AIG’s Mortgage Insurance Company Has Their Ass On The Line

By: Financial Futures and Equity Market Analysis Monday, October 12, 2009 10:11 PM

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Bruce Kastings posted a decent article on Zero Hedge alerting readers to a suit of United Guaranty UG, a mortgage insurance subsidiary of AIG against Bank of America (really BAC's subsidiary Countrywide Financial CFC - the mortgage lender that BAC thought was so wise to purchase in Jan 2008). The long and short of it is that United Guaranty, the mortgage insurer, is suing Countrywide Financial (for "truth-in-lending) fraud. Can anyone be surprised that the lender CFC might have been engaged in fraud?

Kastings article points out that UG should not be held to make Countrywide good on borrower defaults if Countrywide conspired with the borrower in the act of fraud on those loans. It would seem that if UG can readily prove that is so, that they would have some standing, and Countrywide would have to eat its own fraudulent loans. This would hurt the parent company BOA of course. But the judge, according to Kastings, may be leaning towards a decision in favor of CFC. The timeline for all this to happen is just a few weeks away, and the decision will set a precedent for the fate of the mortgage insurance industry, of which I have little sympathy for.

Ok, so here is the deal.

So CFC commits fraud on probably tens of 1,000's of loans if not millions. CFC, knowing millions of borrowers would at some point default, and knowing the borrower was paying for the mortgage insurance in the event of default, why worry. Risk of borrower's default upon loan originators such as CFC has been decomposed through the mortgage insurance loophole right? So why should loan originators such as CFC worry?

This is not unlike the monoline insurers at the end of 2007 and beginning of 2008. To tell the truth, yes, CFC is guilty as the day is long of fraud,and no, the mortgage insurer' should not have to pick up that liability, theoretically.

However, it could be that mortgage insurance in general is not such a good thing after all. Shit, tehy engaged in moral hazard dealing with fraudsters. Maybe, the judge is thinking, let the mortgage insurers swim with the fishes, make them pay the claims and put most every last one of them out of business. Why the hell not? Serves mortgage insurer's right for violating the first rule of business "know your client." In the case of mortgage insurers, they all knew the type of corporate culture there was at mortgage lenders like CFC and New Century (why do you supppose Ken Lewis probably loved these churn and burners schmucks at CFC so much).

In my mind, the judge is probably thinking the world will be better off with a few less mortgage insurers. Hobble the mortgage insurance industry that was riddled with moral hazard so that only the good mortgage insurers whose code of ethics stayed within the guidelines of "best practices." Those mortgage insurers that did not do business with criminals will pick up market share. If mortgage insurers hazard to consort with cockroaches, let their financial souls burn in some layer of Dante's hell.

Yes the industry will shrink. Yes, less people will be able to borrow and get into a home. But also, the industry will be a lot cleaner. the Countrywide lenders of the world won't be able to execute their scams and fraud, and loan originations will not be a business so damn attractive to criminals that get paid high fees doing high volume levels of fraudulent activity. So the criminals will flee the high fee origination business like the cockroaches they are "when truth in lending" actually means "truth in lending" once again.

There is another reason that the MI industry should be forced to shrink. Financial innovation has come to rely way too heavily on insurance products to lay off and decompose risk. Financial innovation should be made much tougher to do in the future. Financial innovators should not be so easily able to hedge and layoff the risks they take onto others. They need to know what it is like to have some skin in the game.

If everyone had some skin in the game from zero% down borrowers, to loan originators, to mortgage insurers, the goddam world would be a whole lot better off.

It is just the sort of good cleansing needed not just for the mortgage insurance industry, but for loan originators too.

I am no fan of BofA or CFC, but in this case, I hope the judge rules in their favor.

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10/15/2009 11:06:05 AM MI Insider by Thomas In response to your article, there are a few things which I think should be stated. CFC (BAC) are not the only lenders that commit "fraud". I use "fraud" loosely because most of it is just greed. I don't think they knew going into many of these loans that the borrower would default and decided to make them anyway just because they had MI coverage on them. The MI only covers a portion of the losses so the lender still gets hit with the bulk of the losses. What they gambled on was that the value of the homes would continue to rise and if the borrower defaulted, they would be able to sell the property with little to no loss. In the event that there was a loss, the MI coverage would be eaten up first before they were impacted. One of the other things that works against the MI's is that they are typically "threatened" that if they want the lenders business, they must take on certain risky loans as well. So with a shrinking lender market. The MI's have to take what they can get to stay in business. The goal is to do as little of the risky loans that you can in order to keep getting business and do as much of the good business that you can do. The problem is that even some of the good business is not as good as you thought when you're at the mercy of the originator for providing the borrower data to you in the first place. When you determine that there was misrepresentation in what was disclosed to you on the part of the borrower's income/assets, etc., the MI should have every right to rescind coverage and return any paid premium to the lender thereby causing the lender to eat the entire loss. What we seem to have here is a pattern of known misrepresentation on the part of CFC and/or their approved list of broker/originator partners. Reply Rating: (0) (0)

In response to your article, there are a few things which I think should be stated. CFC (BAC) are not the only lenders that commit "fraud". I use "fraud" loosely because most of it is just greed. I don't think they knew going into many of these loans that the borrower would default and decided to make them anyway just because they had MI coverage on them. The MI only covers a portion of the losses so the lender still gets hit with the bulk of the losses. What they gambled on was that the value of the homes would continue to rise and if the borrower defaulted, they would be able to sell the property with little to no loss. In the event that there was a loss, the MI coverage would be eaten up first before they were impacted. One of the other things that works against the MI's is that they are typically "threatened" that if they want the lenders business, they must take on certain risky loans as well. So with a shrinking lender market. The MI's have to take what they can get to stay in business. The goal is to do as little of the risky loans that you can in order to keep getting business and do as much of the good business that you can do. The problem is that even some of the good business is not as good as you thought when you're at the mercy of the originator for providing the borrower data to you in the first place. When you determine that there was misrepresentation in what was disclosed to you on the part of the borrower's income/assets, etc., the MI should have every right to rescind coverage and return any paid premium to the lender thereby causing the lender to eat the entire loss. What we seem to have here is a pattern of known misrepresentation on the part of CFC and/or their approved list of broker/originator partners.

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