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US Government to Sue Major Banks for Losses On Sub-Prime Mortgages

Written By:
September 15, 2011 at 12:04 AM

As the statute of limitation nearly ends, the long awaited shoe finally dropped on banks and mortgage companies involved in the country's real estate mortgage and foreclosure embarrassment. The Federal Housing Finance Agency (FHFA) filed class action lawsuit federal courts in Connecticut and New York, asking for damages from 17 domestic and foreign banks for more than $196 billion in mortgage-backed securities it purchased.

The FHFA took over as conservators of Government Sponsored Enterprises - Fannie Mae and Freddie Mac as required under the Economic Stimulus Act of 2009. The agency has the responsibility to protect the assets of the failed GSAs.

The allegations accuse the mortgage companies of fraud and misrepresentation regarding mortgage-backed securities sold to Fannie and Freddie. - estimated at $78 billion and $149 billion of these securities, respectively. Since taking over the administration of Fannie and Freddie, FHFA has received $141 billion of taxpayer funds from the Treasury Department to keep the GSAs afloat.

The Class Action Lawsuit

Unlike many private investors left holding the bag with MBSproducts, the FHFA has the legal authority to gain access to pertinent records necessary to prove bank fraud. Last year, the FHFA exercised its legal muscle by serving subpoenas to issuers and mortgage servicers of the mortgage bonds consisting of sub prime loans and other risky financial products.

The lawsuit names mortgage firms, individual bank executives, and lead underwriters on the MBS, as litigants. According to the FHFA's filing, the core of the issue concerns the vast difference in the mortgage bonds sold to Fannie and Freddie and the investments listed in documents the financial institutions filed with the U.S. Security and Exchange Commission.

Furthermore, the defendants “falsely represented that the underlying mortgage loans complied with certain underwriting guidelines and standards, including representations that significantly overstated the ability of the borrowers to repay their mortgage loans.”

Fannie and Freddie's have strict guidelines for mortgage bonds it purchase from the “private-label” MBS market. Its rules prohibit the purchase of mortgage bonds support by a portfolio of sub prime mortgages. However, the bankers “misrepresented these “high-risk” securities as triple-A investments.

The suit states, “it does not matter how “big” or “sophisticated” a security purchaser is, the seller has a legal responsibility to accurately represent the characteristics of the loans backing the securities being sold."

The defendants in the class action lawsuit are:

To date, this lawsuit represents the most comprehensive litigation filed against financial firms, which accuses them of violating securities regulations and laws covering the sell of residential mortgage bonds. The GSAs have over $200 billion in MBSs, the FHFA contends the lawsuit only involve cases where strong “evidence” of omissions and misrepresentations exists.

The suit comes under the auspices of the 1933 Securities Act and asks the court to award damages and civil penalties.

Class Action Lawsuit Reactions

The lawsuit does have its critics, as some ague that the action simply creates more liability for mortgage companies. Furthermore, the lawsuit could hamper economic recovery and could potentially overwhelm banks and lead to higher costs for borrowers.

The FHFA responded by saying there is a valid reason for concern about the repercussions of the lawsuit on the fragile economy. However, even more critical is the necessity for investors to have trust in the mortgage bond market, which theoretically provides the funds for new mortgages.

Issuers must honor their responsibility to follow regulations to ensure reliability on the truthfulness of the system. The integrity of the country's financial system depends on the enforcement of the laws -- during times of financial prosperity and economic downturn.

Some insiders say the banks plan to fight the allegations, and prove Fannie’s and Freddie’s involvement in the creation of the very securities they complaint about buying. Others believe the FHFA’s action is simply window dressing, and expects settlement of the lawsuit for “pennies on the dollar.”

Most seem to agree, considering the cozy relationship between financial institutions and the federal government, do not expect to see any criminal prosecutions.





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