US FHFA Sues 17 Financial Institutions on Mortgages Securities: Who Pays the Reputation Bill?

(See also the post about the news image of FHFA lawsuit)

US Federal Housing Finance Housing (FHFA) sued 17 firms “to recover losses to Fannie Mae and Freddie Mac” (see Press Release) by Septemeber 2, 2011. FHFA is a federal agency acting as “the regulator and conservator of Fannie Mae and Freddie Mac and the regulator of the 12 Federal Home Loan Banks”, which official Mission statement is to “Provide effective supervision, regulation and housing mission oversight of Fannie Mae, Freddie Mac and the Federal Home Loan Banks to promote their safety and soundness, support housing finance and affordable housing, and support a stable and liquid mortgage market”.

In accordance with its mission, FHFA launched a lawsuit against 17 firms based on”FHFA’s conclusion that some portion of the losses that Fannie Mae and Freddie Mac incurred on private-label mortgage-backed securities (PLS) are attributable tomisrepresentations and other improper actions by the firms and individuals named in these filings. Based on our review, FHFA alleges that the loans had different and more riskycharacteristics than the descriptions contained in the marketing and sales materials provided to the Enterprises for those securities” (Press Release).

One day before, New York Times announced the imminent suing action. Apparently, it came as a surprise legal movement to many people in the market. In this article, the journalist mentionned that a “more than a dozen of big banks” where in the list. But New York Times mentionned only four of them: Bank of America, JP Morgan Chase, Goldman Sachs and Deutsche Bank “among others”.

Article by NYTimes provoked a substantial drop in mentionned companies in Friday 2 September trading (Bank of America -8.3%, JPMorgan -5.3%, Goldman Sachs -4.5%, Deutsche Bank -5.9%). Names of other affected companies came only after the market closed.

Today, Monday 5 September, affected companies in Europe have suffered a major fall, pushing all European stock markets into red. American companies are not trading today due to Labor Day. This was a specific Black Monday by European companies sued by US Federal Agency: Deutsche Bank -8.9%, Credit Suisse -8.1%, RBS -12%, HSBC -3.6%, Barclays -6.7%, Société Générale -8.6%.

The crisis we consider in this post is very interesting to us, as it is a common legal action against 17 different financial institutions. The amount of purchased made by Freddie and Fannie to each institution varies notably. Some affected institutions are American and other are European, (Plus Japanese Nomura). Finally, New York Times did only mention four of them.

The lawsuit has had an immediate tremendous financial impact. Billions of dollars of equity value have wiped away from stock owners’ pokets. This is a natural investor’s reaction to the anticipation of the losses linked to the legal process and the eventual financial fines. What we have observed today is nevertheless probably an irrational overreaction that could be corrected.

FHFA has not provided  numbers about the amount of losses they expect to recover: ““is is premature and potentially misleading to estimate what recoveries would be”. Some analysis estimate that the total sanctions to 17 entities coud reach $30Bn. Keefe, Bruyette & Woods estimate that it could cost as much as $60Bn to banks.

Financial expert John McDermott from Financial Times estimates that total amount of losses expected to recover by FHFA are $40Bn, with Bank of America expected to pay $12Bn, JPMorgan $7Bn and RBS $6.3Bn. The detail of the estimations for each bank are presented in the table.

Other analysists consider that $6Bn fine is more probable. In this latter case, these losses would represent barely 4% of total profits of these firms (Seeking Alpha, Sept 5 2011).

Whatever the extent of the direct financial impact of the lawsuit in terms of litigation costs and final finalcial sanctions, we understand that this case of a US Government Agency against 17 prominent national and international financial firms will be mainly a matter of tremendous reputational costs. This federal agency is in a sense pointing out these companies as key actors in the 2008 financial crisis that costed many sacrifices to US taxpayers and that finally became an economic crisis with the consequence of massive unemployment. A long, public and contrversial judicial process in the midst of the present renewed financial and economic crisis would become a constant media affaire with highly exposure linked to the sued institutions.

News linked to this lawsuit could be all of them severely damaging to banks reputations, as they are understood as being in the hart of the present crisis. This judicial process could render ineffective any other positive reputational efforts and expenditures assumed by the companies in sporsorship or CSR actions.

As already pointed out, the attractive aspect of this reputation crisis is that it is puting 17 companies in the same group, while the level of formally suing responsibility varies enormously, in a ratio 1 to 50. Would the public opinion and investors treat each bank differently or would they treat all of them equally as responsible for the crisis?

Media coverage to this lawsuit will provide us a lot of relevant information about the extent of the reputation damages for each one of the 17 indicted firms. As we have shown in precedent posts and in our research group reports (MRI Universidad de Navarra), we count with a number of tools that may provide useful information and knowledge for firms, practitioners and academia.

We show first in the following figure the amount of Mortgage Securities sold by each sued institution to Fannie and Freddie, in billions of US$, according to Wall Street Journal. We include under the umbrella of Bank of America $6Bn sold directly by BofA plus $26.6Bn by Countrywide Financial and $24.8Bn by Merrill Lynch/First Franklin Financial. Both firms were acquired by Bank of America.

We find that Bank of America, JP Morgan and RBS represent some $120Bn of products sold to Fannie and Freddie, or 61% of all liabilities of all 17 banks. We should note that RBS was not mentioned in the NYTimes article, while it identified Deutsche bank and Goldman Sachs.

The following figure presents the first results concerning the media coverage analysis. We compare the share of all purchased from each financial institutions, against the media coverage received in relation with FHFA lawsuit, in US newspapers. We identify in bold lines the institutions that were identified in NYTimes news.

US media coverage indicates that, as it could be expected, the distribution of news do not follow exactly the extent of expected legal liabilities: institutions that sold “small” amounts of financial products receive a substantial amount of media attention. While the 5 firms with lower financial implications have sold “just” $8Bn representing 4.2% of all funds, they receive a media coverage equivalent to 22.4% of all news about the lawsuit. The top 5 firms by liabilities suppose 76% of all sellings but only 45% of all media impact.

This is a natural result in terms of media coverage, as many newspapers mention all 17 affected companies or at least many of them. Even of the financial liabilities are indicated in the news articles, this balance of news appearances irrespective of liabilities produces paradoxically a negative reputation shift punishing the less affected companies. This result clearly favors the main involved firms: Bank of America, JP Morgan adn Royal bank of Scotland.

A second element emerging from the figure is a first assessment of the reputational impact of being mentioned in the original news at New York Times. Except for Bank of America, all other companies mentioned in the article suffer from a media impact premium in comparison to companies not present in this article. Just compare media impact of JP Morgan vs RBS, which are similar in liabilities. We also observe that Goldman Sachs reveives much more media attention than average, like Deutsche Bank. Citigroup appears also as outlier. Even if the group was not included in the list, it was directly mentioned in the article as a bank being sued by the same kind of financial practices. UBS was also mentioned in the article, but it is not included among the banks issued as UBS reached an agreement some weeks ago with federal authorities.

In the following figure we look just at banks mentioned in New York Times article. We show the relationship between funds involved and media coverage received in US newspapers between Friday 2 and Monday 5. As expected, media coverage of news that mention New York Times (NYTimes News) as source are roughly similar to all four banks, independently of the amount in charge. If we include all news in relation with the FHFA case between Friday 2 and Monday 5 (FHFA news) we see that Bank of America becomes main media reference (share of 28%) while the foreign bank receives lower attention in US newspapers than deserved by funds involved.

A complementary check is to look at banks explicitly mentioned in the headlines. Of course, being in the headline of a news implies a stronger negative reputational impact than just being mentioned in the content of the news. We have selected the headlines of news referring directly to New York Times filtration. Hre we find that newspapers tended to choose Bank of America (56% of all cases) followed by JP Morgan (38%).  Goldman Sachs appeared marginally and Deutsche Bank did not appear in the headlines.

The following set of figures shows media coverage of FHFA lawsuit by countries. Precedent analysis used results using US newspapers. Now we analyze how local media abroad is covering this crisis.

We show the share of news received by each single financial institution. We compare it to mortgages securities sold and against global media coverage. This allows to identify local media treatment specificities. We use bold line marks for identifying banks receiving specific local media attention departing from global trend.

US Newspapers count for 50% of all current news about FHFA lawsuit. This makes that its profil is similar to global coverage. One of the particualrities of US media coverage is that they under represent European continental banks (DB, CS, SocGen), while this does not happen with British firms.

Media from countries in Europe with local banks in the list focus their media coverage in their local affected institution. This is also a natural result, but with our analysis we provide empirical data enabling to estimate its extent.

This result has eveidently serious implications in reputation terms. Key market for any company is the local market, especially if this is a big market. Local market represents many times the biggest share of relevant stakeholders: owners, workers, consumers and relevant public legistation. Reputational issues in the local original market are extremely important for global brands. And this current crisis is linking main local banks to the origin of the economic and financial crisis, that is currently attacking also all these three markets: Britain, France, Germany.

Next figures is media coverage from countries that do not have local banks sued by FHFA. We find that media from Spain follow global media trend, except for Barclays and Nomura, that receive more media attention.

Media from apparently directly unaffected countries like Brazil and India follow basically global media trend.