Top Five Reasons that MBS Lawsuits Are Just Beginning

Posted on May 5, 2011 by igradman

After a few quiet months in the world of mortgage crisis litigation, we have seen a flurry of activity over the last six weeks that should put to rest speculation that mortgage derivative lawsuits are winding down.  To recap these developments, I bring you The Subprime Shakeout’s Top Five Reasons that MBS Lawsuits Are Just Beginning:

Number 5: Statistical Sampling Gains Widespread Acceptance in MBS Cases. I have reported previously on Judge Bransten’s decision in New York state court in the case of MBIA v. Countrywide/BofA to allow MBIA to use statistical sampling and extrapolation to prove its claims for breach of reps and warranties.  I also noted how, in subsequent litigation, Allstate cited those holdings in its complaint as a shortcut to proving widespread breaches in its MBS investments.

Now, United States District Court Judge Paul A. Crotty in the Southern District of New York has lent a new level of credibility to this line of reasoning, becoming the first federal judge to hold that a plaintiff could use statistical sampling to prove a generalized claim for breach, rather than being limited by the “sole remedy” language of the PSA to a loan-by-loan approach (opinion available here).  Though the analysis applied by Judge Crotty in Syncora v. EMC rested on the unique rights of Syncora as a bond insurer, and thus may not be entirely applicable to private investors seeking to employ the same remedy, judges in investor lawsuits may find the opinion’s common-sense approach to the complexities of MBS litigation persuasive.

In particular, Judge Crotty was highly skeptical that the loan-by-loan repurchase protocol was intended to be applied to situations where widespread breaches of reps and warranties were alleged.  This discussion, found in footnote 4 of the opinion, is worth reading in its entirety:

The repurchase protocol is a low-powered sanction for bad mortgages that slip through the cracks.  It is a narrow remedy (“onesies and twosies”) that is appropriate for individualized breaches and designed to facilitate an ongoing information exchange among the parties.  This is not what is alleged here.  Here, Syncora alleges massive misleading and disruption of any meaningful change by distorting the truth.  The futility of applying an individualized remedy to allegedly widespread misrepresentations is evident in the fact that, of the 1,300 loans actually submitted under the repurchase protocol, EMC has remedied only 20.  This .015% [sic] success rate does not bode well for the efficiency of employing the repurchase protocol for a generalized claim of breach.  Accordingly, EMC cannot reasonably expect the Court to examine each of the 9,871 transactions to determine whether there has been a breach, with the sole remedy of putting them back one by one.  This transaction was put together in days and months.  It is now in its second year of litigation.

You heard that right: of the 1,300 loans that Syncora has tried to put back to EMC to date under the repurchase protocol, EMC has agreed to repurchase only 20.  Again, given the evidence emerging about the conduct of that lender, I shouldn’t be surprised that it is ignoring its contractual repurchase obligations entirely.  Yet, somehow, this intransigence still makes my head spin.

Crotty’s language echoes the comments of Judge Bransten during the hearing on MBIA’s statistical sampling motion – that it is simply impractical to think that any court could adjudicate thousands of individual loans – but goes further, finding that the purpose of the repurchase protocol being to address “onesies” and “twosies.”  I believe that other jurists will find this analysis persuasive, thereby encouraging other MBS plaintiffs to come forward with claims of widespread breach, as the pathway to judgment will be significantly shorter and cheaper if sampling can be used.

Number 4: Bank of America Settles Repurchase Claims with AGO for $1.6 billion. On April 15, bond insurer Assured Guaranty, Ltd. (AGO) announced that it had reached a settlement with Bank of America, including Countrywide Financial and its subsidiaries, to resolve rep and warranty issues on 29 MBS deals that AGO had insured on a primary basis.  The settlement included $1.1 bn of cash up front and, according to Bank of America, up to another $500 million through a reinsurance agreement with BofA.  AGO is projecting its losses from first lien Countrywide deals to be $490 million and losses from its second lien deals with Countrywide to top out at $2.4 billion.  If BofA’s estimates of the value of this deal are correct, it could mean the bank is covering over 55% of AGO’s projected losses.

Though some would argue that the amount of this settlement was small compared to the number of breaches of reps and warranties that AGO was finding across all of its loan pools (88% of second liens and 93% of first liens according to AGO’s 2010 10-K), I see this as an out-and-out win for insurers and investors facing MBS losses.  This is the first time that a major bank has settled for any sizeable amount with a private party over rep and warranty liability, and it undermines the banks’ party line–repeated ad nauseum–that these claims were nothing more than sophisticated parties seeking to pass their losses onto somebody else.

Indeed, as commentators have begun to recognize, this settlement gives credence to the notion that monolines and private investors stand to recover a significant portion of their losses related to MBS from the banks that originated or packaged the loans into securities.  The accord may also embolden other plaintiffs to come forward with claims of their own, as it appears that BofA is making a concerted push to put its legacy issues from Countrywide’s portfolio behind it.

Number 3: AIG Jumps into the Fray. The sleeping giant has finally awoken.  Monolithic insurance company AIG, whose investments in the mortgage market forced Uncle Sam to swoop in to its rescue, has finally started taking legal action against some of the banks that induced it to insure mortgage products designed to fail and engaged in other underhanded conduct with respect to these investments.  Last Thursday, April 28, AIG sued two little-known CDO managers, saying they had conspired with affiliates to inflate the prices of these CDOs and create windfall profits and management fees for themselves.

As I’ve discussed before, AIG was forced to release its claims against the issuers of the mortgage securities it had insured through Credit Default Swaps and other derivatives when it accepted bailout money from the New York Fed.  However, AIG did not waive its claims as to the managers of those deals or as to the $40 billion of MBS that AIG purchased outright.  According to several people familiar with this matter, AIG is planning to bring additional lawsuits regarding those investments.  The insurer has hired Quinn Emmanuel, which also represents MBIA and several other bond insurers in MBS litigation, so it certainly looks like AIG is taking these issues seriously.

Notably, AIG’s first lawsuit draws on allegations made by the SEC last year when it accused the same money managers of securities fraud.  This creates a nice segue into the next item…

Number 2: Duetsche Bank and MortgageIT Sued by U.S. Department of Justice for Reckless Lending Practices. Nothing engenders more private follow-on litigation than when the government steps in and decides to sue somebody for fraud or negligence.  Similarly, the DOJ’s 48-page complaint against Deutsche Bank and its subsidiary, MortgageIT (available here), should give would-be plaintiffs substantial fodder upon which to base civil lawsuits against Deutsche for any harms stemming from MBS investments.

The DOJ’s suit accuses Deutsche of several violations of the federal False Claims Act, (carrying the potential for treble damages), as well as common law negligence and gross negligence based upon years of reckless lending.  Notably, though the complaint opens with the statements that, “This is a civil mortgage fraud lawsuit brought by the United States against Deutsche Bank and MortgageIT…[which] repeatedly lied to be included in a Government program to select mortgages for insurance by the Government,” it stops short of actually accusing the lenders of civil fraud.

Perhaps the DOJ, based on the heightened pleading standard for civil fraud, is awaiting the acquisition of better evidence through discovery before bringing any fraud claims (as Ambac recently did), or maybe it doesn’t feel it has a strong enough case to prove all of the elements of common law fraud (including knowledge of falsity, intent to deceive, and detrimental reliance).  Regardless, the allegations in the complaint suggest a strong basis for fraud, and the inclusion of such a claim would only add fuel to the fires of prospective plaintiffs.

Furthermore, Bloomberg reports that this may be only the beginning of U.S. suits against Deutsche and other lenders.  They note that the FHA and HUD are investigating existing loans for other potential claims to refer to the DOJ, and quote one commentator as saying that the Government may have filed this lawsuit as a “test case” before bringing more suit.  These cases, in turn, will beget many times that number of additional civil cases.

Number 1: Levin Report Referred to the SEC and DOJ for Potential Criminal Charges. Okay, remember when I just said that nothing brings about more private litigation than government lawsuits?  Well, I should rephrase that.  Nothing brings about more private litigation than government lawsuits, except for criminal charges.  Of course, as was illustrated most glaringly by Matt Taibbi in the article, “Why Isn’t Wall Street in Jail?” in Rolling Stone Magazine, not a single criminal indictment has been lodged, let alone any convictions obtained, against Wall Street bankers in the wake of the mortgage crisis that destroyed more than 40% of the world’s wealth.

However, it appears that this is about to change. First, Eric Holder testified before the House Judiciary Committee that more suits and prosecutions may follow the Deutsche Bank action discussed above.  In particular, Holder stated that, “we are in the process of looking at a whole variety of these matters, and it is possible that criminal prosecutions will result.”  Not exactly a guarantee, but it’s a start.

Then, just yesterday, the Levin report issued by the U.S. Senate, which finds that Goldman Sachs misled its clients about mortgage derivatives, was formally referred to the DOJ and SEC.  This puts the issue at the “top of the list” for the agencies and increases the likelihood that criminal actions will be brought.  Not only could charges be brought against Goldman and its executives for its actions leading up to the mortgage crisis, but additional charges of perjury could be levied against the executives that testified before Congress, as much of their testimony ran directly contrary to the ultimate findings of the Commission.

Though many were hopeful that all of the buzz surrounding the potential MBS litigation wave would fade with time, these five key developments over the last month or so send a strong signal that we haven’t seen the last of these lawsuits.  In fact, they’re likely just beginning.

[Many thanks to Manal Mehta from Branch Hill Capital for passing along several of the articles referenced in this post.

This updated post corrects some of the numbers with respect to the AGO/BofA settlement in the first and second paragraph of Reason Number 4 – IMG.]

Posted in AIG, allocation of loss, Allstate, Ambac, bailout, banks, BofA, bondholder actions, broader credit crisis, CDOs, CDSs, Complaints, contract rights, Countrywide, Deutsche Bank, discovery, emc, Federal Reserve, Goldman Sachs, incentives, investigations, investors, irresponsible lending, lawsuits, lenders, liabilities, litigation, loss estimates, MBIA, MBS, misrespresentation, monoline actions, mortgage fraud, mortgage insurers, negligence and recklessness, pooling agreements, private label MBS, putbacks, quinn emanuel, rep and warranty, repurchase, SEC, securities, securities fraud, securitization, settlements, sole remedy, statistical sampling, subprime, Uncategorized, waiver of rights to sue, Wall St. | 23 Comments

Pfaelzer Dismissal of Bank of America from Countrywide Suit Throws Investors for a Loop

Posted on April 27, 2011 by igradman

Is Bank of America on the hook for Countrywide’s liabilities for defective loans?  Depends on which judge you ask.

With the recent decision by Judge Mariana Pfaelzer to dismiss BofA as a defendant in the case of Maine State Retirement System v. Countrywide Financial Corp., et al. (“Opinion,” link also provided at the end of this article), a difference of opinion has emerged among jurists over whether BofA should bear successor liability for the debts of its new lending subsidiary.  Judge Eileen Bransten in New York state court held that bond insurer MBIA could proceed with claims against BofA as the successor-in-interest to Countrywide under the theory that the bank’s purchase of the subprime originator constituted a de facto merger.  Judge Pfaelzer, on the other hand, has now ruled in California District Court that the plaintiff pension funds could not make such a claim, and has dismissed BofA from the lawsuit.

Two primary factors account for this difference of opinion.  First and foremost is the fact that each judge applied a different state’s law to the question of whether the plaintiffs had sufficiently alleged that Bank of America’s purchase of Countrywide’s assets should be treated as a de facto merger.  Judge Pfaelzer, turning to California choice of law principles under the federal Erie doctrine (as the forum state), applied Delaware law, which she found had historically used the doctrine of de facto merger “sparingly” and “only in very limited contexts” (Opinion at 6).  Delaware courts have held that this exception to the general rule that the purchasing corporation does not assume the liabilities of the selling corporation in an asset sale generally requires a showing of intent to defraud, such as an allegation that the sale was designed to disadvantage creditors or shareholders.

Over the objections of the plaintiffs in Maine State Retirement, who asked the judge to apply California law, Pfaelzer held that there was an actual conflict between the law of the two states and that Delaware (the state in which Countrywide was incorporated) had a greater interest in seeing its law applied than California (the state in which Countrywide had its principal place of business).  In particular, Pfaelzer found an actual conflict in that California law was much less restrictive than Delaware law in finding a de facto merger, the latter looking more to the substance of the transaction to see if it operated like a merger, notwithstanding its structure.  The Judge then relied on the Restatement (Second) of Conflict of Laws–which is a well-respected but non-binding treatise on conflict of laws principles–in finding that Delaware, as the state of incorporation, had a greater interest in having its law applied to the determination of this issue.  Certainly, this holding would have been stronger had Pfaelzer been able to cite to binding or persuasive case law to support her opinion.

By contrast, Judge Bransten applied New York law to the same question (opinion available here), which operates similarly to California law in looking more to the substance of the transaction than its form.  Bransten did not conduct a choice of law analysis, as the issue was not raised by the parties in the course of arguing the motion to dismiss (transcript available here), and thus simply assumed that New York law applied.  Of course, this did not stop BofA from challenging Bransten’s ruling on appeal, arguing that she should have applied Delaware law to the question of whether MBIA could state a claim for successor liability.  Though this issue is still up on appeal, my take is that BofA is unlike to prevail on an issue it did not appear to raise or properly preserve before the lower court.

The second major factor that contributed to these divergent rulings is the level of detail included by the respective plaintiffs in their allegations regarding the transaction.  The primary inquiry for New York courts in this regard is whether the acquirer absorbed and continued the prior operations of the acquired corporation or dissolved the company’s management and general business operations.  In support of its allegations in this regard in MBIA, the plaintiff alleged facts showing that BofA retired the Countrywide brand, including its website; cited favorable New York case law holding that all-stock acquisitions, such as BofA’s acquisition of Countrywide, suggest that a de facto merger has occurred; and cited to BofA’s pursuit of a settlement of predatory lending suits with state Attorneys General immediately following its acquisition as evidence that BofA had taken over Countrywide’s business.  All of these facts led Bransten to conclude that MBIA had alleged a de facto merger in which BofA intended to absorb and continue the operations of Countrywide.

In Maine State Retirement, the Judge Pfaelzer found that the plaintiffs had not made allegations sufficient to satisfy any of the de facto merger factors under Delaware law.  Namely, the Judge found that the plaintiffs had failed to allege 1) that Countrywide did not receive valid consideration in the acquisition, 2) that the asset sale failed to comport with law, 3) that any creditors or stockholders were injured by way of the sale, or 4) that the sale was designed to disadvantage such creditors or stockholders (Opinion at 15).  Whether the plaintiffs were unprepared for Judge Pfaelzer to apply Delaware law or simply felt that there was little chance of satisfying these factors should Delaware law apply (and, indeed, it would be hard to say that Countrywide shareholders received insufficient consideration for the sale, knowing what we know now), the fact remains that the plaintiffs’ allegations in Maine State Retirement lacked the particularity or the detail of those in MBIA.  That being said, the Maine State plaintiffs had an uphill battle from the beginning, as Pfaelzer had already issued a conclusory ruling in a previous case, entitled Argent Classic Convertible Arbitrage Fund v. Countrywide, to the effect that BofA did not face successor liability for Countrywide because no bad faith had been alleged (the case eventually settled out of court).

All this does little to guide investors and other plaintiffs looking to hold BofA accountable for the fallout from Countrywide’s reckless lending spree leading up to the mortgage crisis.  Certainly, it will mean we’re more likely to see lawsuits against Countrywide brought in New York than California going forward.  But investors can’t be sure that there will be anything to fight for should they take Countrywide to court and secure a judgment.  Though there are no concrete signs that Countrywide is currently unable to satisfy its debts, commentators have speculated that BofA is holding onto a potential trump card–the option of throwing Countrywide into bankruptcy down the road in an attempt to cut off its liability, should the unit reach that point.  If nothing else, this recent decision provides yet another incentive for investors with valuable claims with respect to Countrywide mortgage backed securities and other derivatives to act quickly to enforce these claims.  Each additional day that they wait could mean a smaller pot at the end of the rainbow.

[Update: BofA ultimately dropped its appeal of Judge Bransten’s Order denying the bank’s motion to dismiss on the issue of successor liability — IMG]

Judge Pfaelzer Order Dismissing BofA in Maine State Retirement System v. Countrywide, et al.

Posted in acquisitions, allocation of loss, appeals, balance sheets, banks, BofA, Countrywide, investors, jurisdiction, lawsuits, lenders, liabilities, liquidity, litigation, MBIA, merger, monoline actions, motions to dismiss, private label MBS, responsibility, securities fraud, subprime, successor liability, vicarious liability | Tagged , , , , , | 6 Comments

Federal Regulators Pick Fight with Banks Over Collapsed Credit Unions

Posted on March 29, 2011 by Isaac Gradman

Just when you thought the hubbub surrounding mortgage backed securities (MBS) was starting to subside, federal regulators have taken their most aggressive stance yet against the banks that sold toxic loans as investment grade securities, according to an article in the Wall Street Journal (subscription required). The National Credit Union Administration (NCUA), the agency that oversees federal credit unions and guarantees the deposits of both federal and state-chartered credit unions, has threatened to sue Goldman Sachs, BofA’s Merrill Lynch, Citigroup, and JP Morgan if the banks refuse to refund over $50 billion in MBS purchased by five wholesale credit unions that have since collapsed.

With some minor differences, the NCUA is to credit unions as the FDIC is to banks, overseeing the safety and soundness of the member-owned credit unions that act like banks for groups of workers in the same field (e.g. firefighters, teachers, or military servicepeople). In its role as conservator, the NCUA seized wholesale credit unions WesCorp, U.S. Central, Southwest, Members United and Constitution between 2009 and 2010, which had collapsed under the weight of their investments in MBS. Now, in an effort to recover the losses on the bonds it inherited–currently priced at half their face value–the NCUA is accusing the banks that created them of misrepresenting the risks.

Though many other federal regulators, including the Fed, the FDIC and the Treasury, hold large amounts of distressed mortgage derivatives, none prior to the NCUA has seemed interested in confronting these issuer banks. Sure, the New York Fed, which holds $70 billion worth of these assets from its rescues of Bear Stearns and AIG, has said that it would be engaging in a broad effort to enforce its rights. However, the only public action we’ve seen the Fed take in this regard is to sign its name to the letter sent by Kathy Patrick to Countrywide and Bank of New York back in October 2010. According to several sources, this amounts to little more than an effort at striking a sweetheart deal for BofA that would preserve the bank’s financial strength while setting a low bar for future settlements. Notably, this effort has made very little noise since its opening salvo (with both sides saying that they are currently engaging in negotiations).

The most interesting thing about the NCUA’s efforts is their focus on misrepresentation. As I’ve noted, we’re seeing a trend away from putback lawsuits and towards claims based on misrepresentations by issuing banks, such as Securities Act, Blue Sky and tort claims. Though plaintiffs originally shied away from alleging fraud or misrepresentation because they had little hard evidence to support such claims, significant revelations from discovery in ongoing litigation and testimony in federal investigations have exposed shenanigans in the loan buying and packaging business during the boom years of 2005-2008. In addition, as the recent holding in the FHLB of Pittsburgh case against JPM (analysis here and full order here) makes clear, less evidence is needed than previously thought to ensure the survival of misrepresentation claims.

In the NCUA’s case, sources indicate that the reason the agency is banging the drum of misrepresentation rather than breach of rep and warranty is that it may not be able to overcome the significant procedural hurdles required to obtain standing. The NCUA, on its own, does not appear to hold at least 25% of the voting rights in many MBS trusts, meaning it would have to band together with other investors to pursue these claims. This is still a possibility, but until then, the NCUA is wise to pursue the more accessible Securities Act and Blue Sky claims.

Turning to the big picture, the WSJ article quotes Quinn Emanuel lawyer Jonathan Pickhardt as saying, “[t]here’s plenty more litigation yet to come,” and I tend to agree. The statute of limitations (“SOL”) for federal securities claims is five years, while the SOL for rep and warranty contract claims under New York law is six years, meaning that claims on securities backed by 2005- and 2006-vintage loans will expire en masse by the end of this year. Should institutional investors fail to take action on these assets, despite the emergence of substantial evidence that these assets were misrepresented or defective, they could be exposed to breach of fiduciary duty claims by the pensioners, retirees and ordinary Americans whose funds they oversee.

Thus, I expect to see a significant number of MBS-related lawsuits hit the courts this year, including action by the Investor Syndicate, which has been ominously silent over the last few months. When that 800-lb gorilla finally begins beating its chest, Wall Street and institutional investors alike will be forced to sit up and take notice.

Posted in BofA, bondholder actions, Citigroup, Credit Unions, FDIC, Goldman Sachs, JPMorgan, Kathy Patrick, litigation, Merrill Lynch, misrespresentation, NCUA, private label MBS, Regulators, securities fraud | Leave a comment

Midwinter Conference Sparks Lively Discourse, Focuses on Servicing Deficiencies

Posted on February 16, 2011 by Isaac Gradman

I just returned from my first Midwinter Housing Finance Conference in Park City, Utah.  Though the conference, organized by Brian Hershkowitz, has been an annual favorite of snow-loving housing professionals for decades, it tends to receive far less publicity than the American Securitization Forum (ASF), which takes place around the same time every year.  That will hopefully begin to change, as I found this year’s conference to be engaging and, ultimately, newsworthy, thanks to a keynote speech by Fed Reserve Board Gov. Sarah Raskin that placed the servicing industry directly in the cross hairs.

In fact, while a wide range of topics was discussed during the conference’s three days of presentations and panels, servicing deficiencies dominated the conversation.  Most conference participants agreed that the default servicing model was broken, and continued to be major drag on the recovery of the housing market.  There was also a consensus that servicer conflicts of interest and misaligned incentives played a large role in these deficiencies–stymieing loan modification programs and contributing to the latent foreclosure (aka “fraudclosure”) crisis.  However, it seemed that each participant had a different idea about what it would take to fix this important industry. 

This diversity of opinion can be attributed in part to the complexity of the issues, but also to the diversity of the conference participants themselves–something that I found to be one of the strengths of this conference.  The professionals in attendance were not limited to one segment of the housing industry, but included investors, regulators, bankers, academics, financiers, consultants and members of the press.  Indeed, the number of different opinions about the problems with the servicing industry seemed to outnumber even the participants.

I presented on a panel that served as a microcosm of this blend of viewpoints.  The session was called “Investor Putbacks, MERS & the Capital Markets,” and included a presentation on MERS by Christopher Peterson, a law professor at the University of Utah; a presentation on Trends in Investor RMBS Litigation by me, a blogger and litigation consultant; and a presentation on what investors are looking for these days by Neil Powers, a fixed income investor at Vectors Research Mgmt.  Though the topics and viewpoints differed, they combined nicely in my opinion to paint a multilayer picture of the current MBS landscape.  The lively Q&A that followed only enriched that perspective.  

Of course, another topic that arose frequently during conference sessions was the future of the GSEs, especially with the White House’s release on Friday of a white paper suggesting the gradual winding down of Freddie and Fannie.  Cal Professor Dwight M. Jaffee gave an reassuring presentation on why he believes a privatized US mortgage market will work–a refreshing viewpoint for those of us who believe in the future of private mortgage finance.  This was followed, appropriately enough, by a presentation by Fannie Mae’s Doug Duncan called “Economics and Mortgage Market Analysis,” in which he noted that while housing fundamentals were improving, homeownership rates will likely trend downward due to weakness in demand.

But the most surprising moment in the conference came with Fed Gov. Raskin’s speech, the full text of which is available here.  Striking a decidedly more direct tone than her Fed counterparts, Raskin noted that “widespread weaknesses exist in the servicing industry… [T]hese deficiencies pose significant risk to mortgage servicing and foreclosure processes, impair the functioning of mortgage markets, and diminish overall accountability to homeowners.”  She also called out the servicers that are affiliates of the larger banks, saying:

For those in the housing and mortgage fields, making needed changes will not be easy. In particular, for those in the mortgage servicing industry, it means difficult changes and significant investments to rectify broken systems. For those servicers who are subsidiaries or affiliates of a broader parent financial institution, the responsibility for change and further investment absolutely extends up to that parent company, many of which have enjoyed substantial profits while their servicing arms have been run on the cheap.

While Raskin’s speech was short on aggressive proposals to fix these problems, such as legislating a divestment of servicing arms by the major banks to avoid conflicts of interest, she can be commended for attacking head-on the current problems with default servicing and suggesting a variety of alternative business models that might ease some of the problems with this industry.  And though the Midwinter Conference participants could have had a lively debate about the merits of these various models, I think almost all of us could agree with Raskin’s statement that, “Until these operational problems are addressed once and for all, the foreclosure crisis will continue and the housing sector will languish.”

As I checked out of the St. Regis in Park City and headed home, I was left to marinate on these words and the fact that while responsible servicing might not have prevented the Mortgage Crisis, it certainly would have made the cleanup a whole lot easier.  Here’s hoping that the many intelligent folks I met at Midwinter and throughout this industry can reach a consensus on building a better servicing model going forward.

Posted in ASF, conflicts of interest, Fannie Mae, Freddie Mac, incentives, investors, litigation, Midwinter Conference, Presentations, Winding Down GSES | 1 Comment

Commentators Concur: Trustee Involvement Signals Shift in RMBS Litigation

Posted on February 2, 2011 by Isaac Gradman


A few weeks ago, I published an article suggesting that the increased cooperation of MBS trustees may signal the turning point in bondholder litigation.  It seems I’m not alone in reaching this conclusion.

The following week, on January 27, Adam Levitin, associate law professor at Georgetown University and vocal commentator on banks’ potential liabilities stemming from subprime lending, published a blog post entitled, “Clash of the Titans: RMBS Edition.” The post does a great job of summarizing the key early litigation in this space, including linking to some articles from The Subprime Shakeout, while also analyzing where this trend may be heading.

Levitin’s verdict?  That the storm we’ve long predicted is coming.  Levitin writes, “We’re about to witness the main event in financial institution internecine warefare: investment funds (MBS buyers) vs. banks (MBS sellers).”  The catalyst he identifies is that a group of large institutional investors has banded together and filed suit, in what Levintin calls the first “A-list litigation.”  This would be the case filed by Dexia, New York Life, and TIAA-CREF, among others, against Countrywide and BAC.

Besides including the usual slew of allegations regarding loosening guidelines, breaches of underwriting reps and warranties and misrepresentations regarding lending standards, Dexia and the other plaintiffs raise (for the first time I can recall in either bondholder or insurer litigation) chain of title issues regarding whether ownership of the note and deed was properly transferred through the securitization chain.  The Complaint discusses in detail the revelations of Linda DeMartini from Kemp v. Countrywide that Countrywide routinely did not transfer the mortgage note when it sold a loan into securitization.  Such errors became meaningful after the Massachusetts Supreme Court handed down the Ibanez decision, holding that the entity foreclosing had to able to show that they were the holder of the note and deed at the time they initiated foreclosure proceedings.  As Levitin points out, the Dexia complaint merely scratches the surface on chain of title issues, but it gives credibility to an argument that was long dismissed by the banks as a mere technicality.

Levitin also agrees that trustee intercession on behalf of bondholders could only mean the times are a-changin’. In that regard, Levitin writes, “It looks like the trustees see that it’s checkmate once the investors get to the collective action threshold and are finally squeezing the servicers… This ain’t gonna end pretty.”

One day after Levitin’s article came out, industry publication Debtwire reported a similar trend.  In an article entitled, “JPMorgan slowly loosens grip on loan files in bitter EMC, WaMu buyback disputes” (subscription only), reporter Allison Pyburn, whose writing has long reflected a strong handle on these issues, states:

This week, JPMorgan also agreed to relinquish 400 of the 902 loan files requested that serve as collateral for Bear Stearns Mortgage Funding Trust 2007-AR2, according to a letter filed Wednesday in Delaware Chancery Court in Wilmington. The case, Wells Fargo Bank v. EMC Mortgage Corp., has investor standing in 42% of the deal and loan level data alleged to prove a breach of the 902 loan files requested on 20 September.

Movements by the bank to turn over loan documents to trustees investigating buyback disputes could represent a shift of power between banks and investors seeking buybacks, said an RMBS investor and lawyer familiar with the disputes.  A JPMorgan Chase spokesman declined to comment.

Make no mistake about it, loan files are the key to unraveling this whole mess.  Once bondholders obtain possession of these critical documents–and eventually they will–they will be privy to a mountain of fodder for rep and warranty and misrepresentation claims, and losses will flow back to the originators and underwriters of these toxic loans.  The servicers (a.k.a. the originators and keepers of the files related to many of these loans) have been able to sit on their hands and refuse to turn over loan files thus far because passive trustees and arduous procedural hurdles have stood between the bondholders and loan access rights.  When this changes–and all evidence suggests that it already is–servicers will be left without a leg to stand on, and the files will be produced, either voluntarily, or by court order.  Brace yourself for the ruckus.

Posted in allocation of loss, bondholder actions, chain of title, emc, investors, loan files, servicers, TIAA-CREF, Trustees, Wells Fargo | 3 Comments