October 20, 2019

Fair Game: After a Financial Flood, Pipes Are Still Broken

Many of the nation’s bankers, lawmakers and regulators might well say yes, arguing that safeguards have been put in place to protect against another cataclysm. The voluminous Dodd-Frank law, with its hundreds of rules and new regulatory regimes, was the centerpiece of these efforts.

And yet, for all the new regulations governing derivatives, mortgages and bank holding companies, a crucial vulnerability remains. It’s found in our vast and opaque securities financing system, known as the repurchase obligation or repo market. Now $4.6 trillion in size, it is where almost every financial crisis since the 1980s has begun. Little has been done, however, to reduce its risks.

The repo market, also known as the wholesale funding market, is the plumbing of the financial system. Without it, money could not flow freely, and banks, brokerage firms and asset managers would not be able to conduct their trades and open for business each day.

When institutions sell securities in this market, they do so with the promise that they can be repurchased the next day — hence the “repo market” name. By using this market, banks can finance their securities holdings relatively cheaply, money market funds can invest cash productively and institutions can borrow securities so they can sell them short or deliver them in other types of trades.

Among the biggest participants that provide funding in this market are the money market mutual funds; they lend their cash to banks and other institutions, accepting collateral like mortgage securities in exchange. The money market funds accept a small amount of interest on these overnight loans in exchange for being able to unwind the transactions daily, if need be.

When markets are operating smoothly, most wholesale funding trades are not unwound the next day. Instead, they are rolled over, with both parties agreeing to renew the transaction. But if a participant decides not to renew because of concerns about a trading partner’s potential failure, trouble can arise.

In other words, this is a $4.6 trillion arena operating on trust, which can disappear in an instant.

Both Bear Stearns and Lehman Brothers collapsed after their trading partners in the repo market became nervous and stopped lending them money. For decades, the firms had financed their holdings of illiquid and long-term assets — like mortgage securities and real estate — in the overnight repo markets. Not only was the repo borrowing low-cost, it also allowed them to leverage their operations. Best of all, accounting rules let repo participants set aside little in the way of capital against the trades.

“It was a very unstable form of funding during the crisis and it is still a problem,” said Sheila Bair, former head of the Federal Deposit Insurance Corporation, and chairwoman of the Systemic Risk Council, a nonpartisan group that advocates financial reforms, in an interview. “The repo market is also highly interconnected because the trades are done between financial institutions.”

Some government officials have also voiced concerns recently about risks in the repo market. William C. Dudley, president of the Federal Reserve Bank of New York, referred to the issue in a February speech and Ben S. Bernanke, the Fed chairman, discussed the problems with wholesale funding in a speech in May. The Securities and Exchange Commission published a bulletin in July on the vulnerabilities in the repo market as they relate to money market funds.

Another problem in this market is that only two banks — Bank of New York Mellon and, to a lesser degree, JPMorgan Chase — dominate the business. There used to be a number of clearing banks, as the banks that stand in the middle of the trades are known, but the ranks have dwindled because of industry consolidation.

Unfortunately, these weaknesses remain. “A lot of things have been done to address a lot of specific problems but it doesn’t seem like anything has been done to address the overall problem of institutions losing access to financing,” said Scott Skyrm, a repo market veteran and author of “The Money Noose — Jon Corzine and the Collapse of MF Global.”

Mr. Skyrm said regulators appeared to be tackling the problem through a back door involving capital requirements. For example, new leverage ratios proposed by the international Basel Committee and United States financial regulators would require banks for the first time to set aside capital against the assets they finance in the repo markets. A recent report from J.P. Morgan estimates that under the Basel proposal, the eight largest domestic banks would have to raise $28 billion to $34 billion in capital relating to their repo business.

Banks are likely to consider an alternative: shrinking their repo operations. But the liquidity in this titanic market is essential for the government’s financing of its debt. As the J.P. Morgan report noted, trading volumes in the United States government bond market are closely linked to the amount of repos outstanding. So any contraction in the arena may reduce liquidity in the Treasury market.

SOME experts think that the answer to the repo problem lies in creating a central clearing platform that would allow all participants, not just the banks, to trade directly. Similar platforms have been mandated for derivatives under Dodd-Frank and could be constructed to support the wholesale funding market.

While such an entity would be a too-big-to-fail institution, so are the two banks now serving as intermediaries. And a central clearing platform could be set up as a utility, with officials monitoring transactions and requiring margin payments to finance bailouts in the event of a participant’s default.

Peter Nowicki, the former head of several large bank repo desks, is an advocate of this idea. “Repo is the last over-the-counter market that’s not headed toward central clearing and the Fed should mandate a change,” he said. “Should a large dealer have a problem or the clearing banks have an issue, the repo market could shut down.”

And that, five years after the Lehman collapse, would be an unconscionable failure.

Article source: http://www.nytimes.com/2013/09/15/business/after-a-financial-flood-pipes-are-still-broken.html?partner=rss&emc=rss

High & Low Finance: Don’t Be Alarmed, It’s Just the Economy About to Accelerate

The American markets are getting worried again. But this time the fear is refreshingly different.

The worry is that economic growth may be about to accelerate.

After five years of a disappointing economy, such a concern sounds too good to be true, and perhaps it is. But imagine what will happen if it is not. We’ve been complaining for years about how slow the recovery is. It would be great if it sped up appreciably.

But you might not know that if you listened to some of the commentary these days. Those who see a black cloud behind every silver lining can point to plenty of negatives in a good economy. Bond investors will lose money as the value of long-term bonds declines. That will mean that a lot of people are poorer. Banks own a lot of Treasuries, and some of them could suffer as the value of those bonds decline.

Perhaps rising interest rates will prompt a sell-off in the stock market. Perhaps they will choke off the recovery in the housing market.

The federal government will suffer a hit from having to pay higher interest rates as it borrows money. The Federal Reserve, which has bought a lot of long-term government bonds and mortgage securities, will lose money — perhaps a lot of it — as it sells those securities at lower prices than it paid. It might lose so much money that it stops funneling profits to the Treasury, further damaging the government’s fiscal position.

Added to those specifics is the feeling that we are about to enter unprecedented territory. Just as the Fed never before engaged in quantitative easing, it has never before unwound the positions. Who knows if it can handle the challenge?

“The Federal Reserve will need to carefully navigate through the completion of quantitative easing,” the Organization for Economic Cooperation and Development said this week in its generally gloomy semiannual global economic forecast. “A premature exit could jeopardize the fragile recovery, but waiting too long could result in a disorderly exit from the program with sizable financial losses.”

Of course, we’ve all known that — someday — the Fed would have to start reducing its positions. But on Wall Street, someday can seem a very long way off. “This was supposed to be next year’s trade,” a hedge fund manager told me this week.

What made it seem like this year’s trade was the sudden backup in the bond market that began early in May and accelerated late in the month after the Fed’s chairman, Ben S. Bernanke, mused that the Fed might be able to start to backing off the easing program later this year. The yield on 10-year Treasuries, below 1.7 percent early this month, rose above 2.1 percent on Tuesday.

That may not sound like a lot, but to owners of such bonds, it is a problem. If they bought at the latest auction of 10-year Treasuries, on May 8, the value of their securities fell enough in three weeks to offset more than a year of income.

That latest drop came on the heels of some surprisingly good economic news, as well an upbeat forecast. Last week, the Federal Reserve Bank of New York said it expected the unemployment rate, now 7.5 percent, to fall to 6.5 percent by late next year. That is earlier than the Fed had expected when it said 6.5 percent was the level at which it might choose to back away from quantitative easing,

Then this week the Standard Poor’s Case-Shiller home price index was reported to have leapt 10.9 percent over the year through March. That was the largest gain since 2006, when the housing bubble was in full expansion. And on the same day that was reported, the Conference Board said consumer confidence was at a five-year high.

There are reasons to restrain enthusiasm about both figures, though. Home prices hit their lows for the cycle in March 2012, so this is a bounce off the bottom. And while consumer confidence is up, it is still well below the levels that seemed acceptable before the financial crisis. During the decade before the economy began to crater in 2008, there were only two months — in 2003 — when the index was as low as it is now. And not all statistics are surprising on the upside; first-quarter gross domestic product was revised a bit lower in the latest estimate, released Thursday.

Article source: http://www.nytimes.com/2013/05/31/business/economy/dont-be-alarmed-its-just-the-economy-about-to-speed-up.html?partner=rss&emc=rss

Fair Game: Two Senators Try to Slam the Door on Bank Bailouts

The legislation, called the Terminating Bailouts for Taxpayer Fairness Act, emerged last Wednesday; its co-sponsors are Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican. It is a smart, simple and tough piece of work that would protect taxpayers from costly rescues in the future.

This means that the bill will come under fierce attack from the big banks that almost wrecked our economy and stand to lose the most if it becomes law.

For starters, the bill would create an entirely new, transparent and ungameable set of capital rules for the nation’s banks — in other words, a meaningful rainy-day fund. Enormous institutions, like JPMorgan Chase and Citibank, would have to hold common stockholder equity of at least 15 percent of their consolidated assets to protect against large losses. That’s almost double the 8 percent of risk-weighted assets required under the capital rules established by Basel III, the latest version of the byzantine international system created by regulators and central bankers.

This change, by itself, would eliminate a raft of problems posed by the risk-weighted Basel approach. Under those rules, banks must hold lesser or greater amounts of capital against assets, depending on the supposed risks they pose. For example, holdings of United States government securities are considered low-risk and require no capital to be held against them. Securities or loans that are riskier require more of a buffer against loss.

There are many problems with this arrangement. First, the risk assessments on various types of assets rely heavily on ratings agency grades. In the housing boom, toxic mortgage securities carrying triple-A ratings were considered low-risk, too. As such, they didn’t require hefty capital set-asides.

We all know how disastrous that was. So chalk up this plus for Brown-Vitter: Eliminating risk-weights as part of a capital assessment means less reliance on unreliable ratings.

Risk-weighted asset calculations also give bankers a lot of freedom to understate the perils in their institutions’ holdings.

The bill prevents another type of fudging by requiring off-balance-sheet assets and liabilities and derivatives positions to be included in a bank’s consolidated assets. In addition, the capital cushion that a bank would hold under the bill is liquid and can absorb losses easily. This capital measure would be more transparent than the current system and could not be manipulated.

In a truly courageous move, Brown-Vitter would require United States financial regulators to abandon Basel III. An earlier version of Basel did nothing to prevent the financial crisis and encouraged banks to binge on leverage.

Taxpayers would not be the only beneficiaries in the Brown-Vitter bill. Community banks, which weren’t responsible for bringing the nation’s economy to the brink, would be operating on a more level playing field with the jumbo banks. These large institutions have lower financing costs than community banks because the market understands that regulators will never let them fail.

“This bill will inject more market discipline on the financial services industry,” Mr. Brown said in an interview on Thursday. “The megabanks have a choice to make: they can increase their capital or bring down their size.”

Brown-Vitter has other attributes as well. It would bar bank regulators from giving nondepository institutions access to Federal Reserve lending programs. And it would make it harder for bank holding companies to move assets or liabilities from nonbanking affiliates, like derivatives bets held at a brokerage unit, to the protective umbrella of the parent company that might be rescued by taxpayers in a financial disaster.

Thomas M. Hoenig, the vice chairman of the Federal Deposit Insurance Corporation, supports the bill. “It’s finally taking the discussion in the right direction toward improving the stability of banks and the financial system more broadly,” Mr. Hoenig said in an interview on Friday. Brown-Vitter would also put the United States in a leadership position on financial soundness, he added, which other countries could emulate.

Article source: http://www.nytimes.com/2013/04/28/business/two-senators-try-to-slam-the-door-on-bank-bailouts.html?partner=rss&emc=rss

Fair Game: Don’t Blink, or You’ll Miss Another Bank Bailout

The existence of one such secret deal, struck in July between the Federal Reserve Bank of New York and Bank of America, came to light just last week in court filings.

That the New York Fed would shower favors on a big financial institution may not surprise. It has long shielded large banks from assertive regulation and increased capital requirements.

Still, last week’s details of the undisclosed settlement between the New York Fed and Bank of America are remarkable. Not only do the filings show the New York Fed helping to thwart another institution’s fraud case against the bank, they also reveal that the New York Fed agreed to give away what may be billions of dollars in potential legal claims.

Here’s the skinny: Late last Wednesday, the New York Fed said in a court filing that in July it had released Bank of America from all legal claims arising from losses in some mortgage-backed securities the Fed received when the government bailed out the American International Group in 2008. One surprise in the filing, which was part of a case brought by A.I.G., was that the New York Fed let Bank of America off the hook even as A.I.G. was seeking to recover $7 billion in losses on those very mortgage securities.

It gets better.

What did the New York Fed get from Bank of America in this settlement? Some $43 million, it seems, from a small dispute the New York Fed had with the bank on two of the mortgage securities. At the same time, and for no compensation, it released Bank of America from all other legal claims.

When I asked the Fed to discuss this gift to the bank, it declined. To understand how the settlement happened, we must go back to the dark days of September 2008. With the giant insurer A.I.G. teetering, the government stepped in. As part of the rescue, A.I.G. sold mortgage securities to an investment vehicle called Maiden Lane II overseen by the New York Fed. A.I.G. was bleeding from its toxic mortgage holdings, many of which were issued by Bank of America, and it received $20.8 billion for securities with a face value of $39.2 billion.

In 2011, aiming to recover some of that $18 billion loss, the insurer sued Bank of America for fraud. The case, filed in New York state court, sought $10 billion in damages from the bank, $7 billion of that related to securities that A.I.G. sold to Maiden Lane II. Bank of America, for its part, argued that A.I.G. had no standing to sue for fraud on the Maiden Lane securities. With the sale, Bank of America contended, the right to bring a legal claim against the bank for fraud passed to Maiden Lane II. That entity, controlled by the New York Fed, never brought fraud claims against the bank.

Not so fast, said A.I.G. Under New York law, which governs Maiden Lane II, an entity has to explicitly transfer the right to sue for fraud, it said. The original agreement between the New York Fed and A.I.G. never specified such a transfer, the insurer contended.

To settle this question, A.I.G. filed a separate lawsuit against Maiden Lane II in a New York court last month.

A.I.G.’s $10 billion fraud case against Bank of America, meanwhile, was moved to federal court. For pretrial purposes, the bank asked that Mariana R. Pfaelzer, a federal judge in the central district of California, oversee aspects of the case involving the bank’s Countrywide unit, which was in California. Its request was granted. On Jan. 30, Judge Pfaelzer said she would rule on the issue of who owns the legal claims.

Initially, in an October 2011 letter to A.I.G., the New York Fed agreed that the insurer had the right to seek damages under securities laws on instruments it sold to Maiden Lane II.

But more recently, the New York Fed began helping Bank of America battle A.I.G. In late December, the New York Fed provided two declarations to the bank. One stated that Maiden Lane II had “intended” to receive all litigation claims relating to the mortgage securities, meaning that it alone would have had the right to sue. Another said that the October letter was not an interpretation of the Maiden Lane agreement.

But Jon Diat, an A.I.G. spokesman, said in a statement that “A.I.G. and the Federal Reserve Bank of New York never discussed or agreed on any transfer of A.I.G.’s residential mortgage-backed securities fraud claims to Maiden Lane II.” He added that A.I.G. believes “it is the rightful owner of these claims and remains committed to holding Bank of America and other counterparties responsible for the harm caused.” 

LAST week, the New York Fed opposed A.I.G.’s efforts to have the question of who owns the legal rights decided in New York, whose law governs the Maiden Lane II agreement, rather than in California. It was in this filing that the New York Fed disclosed its confidential July 2012 deal with Bank of America, releasing it of any liability arising from fraud in the Maiden Lane II securities.

Let’s recap: For zero compensation, the New York Fed released Bank of America from what may be sizable legal claims, knowing that A.I.G. was trying to recover on those claims.

Article source: http://www.nytimes.com/2013/02/17/business/dont-blink-or-youll-miss-another-bank-bailout.html?partner=rss&emc=rss

DealBook: Mortgage Crisis Lingers On at Citigroup and Bank of America

More than four years after the financial crisis, many big banks have regained their footing. But Bank of America and Citigroup remain dogged by the past.

On Thursday, the two banks disclosed that substantial legal costs undercut their fourth-quarter earnings. The expenses, the banks said, stemmed from huge settlements involving their mortgage businesses.

While the settlements lifted a dark cloud that hung over the banks, other legal problems will persist. Both banks continue to wrestle with federal authorities over claims they wrongfully evicted homeowners after using shoddy, flawed or inaccurate documents in foreclosure proceedings. Bank of America and Citigroup also face a torrent of private lawsuits asserting that the banks duped investors into buying troubled mortgage securities that later blew up.

“The 2008 collapse was not the flu — it was a major debilitating disease,” said Lawrence Remmel, a partner at the law firm Pryor Cashman. “It takes time rebuilding your strength,” he said, and it is “unpredictable when some of the institutions will fully recover.”

The mortgage overhang weighed on the banks’ quarterly earnings.

While Bank of America notched strong quarterly gains across several divisions, the mortgage settlements drained the bank’s earnings, which plunged 63 percent to $732 million, or 3 cents a share. All told, one-time expenses wiped out $5.9 billion, or 34 cents a share, from the bank’s quarterly earnings.

At Citigroup, a $1.3 billion legal bill dragged down profits. The bank reported a fourth-quarter profit of $1.2 billion, or 38 cents a share, significantly below analysts’ estimates.

On Thursday, Bank of America’s shares dropped 4.2 percent to $11.28. Citigroup’s stock fell 2.9 percent to $41.24.

“Litigation expenses have taken a huge toll,” said James Sinegal, an analyst with the research firm Morningstar.

The results come in contrast to those of competitors like Wells Fargo and JPMorgan. The two banks reported banner profits in recent days, with strong gains in their mortgage businesses. Those banks face their own legal costs, but the damage has been less severe.

For Bank of America and Citigroup, the recent mortgage settlements are a reminder of past mistakes. During the housing boom, Citigroup, like other Wall Street firms, sold to investors billions of dollars of securities backed by subprime mortgages that later hurt its balance sheet. Bank of America largely inherited its mortgage woes through Countrywide Financial, the subprime lending giant it bought in the depths of the financial crisis.

Now, the banks are hoping to close a dark chapter in their histories. This month, Bank of America and Citigroup, along with eight other banks, signed a sweeping $8.5 billion settlement with the Federal Reserve and the Office of the Comptroller of the Currency over foreclosure abuses like erroneous fees and flawed paperwork.

The settlement allowed them to a halt an expensive review of millions of loans in foreclosure. The pact follows a $26 billion deal in February involving the five largest mortgage servicers and 49 state attorneys general, an agreement to resolve accusations that bank employees were blowing through mountains of documents used in foreclosures without checking for accuracy.

Bank of America last week also struck an agreement to resolve claims that it had sold troubled mortgages to the government-controlled housing finance giant Fannie Mae, which suffered deep losses from the loans. The deal put to rest a bitter battle with Fannie Mae that had lingered since the housing bubble burst.

“We put a lot of risk behind us in 2012,” Bruce R. Thompson, the company’s chief financial officer, said in a conference call on Thursday. “We just feel like we’re in a much better place going into 2013.”

Despite the huge payouts, the mortgage headaches will take a while to fully dissipate. On an earnings call on Thursday, John C. Gerspach, Citigroup’s chief financial officer, hinted at the banking industry’s continuing legal woes. “I think that the entire industry is still looking at some additional settlements that are still yet to appear,” he said.

Even if they can reach an understanding with regulators, the banks still face dozens of claims from prosecutors, investors and insurers related to more than $1 trillion worth of securities backed by residential mortgages. “Mortgage-related litigation is at an unprecedented high,” said Christopher J. Willis, a lawyer with Ballard Spahr, which handles securities and consumer litigation.

In October, for example, federal prosecutors in New York accused Bank of America of perpetrating a fraud through Countrywide by churning out loans at such a pace that quality controls were, for the most part, ignored.

A high-stakes lawsuit under way in federal court could also crimp the banks’ future profits. The Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, sued Bank of America and Citigroup, along with 15 other banks, in 2011, claiming that the banks sold securities backed by shaky mortgages.

Beneath the jarring settlements and the headline numbers, Bank of America and Citigroup both reported improvements across their varied divisions. Bank of America reported that fewer homeowners were falling behind on their bills, with the number of home loans delinquent for more than 60 days falling 17 percent in the fourth quarter. And Bank of America’s wealth management unit recorded quarterly profits of $578 million, up 79 percent.

Citigroup was buoyed by gains in its securities and banking group, helped by investment banking, equities and fixed income. The unit reported net income of $629 million for the quarter, in contrast to a $158 million loss in the period a year earlier. Citigroup, which is focused on expanding in markets like Mexico and Asia, reported that revenue within the global consumer banking group increased 4 percent to $4.9 billion in the fourth quarter.

Both banks are also ruthlessly whittling down their expenses to help bolster their profitability. At the end of 2012, Bank of America had 14,601 fewer employees than it had at the end of 2011. Also looking to be leaner, Citigroup said in December that it would eliminate 11,000 jobs worldwide, part of a much larger contraction.

Still, Mr. Gerspach, Citigroup’s chief financial officer, struck a cautious tone on Wednesday during an earnings call. “I don’t think we are alone in still working through some of these legacy issues,” he said.

Article source: http://dealbook.nytimes.com/2013/01/17/mortgage-crisis-lingers-on-at-citigroup-and-bank-of-america/?partner=rss&emc=rss

As Recovery Inches Ahead, Banks Face a New Reckoning

The nation’s largest banks are facing a fresh torrent of lawsuits asserting that they sold shoddy mortgage securities that imploded during the financial crisis, potentially adding significantly to the tens of billions of dollars the banks have already paid to settle other cases.

Regulators, prosecutors, investors and insurers have filed dozens of new claims against Bank of America, JPMorgan Chase, Wells Fargo, Citigroup and others, related to more than $1 trillion worth of securities backed by residential mortgages.

Estimates of potential costs from these cases vary widely, but some in the banking industry fear they could reach $300 billion if the institutions lose all of the litigation. Depending on the final price tag, the costs could lower profits and slow the economic recovery by weakening the banks’ ability to lend just as the housing market is showing signs of life.

The banks are battling on three fronts: with prosecutors who accuse them of fraud, with regulators who claim that they duped investors into buying bad mortgage securities, and with investors seeking to force them to buy back the soured loans.

“We are at an all-time high for this mortgage litigation,” said Christopher J. Willis, a lawyer with Ballard Spahr.

Efforts by the banks to limit their losses could depend on the outcome of one of the highest-stakes lawsuits to date — the $200 billion case that the Federal Housing Finance Agency, which oversees the housing twins Fannie Mae and Freddie Mac, filed against 17 banks last year, claiming that they duped the mortgage finance giants into buying shaky securities.

Last month, lawyers for some of the nation’s largest banks descended on a federal appeals court in Manhattan to make their case that the agency had waited too long to sue. A favorable ruling could overturn a decision by Judge Denise L. Cote, who is presiding over the litigation and has so far rejected virtually every defense raised by the banks, and would be cheered in bank boardrooms. It could also allow the banks to avoid federal housing regulators’ claims.

At the same time, though, some major banks are hoping to reach a broad settlement with housing agency officials, according to several people with knowledge of the talks. Although the negotiations are at a very tentative stage, the banks are broaching a potential cease-fire.

As the housing market and the nation’s economy slowly recover from the 2008 financial crisis, Wall Street is vulnerable on several fronts, including tighter regulations assembled in the aftermath of the crisis and continuing investigations into possible rigging of a major international interest rate. But the mortgage lawsuits could be the most devastating and expensive, bank analysts say.

“All of Wall Street has essentially refused to deal with the real costs of the litigation that they are up against,” said Christopher Whalen, a senior managing director at Tangent Capital Partners. “The real price tag is terrifying.”

Anticipating painful costs from mortgage litigation, the five major sellers of mortgage-backed securities set aside $22.5 billion as of June 30 just to cushion themselves against demands that they repurchase soured loans from trusts, according to an analysis by Natoma Partners.

But in the most extreme situation, the litigation could empty even more well-stocked reserves and weigh down profits as the banks are forced to pay penance for the subprime housing crisis, according to several senior officials in the industry.

There is no industrywide tally of how much banks have paid since the financial crisis to put the mortgage litigation behind them, but analysts say that future settlements will dwarf the payouts so far. That is because banks, for the most part, have settled only a small fraction of the lawsuits against them.

JPMorgan Chase and Credit Suisse, for example, agreed last month to settle mortgage securities cases with the Securities and Exchange Commission for $417 million, but still face billions of dollars in outstanding claims.

Bank of America is in the most precarious position, analysts say, in part because of its acquisition of the troubled subprime lender Countrywide Financial.

Last year, Bank of America paid $2.5 billion to repurchase troubled mortgages from Fannie Mae and Freddie Mac, and $1.6 billion to Assured Guaranty, which insured the shaky mortgage bonds.

But in October, federal prosecutors in New York accused the bank of perpetrating a fraud through Countrywide by churning out loans at such a fast pace that controls were largely ignored. A settlement in that case could reach well beyond $1 billion because the Justice Department sued the bank under a law that could allow roughly triple the damages incurred by taxpayers.

Bank of America’s attempts to resolve some mortgage litigation with an umbrella settlement have stalled. In June 2011, the bank agreed to pay $8.5 billion to appease investors, including the Federal Reserve Bank of New York and Pimco, that lost billions of dollars when the mortgage securities assembled by the bank went bad. But the settlement is in limbo after being challenged by investors. Kathy D. Patrick, the lawyer representing investors, has said she will set her sights on Morgan Stanley and Wells Fargo next.

Of the more than $1 trillion in troubled mortgage-backed securities remaining, Bank of America has more than $417 billion from Countrywide alone, according to an analysis of lawsuits and company filings. The bank does not disclose the volume of its mortgage litigation reserves.

“We have resolved many Countrywide mortgage-related matters, established large reserves to address these issues and identified a range of possible losses beyond those reserves, which we believe adequately addresses our exposures,” said Lawrence Grayson, a spokesman for Bank of America.

Adding to the legal fracas, the New York attorney general, Eric T. Schneiderman, accused Credit Suisse last month of perpetrating an $11.2 billion fraud by deceiving investors into buying shoddy mortgage-backed securities. According to the complaint, the bank dismissed flaws in the loans packaged into securities even while assuring investors that the quality was sound. The bank disputes the claims.

It is the second time that Mr. Schneiderman — who is also co-chairman of the Residential Mortgage-Backed Securities Working Group, created by President Obama in January — has taken aim at Wall Street for problems related to the subprime mortgage morass. In October, he filed a civil suit in New York State Supreme Court against Bear Stearns Company, which JPMorgan Chase bought in 2008. The complaint claims that Bear Stearns and its lending unit harmed investors who bought mortgage securities put together from 2005 through 2007. JPMorgan denies the allegations.

Another potentially costly headache for the banks are the demands from a number of private investors who want the banks to buy back securities that violated representations and warranties vouching for the loans.

JPMorgan Chase told investors that as of the second quarter of this year, it was contending with more than $3.5 billion in repurchase demands. In the same quarter, it received more than $1.5 billion in fresh demands. Bank of America reported that as of the second quarter, it was dealing with more than $22 billion in unresolved demands, more than $8 billion of which were received during that quarter.

Article source: http://www.nytimes.com/2012/12/10/business/banks-face-a-huge-reckoning-in-the-mortgage-mess.html?partner=rss&emc=rss

DealBook: Jury Found Brian Stoker Not Guilty, but Not Necessarily Citigroup

Beau Brendler served as foreman of a federal jury that cleared a former Citigroup manager in a mortgage securities case.Susan Stava for The New York TimesBeau Brendler served as foreman of a federal jury that cleared a former Citigroup manager in a mortgage securities case.

As Beau Brendler sat in the jury box listening to the government’s case against a former Citigroup midlevel executive, the same question kept entering his mind.

“I wanted to know why the bank’s C.E.O. wasn’t on trial,” said Mr. Brendler, who served as the jury’s foreman. “Citigroup’s behavior was appalling.”

Despite that sentiment, Mr. Brendler and his fellow jurors — a group that included a security guard, a lab technician and a full-time musician in a rock ’n’ roll band — cleared the former Citigroup executive, Brian Stoker, of wrongdoing over his role in selling a complex $1 billion mortgage bond deal during the waning days of the housing boom.

But even as the jury reached a consensus that the Securities and Exchange Commission failed to prove its case, it was left with an uneasy feeling that the verdict inadequately described its feelings about Citigroup’s conduct.

“We were afraid that we would send a message to Wall Street that a jury made up of regular American folks could not understand their complicated transactions and so they could get away with their outrageous conduct,” Mr. Brendler said. “We also did not want to discourage the government from investigating and prosecuting financial crimes.”

So the jurors did something extremely rare: They issued a statement alongside their verdict.

“This verdict should not deter the S.E.C. from continuing to investigate the financial industry, review current regulations and modify existing regulations as necessary,” said the statement, which was read aloud by Judge Jed S. Rakoff in Federal District Court in Manhattan on Tuesday.

Mr. Brendler, a 48-year-old freelance writer, wrote the sentence after soliciting input from the seven other jurors. He scratched it out on a yellow sheet ripped from a legal pad, wrapped it around the verdict form and put both in a sealed envelope that was delivered to the judge.

“It wasn’t a particularly eloquent statement, but we hoped it would get a point across,” Mr. Brendler said.

In an informal survey of 11 defense lawyers and prosecutors, not one could recall a case when a jury had issued a statement like the one that the Stoker jury did. Dennis M. Kelleher, a former litigator at Skadden, Arps, Slate, Meagher Flom, said that the jury’s admonition underscored the nation’s prevailing sentiment about the financial services industry.

“These eight ordinary citizens believed what the polls tell us most Americans believe,” said Mr. Kelleher, who now serves as president of Better Markets, a lobbying organization pressing for regulatory reform. “They still would be delighted to see the government hold these banks and some of their executives accountable for misconduct during the financial crisis.”

Mr. Stoker’s trial was one of the few cases related to the financial crisis that has gone to a jury. The case was brought alongside a civil fraud lawsuit accusing Citigroup of misleading clients about a 2007 investment in a collateralized debt obligation, or C.D.O. Citigroup was among the leaders in structuring these complex securities, which were pools of mortgages sliced up into pieces and sold off to investors. The bank marketed more than $20 billion worth of C.D.O.’s, earning enormous fees.

It is widely acknowledged that C.D.O.’s were a root cause of the financial crisis, stoking the demand for subprime mortgages and inflating the housing bubble. The securities also ended up on balance sheets of the large banks, saddling them with crippling losses when the housing market collapsed.

A questionable tactic used by Citigroup and several other banks was at the heart of the Stoker case. Some banks stuffed C.D.O.’s with risky mortgage securities, sold them to unsuspecting customers and then bet against them.

Regulators said that Mr. Stoker, who prepared marketing materials for the deal, knew or should have known that he was deceiving investors by not disclosing that Citigroup helped pick the underlying mortgage bonds in the C.D.O. and then bet that its value would decline. When the housing market collapsed, Citigroup’s clients lost money while the bank made a bundle.

“Citi is a fundamentally different company today than it was before the crisis,” said Danielle Romero-Apsilos, a spokeswoman for the bank. “We continue to work hard to instill a culture of responsible finance.”

Now under new management, Citigroup agreed to pay the government $285 million to resolve its role in the case, but the settlement has yet to receive court approval. Mr. Stoker, however, took his case to trial.

Travis Dawson, 23, a student at Baruch College, also served on the Stoker jury. Before the trial, Mr. Dawson, a lifelong Bronx resident, had been largely uninformed about the ways of Wall Street.

“Where I’m from, you hear Wall Street is an evil place but you really have nothing to base that on,” Mr. Dawson said. “But after sitting on the jury I thought, ‘Wow, greedy, reckless behavior really does happen there.’ ”

In explaining the verdict, both Mr. Dawson and Mr. Brendler said that they believed that Mr. Stoker was made a scapegoat for the industry’s sins. In his closing statement, Mr. Stoker’s lawyer, John W. Keker, hammered away at that point, arguing that his client “shouldn’t be blamed for the faults of banking any more than a person who works in a lawful casino should be blamed for the faults of gambling.”

Mr. Keker underscored this point by showing the jury an illustration from “Where’s Waldo?,” the children’s book in which readers are challenged to find the hidden title character. He likened his client to Waldo, suggesting that Mr. Stoker, 41, was merely a blip in Citigroup’s vast C.D.O. universe.

“Most of this trial had nothing to do with Brian Stoker,” Mr. Keker said.

Mr. Dawson said that the “Where’s Waldo?” allusion resonated.

“I’m not saying that Stoker was 100 percent innocent, but given the crazy environment back then it was hard to pin the blame on one person,” Mr. Dawson said. “Stoker structured a deal that his bosses told him to structure, so why didn’t they go after the higher-ups rather than a fall guy?”

With the trial now finished, the foreman, Mr. Brendler, who lives in Patterson, N.Y., in northeast Putnam County, is back looking for full-time work. He hasn’t held a steady job since 2009, when Consumer Reports laid him off.

He was heartened to see that the S.E.C.’s director of enforcement issued a statement after the verdict that it respected the jury’s decision and would continue to pursue misconduct arising out of the financial crisis. And on Thursday, the S.E.C. lawyers who tried the case called him to ask how they could be more effective.

“I’m glad they’re taking this seriously because the industry seemed completely out of control with no oversight,” Mr. Brendler said. “Wall Street’s actions hurt all of us and we badly need a watchdog who will rein them in.”

Article source: http://dealbook.nytimes.com/2012/08/03/s-e-c-gets-encouragement-from-jury-that-ruled-against-it/?partner=rss&emc=rss

Fair Game: Hazard Insurance With Its Own Perils

It’s about time.

 Investigators are training their sights on a type of hazard insurance policy known as force-placed insurance, a type of policy that has driven up costs for homeowners and pushed some into foreclosure. People who buy certain mortgage securities may be getting hurt, too.

Benjamin M. Lawsky, the superintendent of the New York State Department of Financial Services, is investigating institutions that underwrite and sell force-placed insurance. Last fall, his office began sending subpoenas to insurance agents and brokers. Requests for information also went out to insurance companies that write such policies.

Working his way up the chain, Mr. Lawsky’s office issued a new set of subpoenas late last week. According to a person briefed on the matter who was not authorized to discuss it, the subpoenas went to loan servicers that imposed force-placed insurance on borrowers, as well as to insurers affiliated with those servicers.

Among the servicers that received the subpoenas were Morgan Stanley Mortgage Capital Holdings and CitiMortgage. Insurer affiliates that received requests for information include BancOne Insurance, a unit of JPMorgan Chase, and Alpine Indemnity, an affiliate of PNC.

“Force-placed insurance appears to be the dirty little secret of the mortgage industry,” Mr. Lawsky said in an interview last week. “It is a silent killer harming both consumer and investors while enriching the banks and their affiliates.” 

Representatives of PNC and JPMorgan Chase declined to comment. Mark Rodgers, a spokesman for Citigroup, said the bank was working with Mr. Lawsky’s office. “CitiMortgage does not sell homeowner’s insurance to consumers,” he said. “If a homeowner does not provide an insurance policy, CitiMortgage secures a policy to protect the interest of the investor. Whenever the homeowner submits proof they have obtained insurance on their own, the lender-placed insurance is canceled.” 

A spokesman for Morgan Stanley said its mortgage company “does not have an affiliated agent, broker or insurance company to procure force-placed insurance.”

Force-placed insurance has exploded during the foreclosure crisis. Once a backwater that generated $1 billion a year, it is now a $6 billion-a-year business. Much of its growth has come on the backs of homeowners.

When homeowners run into financial trouble, they often let their hazard insurance lapse. Because lenders require homeowners to be insured against damage or total loss — say, from a fire — policies are then forced on the borrowers and added to their monthly mortgage payments.

There is a lot to love about force-placed insurance — if you sell it. The policies typically cost at least three times as much as ordinary property insurance. Some borrowers have been charged much more — up to 10 times the prevailing rate — according to people knowledgeable about these practices who spoke on condition of anonymity to maintain business relationships.

Mind you, force-placed policies do not protect homeowners from loss. Only lenders are covered. But homeowners must pay the freight. And lender-placed insurance typically does not carry deductibles, as typical policies do.

Borrowers have also complained of being forced to buy this high-priced insurance even when it is unnecessary. Back in 2007, a borrower with a mortgage serviced by Countrywide Financial described how the lender automatically signed her up for flood insurance even though she had proved that such insurance was unnecessary. Not being able to meet the extra payments, she fell behind on her mortgage. Countrywide then began foreclosure proceedings. 

All in all, force-placed insurance represents a major profit center for mortgage servicers and the companies that write the policies. In many cases, you will not be surprised to learn, the servicers and the insurers are affiliated. This sets up the potential for conflicts of interest among loan servicers that are often supposed to represent investors owning mortgage loans bundled into securities.  

Many banks have set up affiliates that provide this insurance or take on some of the risks that other companies have insured, known as reinsurance. These cozy relationships are a focus of investigators.

Consider the potential for mischief when a mortgage servicer administers a loan owned by an investor. If a loss is incurred on the property that is insured by an affiliate of the servicer, it is not in the servicer’s interest to file a claim on behalf of the investor to cover the loss.

Because such relationships are not typically disclosed, investors may be unaware that these conflicts exist. Faced with a loss on the property, the investor may simply accept it without protest.

Insurers that are not affiliated with lenders have paid fees from 15 to 20 percent of the policy to the banks that place the insurance, according to former industry executives. This indicates how lucrative the business is. 

A more consumer-friendly way to deal with insurance lapses would be for servicers to advance money to the borrower’s existing carrier to keep the policy current. Then, the servicer could bill the borrower for the coverage.

But that would stop the lush profits generated by forcing high-cost insurance on borrowers.  

Insurers that provide this kind of insurance say they must charge higher rates because homeowners who allow their policies to lapse are riskier. But these policies are not typically money-losers. According to data from the National Association of Insurance Commissioners, the average loss ratios on lender-placed insurance are about 22 percent. This compares with loss ratios of 65 percent on traditional homeowners insurance.

AMONG the tricks of this trade that investigators may examine is one that sometimes coincides with a mortgage refinancing. During the bubble years and to a lesser extent even today, lenders can add new coverage to existing policies if a property has increased in value. If a homeowner has, say, coverage for a $200,000 home that she refinances for $225,000, the amount of insurance she might be forced to finance is $425,000.

 Mr. Lawsky’s office has recently struck agreements with some servicers that protect against common abuses in this coverage. Last fall, for example, when Goldman Sachs sold Litton Loan Servicing to Ocwen Financial, Mr. Lawsky’s office had to approve the transaction. That approval was conditional upon Ocwen agreeing not to place this type of insurance with affiliates and requiring that it impose only competitively priced policies. 

Adding to homeowners’ troubles by forcing them to buy overpriced insurance is yet another ugly aspect of the mortgage servicing business. Let’s hope that shedding light on these practices will begin the process of eliminating them.

Article source: http://feeds.nytimes.com/click.phdo?i=551b809763479c812cdd7d283c5e997e

Bank of America’s Merrill Unit in Mortgage Settlement

(Reuters) – Bank of America Corp agreed to pay $315 million (201 million pounds) to settle claims by investors who said they were misled about mortgage securities offerings by its Merrill Lynch unit.

The proposed class-action accord is one of the largest settlements of investor claims against banks over seemingly safe mortgage-backed securities that later proved toxic as credit and housing conditions worsened.

It is also the latest step in Bank of America’s efforts to address its legal liabilities stemming from its purchases of Merrill in January 2009 and the mortgage lender Countrywide Financial Corp six months earlier.

Bank of America is based in Charlotte, North Carolina, and is the second-largest U.S. bank by assets.

Lawrence Grayson, a bank spokesman, declined to comment on the settlement. Lawyers for the investors were not immediately available to comment.

The settlement resolves claims by investors, led by the Public Employees’ Retirement System of Mississippi pension fund, that Merrill misled them about the risks of $16.5 billion of mortgage-backed securities in 18 offerings made between 2006 and 2007, before Bank of America bought the company.

The investors said their damages could total billions of dollars, citing a consultant’s estimate.

Bank of America did not admit wrongdoing in agreeing to settle. Its shares rose 9 cents to $5.88 in morning trading.

RAKOFF TO RULE

Reuters in mid-November reported the size of the settlement, citing an unnamed source.

The settlement was disclosed publicly late Monday night in court papers filed in U.S. District Court in Manhattan. The accord requires approval by Judge Jed Rakoff.

Rakoff last week rejected a $285 million settlement between the U.S. Securities and Exchange Commission and Citigroup Inc, attacking the regulator’s practice of letting companies settle cases without admitting they did anything wrong.

It is unclear whether the judge might apply similar reasoning in the Merrill settlement, which could result in disruptions to other private mortgage securities litigation. The government is not part of the Merrill settlement, which resolves private litigation.

“His perspective is different because he doesn’t have to look at the public interest,” said J. Robert Brown Jr, a professor at the University of Denver’s Sturm College of Law.

“I don’t expect him to be particularly bothered by the absence of an admission,” Brown added. “He’ll review the substance and determine whether the terms are reasonable for the class.”

COUNTRYWIDE, INDYMAC, NEW CENTURY

Investors alleged that Merrill’s offering documents misled them about the quality of loans backing their investments, including that they complied with underwriting guidelines.

They also said the investments did not deserve their original investment-grade ratings, being backed by loans from such lenders as Countrywide, Merrill’s First Franklin Financial unit, and the now-bankrupt IndyMac Bancorp Inc and New Century Financial Corp. Most later fell to “junk” status, they said.

The case is separate from litigation over Countrywide mortgage debt being handled by a Los Angeles federal judge.

It is also separate from Bank of America’s proposed $8.5 billion settlement with investors in 530 mortgage trusts with $174 billion of unpaid principal. That accord was negotiated by Bank of New York Mellon Corp as trustee.

The case is Public Employees’ Retirement System of Mississippi et al v. Merrill Lynch Co et al, U.S. District Court, Southern District of New York, No. 08-10841.

(Reporting by Jonathan Stempel in New York; Additional reporting by Alison Frankel; Editing by Derek Caney and John Wallace)

Article source: http://feeds.nytimes.com/click.phdo?i=9a76cb57be7e841b96c44bf14f9bb251

Judge Blocks Citigroup Settlement With S.E.C.

The judge, Jed S. Rakoff of United States District Court in Manhattan, ruled that the S.E.C.’s $285 million settlement, announced last month, is “neither fair, nor reasonable, nor adequate, nor in the public interest” because it does not provide the court with evidence on which to judge the settlement.

The ruling could throw the S.E.C.’s enforcement efforts into chaos, because a majority of the fraud cases and other actions that the agency brings against Wall Street firms are settled out of court, most often with a condition that the defendant does not admit that it violated the law while also promising not to deny it.

That condition gives a company or individual an advantage in subsequent civil litigation for damages, because cases in which no facts are established cannot be used in evidence in other cases, like shareholder lawsuits seeking recovery of losses or damages.

The S.E.C.’s policy — “hallowed by history, but not by reason,” Judge Rakoff wrote — creates substantial potential for abuse, the judge said, because “it asks the court to employ its power and assert its authority when it does not know the facts.”

Judge Rakoff also refers at one point to Citigroup as “a recidivist,” or repeat offender, which has violated the antifraud provisions of the nation’s securities laws many times. The company knew that the S.E.C.’s proposed judgment – that it cease and desist from violating the antifraud laws – had not been enforced in at least 10 years, the judge wrote. 

The S.E.C. did not respond immediately to a request for comment on the judge’s decision, which was released Monday morning. A Citigroup spokesman said the company was studying the decision and had no immediate comment.

Citigroup was charged with negligence in its selling to customers a billion-dollar mortgage securities fund, known as Class V Funding III. The S.E.C. alleged that Citigroup picked the securities to be included in the fund without telling investors, claiming that the securities were being chosen by an independent entity. Citigroup then bet against the investments because it believed that they would lose value, the S.E.C. said.

Investors lost $700 million in the fund, according to the S.E.C., while Citigroup gained about $160 million in profits.

The settlement established none of those allegations as fact, thereby making it impossible for the court to properly judge whether the settlement meets the required standard of being fair, adequate and in the public interest.

“An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous,” Judge Rakoff wrote in the case, S.E.C. v. Citigroup Global Markets. “In any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth.”

The S.E.C. in particular, he added, “has a duty, inherent in its statutory mission, to see that the truth emerges.”

Article source: http://www.nytimes.com/2011/11/29/business/judge-rejects-sec-accord-with-citi.html?partner=rss&emc=rss