Bank Of America In Sub-Prime Pay Out

The Global Financial Crisis was chiefly sparked by a loss of confidence in a single debt vehicle, the securitised sub-prime mortgage. The idea was that individuals with questionable financial histories were granted mortgages which attracted higher interest rates than their more creditworthy peers to compensate lenders for the higher risk of default on the loan. Most people getting such a mortgage would honour the repayment terms and everybody would be happy. Obviously, some borrowers would default, but if these loans were bundled together (securitised) then the overall product would be of investment grade – really. These sub-prime investments proved very popular, but the underlying flaw was that the risk of over exposure had been overlooked and the very nature of the product itself was inherently risky. The crisis erupted when individuals were unable to pay their mortgages, causing the value of the vehicle to plummet.

Bank of America has just agreed to pay the US mortgage giant Fannie Mae $11.6 billion to settle claims that it mis-sold residential home loans which were in reality “toxic debts” (sub-prime mortgages). The sum includes $1.3 billion of compensation with the rest being used to settle the claims. Fannie Mae’s function was to buy mortgages from lenders such that they could then re-lend money to home buyers.

Together with its sister organisation, Freddie Mac, it is estimated that they lost $30 billion during the crisis. A further $140 billion of public money was needed to keep the two businesses operational. Bank of America came to a similar compensation deal with Freddie Mac in 2011.

The sub-prime crisis led to some mortgages being foreclosed on wrongly and some $8.5 billion will be paid by the big 10 US mortgage lenders in compensation to some of those affected. Compensation will run from just a few hundred Dollars up to $125000, totalling $3.3 billion with the rest of the fund being used to write-off loans or provide loan assistance.

Of course, the rating agencies all gave green lights to sub-prime debt vehicles despite the obvious conceptual risk in the product.