On November 11, 2008, Citigroup (here) and Fannie Mae and Freddie Mac (here) announced plans to modify existing home loans in an attempt to help borrowers avoid further foreclosures.


These mortgage relief efforts unquestionably are constructive, even praiseworthy. But as noted on the Real Time Economics blog (here), these efforts represent only a “drop in the bucket.” Among other concerns is that these relief initiatives can only reach “whole loans,” those that have not been broken up and sold into complex debt instruments. Apparently only 20% of troubled loans are whole loans.



As a result, for example, the Citigroup program addresses only mortgages the company itself still holds. With respect to the mortgages that Citigroup services but does not own, Citigroup says that it “will work diligently with investors to secure their approval to expand the program.”



The complications that could arise from investors’ interests in the loans that have been sold is becoming apparent in the wake of  the Bank of America’s earlier relief efforts on the mortgage loans it acquired in the Countrywide acquisition. If the upshot from those efforts is any indication, changes to the underlying mortgages made without investors’ assent could well lead to controversy and even litigation.





On October 6, 2008, Bank of America announced (here) a “proactive home retention program that will systematically modify troubled mortgages.” The program, which included up to $8.4 billion in interest rate and principal reductions for nearly 400,000 customers of Countrywide Financial Corporation, was hailed at the time as a “good framework” for similar arrangements with other mortgage companies.



The program was part of a deal Bank of America reached with the attorneys general of several states to settle claims brought regarding risky loans that Countrywide had originated. The press coverage at the time (refer here) noted that the deal would impact investors that own securities composed of mortgages originated by Countrywide, and that investors’ approval of the deal was required.



Investor’ Concerns


According to a November 10, 2008 Charlotte Observer article (here), it appears that investors may be balking at the Countrywide mortgage deal, and some may be considering suing.

The article cites a white paper (here) prepared by the New York law firm of Grais & Ellsworth, which paper asserts with respect to the deal that “even though Countrywide’s own conduct (or misconduct)” necessitated the deal,



Countrywide plans to pay not a cent of its own (or, rather, of its parent Bank of America) toward the $8.4 billion. Instead, it plans to impose the cost of its settlement on the trusts into which the to-be-modified loans were securitized, and thereby onto holders of certificates in those trusts. In our view, Countrywide’s plan will violate the agreements that govern those trusts.



The Charlotte Observer article quotes Bruce Boisture of Grais & Ellsworth as saying that as the deal reduces mortgage interest rates and principal balances, less cash will be paid into the mortgage trusts, as a result of which the trusts will note have enough cash to pay the trusts’ obligations. Boisture estimates that “385 trusts, representing hundreds of investors and outstanding debt originally worth $465 billion, could be eligible for a lawsuit.”



The white paper asserts that Countrywide had a “hopeless conflict of interest” between its obligations as the mortgage servicer under the securitization documents and as the originating lender that had allegedly engaged in predatory lending. Countrywide’s agreement as the mortgage servicer to modify the mortgages might extinguish the Countrywide’s liability as the loan originator, but, the white paper asserts, the agreements violate Countrywide’s obligations as the loan servicer under the securitization documents.



The white paper concludes by arguing that:



Countrywide and B of A must be assuming that the $8.4 billion will be spread over enough certificateholders that none will think it worth the trouble to protest. By working together for their mutual protection, certificateholders can disabuse Countrywide and B of A of this unfortunate assumption.



According to its website (here), the law firm is hosting a November 18, 2008 webcast “to brief investors” on Countrywide’s plan. The website states that the firm and several investors “are now organizing a coalition to contest Countrywide’s plan through demands on the trustees, and, if necessary, litigation.”




The questions being raised on behalf of the investors in the securities backed by the Countrywide mortgages underscores how difficult it could be to try to provide relief to borrowers whose mortgages were broken up and sold. As the white paper contends, mortgage restructuring potentially could violate the rights of investors owning securities backed by the mortgages.


The dispersion of the Countrywide mortgages amongst as many as 385 trusts and many more investors demonstrates how daunting it could be to secure investors’ consent to the mortgage adjustments. While one might argue that investors would be better of if there are fewer foreclosures, obtaining the assent of investors, who may or may not agree, could prove challenging.



It may be worth noting that mortgage restructuring may not only arguably harm the interests of the investors directly involved, but it could also undermine the appetite of potential future investors for similar investments. If future investors cannot be confident that their interests will not be altered, efforts to reinvigorate the securitization process (and by extension, the home lending process) could be impeded.



The investors’ objections to the Bank of America mortgage workout deal and the prospect of litigation on the investors’ behalf highlights how challenging it may be to come up with solutions that address the predicament of all of the mortgage borrowers.



In each of bailouts and workouts that have flowed across the front pages of the nations’ newspapers in recent days, there have been constituencies that have been aided but there are also constituencies that have been harmed. Equity interests have been diluted or wiped out, debt interests have been subordinated or extinguished, and other interested parties have similarly been disadvantaged..



Some of these disadvantaged parties have sued. For example, AIG shareholders have initiated an action in the Delaware courts seeking to assert their rights to vote on the (original) AIG bailout. There undoubtedly will be others of these disadvantaged constituencies that will bring their grievances to the courts. Including, perhaps, the investors that purchased securities backed by the Countrywide mortgages.



More ERISA Lawsuits: It may be argued that the aggrieved constituencies include, at least in some instances, the employees of the bailed out companies. That appears to be the position of the plaintiffs’ attorneys who, according to their  November 10, 2008 press release (here), have filed a class action against Fannie Mae under ERISA on behalf of Fannie Mae employees who participated in the Fannie Mae ESOP between April 17, 2007 and the present and whose accounts included Fannie Mae common stock.



There may well be employees of other companies that have been affected by the recent financial market turmoil that similarly file actions under ERISA. For example, the Milberg firm issued a November 10, 2008 press release (here) that it is “investigating illegal conduct” by the Hartford Financial Group and certain fiduciaries of the Hartford Investment and Savings Plan. The purported investigation involves supposed violations of ERISA.



The new Fannie Mae ERISA action is merely the latest in a series of actions that have been filed under ERISA as part of the subprime meltdown and the current financial crisis. Since the beginning of the subprime meltdown I have been tallying these ERISA lawsuits here. With the addition of the Fannie Mae lawsuit, the current tally now stands at 19.