Americans Are Still Paying the Tab for Countrywide's Misdeeds

CountrywideWhen whistleblower Kyle Lagow raised concerns about Countrywide Financial's practice of giving bloated appraisals on government-insured loans, he lost his job. Lagow filed a lawsuit resulting in a $1 billion settlement against Bank of America (BAC), which took over Countrywide in 2008.

Lagow wasn't alone in calling out his bosses for bad behavior. There were four other whistleblowers, including Gregory Mackler, who criticized Bank of America's management of the government's Home Affordable Modification Program, which was created to help homeowners struggling to make their mortgage payments.

Together, these five whistleblowers' lawsuits became part of a $25 billion national mortgage settlement this year.

Settlement or no, we're all still paying for Countrywide's bad behavior in two ways:

  • Because of bloated appraisals, many of us are stuck with bigger mortgages at higher rates than we would have otherwise had to pay.
  • As taxpayers, we've been put on the hook for the banks' financial losses -- losses that resulted from their misrepresentation of the financial risk involved in backing government-insured mortgages.

Sticking Buyers With Overinflated Prices

All major banks require a home appraisal before approving mortgage loans in order to ensure that, should the homeowners default, the lender can recoup the investment by reclaiming the assets and reselling the homes.

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Appraisals are supposed to provide an accurate representation of a home's value. So it's natural for buyers to use the appraisal as guidance in the home purchase decision. But that also means that home shoppers can be misled by inflated appraisals and end up buying a too-expensive house.

That's exactly what we saw during the worst of the housing bubble from 2002 to 2007.

With the help of slipshod appraisals, home prices doubled or even tripled in just a few years. Eager consumers rushed in to buy before they were priced out of the market, and greedy buyers moved in, hoping that they could flip the house in a year or two with the help of steadily rising appraisals.

As we know now, the higher they rise, the harder they fall. But it didn't have to happen like that.

Accurate appraisals can help stabilize the housing market by limiting the ability of potential buyers to purchase overpriced homes, since banks will not offer mortgages for amounts higher than the appraised value. Because buyers rely on mortgages to cover most of their home's price, smaller loans limit their ability to shell out the money to cover inflated home prices.

Sticking Taxpayers With the Tab for Risks and Losses

Home buyers aren't the only ones who got jammed up because of Countrywide's inflated appraisals.

The 5 Bank Stocks Facing the Biggest Legal Risks
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Americans Are Still Paying the Tab for Countrywide's Misdeeds

With 10,000 lawsuits against them, you knew they'd be on the list somewhere. JPMorgan estimates it faces up to $3.315 billion in litigation after taxes, beyond what it has already paid out or reserved against. That adds up to 8.8% of the $37.612 billion JPMorgan is expected to earn in 2012-2013.

In 2011, JPMorgan's noninterest expense included $3.2 billion of litigation expense, mostly for mortgage-related matters, compared with $5.7 billion of litigation expense in 2010, according to Nomura's report

Citigroup estimates it is on the hook for up to $2.6 billion in litigation after taxes, beyond what it has already paid out or reserved against. That adds up to 9.9% of the $26.364 billion Citigroup is expected to earn in 2012-2013.

Citigroup faces a variety of regulatory inquiries and class action lawsuits related to its mortgage origination practices. The private lawsuits will not be included in a National Mortgage Settlement, reached last month with 49 state attorneys general and the federal government. Bank of America (BAC), JPMorgan, Wells Fargo (WFC) and Ally Financial, the former GMAC, were also part of the settlement.

Bank of America estimates it faces up to $2.34 billion in litigation expenses after taxes, beyond what it has already paid out or reserved against. That would equate to 10.9% of the $21.455 billion the bank is expected to earn in 2012-2013. The bank faces lawsuits related to mortgage originations and servicing, as well as for alleged failure to disclose its knowledge of ballooning losses at Merrill Lynch ahead of its eventual acquisition of that company.

The $2.34 billion figure, however applies only to "those matters where an estimate is possible," according to the bank's annual 10-K filing with the Securities and Exchange Commission.

Regions Financial estimates it faces up to $221 million in additional litigation costs after taxes, or 12.9% of estimated $1.707 billion in 2012-2013 earnings.

Regions is also on the hook for any litigation related to its Morgan Keegan brokerage unit, which it agreed to sell to Raymond James Financial (RJF) on Jan. 11.

Synovus faces just $39 million in potential litigation costs after taxes, above what it has written down or reserved against. However, that equates to 14.5% of the bank's estimated $270 million in 2012-2013 earnings.

As is the case with Bank of America, however, Synovus's estimates relate only to "those legal matters where [the company] is able to estimate a range of reasonably possible losses," according to its 10-K.

When the bank insured its mortgages through government-owned organizations like the Federal Housing Administration or the Rural Housing Service, its inflated appraisals falsely suggested that Countrywide could recoup its losses on defaulted loans by seizing the homes and reselling them. In other words, it falsely represented the risks taken on by the government insurers, which ultimately had to cover bank losses on defaulted loans.

And the costs for covering these losses are passed on to taxpayers like you and me.

Aside from the more clear-cut costs outlined above, we all paid -- and continue to pay -- for the role banks played in causing the housing bubble and subsequent economic collapse.

Motley Fool contributor M. Joy Hayes, Ph.D. is the Principal at ethics consulting firm Courageous Ethics. She owns shares of Bank of America. Follow @JoyofEthics on Twitter. The Motley Fool owns shares of Bank of America.

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