FHFA SUES 17 BANKS FOR LOSSES ON $196 BILLION IN RISKY HOME LOANS SOLD TO FANNIE MAE AND FREDDIE MAC

The top federal housing regulator filed lawsuits on Friday against 17 of the world's biggest financial institutions, saying they sold $196 billion of risky home loans over four years to Fannie Mae and Freddie Mac without adequately disclosing the risks.

FHFA Filings in PLS Cases, September 2, 2011:

1. Ally Financial Inc. f/k/a GMAC, LLC
2. Bank of America Corporation
3. Barclays Bank PLC 
4. Citigroup, Inc.
5. Countrywide Financial Corporation 
6. Credit Suisse Holdings (USA), Inc.
7. Deutsche Bank AG 
8. First Horizon National Corporation
9. General Electric Company 
10. Goldman Sachs & Co.
11. HSBC North America Holdings, Inc.
12. JPMorgan Chase & Co. 
13. Merrill Lynch & Co. / First Franklin Financial Corp.
14. Morgan Stanley 
15. Nomura Holding America Inc.
16. The Royal Bank of Scotland Group PLC 
17. Société Générale

The suits, filed by the Federal Housing Finance Agency (FHFA), represent the most sweeping action to date from a federal regulator stemming from the mortgage meltdown, which brought the financial system to its knees in the fall of 2008 and helped push the economy into a deep recession

The banks have spent the last three years rebuilding their balance sheets. Now, the legal fallout from the mortgage crisis is creating a new wave of liabilities for them and uncertainty for the financial system. News that the economy added no jobs in August and that the lawsuits were pending slammed the stock market Friday and sent bank stocks tumbling.

The suits come as worries about the health of the banking system and the broader economy are on the rise. Banks depend on economic growth to fuel lending activity; at the same time, the financial condition of the nation's banks is considered to be a key gauge of the economy's overall health.

Friday's lawsuits come amid a wider debate over whether the taxpayer-backed mortgage giants should be doing more to help accelerate a housing recovery. The Obama administration is seeking to enlist the firms to take additional steps that might help a housing recovery, including relaxing tough lending standards that have inhibited mortgage refinancing.

The lawsuits highlight the competing pressures complicating the government's approach to the financial crisis. On one hand, it has slashed interest rates and rescued beleaguered financial institutions to prevent a wider financial disaster. But it has also faced criticism for not taking more aggressive steps, until Friday's action by the FHFA, to recoup losses that have hit taxpayers as a result of the bust.

Rep. Brad Miller (D., N.C.) in a statement on Friday said. 

"Not pursuing those claims would be an indirect subsidy for an industry that has gotten too many subsidies already.  The American people should expect their government not to give the biggest banks a backdoor bailout."

The 17 complaints filed Friday included the following seven major defendants:

• Bank of America Corp. ($6 billion) including Merrill Lynch ($24.853 billion) and Countrywide Financial ($26.6 billion) face combined lawsuits on $57.4 billion in bond deals. 
• J.P. Morgan Chase & Co., where $33 billion in bond deals are at stake. 
• RBS Securities Inc., with $30.4 billion in securities sold to Fannie and Freddie. 
• Goldman Sachs Group Inc. with $11.1 billion securities sold to Fannie and Freddie 
• Deutsche Bank AG with $14.2 billion securities sold to Fannie and Freddie
• Credit Suisse AG with $14.1 billion securities sold to Fannie and Freddie
• Morgan Stanley with $10.58 billion securities sold to Fannie and Freddie

In a statement, FHFA said that it is involved in constructive discussions to settle claims with several of the firms that received complaints.

Bank of America and Deutsche Bank each issued statements Friday denying they had done anything improper.

The FHFA, an independent agency charged with conserving the assets of Fannie Mae and Freddie Mac while they are on government life support, filed the lawsuits on Friday in federal and state court in three jurisdictions.

The FHFA placed Fannie and Freddie into conservatorship three years ago after plunging house prices led to surging loan defaults and wiped out their capital. The U.S. Treasury has spent $141 billion to keep the firms solvent.

Fannie and Freddie don't lend money, instead buying mortgages from banks and bundling them into securities while guaranteeing repayment to investors. The companies have provided financing for the lion's share of U.S. home loans since the housing bubble collapsed.

In a statement, the agency said the complaints "reflect FHFA's conclusion that some portion of the losses that Fannie Mae and Freddie Mac incurred" stem from mortgage investments that had riskier characteristics than "the descriptions contained in the marketing and sales materials."

The lawsuits are bound to be controversial.

Consumer groups will applaud them. There has been widespread discontent among some taxpayers that banks and other financial institutions haven't been sufficiently reprimanded for their roles in the housing and mortgage crisis that has led to millions of Americans ending up in foreclosure, as well as a myriad of other financial and economic problems.

But critics said Friday that the lawsuits represent a "piling on" by federal and state regulators that threaten to crimp credit and undermine a housing recovery.

Andrew Sandler, co-chairman of BuckleySandler LLP, a law firm representing banks in litigation and regulatory enforcement actions. 

"The government is coming at the banks from every direction—the FHFA lawsuits being the most recent example—at the same time the government is putting enormous pressure on the banks to extend credit to help alleviate the housing crisis.  It constitutes a completely incoherent government approach to the housing crisis."

Some banks said Fannie and Freddie were sophisticated investors who understood the risks of subprime securities. As a result, the banks said, they shouldn't be held responsible for the losses that were caused by an unprecedented collapse in housing prices.

"We will vigorously defend against this action," Deutsche Bank AG said in a statement. The German bank said the two agencies had issued and bought trillions of dollars of mortgaged-backed securities "often after hand-picking the loans they now claim should not have been included in the offerings."

Bank of America issued a similar statement, noting that Fannie and Freddie "continued to invest heavily in those securities even after their regulator told them they did not have the risk management capabilities to do so."

Representatives of Barclays, Citigroup, Credit Suisse, Goldman, J.P. Morgan, Nomura and RBS declined to comment. Other bank representatives couldn't immediately be reached for comment.

In putting together the bond deals, banks "routinely" packaged loans into securities even though they had been flagged by third-party due diligence firms as not meeting underwriting guidelines, according to the lawsuits.

Countrywide Financial Corp., for instance, included in securitizations 12% of the mortgages that were deemed defective by Clayton Holdings, a firm that reviewed loans to see if they conformed to underwriting guidelines, according to a report from the fourth quarter of 2006 to the first quarter of 2007, the suit said.

Bank of America included 27% of defective loans, according to the lawsuits, while RBS included 53% of the faulty loans and Citigroup Inc. nearly one-third.

The FHFA's action is just one of a growing number of legal challenges facing banks because of their conduct before and after the mortgage meltdown.

Investors and government regulators, including the National Credit Union Administration, several Federal Home Loan Banks and government-backed American International Group Inc., have filed lawsuits alleging that some big banks violated securities laws in packaging loans into securities.

The banks have also faced increased demands from investors seeking to make banks buy back faulty loans and face lawsuits from insurers who provided financial guarantees when mortgages were packaged into securities.

Meanwhile, state attorneys general and the federal government are currently in negotiations with some of the nation's largest banks over questionable foreclosure practices.

COMMENTARY:  I had a cursory look at the average loan-to-value or LTV (the LTV is the ratio of the balance of the mortgage loan to the value of the mortgaged property when the loan is made) of the various securitizations named in the 17 lawsuits, and was horrified that the average values of the properties were drastically below the loan amounts, in other words, many of those loans were already "underwater" when they were sold to Fannie Mae and Freddie Mac.  

In each lawsuit, the FHFA emphasized the importance of the LTV ratio in measuring the risk of a mortgage loan and said.

"The LTV ratio is among the most important measures of the risk of a mortgage loan, and thus, it is one of the most important indicators of the default risk of the mortgage loans underlying the Certificates. The lower the ratio, the less likely that a decline in the value of the property will wipe out an owner’s equity, and thereby give an owner an incentive to stop making mortgage payments and abandon the property. This ratio also predicts the severity of loss in the event of default. The lower the LTV, the greater the “equity cushion,” so the greater the likelihood that the proceeds of foreclosure will cover the unpaid balance of the mortgage loan."

"Thus, the LTV ratio is a material consideration to a reasonable investor indeciding whether to purchase a certificate in a securitization of mortgage loans. Even small differences in the LTV ratios of the mortgage loans in the collateral group of a securitization have a significant effect on the likelihood that the collateral groups will generate sufficient funds to pay certificate holders in that securitization, and thus are material to the decision of a reasonable investor whether to purchase any such certificate."

In the 17 lawsuits, the FHFA claimed that the 17 defendant banks overstated the LTV for the loan securitizations.  The FHFA  said.

"The Registration Statements for the Securitizations materially overstated the percentage of loans in the Supporting Loan Groups with an LTV ratio at or less than 80 percent,and materially understated the percentage of loans in the Supporting Loan Groups with an LTVratio over 100 percent, thereby misrepresenting the degree of risk of the GSE Certificates."

The FHFA consistently accused the 17 defendant banks of making "false statements of material facts and omissions of material facts".  The FHFA said. 

"The false statements of material facts and omissions of material facts in the Registration Statements, including the Prospectuses and Prospectus Supplements, directly caused Fannie Mae and Freddie Mac to suffer billions of dollars in damages, including without limitation depreciation in the value of the securities. The mortgage loans underlying the GSE Certificates experienced defaults and delinquencies at a much higher rate than they would have had the loan originators adhered to the underwriting guidelines set forth in the Registration Statements, and the payments to the trusts were therefore much lower than they would have been had the loans been underwritten as described in the Registration Statements.

"Fannie Mae’s and Freddie Mac’s losses have been much greater than they would have been if the mortgage loans had the credit quality represented in the Registration Statements."

The FHFA also discovered that the 17 defendant banks consistently under-reported the percentage non-owner occupied loans in each loan securitization.  The FHFA discovered that the actual percentage of non-owner occupied loans was two to three times higher.  The FHFA said.

"The percentage of owner-occupied properties is a material risk factor to the purchasers of Certificates, such as Fannie Mae and Freddie Mac, since a borrower who lives in mortgaged property is generally less likely to stop paying his or her mortgage and more likely to take better care of the property. The loan level review reveals that the true percentage of owner-occupied properties for the loans supporting the GSE Certificates was materially lower than what was stated in the Prospectus Supplements." 

The FHFA is also alledging that the 17 defendant banks committed fraud which is a felony punishable by fines and imprisonment.  Here's the legal definition of fraud:

"A false representation of a matter of fact—whether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosed—that deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury."

"Fraud is commonly understood as dishonesty calculated for advantage. A person who is dishonest may be called a fraud. In the U.S. legal system, fraud is a specific offense with certain features."

"Fraud is most common in the buying or selling of property, including real estate, Personal Property, and intangible property, such as stocks, bonds, and copyrights. State and federal statutes criminalize fraud, but not all cases rise to the level of criminality. Prosecutors have discretion in determining which cases to pursue. Victims may also seek redress in civil court."

"Fraud must be proved by showing that the defendant's actions involved five separate elements: (1) a false statement of a material fact,(2) knowledge on the part of the defendant that the statement is untrue, (3) intent on the part of the defendant to deceive the alleged victim, (4) justifiable reliance by the alleged victim on the statement, and (5) injury to the alleged victim as a result."

I am certainly not an attorney, but if you read the above definition of fraud, it certainly has the appearance of fraud or at least borderline fraud.  Let's put some of these punkasses in prison too. These 17 defendant banks were accomplices in the collapase of the U.S. financial system.  If it were not for the Treasury Department's $700 billion bailout of these banks, the Great Recession would've become The Greatest Recession. 

Reuter's Felix Salmon, with the help of Nick Rizzo, did some basic number crunching on the FHFA lawsuits.  They used three different metrics to see how aggressive any given lawsuit was:

• The number of individual named defendants; 
• The total number of pages in the suit; 
• Whether it asked for punitive damages. 

Here’s the league table conceived by Salmon and Rizzo.  They calculated a total score by taking the number of pages in the lawsuit, adding the number of individual defendants multiplied by 10, and then adding an extra 100 points if the FHFA was asking for punitive damages:

Salmon said:

"JP Morgan, here, is the clear winner — until you realize that Bank of America is split into three different parts. If you take Countrywide, Bank of America, and Merrill Lynch and add their scores together, then the total for BofA reaches 884 points, and no I’m not going to worry about double counting."

"All silliness aside, the total number of named defendants here, including various different individuals and corporate entities, is a whopping 268, including a small amount of double-counting. This is a full-employment act for lawyers, and I’m pretty sure they’re going to be fighting this one out for a long time; I can’t imagine, having put all of this work into these suits, that the government is going to be remotely willing to simply give all of these banks blanket immunity as part of a global settlement with the 50 state attorneys general."

"I’ll have more on the substance of the suits later; suffice to say that they’re strong, and aggressive, and exactly what I’ve been looking for for a while. These banks lied to investors when they put together mortgage securitizations. And one way or another, they’re about to start paying for that. About time too."

What a mess these banks created.  By packaging their mortgages and selling them to Fannie Mae and Freddie Mac, they were able to shrewdly and systemically pass on the potential losses on those loans to the investors of Fannie Mae and Freddie Mac and the federal government.   

I am not an attorney, but if the FHFA's complaints are correct, these 17 defendant banks are going to be reimbursing Fannie Mae and Freddie Mac a hefty sum of money. How much remains to be determined. You can expect an out-of-court settlement that will be in the billions.

Courtesy of an article dated September 3, 2011 appearing in The Wall Street Journal

Comments

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