Investors May Force Banks To Buy Back Faulty Loans

Chuck Burton/AP

President Obama will get a briefing Wednesday on the ongoing foreclosure crisis. Federal law enforcement officials are investigating whether banks broke the law when they submitted faulty paperwork in foreclosure cases.

But this isn't the only mortgage-related headache facing the nation's largest banks. A growing number of investors in mortgage-backed securities are demanding that the banks take back their bad loans.

'The Real Issue'

During the boom years, banks gave out tons of home loans, then packaged them into securities and sold them to investors. Now some of those investors are taking a closer look at what they bought and saying, "Hey, wait a minute."

"All these people want to send these loans back to the originator, and the originator is going to fight not to take them," says Dick Bove, a banking industry analyst at Rochdale Securities. "And that is where the real issue is."

Bove and many on Wall Street seem much more nervous about this investor backlash issue — referred to as put-backs — than the so-called robo-signer controversy, in which bank employees processed thousands of foreclosure documents without properly reviewing them.

In part that's because these put-backs could add up to real money, real fast.

Tuesday, a group of investors representing nearly $50 billion in mortgage-backed securities put Bank of America on notice that they intend to recover their losses. The securities were packed with loans from Countrywide, the notorious subprime lender later bought by Bank of America.

"These are the kinds of securities that go into pension funds [and] insurance company portfolios," says Kathy Patrick, a partner at Gibbs & Bruns in Houston who is representing the investors. "These are supposed to be fully secured and over-collateralized securities with the lowest possible risk of default. That's what they're supposed to be. That's what our clients are entitled to have."

Patrick's not naming her clients. But published reports indicate they include several giants of the investment world — Blackrock, Pimco and MetLife among others.

Protecting Shareholders' Interests

Bank of America CEO Brian Moynihan acknowledged the put-back issue on a conference call with shareholders Tuesday.

"We're not going to just put this behind us to make us feel good," he said. "We're protecting your money. We're protecting the shareholders' money. And we're going to make sure that we're going to pay when due ... not just do a settlement to move the matter behind us."

Figuring out which loans were written properly and which ones might have issues could ultimately require combing through hundreds of thousands of loan files. Moynihan said Bank of America is prepared to do that.

"If you think about it, people are going to come back and say, 'I bought a Vega, a Chevy Vega, but I want it to be a Mercedes with a 12-cylinder,'" he said. "We're not putting up with that, and we will be very ardent with the shareholders' interests."

Up until now, investors have had a hard time getting themselves together to go after the banks. The agreements that created the securities required a large share of the bondholders to agree to any action. Last week, another case against Countrywide was thrown out because not enough were on board.

But Patrick says this group of investors more than meets the threshold.

"Now that bondholders can see there's a path to obtain relief, this issue is going to continue to gain momentum," she says.

Whether investors will be successful in forcing banks to buy back billions of dollars in bad loans is an open question. But the possibility that they might have to was enough to make Wall Street jittery again.