New Threat to Banks: Mortgage Security 'Put Backs'?

Oct. 27, 2010 — -- Could the whole U.S. banking system return to the brink if Bank of America is forced to buy back tens of billions in soured mortgage-backed securities?

At a public hearing today on loan modifications and foreclosures, a Treasury official dismissed that concern despite doubts raised by the Congressional Oversight Panel for the Troubled Asset Relief Program, the group charged by Congress with assessing the effectiveness of the federal bank bailout.

Bank of America is facing a demand by investors, including the Federal Reserve Bank of New York, that the bank buy back $47 billion in mortgage-backed securities. The loans backing the securities, investors argue, didn't live up to pledges made about their quality.

At the hearing this morning, Phyllis Caldwell, the Treasury Department's chief of the Homeownership Preservation Office, said that there was "no evidence of systemic risk" posed by such buy back demands -- also known as "put backs."

"It is still early. We are working very closely with 11 regulatory and federal agencies. We are watching this every day and that at this stage, there appears to be no evidence of a systemic risk," Caldwell said.

Her comments were met with skepticism by COP member and AFL-CIO policy director Damon Silvers, who noted that the Federal Reserve said the securities in question in the Bank of America demand have halved in value.

"If the Fed's request to Bank of America is honored, Bank of America, assuming when they buy them back, they mark them to market, Bank of America will take a $23 billion loss," he said.

If the bank were to later face five such requests, it could amount to a loss that exceeds the bank's $115 billion market capitalization, he said.

Silvers urged Caldwell to retract her statement about systemic risk "because these things can be embarrassing later."

Caldwell did later clarify, saying, "we didn't say there was no risk, we said there didn't appear to be evidence of a major systemic risk."

"I hope that if the Treasury comes back to us and is discussing if we need to deploy further public funds to rescue Bank of America, or such other institutions as might be affected by these events that we get a similar kind of indifference to their fate," Silvers responded.

Robosigning Scandal

During questioning by the panel, Caldwell also addressed the fallout over robosigning allegations that employees at mortgage servicers signed foreclosure paperwork without properly reviewing it.

Caldwell said that the department, which pays mortgage servicers to modify loans through its Home Affordable Modification Program, was waiting to get results of investigations into servicers by various government agencies before taking any action. Caldwell said that the controversy has not affected HAMP because the program deals with homeowners who are not yet in foreclosure.

Confronted with the fact that the Treasury still has a $17.2 billion investment in GMAC, one of the servicers named in the robosigning scandal, Caldwell said that the Treasury Department is regularly in touch with GMAC's management.

GMAC, she said, is working "promptly" to correct documentation problems and Treasury officials are "watching that very very closely and take it very seriously."

The COP hearing comes more than two weeks before a scheduled Senate Banking Committee hearing, called by Chairman Chris Dodd, D-Conn., on allegations of foreclosure irregularities. The committee has not yet announced who will testify at the Nov. 16 hearing.

The Congressional Oversight Panel was created by Congress in 2008 to oversee and assess the effectiveness of the bank bailout. Its reports have been largely critical of the government's execution of the bailout, with the panel most recently arguing that the Treasury Department's reliance on private contractors limited transparency -- a charge that the department refuted.

Most of the panel's discussion today focused on the government's mortgage modification program, which President Obama has said is intended to keep 3-4 million homeowners from foreclosure. The U.S. Treasury Department said only 28,000 homeowners in default were able to secure a permanent loan modification in September, well off the pace the government envisioned.

"It's like a major league batter pledging to swing at every pitch – what matters is not how often we swing, but how often you get on base," panel chairman Sen. Ted Kaufman, D-Del., said. "Treasury can't prevent every foreclosure in this country but it should try."

Arlette Saenz of ABC News contributed to this report.