Feds Mortgage-Security Lawsuits Will Help the Economy -- Eventually

Last Updated Sep 2, 2011 12:59 PM EDT

Lawsuits by Fannie Mae (FNMA) and Freddie Mac (FMCC) against dozens of big banks means the Great Accounting has finally begun. In the long term this will help the economy recover. In the short term? Things will get even uglier -- but that was going to happen anyway.

The NYT reports the Federal Housing Finance Agency will file suits about mortgage securities before Wednesday -- when the statute of limitations runs out -- against Bank of America (BAC), JPMorgan Chase (JPM), Goldman Sachs (GS), Deutsche Bank (DB) and others. Fannie and Freddie lost more than $30 billion buying securities sold by these banks which were at best based on wishful thinking (housing prices only go up) and at worst were plain old fraud (borrowers' incomes were entirely fictitious).

The FHFA case goes a significant step farther than the efforts of private bond holders who want to force banks to buy back tens of billions in crap-filled mortgage-backed securities. The Feds are seeking reimbursement for losses on the securities held by Fannie and Freddie.

The combined actions by public and private bond holders should finally force financial institutions to account for the difference between the outstanding loans and the shrinking value of the collateral assets. Hopefully that will get reveal the true condition of the U.S. financial system. How many zombie banks are there stumbling around the countryside?

Defusing the debt bomb
Balancing the books for real -- and not by gimmicks like mark-to-market rules -- should remove a great deal of uncertainty from the system. This, in turn, would give all those corporations sitting on huge amounts of cash solid information they need to determine whether they need to keep hoarding.

In the best-case scenario, they'd then start putting that money to work. In a less-good scenario they might figure the economy is in such bad shape that huge cash reserves are completely warranted.

Expect the financial services folks to put forth a number of reasons why these cases are either invalid or bad for the economy:
  1. The losses on these securities were the result of a broader downturn in the economy and the housing market, not how they were originated or packaged. In other words, it was not the fact that the chicken had its ass hanging out of the window that caused all those eggs to break as she was laying them.
  2. The lawsuits will further delay recovery in the comatose housing market thereby hurting the broader economy. I would rather wait for Godot than for the housing markets. We have way too many houses on the market and an ever shrinking number of people who can buy them. The presence or absence of these suits won't change that in the least.
  3. Forcing banks to pay billions of dollars will further hurt the financial services industry which had only just begun to further overpay its executives. This is the defense of those who think that the success of these institutions has anything whatsoever to do with the rest of the economy.
In the short-term (and possibly the medium term as well), things will get worse. I repeat: The presence or absence of these suits won't change that in the least.

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  • Constantine von Hoffman On Twitter»

    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald, TheStreet.com, CSO, and Boston Magazine.

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