By David S. Hilzenrath
Washington Post Staff Writer
Friday, December 31, 2010; 4:24 PM
Bank of America's hangover from the housing bubble could be harder to shake in the new year as a result of a recent court decision.
The bank lost a major procedural ruling in a lawsuit over its liability for allegedly toxic mortgages. The ruling will make it harder for the bank to defend itself in that case, and it could set a standard for similar disputes.
Bank of America had tried to set a high bar for plaintiff MBIA Insurance by requiring that the files for each of 368,000 or more disputed loans be evaluated individually. That process would have cost MBIA $75 million, and it would have taken a team of 24 people more than four years, MBIA estimated.
For the bank, it was "the next best thing to avoiding trial altogether," MBIA argued.
Instead, the New York State Supreme Court in late December declared that MBIA can pursue its case by focusing on a statistical sample of 6,000 disputed loans. That could pave the way for a trial to proceed as scheduled in 2011.
"It's a big setback" for Bank of America's "scorched-earth strategy," said David J. Grais, a lawyer involved in other suits against the bank.
MBIA still must prove its case, and "this we believe it cannot do," Bank of America spokesman Jerome F. Dubrowski said in a statement.
The MBIA case is at the forefront of a widening battle over troubled mortgages.
Lenders that issued mortgages during the nation's housing binge typically sold the loans to investors on Wall Street and around the globe. But those deals did not completely rid the banks of the risks. Many of the transactions included money-back guarantees.
Now, Bank of America and other lenders are confronting demands that they buy back billions of dollars of loans from investors because the loans are alleged to never have complied with the lenders' quality assurances, known as "representations and warranties."
For banks, such claims could impose a costly new toll.
MBIA's suit is a variation on the theme. It focuses on loans issued by Countrywide Financial, a big mortgage lender that was taken over by Bank of America. When Countrywide pooled loans into securities and sold them to investors, MBIA provided insurance, promising to cover the principal and interest payments to investors if the borrowers defaulted.
In the suit, MBIA is trying to recoup money it has lost and stands to lose in order to make good on its insurance policies.
If Bank of America must pay damages, delaying or dragging out a reckoning over several years would make it easier for the bank to absorb the blow, said analyst Chris Gamaitoni of Compass Point Research & Trading. Years of future earnings would help cushion the impact.
In an interview, Dubrowski, the Bank of America spokesman, said loans must be examined individually to determine whether they were defective and whether the defect caused the default.
"We have said all along that in cases where there's a valid defect, we will act responsibly and repurchase the loan," Dubrowski said. "But in cases where there is no valid defect, we will defend our interests and the interests of our shareholders."
The bank's chief executive, Brian T. Moynihan, put it more bluntly in a November briefing. He described the battle over the loans as "day-to-day, hand-to-hand combat."
In the Dec. 22 New York State Supreme Court ruling, Justice Eileen Bransten ordered a more streamlined approach. She said statistical sampling is generally accepted, and she cited an appeals court decision from 1856 saying it was acceptable to draw conclusions about 14 bales of cotton based on just several.
MBIA has argued that Countrywide's breaches were pervasive. An MBIA review found that 91 percent of defaulted or delinquent loans in 15 Countrywide pools "show material discrepancies from underwriting guidelines," MBIA said in its lawsuit.
Allstate Insurance, which bought more than $700 million of Countrywide mortgage-backed securities, filed a lawsuit against Bank of America this week making similar claims.
Allstate said Countrywide systematically approved loans that deviated from its own guidelines for such measures as the size of the loan in relation to the value of the property and the amount of the borrower's debts in relation to the borrower's income.
In many cases, it appears that Countrywide falsely represented that the borrower lived in the home, Allstate alleged, citing such evidence as the fact that borrowers had their tax bills sent to other addresses.
Allstate cited an internal Countrywide e-mail from 2006 saying a Countrywide audit found that "approximately 40% of the Bank's reduced documentation loans . . . could potentially have income overstated by more than 10% and a significant percent of those loans would have income overstated by 50% or more."
Bank of America spokesman Bill Halldin said the bank was still reviewing Allstate's lawsuit, "but this unfortunately appears to be a situation where a sophisticated investor is looking for someone to blame for a downturn in the economy and losses on an investment it made."