The legal liability of the top 17 banks went up measurably when the Federal Housing Finance Authority, created to oversee the big GSEs, sued in September, accusing the banks of misrepresenting the quality of billions of dollars worth of consumer mortgages. 

We're starting to get a glimpse of just how much risk that suit represents. Goldman Sachs, for example, has disclosed that it is liable for "reasonably possible" losses of $2.6 billion, up from $2 billion a quarter earlier. That risk stems from suits filed against the bank that cover $15.8 billion in mortgages. The FHFA's suit covers about $11.1 billion of that total. Reuters notes that many entities have rushed to sue just recently to beat a statute of limitations expiration date.

Other banks also face some large burdens. Morgan Stanley recently disclosed that it faced a new suit by investors charging that it sold defective mortgage bonds. Of course it will be years before all this is settled. The FHFA suit alone, which covers $200 billion in soured mortgages, is a legal sprawl already. The judge overseeing the case has asked for the 17 banks to come up with a plan that would allow for a streamlined resolution.

One gets the feeling that it will drag on, as such cases tend to do. It will be interesting to see the extent to which banks hike their reserves for the third quarter. It would be wise to be conservative in its loss estimates, though they might not be able afford to be too conservative while earnings are so weak.

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