BizWeek Reports a Bank of America Threat to Fannie

Which corporate-welfare recipient will end up holding the bag on toxic mortgages?

Bloomberg BusinessWeek’s cover story this week has a very interesting piece of reporting that has flown under the radar. No wonder: It’s buried deep in the long story.

It reports that Bank of America is threatening Fannie Mae to keep it from pushing BofA to buy back its crappy loans:

Bank of America, the nation’s largest lender, has resorted to tough tactics in resisting repurchases of bad loans. Facing pressure from Freddie Mac, one of the two government-controlled mortgage financing companies, to buy back money-losing home loans with problems like inflated appraisals, overstated borrower income, or inadequate documentation, Bank of America issued a blunt threat, according to two people with direct knowledge of the incident. If Freddie Mac did not back off its demands for the buybacks, Bank of America officials said, the bank would take more of the new, more profitable mortgages it is originating these days to rival Fannie Mae, these people said. Freddie and Fannie, known as GSEs (government-sponsored entities), need a steady supply of healthy new loans to climb out of their financial hole.

The claimed threat from Bank of America, which was not put into writing, according to one of these people, was taken seriously enough that it has been discussed at several Freddie Mac board meetings, including one in mid-October. Some officials have urged the Federal Housing Finance Agency—the government conservator that has controlled Fannie and Freddie since they were bailed out in 2008—to confront Bank of America and prevent it from trying to play one against the other, which may be infuriating but is not illegal. “If the tactic worked, I’d be shocked and appalled,” said Thomas Lawler, a former portfolio manager at Fannie Mae and now an economic consultant. “The GSEs are supposed to be run now to minimize losses to the taxpayers. Freddie ought to ignore the threat.”

What a spectacle: one massive corporate-welfare recipient blackmailing another public company-turned-government ward over who’s going to end up holding the bag (I’ll note that Fannie ought to win here: Bank of America underwrote the things).

Taxpayers can only sit and watch: We’re paying for it one way or another. BBW (Hey, I didn’t name the thing!) is good to point that out:

For policymakers, the dilemma is this: Enormous losses will cause problems wherever they end up. They could further harm Fannie and Freddie, which insure the vast majority of the nation’s mortgages and have already received nearly $150 billion in taxpayer support. Or, if Fannie and Freddie succeed in pushing the burden back to the banks, the losses could cripple some of the major institutions that have just emerged from a government bailout… “The Treasury is very aware that they can’t push too hard on this because if you do push too hard it might put the companies in negative capital again,” says Paul J. Miller, an analyst at FRB Capital Markets. “There’s a lot of regulatory forbearance going on.”

The BofA/Fannie info is the newsiest part of this excellent piece by Peter Coy, Paul M. Barrett, and Chad Terhune, and should have been put up higher in the story. But that’s a quibble—you should read the whole thing, which capably surveys the field on the foreclosure fraud scandal. It takes a look at MERS, has an excellent lede anecdote that shows the potential consequences if the banking industry has really destroyed much of the original paperwork, and it has a lot of great reporting on Lender Processing Services, which appears to be one of the key enablers and/or perpetrators in the scandal.

“We are killing our competition!” says Greg Whitworth. It’s a perfect October day on the Jacksonville, Fla., campus of Lender Processing Services (LPS), and Whitworth, a division president, is rallying a crowd of 200 employees inside a big white tent on the sun-drenched banks of the St. Johns River. The company is celebrating what it calls “the Year of the Megas”—key customers Bank of America, Wells Fargo (WFC), and JPMorgan Chase—with a picnic of Mediterranean chicken salad, lemon cooler cookies, and sweet tea.

One gray patch hovers over the celebration: The back-office technology provider’s runaway success means it is tangled up in the foreclosure crisis. “I was thinking about the dark clouds over the company,” Joe Nackashi, the chief information officer, tells the crowd. “Sure, we have made mistakes. But I don’t want to let that cloud this day.”

No, don’t do that, buddy! I mean after all, what are a few investigations when you’re pulling in money hand over fist?

LPS employees “seem to be creating and manufacturing ‘bogus assignments’ of mortgage in order that foreclosures may go through more quickly and efficiently,” the Florida Attorney General’s Office says in an online description of its civil investigation. “We’re concerned that people might be put out of their houses unfairly and unjustly,” Bill McCollum, the attorney general, told Bloomberg Businessweek. In a third investigation, the U.S. Trustee Program, the branch of the Justice Dept. that polices bankruptcies, is looking into whether LPS is “improperly directing legal action” to hasten foreclosures, according to a 2009 opinion issued by the bankruptcy court in Philadelphia. A Trustee spokeswoman declined to comment.

BusinessWeek describes the problems with Lender Processing Services better than I’ve seen elsewhere.

And this is just good context:

Wall Street’s unspoken strategy has been to kick mortgage losses down the road until an economic recovery reinflates the housing market. The faulty-foreclosure crisis has forced the issue back into the present tense, triggering a fight over who will bear the brunt of those losses. The combatants—all of whom are trying to minimize their share of the damage—include homeowners, lenders and mortgage brokers, loan servicers and the underwriters of mortgage-backed securities, the buyers of those securities, title insurers, rating firms, and the federally controlled mortgage buyers Fannie Mae (FNM) and Freddie Mac (FRD).

I always like it when journalists end their pieces on FUBAR situations with ideas to fix or at least ameliorate the situation. BusinessWeek does that here. And its kicker gets at one of the most critical points, noting that:

The longer it drags on, the more the foreclosure crisis corrodes Americans’ faith in their financial and legal systems. A pervasive sense of injustice is bad for the economy and democracy as well.

Amen to that.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.