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"Put backs": A refund for banks' investors?

Signs for Bank of America and Countrywide

TEXT OF INTERVIEW

Kai Ryssdal: It's a rare thing indeed when the biggest bank in the country reports a $7 billion loss, and that's not the lede story of the day.

But such is the state of the financial industry that Bank of America's earnings announcement this morning is playing second banana. Of more interest and importance is the ever-growing discussion of how bad the foreclosure mess might get.

The Marketplace word of the day this Tuesday is "put back." It's the present day corrollary to collateralized debt obligation and credit default swap, neither of which wound up meaning anything good for the banking industry.

We've got our senior business correspondent Bob Moon with us to explain. Hey Bob.

Bob Moon: Hey Kai.

RYSSDAL: All right, put backs. What are they, why do they matter?

Moon: Well first of all, you're turning a transitive verb into a noun, Kai, but here's what the dictionary says: "Return something to where it belongs" is the first definition. And the second is probably more appropriate: "Pay something back to a person or group."

RYSSDAL: Or refund?

Moon: Exactly. Remember we talked about these mortgage-backed securities that were sold to investors, either private funds or the government-backed mortgage-investment giants? They bought up the proceeds from pools of mortgages that get packaged up in the form of these securities.

Now the financial industry calls it a "put back" when the bank or lending institution is forced to buy back the mortgage-backed security at face value -- essentially give a refund to the investors who bought it -- because there was something faulty about the way it was issued or sold.

RYSSDAL: O.K. make the connection for me then, between the foreclosure slowdown we've been hearing about the last couple of weeks with all these paperwork problems and this developing problem of the mortgage bond market.

Moon: Well, this logjam focused a spotlight on the problem of faulty documentation of these mortgages, and we all know that's thrown a wrench into the foreclosure process.

But analysts are saying this "put back" problem goes beyond that, because we're not just talking about people not making their mortgage payments, we're talking about whether the banks can be held liable for misrepresentation or fraud for those bonds and if they'll be on the hook for tens of billions in "put backs." Already Bank of America has paid out more than $3.3 billion to settle claims stemming from faulty underwriting or documentation.

RYSSDAL: So they're paying out some money but they are also saying, out of the other side of their mouths, listen this is simple a paperwork drill. We will fix this, there will be no problem with the bond market; trust us, basically.

Moon: Yeah I'll tell you about what the investors are saying: "I'll see you in court." There are some very big private investors who are pressing the issue: there's a report out today that the big bond-investment firm PIMCO, the private-equity firm BlackRock, and even the Federal Reserve Bank of New York, are demanding the return of $47 billion from Bank of America's Countrywide Financial unit.

Now B of A chief Brian Moynihan has likened this to a war, and during his conference call with analysts today, he argued that the bulk of these mortgage-backed securities is not faulty.

Brian Moynihan: Our perspective on this, we're going to be quite diligent defending the interests of our shareholders. This really gets down to a loan-by-loan determination, and we have, we believe, the resources to deploy against that kind of a review.

Moon: Translation: we can drag this out in the courts if we have to.

RYSSDAL: While they're doing that, is there a way for us to know what is coming? Is this the next version of the credit crisis? How much will this cost the banks? All of those questions.

Moon: That really is the multi-billion dollar question at this point. Analysts for a couple of those too-big-to-fail banks have put the likely price tag around $55 billion, stretched out over many years, they say. In the worst case, a few other analysts say it could end up costing the banks more than $100 billion. And as for what it means to us, we're already seeing a new tightening up of credit. People in the industry tell us loan originators are starting to worry that more loans are going come bouncing back to them, so they're toughening up their underwriting standards. And this could make it even tougher to qualify for a mortgage.

RYSSDAL: Marketplace's Bob Moon, with the latest on the two-headed foreclosure crisis. Thanks Bob.

Moon: Thanks Kai.

About the author

Bob Moon is Marketplace’s senior business correspondent, based in Los Angeles.

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