Put-backs: How much are the banks worth?

Larry Ribstein —  20 October 2010

BoA is trading around $11.  Its book value is $21.45.  The difference has a lot to do with whether investors in mortgage-backed securities will be able to get BoA (and other banks) to repurchase hundreds of billions of dollars of mortgage-backed securities because the bonds didn’t meet representations and warranties in the bond contracts.  Here’s Carney on yesterday’s $47 billion demand against BoA:

The consortium claims that part of Countrywide’s failure to service the loans includes its failure to buy back loans that should have been ineligible to be include in the mortgage securities pools because they didn’t live up to the promised underwriting standards.  

 Quickly scanning through reports I see the following issues, among others:

  • What exactly were the misrepresentations and warranty breaches?  Bloomberg reports that the problems could include faulty appraisals and failing to include appropriate documentation needed for foreclosures. What else?
  • Were they material? If not, they’re not actionable. Bloomberg notes the losses may have resulted from the bad economy rather than loan defects. 
  • Who has standing to sue?  A demand often requires a significant percentage, say 25%, of the holders.  Query:  which holders?
  • What’s the statute of limitations?
  • What is the exposure at the bank level?  Countrywide, for example, is a separate BoA subsidiary.  Can BoA just put it in bankruptcy and walk away?
  • What’s the size of the total problem?  Bloomberg mentions another effort by investors holding more than $500 billion of mortgage-backed securities.

No doubt the banks have legions of lawyers advising them who collectively know some facts and law the market doesn’t.  Banks have limited obligations to affirmatively disclose all the details in real time, and non-material misrepresentations are not actionable. Which means there’s a lot investors don’t know.  A lot of this information involves the legal consequences of various factual scenarios whose likelihood the market could handicap.

Sure would be worth it to investors to get more info.  Think about that yawning gap between BoA’s market and book.

I’ve argued that there’s a demand for legal talent outside of the one-to-one advice market.  This would include selling legal information to the capital markets.  The putback mess would seem to be a time when such information would be particularly valuable.

Larry Ribstein

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Professor of Law, University of Illinois College of Law

2 responses to Put-backs: How much are the banks worth?

  1. 

    Interesting post, loved reading it.

  2. 

    These mechanisms exist. I did consulting for some hedge funds and investment bankers on the Vioxx litigation through Gerson Lehman in ’05 and ’06.

    There’s an additional twist in that there is a sophisticated plaintiffs’ bar with the incentive to provide misinformation about the likely success of their claims in an attempt to create shareholder pressure to settle. If you read through the financial press coverage of the Vioxx litigation from 2004 on, there’s almost always a plaintiff’s lawyer shaking his head and saying that Merck needs to immediately go to the bargaining table. Had Merck capitulated as early as they were being pressured to do, the litigation would have cost them tens of billions rather than $6 billion (including their own legal expenses).