No Put-Backs After All?

by Andrew Stuttaford

The appalling thought that people may have been wrongfully turfed out of their homes is the aspect of the foreclosure mess that, understandably enough, has been grabbing the most headlines, but financial markets have been more worried about something else. Will flaws (mild word) in the documentation of toxic CMOs allow their unfortunate buyers to hand them back (at cost, plus doubtless some compensation) to the banks from which they bought them, bringing yet more ruin in their wake?


Over at CNBC’s NetNet, John Carney doesn’t think so:


[T]he politicians will not let the financial stability of the largest bank in the nation be threatened by contractual rights. Not when there’s an easy fix available that won’t cost taxpayers a dime.

Here’s what is going to happen: Congress will pass a law called something like “The Financial Modernization and Stability Act of 2010” that will retroactively grant mortgage pools the rights in the underlying mortgages that people are worried about. All the screwed up paperwork, lost notes, unassigned security interests will be forgiven by a legislative act.

There’s a big difference between the financial crisis of 2008 and the new crisis. In 2008, banks were destabilized by the growing realization that they were overexposed to the real estate market. Huge portions of their balance sheets were committed to mortgage linked investments that were no longer generating the expected revenues or producing losses. That was a problem of economics that could only be solved by recapitalizing banks or letting some of the biggest banks in the U.S. fail.

The put-back crisis is not driven by economics. It is driven by legal rights. And there’s simply zero probability that the politicians in Washington are going to let Bank of America or Citigroup or JP Morgan Chase fail because of a legal issue.

So here’s what I expect will happen. The lame duck session of Congress will pass a bill that essentially papers over the misdeeds of the banks that originated mortgage securities. Every member of Congress and every Senator who has been voted out of office will cast a vote for the bill. And the President will sign it.

Will the public be outraged?  Probably. Financial bloggers will scream from the high heavens against another bailout of the banksters. Congress may try to create some cost for banks in exchange for the forgiveness, perhaps requiring more mortgage modifications.

But the much feared put-back apocalypse will be laid to rest.


John may be right, but I’m not fully convinced. TARP had a very difficult time in getting through Congress in 2008 and the political landscape is, if anything, even more hostile to the banks than it was back then. Hang onto your hats (again).

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