By Jia Lynn Yang
Washington Post Staff Writer
Tuesday, October 26, 2010; 9:39 PM
Since the financial crisis broke out two years ago, unhappy investors in mortgage securities have struggled to organize themselves and achieve a common goal - force big banks to buy back loans that went bad because of shoddy lending practices.
Now, widespread reports of the banks botching their loan paperwork have breathed new life into the efforts by investors, and they say they are organizing their most aggressive legal offensive yet against the biggest bank in the country, Bank of America.
Once run by a loose group of hedge funds, the investors' campaigns have bulged in size in recent weeks, turning them into a force that could recoup tens of billions of dollars from Bank of America and other large lenders and act as a major drain on their earnings.
Previously, this group struggled to force the banking industry to hand over data critical to their lawsuits. Now with the Federal Reserve Bank of New York, the regulator of mortgage giants Fannie Mae and Freddie Mac, and some of the world's largest funds on board, the investors may be able to compel banks to reveal more about their lending practices.
The newly energized investors present a troubling scenario for the big banks that packaged loans and sold them as securities. On top of fighting off lawsuits from homeowners seeking to challenge foreclosure proceedings, these companies could face months of bitter and costly litigation as angry investors finally unite.
On Wednesday, a team of attorneys leading the charge is holding a conference in New York about failures by banks to properly service loans and their practice of hiring "robo-signers" who signed off on thousands of foreclosure files each month without verifying their accuracy.
The prospect of more lawsuits has already spooked Wall Street. On Monday, Bank of America's stock hit a 52-week low.
"If you think about people who come back and say, I bought a Chevy Vega, but I want it to be a Mercedes with a 12-cyclinder, we're not putting up with that," said chief executive Brian T. Moynihan in an earnings call last week. "We will diligently fight this."
Still, the foreclosure debacle represents a turning point for mortgage investors who have long accused banks of misrepresenting the mortgages they issued. For instance, some investors have accused banks of overstating how many loans were taken out by borrowers using their properties as primary residences, which made the mortgages seem less risky than they actually were.
The robo-signer issue is one more piece of evidence, say investors, that the banks have failed to keep their end of the bargain.
"I think the robo-signers are a battle in a long war," said Bill Frey, chief executive of Greenwich Financial, which filed a suit in 2008 against Countrywide, now owned by Bank of America.
So far, investors have faced two major hurdles in their battle against the banks.
First, the plaintiffs have to prove in court that they hold more than 25 percent of the mortgage securities that they say have problems. This has been tough because investors can't easily find one another. Mortgage securities were sold by banks to investors all over the globe and the names of the buyers are not publicly disclosed.
And, added, Isaac Gradman, an attorney in San Francisco, "The big issue was originally that investors did not want to come forward to reveal what their holdings were."
Earlier this month, New York state Supreme Court Judge Barbara R. Kapnick in New York County tossed out Greenwich's lawsuit against Countrywide for failure to gather enough investors to meet this 25 percent mark.
In recent weeks, the headlines about shoddy lending practices has drawn more investors out of the shadows. Many have begun exploring whether they should join ongoing lawsuits.
"The level of interest has just risen dramatically," said Tal Franklin, a Dallas-based attorney representing investors. Franklin said he has been receiving two or three calls a day from new clients. Franklin has organized a clearinghouse through which investors can band together and yet keep their holdings private.
The other barrier for investors has been proving exactly how banks have broken the contracts attached to the sale of the mortgage securities. The investors are seeking specific information on how loans were underwritten, including whether the bank checked to see if borrowers were being truthful in their income statements, and whether banks lived up to the promises they made to investors in prospectus materials attached to the mortgage securities. The trouble is that banks hold that information and have been unwilling so far to hand any of it over.
Franklin said investors are making progress in this respect. They're analyzing public records and now getting phone calls from attorneys representing homeowners who are offering information on how banks have handled individual loans.
Also, in July, the Federal Housing Finance Agency, acting on behalf of Fannie Mae and Freddie Mac, issued 64 subpoenas seeking documents on private mortgage securities bought by the government-controlled firms. That information, if shared, could prove critical to investor lawsuits.
Estimates range widely on how much banks stand to lose from investor lawsuits. Analysts at Compass Point Research & Trading estimate that the total liability for such private securities is likely to be $133 billion, with a worst-case estimate of $179 billion and a best-case estimate of $55 billion.