Feds sue 17 banks over risky securities

Suit says fraud led to mortgage crisis

9/3/2011

WASHINGTON — Federal regulators launched a legal attack on big banks Friday, claiming the lenders sold nearly $200 billion in fraudulent mortgage investments to housing giants Fannie Mae and Freddie Mac that led to massive losses during the financial crisis.

The lawsuits, brought by the Federal Housing Finance Agency, name 17 domestic and foreign banks as defendants.

According to the filings, the banks “falsely represented” the quality of the loans that were bundled into securities and sold to investors and “significantly overstated the ability of the borrower to repay their mortgage loans.”

The result, the lawsuits claim, were investments that were riskier than the banks led taxpayer-backed Fannie and Freddie to believe, and the securities wound up being worth a fraction of their original value.

Friday’s court filings represent an escalation in the government’s effort to recoup taxpayer losses incurred during the financial crisis.

But the lawsuits raised questions about the toll they could have on the struggling banking sector and the prospects for a housing market recovery.

The federal action underscored the often contradictory relationship between the government and financial firms in the wake of the crisis.

At times, government officials have rescued banks and counted on them to help accelerate the nation’s lagging economic recovery. But often, officials have derided the practices that fueled the financial meltdown and sought to keep banks in check through regulations, negotiated settlements, or litigation.

Some analysts said the lawsuits were filed at a bad time because of sluggish bank lending. They warned that the lawsuits could sap capital from banks, leaving them with even less money to lend, and further weaken the economy.

Others argued that Fannie and Freddie were sophisticated investors who helped shape the securities they bought.

One former executive at a financial institution that bought and sold mortgage securities, and who spoke on the condition of anonymity, criticized the suits, saying that “the whole thing has gotten ridiculous and out of hand. The banks are big boys. Fannie Mae and Freddie Mac are big boys. The people who invested in private securities are big boys.”

Added another bank official: “These are folks that were involved in creating these securities. The idea that Fannie and Freddie were victims in this, it defies credibility.”

But James Millstein, a former Treasury official who oversaw the reorganization of bailed-out insurance giant American International Group, said “the anti-fraud provisions of the securities laws don’t have a big-boy exemption. There isn’t one rule for little investors and another rule for big investors.”

He said the government had a duty to pursue its claims.

“I don’t think it’s going to do anybody any good if the price of getting banks to do what they’re supposed to do is giving them a pass on violating the securities laws,” he said, “particularly when it involves an entity currently being subsidized by the taxpayers.”

One factor driving the Federal Housing Finance Agency to act now is Thursday’s expiration of the statute of limitations on claims related to securities sold before the government seized Fannie and Freddie three years ago.

The agency has been negotiating with the banks for months, said people familiar with those talks, but it had to file suit to protect its claims.

The Federal Housing Finance Agency’s lawsuits say the banks routinely assembled mortgage investments using loans that had been singled out as falling short of guidelines.

The abundance of mortgage-backed securities created by the financial industry during the lead-up to the crisis continues to cost some firms dearly.

A handful of the nation’s largest banks is embroiled in settlement talks with federal officials and state attorneys general over shoddy foreclosure practices that sparked a national uproar last fall.

Fannie and Freddie loaded up on mortgage-backed securities during the years of the housing boom, many of them backed by risky loans, and suffered staggering losses when the real estate market collapsed. Those losses largely have been plugged with more than $150 billion in federal aid under a deal arranged in September, 2008, when the government seized the two firms to keep them afloat.