Government Sues Banks, Sacks Housing Industry

The Federal Housing Finance Agency (FHFA) has recently brought suit against a handful of the world’s largest banks, alleging that the mortgage-backed securities they sold to federal lending …

The Federal Housing Finance Agency (FHFA) has recently brought suit against a handful of the world’s largest banks, alleging that the mortgage-backed securities they sold to federal lending firms Fannie Mae and Freddie Mac, violated securities laws. Objectively, the job of the FHFA is to protect the interests of Fannie and Freddie, but critics argue taking this action – especially considering there are the very banks the government was bailing out with these securities purchases – is only going to hurt people who need loans by causing banks to restrict or stop lending. This, ultimately, will further damage a suffering housing market, which the very same administration is claiming it is trying to fix. For more on this continue reading the following article from The Street.

When I first read about the lawsuit by the Federal Housing Finance Agency (FHFA), conservator of mortgage giants Fannie Mae and Freddie Mac, against more than a dozen big banks, I thought, why is the government suing banks for billions of dollars when it just spent billions of dollars bailing the banks out?

And why would the government want to weaken the banks further, when what the ailing housing market needs most right now is mortgage liquidity?

Unfortunately, my questions are really the tip of the iceberg.

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At face value, the lawsuit makes sense; the role of the FHFA is to limit losses to Fannie and Freddie. The two have taken about $33 billion in losses from mortgage backed securities they bought from the big banks. They claim the big banks misrepresented the loans in the securities, that said loans were poorly underwritten, using inflated or falsified borrower incomes. Fannie and Freddie were the largest buyers of private label mortgage-backed securities from 2004 to 2007.

I’m not going to argue the merits of the suit, like what Fannie and Freddie’s role was in checking these securities they were buying, given that they played a big part in crafting and choosing them. Others will surely do that ad nauseum. What’s more important to me is how this and the growing ocean of litigation affect the housing recovery.

Now you have a government lawsuit hitting the big banks, just as the government, in the form of the Justice Department, is trying to negotiate a big bank settlement with the fifty state attorneys general over so-called "robo-signing" foreclosure practices. That one allegedly has a $20 billion price-tag, but recent drama over whether to include securitization issues in the settlement threatens to derail a big chunk of that and open the banks up to more litigation. How ironic.

If you’re a big bank, facing sizeable payment for your past sins (or as in the case of Bank of America(BAC), sins of companies you bought, like Countrywide Financial), what do you do now? You likely make loans more expensive and harder to get, or you get out altogether. This week Bank of America dropped its correspondent lending business, a huge blow to that market. Bottom line, it hits housing.

"You’re going to get liquidity withdrawn from the housing sector. When you look at what the GSE’s [Fannie and Freddie] were set up to do, the GSE’s were set up to add liquidity to the system," says Paul Miller of FBR Capital Markets.

Meanwhile the Obama administration is struggling for ways to try to save the housing market, specifically a big refinance plan through Fannie and Freddie, which would of course require cooperation from the big banks who service so many of their loans. So is the government, in the form of the FHFA, cutting off its nose to spite its face?

"The problem is that there is no one set policy by the government on housing, and the individual regulator and government agencies are operating independently of each other," says Miller. "It all goes back to Congress and the Administration kicking the can on housing policy."

This article was republished with permission from The Street.

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