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Seattle Federal Home Loan Bank goes after Wall Street

Top of the News: Americans have waited in vain for prosecutions of the banksters for helping cause the Great Recession through their swindles, ooops, risky bets on exotic securities and derivatives. Now some simple justice may come from lawsuits filed by the Federal Home Loan Bank of Seattle.

According to The Wall Street Journal, the institution has filed 11 suits in King County Superior Court claiming that underwriters misled it about the quality of $4 billion of mortgage-backed securities it bought during the housing boom. The banks include Bear Stearns, now owned by JPMorgan Chase, Goldman Sachs, Morgan Stanley and Countrywide, now owned by Bank of America. It's demanding that the banks buy back the securities plus interest.

The federally chartered FHLB is one of 12 such institutions set up by the government during the Depression and owned by more than 8,000 banks and thrifts, intended to provide stable credit, especially to savings and loans, and small, rural banks. The Seattle FHLB was badly wounded by Washington Mutual, which accounted for a third of its lending business.

The Seattle bank wants the cases moved to federal court, and they will be closely followed by wronged investors.

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The Back Story: Foreign holdings of U.S. Treasuries fell by a record $53 billion in December. The biggest change was China and Japan reducing their appetites for the securities (China cut back more than $34 billion).

Make of it what you will. A month doesn't signal a trend, but clearly foreign investors worry about the Fed's ability to deal with inflation, the federal deficit and the continued weakness in the American economy. Conservatives will see this as a sign the U.S. is headed to Greece's fate without massive budget cuts (but not in their districts). Liberals will warn it's another sign that our two wars and massive defense spending are unsustainable (while continuing those policies).

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Congress passed the Federal Home Loan Bank Act, which established the FHLBank System, in 1932, during the Great Depression. This was in order to provide funds to "building and loan" institutions, providing liquidity and making mortgages available. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) abolished the Federal Home Loan Bank Board and transferred responsibility for oversight of the Federal Home Loan Banks to the Federal Housing Finance Board. At that time the Bank Board’s previous supervisory and regulatory responsibilities with respect to thrift institutions and their holding companies were transferred to the newly created Office of Thrift Supervision, under the U.S. Department of the Treasury. FIRREA also allowed all federally-insured depository institutions to join the FHLBank System, including commercial banks and credit unions.

On July 30, 2008, the Housing and Economic Recovery Act of 2008 (HERA) became law. The FHLBanks were referenced in this legislation, and the two changes were 1) the existing regulator (the Federal Housing Finance Board) was replaced with the Federal Housing Finance Agency, and 2) the Secretary of the Treasury was authorized to purchase FHLBank debt securities in any amount through December 31, 2009. After that time, the limit would return to the original $4 billion.

On January 8, 2009, Moody's said that only 4 of the 12 FHLBs may be able to maintain minimum required capital levels.[2]

On September 7, 2008, the U.S. Treasury announced a new credit facility for the three housing government-sponsored enterprises. This enabled the Secretary of the Treasury to purchase FHLBank debt in any amount subject to the pledging of secured loans as collateral. The authority for this facility expired on December 31, 2009.

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We force the seller of eggs with a few that have salmonella in them to recall all of them and eat the expense of doing so. Why is it again that the Federal Government does not force all of this crap back on the securitizers?

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Oh, and as for "systemic risk"? The Kanjorsky Amendment to the Dodd/Frank bill, which is now law, provides for prospective seizure and resolution of systemically-important financial institutions that would impose a risk on the system should they collapse, if there is a plausible reason to believe that such an outcome could be in the offing.

It's time to use this authority and fix this problem.

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Bank of America, the Countrywide unit of Bank of America, Barclays, Deutsche Bank, Morgan Stanley, and UBS are being sued by Federal Home Loan for allegedly making misleading statements about their asset-backed securities and the credit quality of the mortgage loans that backed these securities. Six complaints detailing these claims were filed in state courts in Seattle in December and were transferred to federal court starting January 22, 2010, the article said.

According to the complaints, Federal Home Loan claims the banks also made misleading or “untrue” statements about underwriting guidelines of mortgage-loan originators who were “failing frequently, and increasingly frequently, to follow quality-assurance practices intended to detect and prevent fraud.”

As purchases were made under these misleading statements, Federal Home Loan says it wants to recover at least a portion of the purchase price, plus interest, of certificates purchased since 2005, Nypost.com said.

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Tuesday, March 16, 2010
Federal Home Loan Bank of San Francisco Sues Over RMBS Losses As Investor Actions Build Steam
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 (links to copies posted 'here and here' at link above) 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.

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Federal Home Loan Bank sues Wall Street Banks for Billions

by CalculatedRisk on 3/20/2010 09:33:00 PM

This was lawsuit was filed on March 15th. Here are some details from the bank and see Morgenson's story in the NY Times for more ...

From the Federal Home Loan Bank of San Francisco: Statement Regarding PLRMBS Litigation

Today the Federal Home Loan Bank of San Francisco (Bank) filed complaints in the Superior Court of California, County of San Francisco, against nine securities dealers in relation to certain of the Bank’s investments in private-label residential mortgage-backed securities (PLRMBS). The Bank is seeking to rescind its purchases of 134 securities in 113 securitization trusts, for which the Bank originally paid more than $19.1 billion. The Bank’s complaints allege that the dealers made untrue or misleading statements about the characteristics of the mortgage loans underlying the securities.

All of the PLRMBS 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.

From Grechen Morgenson at the NY Times: Pools That Need Some Sun

The suit, filed March 15 in state court in California, seeks the return of the $5.4 billion as well as broader financial damages.
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The defendants in the Federal Home Loan Bank case were among the biggest sellers of mortgage-backed securities back in the day; among those named are Deutsche Bank; Bear Stearns; Countrywide Securities, a division of Countrywide Financial; Credit Suisse Securities; and Merrill Lynch. The securities at the heart of the lawsuit were sold from mid-2004 into 2008 ...

In the complaint, the Federal Home Loan Bank recites a list of what it calls untrue or misleading statements .... The alleged inaccuracies involve disclosures of the mortgages’ loan-to-value ratios ... as well as the occupancy status of the properties securing the loans. ...

Finally, the complaint said, the sellers of the securities made inaccurate claims about how closely the loan originators adhered to their underwriting guidelines.

All the private mortgage insurers are working hard to rescind as many insurance policies as possible based on fraud and misrepresentation . As are Fannie and Freddie.

Fannie Mae and Freddie Mac may force lenders including Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co. and Citigroup Inc. to buy back $21 billion of home loans this year as part of a crackdown on faulty mortgages.

It makes sense that the Federal Home Loan Banks get more aggressive too.