Breaking News: BofA Close to Reaching $8.5 bn Settlement with BlackRock, PIMCO (100th Post)

Posted on June 29, 2011 by igradman

As part of the Subprime Shakeout’s 100th Post (woo-hoo!), I bring you an analysis of some big, breaking news: today, the Wall Street Journal reported that Bank of America was closing in on an agreement with the investor group led by Kathy Patrick to pay $8.5 billion to settle claims over mortgage backed securities.  If true, this would be the largest MBS settlement to date arising out of the mortgage crisis.

I first reported on this investor effort back in October 2010.  You can find my initial take here, a link to the demand letter sent by Patrick here, and a link to the response fired off by BofA here.  While we heard early in 2011 that the parties would extend all deadlines while they negotiated, we had heard very little about the progress of these efforts until today.

While the details of the purported settlement are sketchy, the WSJ report states that the current investor group includes 22 institutions, including BlackRock, PIMCO, the New York Fed, MetLife and Freddie Mac, which collectively hold $56 billion worth of mid-2000s vintage MBS.  Though it did not report on any impending settlement, Bloomberg also published an article today on these negotiations, and stated that the value of the securities at issue was $84 billion, while the original principal value of the securities was $182 billion.  While it is not entirely clear how these numbers line up, my best guess is that the investor group holds approximately $56 billion of the $84 billion outstanding.

What’s also unclear is how much of the reduction in the value of the bonds at issue is as a result of pay-downs and prepayments, and how much is as a result of the trusts taking losses on foreclosed properties.  Thus, it is difficult to assess what percentage of potential damages from investor claims is being born by BofA under the settlement.  My initial reaction is that, while the absolute dollar amount sounds large, this settlement is ultimately fairly small compared to the potential damages.

This result would be consistent with the consensus among commentators regarding this investor group, including some of the comments contained in today’s Bloomberg article and my initial take on this effort: namely, the investors involved have significant other business dealings with BofA (a.k.a. conflicts), and thus would not seek an aggressive settlement.  At the same time, BofA has exhibited a growing interest in resolving its legacy RMBS liability, and thus would be interested in entering into a sweetheart settlement with a prominent group of investors that would set a precedential ceiling on future recoveries and discourage other investors from coming forward.

Without seeing the terms of the settlement and the details of the group’s holdings, it’s impossible to know what claims are being released in this settlement and how the proceeds are to be shared.  For example, if the group is being paid outside of the trust waterfalls, and thus receiving the entire $8.5 billion, then the investors would actually be recovering much larger proportion of their potential damages (while potentially throwing the other investors who did not participate in the settlement under the bus, either by purporting to release their claims, or by making it impossible for those other investors to gain standing to sue).

However, sources have indicated that the settlement funds will actually be paid into the trust waterfalls.  This would be ostensibly more equitable, in that all bondholders would be entitled to receive a share of the settlement proceeds, depending on their seniority.  However, query how equitable it really is for a portion of the bondholders (and most likely the senior portion, since these are primarily institutional investors) to set the settlement amount for the rest of the non-participating bondholders, and to receive the lion’s share of the benefits based on their more senior bond position.  Whether the investor group could or would engineer such a settlement remains to be seen.

Regardless, the fact that these investors got any money at all out of the nation’s largest bank, let alone a material dollar amount, might actually encourage other investors to come forward.  A settlement of this size would reveal that BofA’s initial rhetoric, that it would fight these claims tooth and nail until they were forced to pay, was just that–empty rhetoric.  For example, BofA CEO Brian Moynihan stated during the company’s third quarter 2010 earnings call that, “we will go in and fight this.  It’s worked to our benefit to—we have thousands of people willing to stand and look at every one of these loans.”  Further, this settlement undermines BofA’s recent estimate that the cost of its legacy RMBS putback issues would not exceed $10 billion.  BofA cannot seriously assume that this is the only large investor group with which it will have to tangle over defective Countrywide loans.

The simple truth is that investors have significant amounts of viable repurchase and Securities Act claims stemming from their purchase of Countrywide-issued or originated MBS, and BofA will be forced to confront many additional claims by investors in the coming years.  These additional investors might not have the same level of business dealings with BofA and thus might be willing to take more aggressive steps in pursuing reimbursement for its losses.  In that case, BofA’s strategy of creating a lowball settlement to discourage investors from coming forward might end up backfiring and further eroding the already strained capital on BofA’s balance sheet.

Posted in allocation of loss, balance sheets, banks, BlackRock, BofA, bondholder actions, contract rights, Countrywide, damages, demand letter, Freddie Mac, investors, Kathy Patrick, lawsuits, liabilities, loss estimates, PIMCO, private label MBS, putbacks, RMBS, settlements | 3 Comments

FDIC Sues LPS and CoreLogic Over Appraisal Fraud; Shows Investors Leaving Money on the Table

Posted on May 30, 2011 by igradman

In another sign that the Federal Government is turning its focus towards prosecuting the securitization players who may have contributed to the Mortgage Crisis, the FDIC filed separate lawsuits against LSI Appraisal (available here) and CoreLogic (available here) earlier this month.  In the suits, both filed in the Central District of California, the FDIC, as Receiver for Washington Mutual Bank (“WAMU”), accuses vendors with whom WAMU contracted to provide appraisal services of gross negligence, breach of reps and warranties, and other breaches of contract for providing defective and/or inflated appraisals.  The FDIC seeks at least $154 million from LSI (and its parent companies, including Lender Processing Services and Fidelity, based on alter ego liability) and at least $129 million from CoreLogic (and its parent companies, including First American Financial, based on alter ego liability).

As we’ve been discussing on The Subprime Shakeout this past month, the U.S. Government has stepped up its efforts to pursue claims against originators, underwriters and other participants in mortgage securitization over irresponsible lending and underwriting practices that led to the largest financial crisis since the Great Depression.  This has included the DOJ suing Deutsche Bank over reckless lending and submitting improper loans to the FHA and the SEC subpoenaing records from Credit Suisse and JPMorgan Chase over so-called “double dipping” schemes.  The FDIC’s lawsuit is just the latest sign that much more litigation is on the horizon, as it focuses on yet another aspect of the Crisis that is ripe for investigation–appraisal fraud.

Granted, those familiar with the loan repurchase or putback process have long recognized that inflated or otherwise improper appraisals are a major category of rep and warranty violations that are found in subprime and Alt-A loans originated between 2005 and 2007.  In fact, David Grais, in his lawsuits on behalf of the Federal Home Loan Banks of San Francisco and Seattle, focused the majority of his allegations against mortgage securitizers on inflated appraisals (ironically, the data Grais used in his complaints was compiled by CoreLogic, which is now one of the subjects of the FDIC’s suits).

Grais likely zeroed in on appraisals in those cases because he was able to evaluate their propriety after the fact using publicly available data, as he had not yet acquired access to the underlying loan files that would have provided more concrete evidence of underwriting deficiences.  But, appraisals have been historically a bit squishy and subjective–even using retroactive appraisal tools–and absent evidence of a scheme to inflate a series of comparable properties, it can be difficult to convince a judge or jury that an appraisal that’s, say, 10% higher than you would expect was actually a negligent or defective assessment of value.

The reason that the FDIC/WAMU is likely focusing on this aspect of the underwriting process is because it’s one of the few avenues available to WAMU to recover its losses.  Namely, the FDIC is suing over losses associated with loans that it holds on its books, not loans that it sold into securitization.  Though the latter would be a much larger set of loans, WAMU no longer holds any ownership interest in those loans, and would not suffer losses on that pool unless and until it (or its new owner, JPMorgan) were forced to repurchase a significant portion of those loans (read: a basis for more lawsuits down the road).

Which brings me to the most interesting aspect of these cases.  As I mentioned, the FDIC is only suing these appraisal vendors over the limited number of loans that WAMU still holds on its books.  In the case against LSI, the FDIC only reviewed 292 appraisals and is seeking damages with respect to 220 of those (75.3%), for which it claims it found “multiple egregious violations of USPAP and applicable industry standards” (LSI Complaint p. 12).   Only 10 out of 292 (3.4%) were found to be fully compliant.  Yet, the FDIC notes earlier in that complaint that LSI “provided or approved more than 386,000 appraisals for residential loans that WaMu originated or purchased” (LSI Complaint p. 11).

In the case against CoreLogic, the FDIC says that it reviewed 259 appraisals out of the more than 260,000 that had been provided (CoreLogic Complaint pp. 11-12).  Out of those, it found only seven that were fully compliant (2.7%), while 194 (74.9%) contained multiple egregious violations (CoreLogic Complaint p. 12).  And it was the 194 egregiously defective appraisals that the FDIC alleges caused over $129 million in damages.

Can you see where I’m going with this?  If you assume that the rest of the appraisals looked very similar to those sampled by the FDIC, there’s a ton of potential liability left on the table.

Just for fun, let’s just do some rough, back-of-the-envelope calculations to provide a framework for estimating that potential liability.  I will warn you that these numbers are going to be eye-popping, but before you get too excited or jump down my throat, please recognize that, as statisticians will no doubt tell you, there are many reasons why the samples cited in the FDIC’s complaints may not be representative of the overall population.  For example, the FDIC may have taken an adverse sample or the average size of the loans WAMU held on its balance sheet may have been significantly greater than the average size of the loans WAMU securitized, meaning they produced higher than average loss severities (and were also more prone to material appraisal inflation). Thus, do not take these numbers as gospel, but merely as an indication of the ballpark size of this potential problem.

With that proviso, let’s project out some of the numbers in the complaints.  In the LSI/LPS case, the FDIC alleges that 75% of the appraisals it sampled contained multiple egregious violations of appraisal standards.  If we project that number to the total population of 386,000 loans for which LSI/LPS provided appraisal services, that’s 289,500 faulty appraisals.  The FDIC also claims it suffered $154 million in losses on the 220 loans with egregiously deficient appraisals, for an average loss severity of $700,000.  Multiply 289,500 faulty appraisals by $700,000 in losses per loan and you get a potential liability to LSI/LPS (on just the loans it handled for WAMU) of $202 billion.  Even if we cut the percentage of deficient appraisals in half to account for the FDIC’s potential adverse sampling and cut the loss severity in half to account for the fact that the average loss severity was likely much smaller (WAMU may have retained the biggest loans that it could not sell into securitizations), that’s still an outstanding liability of over $50 billion for LSI/LPS.

Do the same math for the CoreLogic case and you get similar results.  The FDIC found 74.9% of the loans sampled had egregious appraisal violations, meaning that at least 194,740 of the loans that CoreLogic handled for WAMU may contain similar violations.  Since the 194 egregious loans accounted for $129 million in losses according to the Complaint, that’s an average loss severity of $664,948.  Using these numbers, CoreLogic thus faces potential liabilities of $129 billion.  Even using our very conservative discounting methodology, that’s still over $32 billion in potential liability.

This means that somewhere out there, there are pension funds, mutual funds, insurance funds and other institutional investors who collectively have claims of anywhere from $82 billion to $331 billion against these two vendors of appraisal services with respect to WAMU-originated or securitized loans.  For how many other banks did LSI and CoreLogic provide similar services?  And how many other appraisal service vendors provided similar services during this time and likely conformed to what appear to have been industry practices of inflating appraisals?  The potential liability floating out there on just this appraisal issue alone is astounding, if the FDIC’s numbers are to be believed.

The point of this exercise is not to say that the FDIC necessarily got its numbers right, or even to say that WAMU wasn’t complicit in the industry practice of inflating appraisals.  My point is that these suits reveal additional evidence that investors are sitting on massive amounts of potential claims, about which they’re doing next to nothing.  Where are the men and women of action amongst institutional money managers (and for that matter, who is John Galt?)?  Are they simply passive by nature, and too afraid of getting sued to even peek out from behind the rock? Maybe this is why investors don’t want to reveal their holdings in MBS – they’re afraid that if unions or other organized groups of pensioners realized that their institutional money managers held WAMU MBS and were doing nothing about it, they would sue these managers and/or never run their money through them again.

The better choice, of course, would be to join the Investor Syndicate or one of the other bondholder groups that are primed for action, and then actually support their efforts to go after the participants in the largest Ponzi scheme in history (an upcoming article on TSS will focus on the challenges that these groups have faced in getting their members actually motivated to do something).  It seems that these managers should be focused on trying to recover the funds their investments lost for their constituents, rather than just acting to protect their own anonymity and their jobs.  If suits like those brought by the FDIC don’t cause institutional money managers to sit up and take notice, we have no other choice but to believe these individuals are highly conflicted and incapable of acting as the fiduciaries they’re supposed to be.  Of all the conflicts of interest that have been revealed in the fallout of the Mortgage Crisis, this last conflict would be the most devastating, because it would mean that the securitization participants who were instrumental in causing this crisis, and who were themselves wildly conflicted, will largely be let off the hook by those they harmed the most.

Posted in allocation of loss, appraisals, causes of the crisis, Complaints, conflicts of interest, CoreLogic, FDIC, Federal Home Loan Banks, fiduciary duties, irresponsible lending, lawsuits, liabilities, loan files, loss causation, LPS, private label MBS, re-underwriting, rep and warranty, RMBS, statistical sampling, subprime, successor liability, underwriting practices, valuation, WaMu | Tagged , , , , | 2 Comments

MBS Lawsuit Drivers Part II: Two More Reasons Why MBS Cases Should Jump in 2011

Posted on May 16, 2011 by igradman

by Josh Silverman, guest blogger

Mortgage-backed securities (“MBS”) litigation should expand this year, as Isaac Gradman correctly pointed out on The Subprime Shakeout in his Top 5 Reasons That MBS Lawsuits Are Just Beginning.   The sheer number of lawsuits continues to increase, and businesses that typically shy away from securities fraud litigation are now getting involved.  Even banks and insurers are starting to file MBS cases – including big names like Allstate, Dexia, Mass Mutual and the Federal Home Loan Banks of Boston, Seattle, San Francisco and Pittsburgh.

After a rocky start, the law is getting better for MBS plaintiffs, too, at least in individual (non-class) actions.  The positive developments identified in Isaac’s post could embolden additional MBS investors to pursue legal remedies.

But in my view the jump in individual MBS lawsuits is not due solely, or even primarily, to shifting sentiment.  Instead, many MBS investors are filing suit now because it may be their last chance to do so.  If they wait, good claims could expire, and downsized MBS class actions no longer give them cover to observe from the sidelines.  As described below, these two factors could be the primary drivers of an increase in MBS lawsuits this year.

Expiring Statutes of Limitation

All civil claims are subject to a limitations period, also called a statute of limitations.  These operate like a shot clock in sports, requiring plaintiffs to take action within a certain amount of time or lose forever the ability to seek recovery.

Naturally, the best claims for MBS investors also have the shortest limitations period.  Claims under Sections 11 and 12 of the Securities Act of 1933 are widely considered to be the most pro-plaintiff causes of action in federal securities laws.  Plaintiffs bringing these claims do not have to prove the thorniest issues like intent, causation and reliance.   Instead, they only have to prove that the defendant made a material misrepresentation in a registration statement or prospectus (and for Section 12, that the defendant sold the MBS).  But Section 11 and 12 claims can currently only be brought within the earlier of one year after an investor discovered or should have discovered the fraud, or three years after the SEC filing in question (note that some legal commentators have argued that the longer statute of limitations of five years from the filing and two years from discovery, set forth in Sarbanes-Oxley, should apply to Section 11 and 12 claims that “sound in fraud”; however, courts have generally rejected that view).

For all practical purposes, that means that Section 11 and 12 claims for MBS issued between 2005 and 2007 will be time-barred unless the limitations period was tolled (suspended).  Under federal law, the statute of limitations can sometimes be tolled when the plaintiff falls within the class definition of a pending class action.  However, this is one area where the law has not developed favorably for MBS investors.  Lower courts adopted a limited view of tolling in Wells Fargo, Countrywide, and other class action MBS cases.  Expect this issue to reach the appellate courts in 2011.

Other types of claims have more generous limitations periods, but many are now on the brink of expiring.  A typical securities fraud claim under Section 10(b) of the Securities and Exchange Act of 1934 can be brought within two years of discovery, or no more than five years after the misrepresentations were made.  Fraud and negligent misrepresentation claims under state common law generally have a 2-5 year limitations period running from the discovery of the misrepresentation.

These statutes of limitation will force undecided MBS investors off the fence.  Many will lose claims if they don’t act shortly.

MBS Class Actions Get Smaller

Shrinking MBS class actions may also spike the number of filings in 2011, as investors formerly covered by a class action find they have to proceed on their own.

After the credit meltdown of 2008, class actions were filed against most major private-label MBS issuers.  These lawsuits included very broad class definitions, often covering several dozen or even hundreds of separate MBS securitizations.   An MBS investor included in one or more of these large classes might hold off filing its own lawsuit to see what level of recovery could be achieved in the class actions.

But federal courts have since dramatically narrowed the majority of MBS class cases. Notwithstanding their broad class definitions, numerous decisions have limited class actions to the specific MBS securitizations owned by the named plaintiffs in those lawsuits.

The impact has been profound.  Claims for 85 of the 94 MBS securitizations originally included in the Lehman Bros. MBS class action have been dismissed.  91 of 106 IndyMac MBS were pared from that class action.  And in the Countrywide MBS class action, an amended complaint filed in December dropped all but fourteen of the 427 Countrywide MBS once part of various class actions against that issuer.   MBS investors no longer part of these class actions can only obtain recovery by filing their own lawsuits.

Between these two factors and the five reasons identified by Isaac, 2011 should be an active year for MBS filings.  Stay tuned…

Josh Silverman is of counsel at Pomerantz Haudek Grossman & Gross LLP and a fan of The Subprime Shakeout.  Silverman exclusively represents investors in securities litigation and was co-lead counsel representing three multi-billion dollar state funds in a leading MBS case against Countrywide.  He welcomes your comments and can be reached by email at jbsilverman@pomlaw.com.  The ethics rules in his state require him to remind you that this post is not legal advice.

Posted in Allstate, banks, bondholder actions, class actions, Countrywide, Federal Home Loan Banks, guest posts, IndyMac, lawsuits, litigation, MBS, mortgage fraud, private label MBS, securities, securities fraud, statutes of limitations | Tagged , , | Leave a comment

Compass Point to Hold Follow-Up Call on Repurchase Risks

Posted on May 11, 2011 by igradman

Compass Point Research & Trading is hosting a conference call tomorrow, May 11 at 11:00 AM Eastern to discuss recent developments in mortgage repurchase litigation.  For those interested in participating, the call-in number is 877.641.0093.  Compass Point’s Jason Stewart will be the moderator on the call.

A full version of the invitation is embedded below.  Compass’ last call and corresponding report from August 2010 garnered significant attention for its stark assessment of the potential repurchase liability facing the major banks and subprime lenders.

I will again be a featured expert on this call, along with Richard Barrent, the President and COO of the Barrent Group.  We will be discussing following topics before taking Q&A from participants:

  • The current threshold that needs to be met in order to receive rescission ‐ does causation of default need to be proven?
  • What are the differences, if any, in success ratios of rescission requests by loan category?
  • A discussion of the Maine Retirement system ruling on the de facto merger of Countrywide and Bank of America (BAC—NC).
  • Will the inclusion of Bank of New York Mellon (NK—NC) in the Walnut Place lawsuit cause trustees and investors to work more
    closely together?
  • What are the different stages of resolution by investor category? Has the Bank of America (BAC—NC) and Assured Guaranty (AGO—
    NC) settlement changed the landscape?
  • Does some type of structured settlement make sense as the ultimate resolution?

Based on the turnout for the last call and the media attention it received, I expect this call to be well-attended and feature some great questions and insights from the speakers and participants.  I will be available in the coming days for follow-up consultations on these topics, as well.  Hope to hear some readers of The Subprime Shakeout on the call tomorrow.  Looking forward to it!

Private Label RMBS Litigation Conf Call(1)

Posted in Compass Point, lawsuits, litigation, rep and warranty, repurchase, securitization, subprime | Leave a comment

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