Recently, Bank of America lost in a ruling over whether or not MBIA (MBI, Financial) must show that its damages were caused by the allegedly material misrepresentations instead of the overall housing decline. MBIA was forced to make payments on loans it insured during the housing market collapse of 2008. MBIA claims that Countrywide, now part of Bank of America (BAC, Financial), made material misrepresentations. MBIA also says it would have not insured the loans in question if it were not for Countrywide’s promises regarding the quality of the loans.
In its defense, Bank of America claimed that MBIA had to prove that damages were caused by misrepresentations instead of the actual housing decline. The ruling in favor of MBIA instead of Bank of America and Countrywide makes it harder for lenders to avoid responsibility for their claims and holds them responsible even when the entire housing market was in crisis.
This ruling over causation is significant as it makes it easier for the insurers to recoup damages caused by the quality representations. Insurers depend on the lenders to provide accurate information in order to make appropriate judgments as to the risk insuring the loans. If Bank of America had instead won the ruling, lenders could hide behind the housing collapse and blame the market for their mistakes, avoiding their own responsibilities to provide accurate information. This is a slightly circular situation in that the bubble collapse created the loss in the misrepresented paper, but the misrepresented loans also caused the bubble and subsequent collapse. The only real issue here is whether the banks get away with the lies or not.
Now, other lenders will be affected from this ruling and others like it. For Bank America, the causation issue means that $8 billion to $9 billion in potential liabilities may be added from bond insurers according to Branch Hill Capital Partners. Bank of America spokesperson Grayson says the estimates are “consistently overstated.” Banks and brokers with lending facilities are extremely leveraged. The assets on their books are gigantic in comparison to the net shareholder equity that is the stock price. Whatever the loan exposure, companies will have to consider any potential risk of damages if their loan quality was misrepresented, a practice which was rampant.
Banks control trillions in loans that may or may not be insured. The market cap of Bank of America shows $58 billion at current stock prices, yet the financials show shareholder equity of $230 billion as of September 2011. Depending on your outlook, you might say either the current market cap and stock price is too low or you might say $230 billion is too high given the unknowns. Contrast the market cap figures to the $2.2 trillion in assets on the books as of September 2011. This is why the housing collapse has been so devastating to banks since a small move in housing can create losses at least 10-20 times greater due to this balance sheet leverage. This same leverage that hurts them today was the same leverage that provided the incentive to misrepresent the insurers years ago.
The ruling and related settlements are significant for lenders in that they will be held more closely responsible for their negligence and misrepresentations when making and packaging loans. Rulings like these that do not require the insurers to prove causation will open further litigation against the lenders and, therefore, future practices will be reflecting the newly reinforced consequences.
When you step back to think about it, it sure makes a lot of sense that the banks be held accountable for their false promises and risky practices encouraged by the previous government administrations promoting housing for everyone. The housing led financial crisis will have left scars that may hinder another easy money bubble for many years until real demand from positive economic fundamentals and income gains are the cause of forward housing demand. These long and drawn out processes in assigning blame and liability are necessary to restore confidence in the system.
As far as stock prices are concerned, prices are either too cheap or still bad bets depending on your view of the housing market going forward and your view of the level of pessimism priced in. As I predicted months ago, Bank of America shares would fall below their 52-week low at the time. In fact, they did. The financial sector as a whole has been beaten up and underperformed the market. But have they been oversold too far in overwhelming pessimism? Or will a steady flow of litigation fees and damages continue to drain the banks in a still weak housing environment? Well that’s the whole dilemma for investors looking for value in the sector.
Investors who remember the recent bubble in housing in the past decade with all its profits should wipe the memory of it. If the tech bubble before taught us anything, it’s that it takes years for the market to heal and recover from the excesses. For many years to come, rulings like the MBIA vs. Bank of America will continue to haunt lenders as well as the continuous supply of expensive houses will put a ceiling in housing. The market will be sideways at best for years to come until the fundamentals are finally overwhelming the pessimists and previously burned investors. Just like every other bubble, this one is basing and will be mostly a waste of time and only frustrate investors if not lose investors other opportunities in other sectors. This is the lesson that past bubbles give us.
In its defense, Bank of America claimed that MBIA had to prove that damages were caused by misrepresentations instead of the actual housing decline. The ruling in favor of MBIA instead of Bank of America and Countrywide makes it harder for lenders to avoid responsibility for their claims and holds them responsible even when the entire housing market was in crisis.
This ruling over causation is significant as it makes it easier for the insurers to recoup damages caused by the quality representations. Insurers depend on the lenders to provide accurate information in order to make appropriate judgments as to the risk insuring the loans. If Bank of America had instead won the ruling, lenders could hide behind the housing collapse and blame the market for their mistakes, avoiding their own responsibilities to provide accurate information. This is a slightly circular situation in that the bubble collapse created the loss in the misrepresented paper, but the misrepresented loans also caused the bubble and subsequent collapse. The only real issue here is whether the banks get away with the lies or not.
Now, other lenders will be affected from this ruling and others like it. For Bank America, the causation issue means that $8 billion to $9 billion in potential liabilities may be added from bond insurers according to Branch Hill Capital Partners. Bank of America spokesperson Grayson says the estimates are “consistently overstated.” Banks and brokers with lending facilities are extremely leveraged. The assets on their books are gigantic in comparison to the net shareholder equity that is the stock price. Whatever the loan exposure, companies will have to consider any potential risk of damages if their loan quality was misrepresented, a practice which was rampant.
Banks control trillions in loans that may or may not be insured. The market cap of Bank of America shows $58 billion at current stock prices, yet the financials show shareholder equity of $230 billion as of September 2011. Depending on your outlook, you might say either the current market cap and stock price is too low or you might say $230 billion is too high given the unknowns. Contrast the market cap figures to the $2.2 trillion in assets on the books as of September 2011. This is why the housing collapse has been so devastating to banks since a small move in housing can create losses at least 10-20 times greater due to this balance sheet leverage. This same leverage that hurts them today was the same leverage that provided the incentive to misrepresent the insurers years ago.
The ruling and related settlements are significant for lenders in that they will be held more closely responsible for their negligence and misrepresentations when making and packaging loans. Rulings like these that do not require the insurers to prove causation will open further litigation against the lenders and, therefore, future practices will be reflecting the newly reinforced consequences.
When you step back to think about it, it sure makes a lot of sense that the banks be held accountable for their false promises and risky practices encouraged by the previous government administrations promoting housing for everyone. The housing led financial crisis will have left scars that may hinder another easy money bubble for many years until real demand from positive economic fundamentals and income gains are the cause of forward housing demand. These long and drawn out processes in assigning blame and liability are necessary to restore confidence in the system.
As far as stock prices are concerned, prices are either too cheap or still bad bets depending on your view of the housing market going forward and your view of the level of pessimism priced in. As I predicted months ago, Bank of America shares would fall below their 52-week low at the time. In fact, they did. The financial sector as a whole has been beaten up and underperformed the market. But have they been oversold too far in overwhelming pessimism? Or will a steady flow of litigation fees and damages continue to drain the banks in a still weak housing environment? Well that’s the whole dilemma for investors looking for value in the sector.
Investors who remember the recent bubble in housing in the past decade with all its profits should wipe the memory of it. If the tech bubble before taught us anything, it’s that it takes years for the market to heal and recover from the excesses. For many years to come, rulings like the MBIA vs. Bank of America will continue to haunt lenders as well as the continuous supply of expensive houses will put a ceiling in housing. The market will be sideways at best for years to come until the fundamentals are finally overwhelming the pessimists and previously burned investors. Just like every other bubble, this one is basing and will be mostly a waste of time and only frustrate investors if not lose investors other opportunities in other sectors. This is the lesson that past bubbles give us.
