Congress Seeks Fannie, Freddie Exit as Banks Eat Soured Loans

The regulator overseeing Fannie Mae and Freddie Mac said his agency’s review of subpoenaed records doesn’t mean it is “pursuing anybody” for selling bad loans to the U.S.-backed mortgage giants before the credit crisis.

The Federal Housing Finance Agency’s review of documents sought by 64 subpoenas in July is simply looking for errors or omissions that could compel lenders to bear losses, Edward J. DeMarco, the regulator’s acting director, told a House Financial Services subcommittee at a Washington hearing today.

“The losses are extraordinary and we owe it to the American taxpayer to find out where these losses are coming from,” said DeMarco, whose agency has overseen Fannie Mae and Freddie Mac since they were seized in September 2008 amid a financial crisis that pushed them to the brink of collapse.

Regulators are under pressure from lawmakers to stem losses for taxpayers and recoup money from banks that sold faulty loans to Fannie Mae and Freddie Mac without hindering the housing market’s recovery. DeMarco and Michael Barr, the Treasury Department’s assistant secretary for financial institutions, were called to testify today about the progress they’ve made since the companies came under government control.

Congress and the Obama administration are weighing the future of the two companies as part of an overhaul of the U.S. housing finance system. Fannie Mae, based in Washington, and Freddie Mac, based in McLean, Virginia, lost $166 billion on guarantees of single-family mortgages from the end of 2007 through the second quarter, according to the FHFA. Treasury Secretary Timothy F. Geithner has promised a comprehensive proposal by January.

‘Biggest Problem’

“The biggest problem in the economy is that we have 3 or 4 million too many homes,” said Chris Kotowski, a banking analyst at Oppenheimer & Co. The solution “will take another two or three years to work,” he said.

The clean-up effort includes seeking refunds from lenders who sold loans based on false or misleading information, and the two government-backed firms aren’t the only ones demanding buybacks. The Federal Reserve, private mortgage investors and mortgage insurers are combing through loan documents for faulty appraisals, inflated borrower incomes and missing documentation that would support a refund request.

As of the end of the second quarter 2010, Fannie Mae had $4.7 billion in outstanding repurchase requests, and Freddie Mac had $6.4 billion in outstanding repurchase requests. DeMarco said that outstanding repurchase requests continue to be “of concern.”

Misrepresentations

The FHFA in July issued 64 subpoenas to firms that sold mortgage-backed securities to Fannie Mae and Freddie Mac, trying to determine whether misrepresentations or omissions might require issuers to repurchase the loans. Lawsuits tied to faulty mortgages were filed against lenders or underwriters by bond insurers such as MBIA Inc. and by at least three Federal Home Loan Banks, according to analysts.

Lenders are resisting some buyback demands, with Bank of America Corp., the biggest U.S. lender and largest servicer of Fannie Mae’s loans, calling negotiations a battle that it’s fighting “loan-by-loan.” Among those lodging claims, Chief Executive Officer Dominic Frederico at Assured Guaranty Ltd. said last month that the talks are “like Chinese water torture. They’re very painful, have taken a long time.”

Assured, based in Hamilton, Bermuda, has asked federal and state banking and insurance regulators to intervene in the disputes, Frederico told analysts during a conference call.

Barney Frank

Representative Barney Frank, the Massachusetts Democrat who leads the Financial Services Committee, has urged the Obama administration to ensure FHFA uses its full legal authority to recover money from banks. Frank endorsed a letter signed by lawmakers including Paul Kanjorski, the Pennsylvania Democrat who led today’s subcommittee hearing.

Bankers have faced more queries from analysts during this month’s round of investor presentations, and some companies have begun breaking out data. Repurchase demands are running at about $1 billion a quarter at JPMorgan Chase & Co., Chief Executive Jamie Dimon, 54, said yesterday at a Barclays Capital investor conference in New York.

“It’s expensive,” said Dimon, whose New York-based bank ranks second by assets after Bank of America. “I think that will continue the rest of this year, next year and maybe a little bit longer.”

Repurchases have cost the four biggest U.S. lenders $9.8 billion, according to Credit Suisse Group AG. The total could exceed $179 billion for 11 of the largest lenders, according to Chris Gamaitoni, an ex-senior financial analyst at Fannie Mae who now works at Compass Point Research and Trading LLC, a Washington-based investment bank.

The Association of Financial Guaranty Insurers, a trade group for companies that provide private insurance for defaulted mortgages, said Bank of America may owe its members $10 billion to $20 billion alone for breaches of representations and warranties, as the buyback guarantees are called.

Limited Damage

The Federal Reserve Bank of New York, which wouldn’t say how much it was seeking in buybacks, has $69.1 billion in mortgage and other assets it took on when it helped rescue American International Group Inc. and Bear Stearns Cos. in 2008.

Bank of America has paid $3.86 billion related to buybacks since the third quarter of 2008, according to an investor presentation in New York yesterday. The Charlotte, North Carolina-based company still faces $11 billion in unresolved requests and insurers have sought files on $9.8 billion more, according to regulatory filings.

The bank has reserves of $3.9 billion to cover mortgage buybacks and has called the losses manageable, according to yesterday’s presentation by CEO Brian T. Moynihan, 50.

Requests Denied

Bankers say that not all requests become claims, and not all claims translate into actual buybacks. About half the requests don’t survive scrutiny, according to Credit Suisse, and as for valid claims, losses are typically less than the stated amount of the loans. That’s because loans are typically backed by collateral and covered by reserves, according to bankers. Loss estimates from analysts range from 35 percent to 60 percent.

Kotowski at Oppenheimer estimates $7.4 billion of losses over the next year for six of the biggest U.S. banks, including Bank of America and New York-based Citigroup Inc. and JPMorgan. That’s one of the lower forecasts among Wall Street analysts.

“Just because people are bringing suits doesn’t mean they have merit, doesn’t mean they’re going to get everything they want,” Kotowski said.

To contact the reporters on this story: Lorraine Woellert in Washington at lwoellert@bloomberg.net; Dawn Kopecki in New York at dkopecki@bloomberg.net

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