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One month ago, with the filing by the Federal Home Loan Bank of Seattle of eleven lawsuits against the major Wall Street creators of residential mortgage-backed securities (RMBS), I speculated that the floodgates of investor litigation may finally be swinging open. Yesterday, the filing by the Federal Home Loan Bank of San Francisco (“FHLB of SF”) of two lawsuits seeking the rescission of over $19 billion of purchases of RMBS made it official–the flood is upon us.
The lawsuits (copies posted here and here) were filed in San Francisco Superior Court against a laundry list of the most prominent subprime and Alt-A securitization masterminds, including Deutsche Bank, J.P. Morgan, Bear Stearns, Credit Suisse, Royal Bank of Scotland, Morgan Stanley, UBS and Merrill Lynch. Both actions contain claims for relief based on violations of the California Corporations Code for untrue or misleading statements (CCC sections 24501 and 25501), the Securities Act of 1933 for untrue or misleading statements in registration statements (Section 11) and in the sale of securities (Section 12(a)(2)) and for liability of controlling persons (Section 15), and common law and statutory claims for rescission and negligent misrepresentation. The FHLB of SF is represented by Grais & Ellsworth LLP, a New York litigation boutique, and Goodin, MacBride, a small San Francisco shop. Grais & Ellsworth, which is emerging as a major player in RMBS bondholder litigation, also represents the FHLB of Seattle in the investor action filed last month, as well as Greenwich Financial in its suit against Countrywide (see complaint here, link to attorney David Grais discussing the lawsuit here, and a collection of my prior postings on the lawsuit here).
In a statement issued yesterday, the FHLB of SF confirmed that it was seeking to rescind its purchases of 134 securities in 113 securitization trusts, for which the Bank paid more than $19.1 billion. The statement went on to note that, “[a]ll of the [private-label RMBS] in the Bank’s mortgage portfolio, including those identified in the complaints filed today, were rated AAA when purchased, based on the information provided by the securities dealers. The Bank employs conservative criteria and guidelines for all its MBS investments.”
Though these lawsuits are certainly the largest RMBS investor lawsuits stemming from the financial crisis, they follow on the heels of several similar actions filed since the year began, including an action by the the International Union of Operating Engineers-Employers Construction Industry Retirement Trust against UBS and others in the District Court of New Jersey and an action by Footbridge Limited Trust against Countrywide/BofA and others in the Southern District of New York.
The FHLB of SF complaints read more like educational pieces about investing in asset-backed securities than claims for securities fraud. They are long on explanations about the creation of securitizations, the players involved and the sale of securities, but short on factual allegations about the misrepresentations underlying the bank’s causes of action. The basic allegations as to each claim and each Defendant are that 1) the Defendants made representations in RMBS prospectuses that underlying loans would meet certain quality control standards and underwriting guidelines; 2) these statements turned out to be false because the originators were actually making frequent and unjustified exceptions to these guidelines and failing to follow quality-control practices to detect fraud; and 3) these misrepresentations materially increased the risk of the certificates.
Yet, from my reading, the only facts or evidence that the FHLB of SF has to support its claims is that the loans in the pools that have been foreclosed-upon sold for a fraction of the value ascribed to them, and further, that an analysis of an industry-standard database of securitized loans reveals that the drop in value could not have been caused by the decline in the housing market. (All of these allegations as to particular securitizations are contained in numerous “Schedules” attached to the complaints. I’ve posted a sample of one such Schedule here, which appears representative of the voluminous attachments.)
Were you expecting more? I was. It’s not everyday you see a major institutional investor with tens of billions of dollars under management file a lawsuit against nine
of the largest investment banks in the world on circumstantial evidence. Granted, these complaints were far more streamlined, logical and understandable than the eleven rambling, 80+ page complaints filed by the FHLB of Seattle last month (a sample of one such complaint–against Credit Suisse–is posted here). But, couldn’t the bank have alleged more details about the underwriting of the underlying pool of loans, including the percentage that contained underwriting defects or the instance of borrower fraud found therein? Not if they don’t have the underlying loan files.
What I realized is that one of the biggest battles raging right now behind the scenes between RMBS investors and servicers/lenders is the battle over loan files. Servicers, who often originated these abysmal loans, and who are currently suspected of additional malfeasance in the servicing of these loans (see prior articles here and here), are loathe to turn over loan files that would reveal the depths of their depravity. And securitization trustees, the only players with the authority to obtain loan files and enforce servicer obligations, are incentivized by the structure of most securitizations to be passive and averse to confrontation.
So, the likely answer is that the FHLB of SF and other RMBS investors have been denied the underlying loan files necessary to determine how bad the underwriting and servicing of these loans has really been. With statutes of limitations deadlines likely approaching, they have been forced to file suit before having all the facts and hope that they can gather hard evidence in discovery. If they can’t, plaintiffs like the FHLB of Seattle and SF will have a very hard time overcoming a motion to dismiss, let alone obtaining a verdict in their favor.