A news item recently got lost in the shuffle of political news. The Federal Government is suing Bank of America for defrauding Fannie Mae and Freddie Mac by selling them bad mortgages, causing a wave of foreclosures and bankruptcy filings. One of the reasons the mortgage and real estate market is taking so long to recover is because of how complicated and tangled the mortgage industry got in the early 2000’s. Why has it taken so long for banks to clear out the backlog of foreclosures? We once thought one of the big things holding them back was the mortgage servicing suit that was being negotiated by the five biggest banks, the State Attorney Generals and the Federal Government. That got settled and the mess is still hanging out there.
One part of the perfect storm that came together to make the mess was mortgage-backed securities. That is what this latest lawsuit is all about. The mortgage companies would originate mortgages, package them together as a security or investment and sell them to Fannie Mae and Freddie Mac. The product was no longer a loan that the mortgage company was collecting on, but a security that they were selling and getting their money up front. The more mortgages they originated they more securities they could sell. The Mortgage Backed Securities Department was going back to the Mortgage Department telling them get us more loans that we can sell. This is why the banks started making No Document and Stated Income loans. They didn’t care if the home owner couldn’t afford the mortgage. That would be the problem of the person who bought the security. Ultimately, it lead to a lot of home owners getting in over their head and being forced into bankruptcy. We saw a huge wave of bankruptcy in Waldorf and Lexington Park over the last 4-5 years.
When the bubble burst Fannie Mae and Freddie Mac started to realize that the mortgages backing these securities were backed by bad mortgages. When those mortgages failed, and the economy put the squeeze on so many people who were making it before things turned bad, foreclosures and bankruptcy inevitably followed. The problem is that these securities and other mortgage-backed investments became so complicated that it still may be years before the whole mess gets untangled. Lawsuits move notoriously slow, and there is little chance this one will get settled anytime soon.