Big U.S. banks are leading the U.S. stock market down today.

The driver here isn’t simply the prospect of slower economic growth represented by the lack of any job growth in August data released today—although that certainly doesn’t help.

Bank stocks are reeling because the big U.S. mortgage lenders and mortgage packagers are reportedly facing a suit be filed next week from the Federal Home Finance Administration, the agency that represents Fannie Mae and Freddie Mac, seeking to force these financial companies to repurchase bad mortgages. The amounts at stake, and it’s extremely hard to put a dollar figure on this suit, could dwarf the $20 billion sought in a suit brought by the nation’s states attorneys general. Fannie Mae and Freddie Mac own about $227 billion of the so-called private label mortgages that are the subject of this suit. (Bank of America probably faces the biggest exposure since it sold the most of these private label mortgages to Fannie Mae and Freddie Mac.)

No surprise then that Bank of America (BAC) was down 8.7% as of 3:30 p.m. New York time, JPMorgan Chase (JPM) 4.7%, Goldman Sachs Group (GS) 5%, Citigroup (C) 5.1%, and Wells Fargo 4.5%.

The suit would be the result of 64 subpoenas issued last year to originators and servicers of mortgage-backed securities. The statute of limitations is due to expire next week so the Federal Home Finance Administration has to file or forever hold its piece.

The subpoenas and the likely suit focus on so-called private label mortgage-backed securities originated by mortgage lenders, packaged by Wall Street investment companies, and then sold to investors. Fannie Mae and Freddie Mac were permitted to buy slices of these securities that carried AAA ratings. As of the end of July, the two companies, now owned by taxpayers, held nearly $78 billion and $149 billion in such securities.

Private label mortgage-backed securities have been among the worst performing mortgage-backed assets, showing the kind of losses nobody expects from AAA-rated securities. The likely suit would allege that the banks in question misrepresented the content of the mortgage pools when they packaged them and sold them to Fannie Mae and Freddie Mac. Testimony in front of the Financial Crisis Inquiry Commission showed that a large percentages of mortgages included in mortgage-backed securities deals had received inadequate due diligence and that the big Wall Street investment companies ignored those problems and packaged them in the mortgage pools anyway.

A suit from the Federal Housing Finance Agency would be a nightmare for the big mortgage banks not just because of the sums involved, but because it would also pretty much blow up all other efforts to put together settlements that would cap bank liabilities. Forget about the proposed settlement with state attorneys—a settlement already in danger. And it would almost certainly bring other investors into court demanding that banks buy back their mortgage paper too.

But the effects don’t stop there. Read more

The sharks are no longer circling Bank of America (BAC). They’ve moved in with jaws wide open.

Who knew that the $4 billion acquisition of Countrywide Financial would keep adding fresh blood to the water even now three years after Bank of America acquired the mortgage lender in 2008?

Bank of America tried to stem the attack first with a $5 billion investment from Warren Buffett and then with the announcement today that the bank would sell half its stake in China Construction Bank. That sale would raise $8.3 billion. About $3.5 billion of that would go to improve the bank’s Tier One capital position.

But neither move put off the mortgage sharks.

First, the $8.5 billion deal brokered by Bank of New York Mellon back in June threatens to come apart. Read more

The stock market is haunted by ghosts of the bear market of 2000 and the financial crisis of 2008.

Every time oil tumbles or silver plunges I can feel the icy fingers of 2008 creep down my spine and I can hear fear in my email. Should I sell my shares of Freeport McMoRan Copper & Gold (FCX)? I was asked more than once when silver was on its way from $49 to $35? Understandable question. In 2008 shares of the copper and gold miner fell from $57.73 on June 4 to $12.18 on November 26, 2008. Who wants to go through that again?

When Renren (RENN), the Chinese Facebook, goes public at 75 times revenue or when the IPO of LinkedIn (LNKD) soars to more than $120 a share from its $45 offering price before closing at $94 on its first day of trading, it brings back memories of the dot.com bubble that saw Yahoo! (YHOO) rocket 154% on its first day of trading. The dot.com bubble turned into the tech bubble and both eventually burst wiping out not only newcomers like WorldCom  but also old established names such as Lucent Technologies and Nortel.

When Greece totters on the edge of default with yields on its 10-year bonds breaking 17%, it revives fears of the mortgage-backed asset collapse that took down Bear Stearns and Lehman Brothers—and almost claimed Citigroup (C) and American International Group (AIG) and the world financial system too.

This remembrance of bears past is a good thing. Fear is as essential to financial markets as hope. Without the latter nobody would buy anything and without the former everybody would buy everything.

But investors are supposed to move from blind panic to rational fear as a crisis moves further and further back into the rear view mirror. (Although it’s always wise to remember “Objects in mirror are closer than they appear.”) We’re supposed to have learned something from a crisis that will make it less likely to repeat in the future, but we’re not supposed to jump at every noise or lock ourselves in a panic room whenever a car alarm goes off.

So what have we learned and what do those lessons tell us about the current likelihood of a crisis turning into a market-shaking bear? (The kind of crisis I’m writing about here is quantitatively and qualitatively different from the kind of ordinary volatility or the 10% correction that investors go through regularly—and that emerging markets officially entered on May 23.) Read more

Let me set you a riddle.

How is the recent crash in the price of silver like the crash in the mortgage market that almost took down the global financial system?

The two are of very different dimensions, certainly. The silver crash simply took silver from near $50 an ounce to $35 and set off a one-week selloff in the price of other commodities that roiled the U.S. stock market. The mortgage crisis took down Bear Stearns and Lehman Brothers—and almost got American International Group and Citigroup. It took massive intervention by the Federal Reserve and the world’s other central banks to keep financial markets operating at all and we’re all still paying the price of the Great Recession that followed.

But they have a curious and important similarity. Both involve an attempt to hedge away risk—that itself actually created exactly the kind of explosive financial downdraft that the hedging was intended to make impossible or at least unlikely.

The lesson here is that the flight to safety carried to enough of an extreme by enough investors can turn into its own financial bubble. Safety carried to excess is the exact antithesis of safety.

Let me explain what I mean and then suggest what this tells us about the future of the financial markets. Read more

They’re doing What? Again?

How quickly they forget.

Northern Rock, the first British bank to be taken over by the British government at taxpayer expense during the global mortgage crisis, is back in the 10% down mortgage business.

And regulators are cheering the bank on because the bank need to show more revenue as it gets ready to sell shares to the public again.

Northern Rock ran into trouble in 2007 as the mortgages it had made to riskier borrowers went south with the British real estate market. A big part of the problem was that the bank’s most aggressive products didn’t leave borrowers any room for error if the price of their house dropped or the economy went into recession. Northern Rock’s most famous product was the “Together” mortgage that let borrowers take out a mortgage or up to 125% of the value of the house they were financing.

In February 2008 the government essentially nationalized the bank in order to protect depositors and stabilize the financial markets. Loans to the bank came to 25 billion pounds (and the pound was worth something then.) Guarantees added an additional 30 billion.

Since then a chastened Northern Rock has required borrowers to put down 15% to get a mortgage. But that’s about to change. Read more