Pushback on Freddie Mac Buybacks?

Funny thing about elephant stampedes. A herd of pachyderms might be stomping villages flat, driving the terrified villagers before it, and generally scaring the stuffing out of every mortal man and woman that crosses its path. Suddenly, the rampaging tuskers comes to a screeching halt when a great white hunter levels an elephant gun and starts blasting away.

That may be happening to one of the elephant herds in the mortgage banking business, Freddie Mac, whose irresistible force of  loan buy-back demands appears to be meeting the immovable object of JPMorgan Chase. At least, that the line of an article in today's American Banker (paid subscription required).

To make a long story short,

• the late, great Washington Mutual Savings sold loans to Fredddie Mac and serviced them for Freddie;
•  JPMorgan Chase bought Wamu;
•  Freddie Mac has demanded that JPMorgan Chase, as successor to Wamu's interest in the loans and the loan servicing, buy back the loans for various reasons (which Freddie Mac has a right to demand under its selling and servicing agreements);
•  JPMorgan Chase "may refuse to repurchase" the loans. At least, that's what Freddie Mac alleged in recent public filings.

Industry lawyers familiar with the dispute, speaking on condition of anonymity because they do work for the companies, said that whether it goes to court could depend on the legal language used by regulators in the rushed deal to rescue Wamu.

Theoretically, Freddie could terminate Wamu's servicing rights or seize the portfolio and try to find another servicer. But few companies are willing to accept any portfolio of loans with a high level of repurchase risk, observers said. Freddie also could settle the matter by putting a ceiling on its repurchase demands.

The conflict shows how the GSEs are caught between "a rock and a hard place," as one lawyer put it. Though they want to be repaid for defective-loan sales, they also need financially strong servicers to take over the portfolios of increasingly troubled originators.

Traditionally, both Freddie Mac and its big sister, Fannie Mae, have been the biggest gorillas in the jungle. If you want to sell loans to and/or service loans for either of them, then you'd better jump when they say jump. In most cases, regardless of legitimate legal defenses, most lenders who intend to stay in the mortgage lending and/or servicing business decide to accommodate the buyback demands of a GSE. Given the crisis in the mortgage markets, it's no surprise that, according to the American Banker, Freddie has tripled the amount of its repurchase demands in the past year. Unfortunately for Freddie, it's finding that many of the sellers are no longer willing to be pushovers or, even worse, the sellers may have already "rolled over" and played dead, i.e., they expired. It's tough getting a dead man to take your threats seriously.

"Historically, it's been hard to argue with Fannie and Freddie on repurchase demands because if you didn't do what they said, they could yank the servicing portfolios," said one industry lawyer. "Fannie and Freddie are experiencing what happened to the private investment banks last year, which made hundreds of millions of repurchase demands on subprime companies that they were never able to realize."

From what little is disclosed in the article about the facts, Freddie Mac's legal position appears to be strong. The Purchase and Assumption Agreement with the FDIC as Receiver for Wamu provides that JPMorgan Chase specifically assumed all mortgage servicing obligations of Wamu.

"Fannie and Freddie forever have had in their guidelines that, as a condition to accepting the transfer of servicing, the purchaser must assume the original reps and warranties," said a lawyer who represents both JPMorgan Chase and Freddie. "Chase, as an active buyer and seller of Fannie and Freddie servicing, is well aware of that. What they're saying here is that, because it's coming out of the functional equivalent of bankruptcy, they should be relieved of the repurchase liabilities."

That argument didn't work following the savings and loan debacle of the 1980s and 1990s. Why should it work any better this time around?

While an unnamed attorney is quoted as stating that JPMorgan Chase inserted language in the P&A Agreement to protect itself from buyback liabilities, I couldn't find it. Not that I looked that hard, inasmuch as I'm not being paid to do so. Perhaps a more observant reader (or a less inebriated one) will pick up the saving passage.

Regardless of the legal positions, it's interesting to finally see a case where the financial strength of an opponent of a GSE is impressive enough, and the need for its servicing support sufficiently important to the GSEs, that a GSE can't run roughshod over a bank and force-feed it loan buybacks.

We'll be watching this little tussle with interest.