Easy Street

The Potential Price Tag for FHFA Lawsuits: $60 Billion

Heidi Moore Sep 6, 2011

On Friday afternoon, the Federal Housing Finance Administration – that’s the government conservator that controls Fannie Mae and Freddie Mac – filed suit against 17 banks.

Today, Keefe Bruyette & Woods handicaps those lawsuits in a good research note. Below, you’ll find your field guide to KBW’s scorecard.

How much could the lawsuits cost the banks?

KBW’s “very preliminary analysis” suggests that the FHFA lawsuits – if they’re successful – could cost banks about $60 billion.

That’s $60 billion – in American dollars?

Yes, but that’s not all. If the FHFA makes a winning case, those bad loans could end up changing hands again, with all the sales considered void. (Think of this like the times you try to untangle your computer cord but then you end up having to unplug everything and you end up with a big mess.) KBW notes, “If FHFA is successful in showing that securities laws were violated then the loss would not be restricted to defective loans. The sale could be rescinded and the securitizer would receive the loans back. In this case, the loss to the originator would be the difference between cost and market value for all loans in the securitization, not just the defective ones. In our analysis, we assume losses on all defective and delinquent loans.”

How successful are the lawsuits likely to be?

The most likely outcome of the FHFA suits will be a settlement, KBW says, partly because Fannie and Freddie seem to have a weak case: “We believe that the defendants have strong defenses that could result in litigations stretching out for a significant length of time. As a result, we would expect the most likely scenario to be a settlement between the mortgage originators and the FHFA for a much smaller amount [than $60 billion.]”

KBW believes the banks have a pretty strong defense in this case: that “Fannie Mae and Freddie Mac were among the most sophisticated investors in the mortgage market.” (Not only were they among the most sophisticated, they set many of the rules, a subject I tackled over the weekend.)

Few such lawsuits have gone anywhere so far – although they are being filed nearly weekly, so one of them may break away from the pack and be the one that succeeds.

Why would the FHFA suit be different? There’s a more powerful plaintiff, for one thing: the government. One power the FHFA has that those other plaintiffs don’t is a powerful one: because the FHFA is a government agency, it can issue subpoenas.

The only question then, is this: what possible mortgage document are banks holding that hasn’t already been submitted and combed through by regulators or Congress?

What do other people think this will cost?

Matt Levine at DealBreaker has a very good post rounding up the various estimates of how much the lawsuit will cost. Bonus: a great chart. He also makes the excellent point that Fannie and Freddie wouldn’t sue for more money than they lost. Of course, they lost about $82 billion – an enormous number.

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