A hedge fund's decision to sue troubled mortgage lender Countrywide Financial Corp. over the company's loan modification program could mean trouble ahead for similar programs.
As government officials pressure banks to modify mortgages to help struggling homeowners, frustrated investors who own pieces of those mortgages are likely to push back in court.
"These investors decided to go into the banking business, and now they don't like the results," said Gonzalo Freixes, a professor at the UCLA Anderson School of Management. "I think you will see more lawsuits."
The recent suit stems from Countrywide's agreement to settle allegations from about a dozen state attorneys general that the company engaged in predatory lending practices. As part of the settlement, Countrywide, which is based in Calabasas and was acquired in July by Charlotte, N.C.-based Bank of America Corp. for $2 billion, agreed to modify up to 400,000 loans.
When the agreement was announced in October, it was widely hailed as landmark decision to assist homeowners fighting to meet mortgage payments. But it put investors in a bind, given the structure of mortgage-backed securities which promise investors a certain rate of return assuming that the underlying mortgages supporting the bonds perform.
If they protested, they would take an unpopular position at a time when it had become politically popular to go after Wall Street investors. If they held their tongues, they stood to absorb potentially billions of dollars as the modified home loans produced lower income.
"From an investor's point of view, you were damned if you do, damned if you don't," said Lon Morton, chief executive of Calabasas-based Morton Capital Management, an investment firm not involved in the lawsuit.
The lawsuit against Countrywide, filed in New York on Dec. 1 by Connecticut-based Greenwich Financial Services LLC, charges that under the terms of its bond agreements Countrywide must purchase from investors all the loans on which it reduces payments.
"Countrywide plans not to absorb the $8.4 billion reduction in mortgage payments itself but rather to pass most or all of that reduction on to the trusts that purchased mortgage loans from Countrywide," the lawsuit charges.
The lawsuit is seeking class-action status on behalf of 374 trusts holding Countrywide loans that could lose up to $25 billion, said William Frey, president of Greenwich Financial. Fey said Countrywide's modifications could apply to $80 billion worth of loans.
"Countrywide got caught speeding and they want the guy in the passenger seat to get arrested," Frey told the Business Journal.
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