By RUTH SIMON And NICK TIMIRAOS
The 17 lawsuits filed Friday by federal
regulators against some of the world's biggest financial institutions hinge on a
simple premise: The mortgage loans that banks packaged into securities often
didn't meet the underwriting guidelines the banks outlined in their securities
filings.
The lawsuits, filed by the Federal Housing Finance Agency, allege that the banks made untrue statements and omitted key facts when they sold mortgage investments to loan giants Fannie Mae and Freddie Mac.
The suits involve $196 billion in mortgage bonds packaged by some of the world's biggest banks. In addition to the banks, the suits name more than 100 executives who signed offering statements for the securities. Several of the named banks denied the allegations, didn't respond to requests for comment or declined to comment.
The FHFA didn't specify how much it is seeking in damages.
Fannie and Freddie don't make loans directly, but they support housing markets by buying mortgages from banks and then selling them to investors as securities, providing guarantees to investors.
During the housing boom, the two companies augmented their role in the housing market by purchasing privately issued mortgage securities as investments.
It is those investments at issue in the suits. Analysts said the cases could ultimately turn on whether the FHFA can show that Fannie and Freddie, given all their expertise in evaluating mortgage risks, were misled about the quality of the loans backing those investments.
Citing detailed loan information, the FHFA lawsuits allege that the banks repeatedly misrepresented or made untrue statements about basic characteristics of loans in the securities, such as the portion of borrowers who lived in their homes and the percentage of the property's value being financed.
Banks "routinely" packaged loans into securities even though they had been flagged by third-party due diligence firms as not meeting underwriting guidelines, according to the lawsuits.
"It's a great myth that you can't defraud sophisticated financial parties," said William K. Black, a former bank regulator involved with hundreds of successful savings-and-loan-era prosecutions. "Models cannot protect you against fraudulent loans" or inadequate disclosures.
The FHFA's review of a sample of loans in one Goldman Sachs Group Inc. bond deal cited in a lawsuit found that the portion of properties that appeared not to be owner-occupied was nearly double the amount stated in the prospectus supplement.
Goldman Sachs declined to comment.
The banks are likely to argue that Fannie and Freddie knew that the loans were risky and that losses were due to underlying economic conditions, not faulty underwriting. "It will become clear that the plaintiffs knew as much as the defendants about the quality of these loan portfolios," says Andrew Sandler, co-chairman of BuckleySandler LLP, a law firm representing banks in litigation and regulatory enforcement actions.
Roughly a dozen investors and government agencies, including at least five federal home loan banks, American International Group Inc. and the National Credit Union Administration, have filed similar lawsuits.
Both the FHFA and NCUA have an edge over some other plaintiffs because they have subpoena power that has provided them with access to loan files.
Given that evidence from the loan files, "it would be amazing if these complaints do not survive motions to dismiss," said David Grais, an attorney in New York who represents several Federal Home Loan Banks in similar legal actions. Many of the other lawsuits are still in their early stages; most have survived motions to dismiss.
Write to Ruth Simon at ruth.simon@wsj.com and Nick Timiraos at nick.timiraos@wsj.com
The lawsuits, filed by the Federal Housing Finance Agency, allege that the banks made untrue statements and omitted key facts when they sold mortgage investments to loan giants Fannie Mae and Freddie Mac.
The suits involve $196 billion in mortgage bonds packaged by some of the world's biggest banks. In addition to the banks, the suits name more than 100 executives who signed offering statements for the securities. Several of the named banks denied the allegations, didn't respond to requests for comment or declined to comment.
The FHFA didn't specify how much it is seeking in damages.
Fannie and Freddie don't make loans directly, but they support housing markets by buying mortgages from banks and then selling them to investors as securities, providing guarantees to investors.
During the housing boom, the two companies augmented their role in the housing market by purchasing privately issued mortgage securities as investments.
It is those investments at issue in the suits. Analysts said the cases could ultimately turn on whether the FHFA can show that Fannie and Freddie, given all their expertise in evaluating mortgage risks, were misled about the quality of the loans backing those investments.
Citing detailed loan information, the FHFA lawsuits allege that the banks repeatedly misrepresented or made untrue statements about basic characteristics of loans in the securities, such as the portion of borrowers who lived in their homes and the percentage of the property's value being financed.
Banks "routinely" packaged loans into securities even though they had been flagged by third-party due diligence firms as not meeting underwriting guidelines, according to the lawsuits.
"It's a great myth that you can't defraud sophisticated financial parties," said William K. Black, a former bank regulator involved with hundreds of successful savings-and-loan-era prosecutions. "Models cannot protect you against fraudulent loans" or inadequate disclosures.
The FHFA's review of a sample of loans in one Goldman Sachs Group Inc. bond deal cited in a lawsuit found that the portion of properties that appeared not to be owner-occupied was nearly double the amount stated in the prospectus supplement.
Goldman Sachs declined to comment.
The banks are likely to argue that Fannie and Freddie knew that the loans were risky and that losses were due to underlying economic conditions, not faulty underwriting. "It will become clear that the plaintiffs knew as much as the defendants about the quality of these loan portfolios," says Andrew Sandler, co-chairman of BuckleySandler LLP, a law firm representing banks in litigation and regulatory enforcement actions.
Roughly a dozen investors and government agencies, including at least five federal home loan banks, American International Group Inc. and the National Credit Union Administration, have filed similar lawsuits.
Both the FHFA and NCUA have an edge over some other plaintiffs because they have subpoena power that has provided them with access to loan files.
Given that evidence from the loan files, "it would be amazing if these complaints do not survive motions to dismiss," said David Grais, an attorney in New York who represents several Federal Home Loan Banks in similar legal actions. Many of the other lawsuits are still in their early stages; most have survived motions to dismiss.
Write to Ruth Simon at ruth.simon@wsj.com and Nick Timiraos at nick.timiraos@wsj.com
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