Nov. 10--Countrywide Financial Corp.'s legal settlement last month, which requires it to relax the terms of some 400,000 mortgages, was good news for struggling homeowners. But a New York law firm says the settlement isn't fair to the people who invested in Countrywide's mortgage-backed securities, and it's trying to drum up interest in challenging the settlement.

That has some consumer advocates and lawmakers who pushed for the loan workouts up in arms, saying their work will be unraveled and that homeowners will be caught in the cross-fire. But some of the investors, who have already suffered substantial losses due to the withering housing market, say they could lose even more if those mortgages are renegotiated.

Successful or not, the potential lawsuit is a reminder that fixing the mortgage meltdown will be as complicated as the web of investors, securitizers and second-mortgage lenders holding stakes in most every mortgage. The law firm, Grais & Ellsworth, will hold a meeting this morning for securities investors interested in taking legal action against Countrywide and its parent, Charlotte's Bank of America Corp.

Bank of America Corp. bought Countrywide, a California mortgage lender known for exotic loans, this summer. Countrywide had been sued by North Carolina and other states that alleged it had practiced predatory lending. Last month, Bank of America settled those suits by agreeing to $8.4 billion worth of mortgage modifications, also called loan workouts, which can help struggling borrowers avoid foreclosure with measures such as reducing their interest rate or waiving late fees.





Grais & Ellsworth may challenge the settlement because it says Countrywide is violating its agreements with securities investors. According to the law firm, those agreements require Countrywide to repurchase any loans that it modifies or any loans that violate standards on predatory lending. Countrywide has not said that its loans were predatory or otherwise unlawful.

In a letter published on Grais & Ellsworth's Web site, partner Bruce Boisture wrote that Countrywide "plans to pay not a cent of its own" toward the cost of the loan workouts, but will force the securities investors to foot the bill, "even though it is Countrywide's own conduct (or misconduct)" that caused the settlement.

Bank of America spokesman Dan Frahm said the cost of the loan workouts will be fully incurred by Countrywide. "We're confident it (the settlement) has benefits for both the customers and the investors," Frahm said.

"The program has been public for a month, and we have not had any challenges from any of the investors that are in the program," he added.

In a news release last month, Bank of America's chief financial officer, Joe Price, said the cost of restructuring the loans was within projections that Bank of America made when it bought Countrywide. Through the settlement, the bank could eat the cost for up to $8.4 billion in bills it never collects on. Price indicated that the settlement could save money in the long term, by stemming foreclosure losses. Bank of America also said that some of the loan workouts "will be subject to compliance with servicing contracts and some will require investor approval."

Like other lenders, Countrywide did not keep most of the loans it made on its own books, but instead packaged them into securities and sold them to trust funds and other investors. Those funds pay their investors interest and principal from the payments they receive from the homeowners. If interest rates or principal balances on those loans are reduced, less cash comes into the trust. Boisture says that when that happens, the trusts will not have enough cash to pay the obligations previously promised to the bondholders.

Boisture estimates that 385 trusts, representing hundreds of investors and outstanding debt originally worth $465 billion, could be eligible for a lawsuit. Asked about reaction from investors, Boisture replied: "I would characterize it as a significant level of interest in learning about the issues and considering their options."

Loan workouts are becoming increasingly common, as banks try to stem their losses from subprime loans and the government announces its own initiatives, such as the HOPE for Homeowners program, to help banks absorb the costs of the mortgage modifications. Though most parties -- the borrower, the bank and the community -- will benefit from a loan workout, a securities investor might not, said Ira Rheingold, executive director of the National Association of Consumer Advocates.

"It shows how crazy things have become," Rheingold said. "We've created this system where stopping a foreclosure doesn't help everybody."

Rheingold said that securities investors may sue lenders over loan workouts for two reasons: They might say the lender needs their permission to modify a loan, or they might say the lender must reimburse them if the loan workouts hurt the securities' financial interests.

When JPMorgan Chase & Co. announced an expanded loan workout program last month, it aimed the program toward borrowers whose mortgages are still owned by Chase. The New York bank owns about 22 percent of the $1.5 trillion in home loans that it services. "Chase will continue to work diligently with investors to get their approval to apply these programs to the loans it services for others, so its efforts have the broadest possible impact," the bank said.





Bank of America says it owns about 12 percent of the 400,000 loans included in the workout settlement.

And there are other parties, in addition to the securities investors, that may protest the wave of loan workouts. For example, the lenders that make second-mortgage loans or home-equity loans often get left in the cold in a loan workout, since they're second in line to collect payments from a homeowner

Last month, members of the House Financial Services Committee sent terse letters to two hedge funds, one in Connecticut and one in Colorado, that were reportedly discouraging banks from participating in HOPE for Homeowners, because they feared the loan workouts would hurt the value of their securities. "Your decision is a serious threat to our efforts to respond to the current economic crisis..." wrote the representatives, who included N.C. Democrat Mel Watt and committee chairman Barney Frank. "For the hedge fund industry, which has flourished for much of the past decade, to take steps so actively in opposition to what is currently in the national economic interest is deeply troubling and will clearly have serious implications for the rules by which we operate in the future if this posture of obstruction of our efforts is maintained."

They have asked the heads of both hedge funds to testify at a hearing Wednesday.



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