The New York Times is reporting that AIG is planning to sue Bank of America over losses related to mortgage backed securities. Click Here to read the entire NYT article.
But the real essence of this story reaches back to the companies that were originating the mortgages in the first place. Bank of America made the mistake of buying the mortgage giant Countrywide, back in January of 2008, just as Countrywide was on the verge of failure. At the time, B of A must have thought they were buying the largest residential mortgage company in the U.S. at a bargain price. But it’s looking more and more like B of A got more than they bargained for.
At the time this purchase went down, I was sure that there must be some secret deal between the U.S. government and B of A. I knew that Countrywide was neck deep in bad mortgages, and was absolutely amazed that B of A would even consider buying Countrywide. Perhaps B of A actually thought it was a good acquisition.
By 2008, I had been consulting for years with large investment companies who specialized in buying up distressed residential properties. In the course of this work, I regularly examined the public mortgage records of hundreds of properties the company was considering buying. From a negotiating standpoint, this information was helpful because it told us how much debt was on the property. And if you compared any existing cash flow against mortgage debt, it provided an excellent indication of whether the seller might be in financial trouble already. If the cash flow was significantly lower than required to service the mortgage debt, you knew for sure that the property was highly likely to become a candidate for foreclosure.
As a result of this work I had an exceptional “behind-the-scenes” look at what was actually happening at the street level, where mortgages were concerned.
As early as 2003 I was stunned by the high ratio of over financed properties I was seeing. One of the most common types was an 80% first mortgage, with a 20% second mortgage. These 80/20 “piggybacks” as they were called, were being used extensively to obtain “no money down” financing on both owner occupied and investment properties that were being used for rental. But 100% financing rarely works out. It is “Finance 101” that properties tend to have higher rates of foreclosure, as the Loan To Value rate increases. And 100% financing on a rental property is the “kiss of death”. Even with full occupancy, they may not generate a viable positive cash flow.
The second mortgage holders I saw listed in the public records were a “who’s who” of the financial world. Bear Sterns was very prominent among them. Often one bank had the first mortgage and another financial entity such as a big European bank was named as the second mortgage holder. In the case of Countrywide, they were notable in my experience for often holding the first mortgage and a second mortgage on the same property. I remember thinking at the time how odd it was to see this.
As the housing boom progressed, the percentage of properties that were over financed grew very large. By 2004 I began to wonder how wide-spread this was. I was in Atlanta, GA. If it were like this in other big cities around the country, well, the implications were disturbing. As the housing market collapse unfolded in late 2008, my worst fears were realized.
AIG was caught in the middle of all this. Early on, they collected huge sums of money from the mortgage market players who rushed to hedge their mortgage bets with “insurance” from AIG. On the front end, it looked like AIG couldn’t lose, when given the historically low foreclosure rate in the U.S. But virtually no one had any idea how widespread the mortgage games really were.
If AIG is successful in this suit, it may provide the first real accountability test in the question of who is actually going to be held responsible for the mortgage mess. But it is safe to say that it should not be the U.S. taxpayers, who have been the real losers in all of this, and are still paying the price via AIG, for the reckless behavior of others.