The New Bank Stress Tests Show Just How Serious the Mortgage Mess Is

Another Sign the Mortgage Documentation Mess Is Terribly Serious
Another Sign the Mortgage Documentation Mess Is Terribly Serious

A couple of days ago, the Congressional Oversight Panel charged with monitoring the financial markets recommended that the nation's big banks be stress tested again, because if problems with mortgage-backed securities are widespread, the consequences could be dire. Now, the Federal Reserve has announced it will do so, in part to "assess their exposure to so-called 'put-backs' of mortgages," a move it would be unlikely to take if the risk was viewed as trivial.

Similarly, as part of a multi-agency investigation into the mortgage mess, the Fed is "evaluating the potential macroeconomic effects of foreclosure documentation problems to the mortgage and housing markets." Again, that would be an odd use of resources if the banks' spin that the problems are limited and easily fixable were true.

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As I explained in a DailyFinance column Wednesday, investors may be able to force the banks to buy back the mortgage-backed securities they issued. Some investors are already trying or threatening to do so. But how great is the risk to each bank? The Fed won't tell, as "the results of the new capital reviews won't be made public," reports the The Wall Street Journal. The Securities and Exchange Commission, however, may make the banks come clean. Apparently, the SEC thinks current level of disclosure of litigation risks is inadequate, and wants to see that public disclosure beefed up, according to Reuters.

The SEC isn't looking for case-by-case estimates, but a real disclosure of aggregate risks, according to the Am Law Litigation Daily, and the regulator is so serious about it that, every time a large settlement or verdict is announced that has a material impact on a company's financial statements, the commission is going to review that company's past disclosures to make sure they were complete. As a result, I'd imagine that next quarter, the SEC filings of the big banks will shed some light on the put-back risk.

Meanwhile, the 50-state foreclosure probe rolls on, as the attorneys general push back against bank industry PR efforts that suggest a deal is imminent. Likewise, the multi-agency federal probe is expected to last another month or two at least. Given how broad that inquiry is -- it looks at banks, MERS, and foreclosure intermediaries like Lender Processing Services -- I can only hope that two more months really is enough time to do the job right. The government cannot be seen as yet again protecting the banking industry at the expense of everyone else.