A Little Insight into Forced Repurchases from Fannie and Freddie

The fact that the mortgage market and the GSEs are screwed up is not a new story, but these requests for repurchases from Fannie, Freddie and the mortgage insurers is  surely one to keep an eye on particularly if you are an investor in bank stocks.  (I am an involuntary investor in bank stock as a result of receiving a good chunk of my compensation in the form of unvested restricted bank stock.  If it weren’t for that, I wouldn’t touch these stocks with my worst enemy’s money, owing to the lack of transparency on the marking of assets.

One little-discussed aspect of this is that Freddie doesn’t do at the time of purchase (or at least didn’t as of 14 months ago when I last cared about this topic).  They rely on the automated approval engines at the time of purchase, then once a mortgage defaults, they go back and figure out if they should have bought it in the first place.  If it fails that test, they seek reimbursement from the party that sold them the mortgage.  Unfortunately for us taxpayers, there are many originators that are no longer in business, so there’s no one to put the defaulted mortgage back to.  In the case of the big bank mortgage shops, these levels of repurchases are, theoretically, being reserved against in current earnings figures, but those reserves are only as good as their current default estimates and reliant upon an expost facto review of the original underwriting.  Many articles have pointed out, the underwriting being done during the go-go days was often quite shoddy, both in terms of creditworthiness of borrowers and documentation.    Original loan and underwriting documentation was either lost, faked or never existed.  These practices, from which very few sellers are immune, make it pretty easy pickings for Fannie and Freddie to argue that the defaulted mortgage their holding should be repurchased.

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