If life gives you rotten lemons ... sue the banks

ROLL up for the latest round of the sub-prime blame game! In an almost farcical turn of events, the world’s biggest buyers of dodgy mortgages and mortgage securities – government-sponsored Fannie Mae and Freddie Mac – are now suing banks for selling them the “old lemons”, as Goldman allegedly called the stuff in private.

In more than a thousand pages of legal guff, the Federal Housing Finance Agency (FHFA) – the overseers of Fannie Mae and Freddie Mac – lays out its case against 17 banks that issued residential mortgage-backed securities (RMBS).

First there are accusations of negligence or fraud. The banks, FHFA says, sold RMBS with false information on the cover sheet, misleading buyers about how many of the mortgages in the portfolio related to owner-occupied homes (which supposedly merit a better credit rating).

If true, there’s a case to answer here – whether the misinformation came from underwriters or the packagers of RMBS.

But then there’s the overarching argument. The gist is that Fannie and Freddie were sold RMBS based on portfolios of mortgages that overvalued the homes in question and had credit ratings that weren’t justified. The banks should have known this, FHFA claims, because using “an industry standard automated valuation model”, it’s clear the houses were priced too high.

Well, here’s one reason that bad loans and bad homes were over-priced: because from 2002 onwards, and with an increasing voracious appetite, Fannie Mae and Freddie Mac bought them in droves. At the peak, in 2007, this daring pair bought a staggering 600,000 loans on houses where the buyer had put down less than five per cent of the capital.

In other words, if you help to create a booming market for nasty old lemons, don’t expect to be sold fresh lemonade.