Boom Times For GSE, Bank Buybacks

In early 2006 I wrote a story about how loan buyback requests from Merrill Lynch & Co. played a key role in the failure of Acoustic Home Loans of California, a then-fast-growing subprime lender that had been “upstreaming” product to the Wall Street behemoth.Merrill, it appeared, had thrown down the gauntlet: it would finance Acoustic through warehouse lines and purchase its originations but it was getting pretty tired of all the “early payment defaults” it was seeing.Merrill wanted Acoustic to either buy back the bad loans it was selling or compensate the firm for its troubles. After a few months of back-and-forth that started in late 2005, Acoustic threw in the towel and closed its doors. It was thinly capitalized and could ill-afford to repurchase much of anything.Zoom ahead four years to 2010 and what do we see? Answer: Suddenly every firm under the sun is playing the loan buyback game — Fannie Mae, Freddie Mac, the mega-bank correspondent lenders (Bank of America and Wells Fargo) and even the Federal Home Loan Banks. The message seems to be clear: If your company sold another firm a defective product (in this case mortgages) you will be held liable under the “reps and warranties” clause. It doesn’t even matter if the loans are performing.Not only are Fannie and Freddie forcing buybacks on seller/servicers that sold them mortgages that eventually went south, in some cases they are asking for repurchases on performing notes — when it is discovered that these mortgages violated the term sheets.What’s going on here? It would appear that it’s “cover your back” time in the mortgage industry — and with no end in sight. The lawyers have been unleashed and are following the money.The question mortgage bankers and investors are asking is this: When will the madness end? Chances are not any time soon. GSE seller/servicers, historically, tolerated buyback requests from Fannie and Freddie but also had an “out.” In the old days, if Freddie played a little too rough, Countrywide Home Loans (for example) could go across the river to Fannie Mae (which it did).But today the GSEs are de-facto arms of the federal government — and the only game in town. If Fannie or Freddie asks for a buyback (or compensation in lieu) the seller/servicer has little choice. Depositories are better positioned to handle a buyback because (as it was explained to me) a bank can put the loan in portfolio and forget about it, especially if the note is current.But there is a bigger picture to think about here. Uncle Sam owns the government-sponsored enterprises, which are supported by taxpayer money. Some of the firms Fannie and Freddie are hitting up for repurchases (Bank of America, Chase, Wells and others) have, in the past, been the recipients of TARP money, another tax payer-funded program. So essentially, we have taxpayer-funded giants (Fannie Mae/Freddie Mac) hitting up taxpayer supported seller/servicers to recoup losses.After a while it sounds like a process of moving government money from one pocket to another. Maybe there’s justice in all this. And maybe not. Bad actors should be held responsible, of course, but increasingly I’m hearing stories out there of buyback requests being forced on mortgages that are two and three years old. And that means the early payment default clause has expired. However, that’s where the lawyers and auditors come in. They scrub the file down, trying to find the smallest of underwriting violations that would trigger fraud clauses. Apparently, fraud is not subject to any type of statute of limitations.When will it all end? Not anytime soon, unless delinquencies begin to dry up. As one former Wall Street managing director told me: “Three years after a loan is made and suddenly Fannie or Freddie wants a buyback. It seems ridiculous. Whose portfolio can stand that test of time?” ♦