By ANDREW JEFFERY

This post first appeared on Minyanville.

$100 billion just isn’t what it used to be.

Over the weekend, Freddie Mac (FRE) requested a second draw on its Treasury Department credit facility, saying $30-35 billion would suffice to keep its net worth above zero, thank you very much. After taking $14 billion in the third quarter of last year, Freddie has now chewed through almost half its $100 billion taxpayer-provided safety net in just 5 months.

According to Bloomberg, Freddie’s fourth -quarter operating losses triggered the need for additional funds, as its massive mortgage portfolio continues to sour. Analysts expect Freddie’s sister company, Fannie Mae (FNM), to request a similar draw when it announces fourth-quarter results in February.

As one analyst told Bloomberg, “[Fannie and Freddie’s] losses are going to be much higher than anyone anticipated. The more and more that people are digging into these portfolios, they’re finding out the more and more these guys were doing subprime and Alt-A loans and classifying them as prime.”

Defaults on prime mortgages, which are supposed to be given out to borrowers with good credit and stable jobs, are now increasing at a faster rate than the subprime loans that get so much headline play. According to the latest Mortgage Bankers Association Delinquency Survey, 2.87% of all prime loans were delinquent in the third quarter of last year, up 85% from the same period a year ago.

Keep in mind those figures are through September 2008 and don’t include the abysmal economic conditions of the past 4 months. And as layoffs mount and the economy continues to contract, the previously well-to-do are facing the same economic hardships those “subprime” people have been dealing with for almost 2 years.

Fannie and Freddie, despite not technically being involved in subprime lending, drove industry trends, and, in many ways, set precedents followed by the rest of the mortgage industry. Their drive to automate the loan underwriting process created massive opportunities for fraud. Both savvy and ignorant originators easily duped the system, jamming subprime borrowers into prime loans, which neatly showed up on bank balance sheets as AAA-rated assets.

The sieve-like automated systems were adopted by other big lenders, such as Countrywide, Washington Mutual, Bear Stearns, Lehman Brothers, IndyMac and Wachovia.

Now that none of those firms exist, loans originated under the guise of “prime” are turning out to be anything but. Bank of America (BAC), JPMorgan (JPM) and Wells Fargo (WFC), heretofore the strongest banks in the country, who absorbed many of those defunct lenders, are now faced with mounting losses on loans they thought were of the highest quality.

As I noted about this time last year, while everyone was so focused on subprime, prime mortgages — a market about 4 times as large — quietly presented a far bigger threat to the financial system. Now, as the government has bailed out 2 of the 4 remaining big American banks, those loans threaten the federal balance sheet.

Where’s TARP 2 when you need it?

This post first appeared on Minyanville.

Despite the Armageddon-esque financial turmoil of recent weeks, one thing about America hasn’t changed: If you really want someone to do something, sue them.

They lined up in droves: Cities, counties and states sued the pants off Countrywide for its shady lending practices. California, Illinois and Florida all alleged the lender fleeced American homeowners, jamming them into loans they had no hopes of repaying.

Now, Bank of America (BAC), who purchased the troubled California-based lender earlier this year, is stuck cleaning up the mess. Earlier this month, the bank agreed to pay more than $8 billion to settle lawsuits filed against Countrywide. Friday, the Los Angeles Times ran through the details of its plan to help as many as 395,000 troubled borrowers:

• Only owner-occupiers (not investors) with subprime or option ARMs qualify for assistance
• Interest rates may be reset as low as 2.5%
• Prepayment penalties and late fees will be waived
• Upside-down borrowers may have principal reduced
• Borrowers who lost their homes (or don’t qualify for assistance) will receive an average of $2,000.

Notably, Bank of America managed to get most investors who bought Countrywide’s mortgage-backed securities to agree to the plan. Holders of these assets have previously balked at such sweeping plans, since modifications usually lower a loan’s cash flow and decrease the value of securities behind it.

Efforts to get lenders to work aggressively with borrowers to avoid foreclosure have been largely ineffective. To be sure, there has been progress, but it’s fallen mightily short of promises the Bush Administration made last year when it announced its pilot program, HOPE NOW.

The aggressive plan, which Congressman Barney Frank, capitalism’s new public enemy number-one, called “the first truly comprehensive plan we’ve seen from the private sector,” could set the stage for a deluge of lawsuits.

The precedent has now been set: The way to stop foreclosures is to start suing banks.

I remember sitting in a meeting in early 2006, when a German bank that had lent our mortgage finance firm a few hundred million dollars asked why we didn’t get into the lucrative option-ARM market. The response: “We don’t want to touch those things. They’re a class action lawsuit waiting to happen.”

Indeed.

Other than Countrywide, the biggest writers of option ARMs during the boom were Washington Mutual, Bear Stearns and Wachovia. Not a single one remains independent.

The proud new owners of these banks, JPMorgan (JPM) (WaMu and Bear) and Wells Fargo (WFC) (via Wachovia) would do well to beef up their legal departments.

This post first appeared on Minyanville.

When Bank of America (BAC) agreed to buy Countrywide, it didn’t just take on a mountain of questionably valued mortgage-related assets. It also took on huge legal liability.

San Diego City Attorney Mike Aguirre, who has a penchant for punitive lawsuits that rarely result in much more than a media frenzy, is accusing Countrywide of defrauding thousands of San Diego homeowners. A lawsuit has already been brought at the state level by California Attorney General Jerry Brown, as well as in several other states, including Washington and Illinois.

San Diego’s suit takes aim at Countrywide’s alleged practice of coercing borrowers into risky adjustable rate mortgages (ARMs). Aguirre hopes to make San Diego a “foreclosure sanctuary” by preventing foreclosure proceedings on any property secured by a subprime ARM where the borrower owes more than the home is worth. (For more on what the glut of upside-down homeowners means for the future of the housing market, please read Finding the Bottom in Housing.)

The litigious City Attorney isn’t satisfied with just taking aim at Countrywide (and, by extension, Bank of America). Aguirre said he’s planning similar suits against Washington Mutual (WM), Wells Fargo (WFC) and Wachovia (WB).

While Aguirre’s heart may be in the right place, foreclosure moratoriums aren’t part of the road to recovery for the housing market. Opportunistic mortgage market participants are buying delinquent mortgages on the cheap, forgiving some part of the debt and giving borrowers a fresh start. Government intervention in this process will simply scare off lenders, since they’ll have limited recourse if the loan goes sour.

At best, such suits will simply drive up the cost of new mortgages. At worst, they’ll bring the recovery process to a standstill.

Foreclosures are nasty, painful and tragic. They are, however, a necessary part of the mortgage process, enabling lenders to recoup losses on bad loans.

Mandating an end to foreclosures is like telling the IRS it can’t go after tax evaders or preventing cops from chasing down burglars. This is not to say victims of foreclosures are criminals or necessarily deserve to be thrown out on the street, but living in a law-abiding society means that contracts must be enforced.

The moment we waive one group’s obligation to honor their collective word, the floodgates are open.

This certainly isn’t the last lawsuit we’ll see following the collapse of the mortgage market. In fact, it’s just the tip of the iceberg. A couple years from now, when Option ARMs begin to reset, class action lawsuits will bear down on lenders like a rumbling avalanche rolling down a steep slope.

Banks would be wise to get long some lawyers.