Here come the lawsuits

It appears the 60 million dollar Goldman settlement in Massachusetts has the potential to create a windfall of lawsuits by states against the large banks. I causally read this article a few days ago, but didn't really think about the implications of what had taken place. Bruce Krasting had an interesting post on the article:

This means next to nothing for Goldman Sachs. However, a very dangerous precedent has been set. In the critical years 2005-2007 Goldman was ranked 15th in the League Tables for sub prime and Alt-A origination/securitization. Goldman’s management must be pleased as punch with that poor showing today. Those that ranked high on that list are no doubt consulting with their attorneys. 

If Goldman gets its hand slapped for $60mm over 714 mortgages what does this mean for Countrywide Financial? They were very big in Boston. Merrill Lynch was at the top of those securitization tables. That is what got Stan O’Neal fired. If the settlement in Boston is representative of what will be forthcoming then Bank of America is going to be facing a very big number. And that is just Massachusetts. The AGs in the all of the other states, especially Florida, Nevada, Arizona and California must be licking their chops at this news.

This is lining up badly for the banks. The States are broke. They will see this as a source of revenue. Politicians will also like it. They will be able to claim that they are helping their constituents. Word on this will spread quickly from borrower to borrower. Every one of them will be looking for a break.

The settlement makes an important distinction between first and second mortgages. The rights of the second mortgages are clearly subordinated in the deal. This is how a bankruptcy court would treat the two classes of debt. This provides a clue on how these ‘seconds’ will be treated in the future. 

One of the largest sources of these second mortgages is the Mortgage Insurance Industry. They provide a guaranty of payment on the first loss of 20%. This product competed with the second mortgage industry. It created the same result for the borrower, the ability to buy a home with no money down. Precisely what Goldman is paying up for. In this case what quacks, walks and swims like a duck is likely to be treated like a duck.

Fannie Mae and Freddie Mac hold tens of billions of these insured or ‘enhanced’ mortgages. FHFA recently reported that the Agencies collectively held or guaranteed 30.2 million mortgages. Of that amount 16%, or 4.8 million are identified as “Non Prime”. Put differently, the Agencies hold 6,000 times more non-prime mortgages then Goldman originated in Boston.