FRAUD: The Significance of the Game Changing FHFA Lawsuits

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FHFA ACCUSES BANKS OF FRAUD: THEY KNEW THEY WERE LYING

“FHFA has refrained from sugar coating the banks’ alleged conduct as mere inadvertence, negligence, or recklessness, as many plaintiffs have done thus far.  Instead, it has come right out and accused certain banks of out-and-out fraud.  In particular, FHFA has levied fraud claims against Countrywide (and BofA as successor-in-interest), Deutsche Bank, J.P. Morgan (including EMC, WaMu and Long Beach), Goldman Sachs, Merrill Lynch (including First Franklin as sponsor), and Morgan Stanley (including Credit Suisse as co-lead underwriter).  Besides showing that FHFA means business, these claims demonstrate that the agency has carefully reviewed the evidence before it and only wielded the sword of fraud against those banks that it felt actually were aware of their misrepresentations.”

It is no stretch to say that Friday, September 2 was the most significant day for mortgage crisis litigation since the onset of the crisis in 2007.  That Friday, the Federal Housing Finance Agency (FHFA), as conservator for Fannie Mae and Freddie Mac, sued almost all of the world’s largest banks in 17 separate lawsuits, covering mortgage backed securities with original principal balances of roughly $200 billion.  Unless you’ve been hiking in the Andes over the last two weeks, you have probably heard about these suits in the mainstream media.  But here at the Subprime Shakeout, I like to dig a bit deeper.  The following is my take on the most interesting aspects of these voluminous complaints (all available here) from a mortgage litigation perspective.

Throwing the Book at U.S. Banks

The first thing that jumps out to me is the tenacity and aggressiveness with which FHFA presents its cases.  In my last post (Number 1 development), I noted that FHFA had just sued UBS over $4.5 billion in MBS.  While I noted that this signaled a shift in Washington’s “too-big-to-fail” attitude towards banks, my biggest question was whether the agency would show the same tenacity in going after major U.S. banks.  Well, it’s safe to say the agency has shown the same tenacity and then some.

FHFA has refrained from sugar coating the banks’ alleged conduct as mere inadvertence, negligence, or recklessness, as many plaintiffs have done thus far.  Instead, it has come right out and accused certain banks of out-and-out fraud.  In particular, FHFA has levied fraud claims against Countrywide (and BofA as successor-in-interest), Deutsche Bank, J.P. Morgan (including EMC, WaMu and Long Beach), Goldman Sachs, Merrill Lynch (including First Franklin as sponsor), and Morgan Stanley (including Credit Suisse as co-lead underwriter).  Besides showing that FHFA means business, these claims demonstrate that the agency has carefully reviewed the evidence before it and only wielded the sword of fraud against those banks that it felt actually were aware of their misrepresentations.

Further, FHFA has essentially used every bit of evidence at its disposal to paint an exhaustive picture of reckless lending and misleading conduct by the banks.  To support its claims, FHFA has drawn from such diverse sources as its own loan reviews, investigations by the SEC, congressional testimony, and the evidence presented in other lawsuits (including the bond insurer suits that were also brought by Quinn Emanuel).  Finally, where appropriate, FHFA has included successor-in-interest claims against banks such as Bank of America (as successor to Countrywide but, interestingly, not to Merrill Lynch) and J.P. Morgan (as successor to Bear Stearns and WaMu), which acquired potential liability based on its acquisition of other lenders or issuers and which have tried and may in the future try to avoid accepting those liabilities.    In short, FHFA has thrown the book at many of the nation’s largest banks.

FHFA has also taken the virtually unprecedented step of issuing a second press release after the filing of its lawsuits, in which it responds to the “media coverage” the suits have garnered.  In particular, FHFA seeks to dispel the notion that the sophistication of the investor has any bearing on the outcome of securities law claims – something that spokespersons for defendant banks have frequently argued in public statements about MBS lawsuits.  I tend to agree that this factor is not something that courts should or will take into account under the express language of the securities laws.

The agency’s press release also responds to suggestions that these suits will destabilize banks and disrupt economic recovery.  To this, FHFA responds, “the long-term stability and resilience of the nation’s financial system depends on investors being able to trust that the securities sold in this country adhere to applicable laws. We cannot overlook compliance with such requirements during periods of economic difficulty as they form the foundation for our nation’s financial system.”  Amen.

This response to the destabilization argument mirrors statements made by Rep. Brad Miller (D-N.C.), both in a letter urging these suits before they were filed and in a conference call praising the suits after their filing.  In particular, Miller has said that failing to pursue these claims would be “tantamount to another bailout” and akin to an “indirect subsidy” to the banking industry.  I agree with these statements – of paramount importance in restarting the U.S. housing market is restoring investor confidence, and this means respecting contract rights and the rule of law.   If investors are stuck with a bill for which they did not bargain, they will be reluctant to invest in U.S. housing securities in the future, increasing the costs of homeownership for prospective homeowners and/or taxpayers.

You can find my recent analysis of Rep. Miller’s initial letter to FHFA here under Challenge No. 3.  The letter, which was sent in response to the proposed BofA/BoNY settlement of Countrywide put-back claims, appears to have had some influence.

Are Securities Claims the New Put-Backs?

The second thing that jumps out to me about these suits is that FHFA has entirely eschewed put-backs, or contractual claims, in favor of securities law, blue sky law, and tort claims.  This continues a trend that began with the FHLB lawsuits and continued through the recent filing by AIG of its $10 billion lawsuit against BofA/Countrywide of plaintiffs focusing on securities law claims when available.  Why are plaintiffs such as FHFA increasingly turning to securities law claims when put-backs would seem to benefit from more concrete evidence of liability?

One reason may be the procedural hurdles that investors face when pursuing rep and warranty put-backs or repurchases.  In general, they must have 25% of the voting rights for each deal on which they want to take action.  If they don’t have those rights on their own, they must band together with other bondholders to reach critical mass.  They must then petition the Trustee to take action.  If the Trustee refuses to help, the investor may then present repurchase demands on individual loans to the originator or issuer, but must provide that party with sufficient time to cure the defect or repurchase each loan before taking action.  Only if the investor overcomes these steps and the breaching party fails to cure or repurchase will the investor finally have standing to sue.

All of those steps notwithstanding, I have long argued that put-back claims are strong and valuable because once you overcome the initial procedural hurdles, it is a fairly straightforward task to prove whether an individual loan met or breached the proper underwriting guidelines and representations.  Recent statistical sampling rulings have also provided investors with a shortcut to establishing liability – instead of having to go loan-by-loan to prove that each challenged loan breached reps and warranties, investors may now use a statistically significant sample to establish the breach rate in an entire pool.

So, what led FHFA to abandon the put-back route in favor of filing securities law claims?  For one, the agency may not have 25% of the voting rights in all or even a majority of the deals in which it holds an interest.  And due to the unique status of the agency as conservator and the complex politics surrounding these lawsuits, it may not have wanted to band together with private investors to pursue its claims.

Another reason may be that the FHFA has had trouble obtaining loan files, as has been the case for many investors.  These files are usually necessary before even starting down the procedural path outlined above, and servicers have thus far been reluctant to turn these files over to investors.  But this is even less likely to be the limiting factor for FHFA.  With subpoena power that extends above and beyond that of the ordinary investor, the government agency may go directly to the servicers and demand these critical documents.  This they’ve already done, having sent 64 subpoenas to various market participants over a year ago.  While it’s not clear how much cooperation FHFA has received in this regard, the numerous references in its complaints to loan level reviews suggest that the agency has obtained a large number of loan files.  In fact, FHFA has stated that these lawsuits were the product of the subpoenas, so they must have uncovered a fair amount of valuable information.

Thus, the most likely reason for this shift in strategy is the advantage offered by the federal securities laws in terms of the available remedies.  With the put-back remedy, monetary damages are not available.  Instead, most Pooling and Servicing Agreements (PSAs) stipulate that the sole remedy for an incurable breach of reps and warranties is the repurchase or substitution of that defective loan.  Thus, any money shelled out by offending banks would flow into the Trust waterfall, to be divided amongst the bondholders based on seniority, rather than directly into the coffers of FHFA (and taxpayers).  Further, a plaintiff can only receive this remedy on the portion of loans it proves to be defective.  Thus, it cannot recover its losses on defaulted loans for which no defect can be shown.

In contrast, the securities law remedy provides the opportunity for a much broader recovery – and one that goes exclusively to the plaintiff (thus removing any potential freerider problems).  Should FHFA be able to prove that there was a material misrepresentation in a particular oral statement, offering document, or registration statement issued in connection with a Trust, it may be able to recover all of its losses on securities from that Trust.  Since a misrepresentation as to one Trust was likely repeated as to all of an issuers’ MBS offerings, that one misrepresentation can entitle FHFA to recover all of its losses on all certificates issued by that particular issuer.

The defendant may, however, reduce those damages by the amount of any loss that it can prove was caused by some factor other than its misrepresentation, but the burden of proof for this loss causation defense is on the defendant.  It is much more difficult for the defendant to prove that a loss was caused by some factor apart from its misrepresentation than to argue that the plaintiff hasn’t adequately proved causation, as it can with most tort claims.

Finally, any recovery is paid directly to the bondholder and not into the credit waterfall, meaning that it is not shared with other investors and not impacted by the class of certificate held by that bondholder.  This aspect alone makes these claims far more attractive for the party funding the litigation.  Though FHFA has not said exactly how much of the $200 billion in original principal balance of these notes it is seeking in its suits, one broker-dealer’s analysis has reached a best case scenario for FHFA of $60 billion flowing directly into its pockets.

There are other reasons, of course, that FHFA may have chosen this strategy.  Though the remedy appears to be the most important factor, securities law claims are also attractive because they may not require the plaintiff to present an in-depth review of loan-level information.  Such evidence would certainly bolster FHFA’s claims of misrepresentations with respect to loan-level representations in the offering materials (for example, as to LTV, owner occupancy or underwriting guidelines), but other claims may not require such proof.  For example, FHFA may be able to make out its claim that the ratings provided in the prospectus were misrepresented simply by showing that the issuer provided rating agencies with false data or did not provide rating agencies with its due diligence reports showing problems with the loans.  One state law judge has already bought this argument in an early securities law suit by the FHLB of Pittsburgh.  Being able to make out these claims without loan-level data reduces the plaintiff’s burden significantly.

Finally, keep in mind that simply because FHFA did not allege put-back claims does not foreclose it from doing so down the road.  Much as Ambac amended its complaint to include fraud claims against JP Morgan and EMC, FHFA could amend its claims later to include causes of action for contractual breach.  FHFA’s initial complaints were apparently filed at this time to ensure that they fell within the shorter statute of limitations for securities law and tort claims.  Contractual claims tend to have a longer statute of limitations and can be brought down the road without fear of them being time-barred (see interesting Subprime Shakeout guest post on statute of limitations concerns.

Predictions

Since everyone is eager to hear how all this will play out, I will leave you with a few predictions.  First, as I’ve predicted in the past, the involvement of the U.S. Government in mortgage litigation will certainly embolden other private litigants to file suit, both by providing political cover and by providing plaintiffs with a roadmap to recovery.  It also may spark shareholder suits based on the drop in stock prices suffered by many of these banks after statements in the media downplaying their mortgage exposure.

Second, as to these particular suits, many of the defendants likely will seek to escape the harsh glare of the litigation spotlight by settling quickly, especially if they have relatively little at stake (the one exception may be GE, which has stated that it will vigorously oppose the suit, though this may be little more than posturing).  The FHFA, in turn, is likely also eager to get some of these suits settled quickly, both so that it can show that the suits have merit with benchmark settlements and also so that it does not have to fight legal battles on 18 fronts simultaneously.  It will likely be willing to offer defendants a substantial discount against potential damages if they come to the table in short order.

Meanwhile, the banks with larger liability and a more precarious capital situation will be forced to fight these suits and hope to win some early battles to reduce the cost of settlement.  Due to the plaintiff-friendly nature of these claims, I doubt many will succeed in winning motions to dismiss that dispose entirely of any case, but they may obtain favorable evidentiary rulings or dismissals on successor-in-interest claims.  Still, they may not be able to settle quickly because the price tag, even with a substantial discount, will be too high.

On the other hand, trial on these cases would be a publicity nightmare for the big banks, not to mention putting them at risk a massive financial wallop from the jury (fraud claims carry with them the potential for punitive damages).  Thus, these cases will likely end up settling at some point down the road.  Whether that’s one year or four years from now is hard to say, but from what I’ve seen in mortgage litigation, I’d err on the side of assuming a longer time horizon for the largest banks with the most at stake.

Article taken from The Subprime Shakeout – www.subprimeshakeout.com
URL to article: the-government-giveth-and-it-taketh-away-the-significance-of-the-game-changing-fhfa-lawsuits.html

22 Responses

  1. Word Mark FHA123.COM
    Goods and Services IC 036. US 100 101 102. G & S: COMPUTER SERVICES, NAMELY, OFFERING LENDING AND PROVIDING FINANCIAL INFORMATION ALL IN THE FIELD OF CONSUMER AND MORTGAGE LENDING THROUGH A GLOBAL NETWORK. FIRST USE: 20081015. FIRST USE IN COMMERCE: 20081015
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    Mark Drawing Code (4) STANDARD CHARACTER MARK
    Trademark Search Facility Classification Code LETTER-3-OR-MORE FHA Combination of three or more letters as part of the mark
    NOTATION-SYMBOLS Notation Symbols such as Non-Latin characters,punctuation and mathematical signs,zodiac signs,prescription marks
    NUM-26-UP 123 Other Numerals – 26 and Up
    Serial Number 77536331
    Filing Date July 31, 2008
    Current Basis 1A
    Original Filing Basis 1B
    Published for Opposition February 10, 2009
    Registration Number 3775598
    Registration Date April 13, 2010
    Owner (REGISTRANT) FAVILLA, JAMES L DBA REGIONAL HOME MORTGAGE LIMITED LIABILITY COMPANY NEW JERSEY 1150 Raritan Road, Suite 104 Cranford NEW JERSEY 07016
    Type of Mark SERVICE MARK
    Register PRINCIPAL
    Live/Dead Indicator LIVE

  2. I dont know if you guys recall but Treasury made a deal with wells fargo during the aig primer. Treasury essentially became majority owner in Wells buy “purchaseing” shares of the MBS bs…Ill look for the contract, in my historical melay….

  3. And cubed2K…

    The reason you never read stories about any of those bank CEOs forgoing on their bonuses or their abscene salaries is because… they simply don’t. In order for someone to forgo of something, he has to first have a conscience. Then he has to be aware of others and not blame them for the tough times they go through. Remember when we learned that the bailout was serving to pay for insane bonuses to AIG directors? We The People balked at it. A few congress members mentioned it. And we were told that “Jeez, those were already negotiated a long time ago and cannot, legally, be eliminated. They MUST be honored!” Seriously stinking B.S.

    Those Jamie Dimon of this world have been drooling over the “irresponsibility” of homeowners and the “moral risks” attached to loan modifications. Our own government declared that nothing would be done to help the immorality of “real estate” speculators, simply ignoring the fact that most people who lost their home actually lived in them and had not “shamlessly speculated”. Huge denial at every level of government, Congress, banking, even homeowners, shamed for their failure to pay for a mortgage they had contracted in good faith while they had a full-time job, etc. Incredible bad faith (which, by the way, is actionable…) on everyone else’s part.

    Let’s wait for action. And take action. One homeowner at a time.

  4. E. Tolle….
    You hit the nail on the head with your statement about Alabama!!! I live here, and yes, this has to be the most ill informed, back-woods law states I’ve ever lived in.
    However, I will say that Nick Wooten is one of Alabama’s finest attorneys, and one of maybe one handful of them that seems to really get what is going on with the mortgage crisis. I truly enjoy reading his depos online. This guy, in my opinion, is one of few who have all his “wheels” on the road.
    I am sitting back, patiently waiting to see what transpires with all 17 of the FHFA suits. It will be interesting to see just what government entity or private big-wig runs to the aide of floundering lending institutions now….
    Hey Buffett….got any more money you wanna squander???

  5. Cubed2k

    I feel your pain. And that, my friend, is exactly why we are in such a deep sh**: people stopped being the most important asset of the country about 25 years ago. Money replaced it. As long as you had money, as a business owner, you could treat people like slaves, you could fire them overnight, you cold do anything you wished to them. What was the worse that could happen? You would get sued, you would buy yourself a few “good” attorneys, some unscrupulous sharks who would “find the dirt” in your opponent’s lafe and you would win the lawsuit.

    That’s how revolutions start: people realize all of a sudden that they have become disposable commodities, that they are secondary to anything. Education start suffering, social programs are eliminated, unions are broken up, freedom is taken away from the poor while the rich become obscenely rich and obscenely obnoxious. And one day… POW! People rebel and riot. By then, the military suffered, police suffered, everybody suffered so much that the rich don’t have anyone to support them anymore.

    Happened in France during the revolution. Happened in Russia during the revolution. Happened in Cuba, recently in Lybia and Tunisia, always happens. That is what leads to revolutions. The banks don’t have a clue that it is coming closer and closer. The problem is that, afterwards, we never know what will follow. Dictatorship? Facism? Real peace? Depends on the extent of the previous damages and the violence of the revolution…

  6. @ Christopher King, the person in your video makes repeated claims concerning Fannie, Freddie and Ginnie Mae. They are NOT in receivership as stated, but in conservatorship. Big difference that. This person seems to insinuate having some secret knowledge about this assertion.

    Maybe a fact check is in order?

  7. More reasons to hate the banks/Wall Street:

    http://www.huffingtonpost.com/2011/09/14/how-banks-cause-world-hunger_n_960926.html

    The whole system must change—before the planet is destroyed…I fear we haven’t much time…

  8. PS Carie that’s awesome. Google “Lamar Gunn + Mortgage Movies”

  9. you know, I’d rather get robbed by a home invader than these banks and wall street. At least you can see and know who is the enemy. And if you got a gun, out he goes.

    But the banks and financial institutions and wall street………..all hiding behind layers and layers and codes and codes and congress.

    so bank of AMERICA lays off thousands of people, like I give a flying you how what.

    How come you never see stories like Jamie Dimon, CEO of Chase, forgo’s his bonus’s so as to save 1000’s of jobs at Chase. How Come?

    How Come no stories that board of directors at these wall street firms gave up their salary to save jobs????????????

    How come no stories like that??????

    oh, the all too obvious that isn’t so obvious.

    They care about America?????????? OK, yah right.

    Tell me all these board of directors, ceo’s, top management and so on, traders on wall st, can’t do without their bonus’s to save jobs. They are already rich, don’t you think?

    Now, I ain’t a socialist or a commie or somebody promoting distribute the wealth from the rich to the poor (or if you define a poor person as somebody who can’t or won’t work for exchange). I ain’t that,

    but I think you get the gist of my communication.

    Like in 2008 when the financial crisis hit, whatever that means as the media does not define it. why our good all American companies such as Chase raised credit card rates across the boards to 30%. Grab your ankles and squeal like a pig.

  10. Hi guys, time for a new Mortgage Movie. By the time I got home I had dozens of hits from these guys after I left my card…. but if they’re not connected in any way with the mortgage side then why bother…. anyway all three of these women at lunch today have Wells Fargo cases so we paid a visit to a local Wells Fargo office…. which is coincidentally half a mile from my old digs at Alpha Title….

    http://mortgagemovies.blogspot.com/2011/09/kingcastmortgage-movies-present-visit.html
    THURSDAY, SEPTEMBER 15, 2011

    KingCast/Mortgage Movies present: A visit with Wells Fargo Advisors who say… “We’re not the Mortgage Side!”

  11. Here we go:

    http://www.huffingtonpost.com/2011/09/15/wells-fargo-sues-jp-morgan_n_964920.html

    “In a complaint made public on Wednesday in the Delaware Chancery Court, Wells Fargo accused JPMorgan’s EMC Mortgage LLC unit of refusing its demands that EMC buy back the loans, which were contained in Bear Stearns Mortgage Funding Trust 2007-AR2.”

    When are they just going to come out and say the WHOLE TRUTH: The TRUSTS are EMPTY.

    I guess they have to kick a few more million people out of their houses first.

  12. Why worry about MERS when this is the truth:

    “…The Depositor owns the Trust — and while the Trust was performing – the Depositor, on behalf of the Trust would be the party to bring the action. However, these Trusts have now been brought back on parent corp. (to Depositor) balance sheets because the Trusts—as “off-balan­ce sheet” SPVs — have been effectivel­y dissolved. The only tranche holders to remnants of the Trusts is the US Government or the Depositor (parent) itself. You should be preparing to demonstrat­e that the loan was not validly conveyed to any Trust (which they were not). Do this by requesting the Mortgage Schedule which should accompany the Mortgage Loan Purchase Agreement (MLPA) — and the MLPA cannot be an “intent” to sell — it must be validly executed and notarized (we know about those notaries). And, importantl­y, if MLPA and Mortgage Schedule can be proven, servicer must prove that all default payments have been paid to the trust on borrower’s behalf. If not, loan has been removed from the Trust with collection rights sold/swapp­ed to a Third Party…

    They can not prove anything.”

  13. If I remember correctly, the MERS v. Henderson case is the one where Nick Wooten deposed R. K. Arnold. Alabama’s always had two wheels on the road and the other two in the ditch, especially when it comes to supporting the FIRE lobby. Not to mention that it was Bachus’ district that did that multi-billion dollar fraud deal with Chase or Sachs or whoever that Matt Taibi wrote about….the water works debacle.

  14. The Banksters are not the problem and neither is Bernanke. It is the Oligarchs that back them

  15. Banksters: “But, these were sophisticated investors, they should have known better!”

    FHFA: Doesn’t matter….fraud is fraud….

    Banksters: “But we’re not successors in interest to those bad, bad originators and depositors. Just because we’ve said that in foreclosures across the nation, well, we didn’t really mean it!”

    FHFA: Fraud is fraud.

    Banksters: It was simply inadvertence. It more than likely won’t happen again. We’ll try harder….is there any incentive structure? Bonuses? We work better with bonuses….

    FHFA: Turn over the tapes.

    Banksters: Hey wait….we’re too big to fail, remember? You can’t do this! Just ask Baucus, or Hatch…hey, where’s Dodd? We paid him through 2012! This can’t be happening in America! We’re paid up, and these aren’t the regulations we agreed upon! Get Obama in here right away, ask him about our agreement, or rather, his chief of staff, President Daley, he’ll tell you. You can’t get away with this. We own this place, remember?

  16. The Attorney Generals and Obama Administration buying time for Banksters with bogus Lawsuits and Commitees. The Banksters continue to Foreclose at record pace

    What is Warren Buffets’ connection?

    http://www.huffingtonpost.com/2011/09/15/home-foreclosures-august_n_964338.html

    Be Strong and Courageous

  17. I too am waiting for the Wells Fargo suit to come out .. wouldn’t surprise me if they were providing evidence in return for a pass..

  18. Warren Buffet owns how much of Wells Fargo? hint hint

    NEVER AGAIN

  19. NEWS ALERT!

    An “insider” has leaked me a copy of the proposed settlement the FHFA is going to offer the banks.

    “You must promise and pinky-swear you will be good-little-boys from now on, and make sure you try to stop forging signatures on loans, and pay the FHFA a fine of 1% of 1% of the next bail-out money we will give you. In exchange we will forgive you all the past fraud, and not put anyone in our nasty federal spas”

  20. I’ve been waiting since August of 2006 for something like this to emerge. Finally! Praise God! My fingers are thankful also. Ha!

  21. THis was a long disertation to explain fraud. This would be even more intresting if you wouls explain exactly why wells fargo has been left out of this lawsuit. All this shows me they can ramshackle home owners steal homes from101 yr olds sell homes they dont own and even tell current mortgage holders not to pay yet they get away with it? please explain would have a better disertation if wells fargo was included

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