado Annie of Wall Street, after the character in the musical “Oklahoma” who sang, “I always say ‘Come on, let’s go!’ just when I ought to say nix.”

There was a lot of that willingness to proceed while ignoring risks during the credit boom that preceded the crash. Nowhere was it on display more than in the transactions that led to the battles now being waged.

Put briefly, Countrywide sold a lot of mortgage loans to securitizations it created, and paid small premiums to MBIA to insure that investors would not lose money. MBIA issued that insurance after doing no work at all to verify that the loans met the stated criteria, instead relying on Countrywide’s assurances and promises it would buy back bad loans. The securities got top ratings from Moody’s and Standard Poor’s, which also chose to trust rather than verify.

MBIA in those days — the securitizations in dispute covered second-mortgage loans issued between 2004 and 2007 — was a supremely confident organization. It had grown by selling insurance on municipal bonds, insurance that it was confident would never lead to any claims, or at least not to any significant ones. Other insurers had leapt into its market, and MBIA was fighting for market share in the rapidly growing securitization market.

In 2004, the insurer made a fateful decision, to stop doing due diligence on mortgage loans before it issued insurance on securities based on those loans. Countrywide says the evidence shows that MBIA thought premiums were so low that it needed to cut costs; MBIA says that had it taken the time to check, it would have lost the business to competitors.

Countrywide, also fighting for market share, was cutting corners, too. A lot of the home loans it made and put into securitizations seem not to have met the required criteria, a fact that would have been obvious with even minimal review efforts. But nobody was checking.

After the financial crisis exploded, it became clear that MBIA was in enough trouble that it would never be able to sell any new muni bond policies unless it did something. It came up with a clever idea to split in two. The good — United States muni bond — policies would go into one unit. The unit would be well capitalized and have no responsibility for the bad — the foreign government and structured finance — policies. MBIA got its regulator, what was then the New York State Insurance Department, to approve the deal before those who owned the structured finance policies found out about that.

One suit, in which Bank of America challenged the split, went to trial this year. It has been five months since the trial ended, but no verdict has been announced. Whatever that judge decides, an appeal is likely. Another judge, hearing a suit filed by MBIA claiming that Countrywide committed fraud in unloading bad mortgages into the insured securitizations, may soon decide whether to throw out the suit (as Countrywide wants) or declare MBIA a winner without a trial (as MBIA wants.)

Unfortunately for MBIA, the deadline for getting more cash is approaching. It expects to pay out a lot of money on one set of particularly foolish policies — with Merrill Lynch, now owned by that same Bank of America, as the recipient. It appears that MBIA will not have the cash to pay the claims, although it is not clear how soon that will happen.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2012/11/16/business/bank-of-america-and-mbia-revisit-the-mortgage-debacle.html?partner=rss&emc=rss