Banks Offered a Deal on Foreclosure Flaws—Will They Bite?

Probably not: they will hold out for the best deal they can get to eliminate as much uncertainty as possible

These days, it's hard to keep all of the mortgage-related lawsuits against banks straight. Investors are suing banks over bad mortgage-backed securities, claiming that securitization procedures were flawed. The Federal Housing Finance Agency has also filed lawsuits, saying that banks misled Fannie and Freddie about the quality of the mortgages underlying the bonds they purchased. Finally, states are suing big banks over their foreclosure practices, alleging that they didn't follow the law. The banks have reportedly been offered a settlement on that last suit by the group of state attorneys general. Unfortunately, the deal the states are offering isn't likely to be accepted.

Shahien Nasiripour at the Financial Times reports on the latest progress in the settlement talks. He writes:

Though the counteroffer attempts to release the banks from liability with respect to home repossessions, and explicitly states that the release does not include securitisation claims, the language is broad enough in that it could prevent state officials from bringing securitisation claims in the future should they sign up to the agreement.

This gets a little complicated. The question here is whether the settlement should include only documentation practices related to foreclosure procedures or also banks' broader documentation missteps, which would extend to the securitization process.

Obviously, banks would prefer the latter, while aggressive state attorneys general would prefer to leave the banks with some securitization liability so they could go after them in future lawsuits. Banks will almost certainly demand that any settlement includes the broader option, particularly if the sum of damages they agree to is in the tens of billions of dollars. To justify a settlement of that size, banks will want some assurance that their liability is contained.

But Nasiripour also says that banks are "pressing for immunity from a raft of alleged civil violations and have called the latest proposal a 'non-starter'." It's not clear what is being said here. Do banks actually believe that they can avoid private civil suits brought by investors if the state attorneys general provide them with some broad immunity on securitizations? If such a result is possible, then it isn't hard to understand why banks would be angling for such immunity. Then, additional mortgage security lawsuits brought by investors would be very hard to win -- they would need to prove fraud.

A quick, clean resolution to this mess would be best for everybody. As long as this uncertainty casts a dark shadow over the financial industry, banks will have to remain ultra-conservative in their lending to ensure they have enough padding to accommodate losses that could be coming. And if banks aren't lending as much as they normally would be, then the recovery will just be that much slower.

An even bigger concern here is that investors could become very worried about all of the pending litigation facing the big banks and begin to dump their equity, which could lead to another financial crisis if panic sets in. The FT piece puts the state settlement dollar value between $10 billion and $25 billion. If that doesn't cap losses, then banks could face another $20 billion to $60 billion in losses from the FHFA lawsuits filed last week. Banks could easily see tens of billions dollars more in losses related to lawsuits brought by other investors. These are big numbers that could easily spook investors if banks can't shake these lawsuits.

But according to a Reuters report, a broad-based settlement might not come anytime soon. It quotes a spokesman for Iowa Attorney General Tom Miller, who leads the charge, as saying that the no deal has been offered that includes securitization. If the states and the banks remain that far apart, then a realistic agreement isn't likely near.

Image Credit: REUTERS/Rebecca Cook