PIMCO, BlackRock, and NY Fed Ask BofA to Repurchase Mortgage Bonds

The fears behind mortgage bond-gate might be real after all. Reports indicate that Bank of America has been asked to repurchase some of its mortgage bonds by some very prominent investors due to procedural failures. Who are those investors? BlackRock Inc. -- the largest money manager in the world, PIMCO -- the largest Bond fund investor, and the New York Federal Reserve are said to be among them. So these investors aren't exactly Moe, Larry, and Curly. This is serious.

Bank of America is the target thanks to its acquisition of Countrywide in 2008. These investors say that Countrywide failed to properly service mortgages which were repacked into bonds. How many bonds? According to Bloomberg, these investors want Bank of America to repurchase $47 billion worth. The article also indicates that Metlife, the biggest U.S. life insurer, is expected to join this group of investors demanding repurchase.

Here's the specific problem they cite, from Bloomberg:

Countrywide also hasn't met its contractual obligations as a servicer because it hasn't asked for repurchases itself and is taking too long with foreclosures, either because of document or process mistakes or because it doesn't have enough staff to evaluate borrowers for loan modifications, Patrick said. If the issues aren't fixed within 60 days, BNY Mellon should declare Countrywide in default of its contracts, she said.

In this case, the mortgages bonds in question are full of bad loans, meaning that these investors hope to push losses back to Bank of America. In other words, even if the bank had tens of billions of dollars of cash lying around to repurchase these bonds, it will incur substantial losses if it does. Bank of America could also try to settle with these investors somehow, if it believes that their demand is somewhat justified. That, of course, would also result in losses, though they would be somewhat smaller.

With investors of this stature looking to force a bank as significant as Bank of America to buy back bonds, you can expect a tidal wave to begin. Other mortgage bond investors will almost certainly begin to follow suit. Other banks will also likely be the target of similar demands. If banks refuse, then lawsuits will likely follow.

It's hard to see how this ends well for the mortgage market in the short-term. The sort of best-case scenario for banks would be investors were bluffing or if courts eventually decided the banks didn't actually violate any covenants. If the courts do get involved, another potential solution for banks would be for Congress to pass some bill that provided a way for them to wiggle out of the problem. Of course, that would enrage investors and bank-haters alike.

All other paths lead to losses for banks. If banks are forced to absorb big losses, however, then the financial industry could hiccup again.