What Do Bank of America And The Federal Home Loan Banks Have In Common? A Lawsuit & PwC

Have you been following the trials and tribulations of Bank of America and their auditor, PricewaterhouseCoopers, LLP?

I have.

My latest column at Forbes.com highlights the bank’s latest worry – the Federal Home Loan Banks are joining the dispute over their record mortgage crisis settlement.

What’s the hedge when a long tail profitable relationship turns into fat tail risk?

Bet on both sides.

In 2010, PricewaterhouseCoopers had $141 million reasons to arbitrage their relationship between Bank of America and the Federal Home Loan Banks. As auditors of both, they play both sides in what looks to be a major battle brewing between Bank of America and some major investors, who include several of the Federal Home Loan Banks (FHLBs), over the Bank of New York Mellon (BONY) mortgage servicing settlement.

Bloomberg, July 21, 2011: Investors in Countrywide Financial Corp. mortgage bonds may be owed three times or more of what they’re being offered in an $8.5 billion settlement with Bank of America Corp. (BAC), a group of Federal Home Loan Banks said… The Federal Home Loan Banks of Boston, Chicago, Indianapolis, Pittsburgh, San Francisco and Seattle are seeking to intervene in the case and may oppose the settlement, according to court papers… The home loan banks criticized assumptions in an expert report completed for Bank of New York Mellon Corp. (BK), the trustee for the mortgage-bond trusts. The report’s estimate of a reasonable settlement would rise to $22 billion to $27.5 billion if it assumed that Bank of America would have to buy back all loans in default and which breached representations and warranties, instead of 40 percent.

The problem at Bank of America is inadequate reserves for repurchase risk borne of bad representations and warranties and it’s been stewing for a while. The first big crisis failure, mortgage originator New Century Financial, experienced just the kind of out of control death spiral Jonathan Weil is now warning about with Bank of America.

New Century Financial didn’t reserve adequately for repurchase risk. KPMG, their auditor, settled claims they allowed executives to fudge the models used to make the estimates. A “sudden” liquidity crisis ensued when all their warehouse lines were called at once.

KPMG was also auditor for Countrywide, the sharpest thorn in Bank of America’s side.

Read the rest here, “PwC Hedges Bet Between Bank of America And Federal Home Loan Banks.”