8 Things You Should Know About the New Lawsuit Against the Banks That Torpedoed the Economy
It was Friday afternoon, near market closing time, when the Federal Housing Finance Agency filed lawsuits against 17 big banks for their role in the subprime mortgage crisis that created, in turn, the financial crisis we're still struggling with today.
The suits accuse the banks of fraud, of lying to the federal government and to investors about the quality of the securities they were making by cranking out more and more subprime loans. The charge allows the FHFA to ask for punitive damages as well as actual damages. The amount of the suits is not yet known, but they allege nearly $200 billion in fraudulent securities were sold just to Fannie Mae and Freddie Mac, the government-backed (and now, post-bailout, basically government-owned) mortgage lenders.
The news was big, yet it was dropped in the Friday news-dump hole before a holiday weekend, probably to try to mitigate its impact on stock prices. (Markets also take a day off for Labor Day, though one has to doubt they thank workers for the rest.) Otherwise, you'd think they would have broken the news in a big way on a day when people might actually be paying attention.
The suits were filed in advance of a September 8 deadline—the statute of limitations on claims over subprime mortgage-backed securities sold to Fannie and Freddie. The FHFA was created in 2008 as conservator for the two lenders, which have been given $170 billion in government cash in order to keep them afloat.
So the government, representing the taxpayers (you and me) who own Fannie and Freddie, is filing suit against 17 of the world's biggest banks, including our old friends Bank of America (and its subsidiaries Merrill Lynch and Countrywide, named separately), Goldman Sachs, and JP Morgan Chase as well as Deutsche Bank, the Royal Bank of Scotland (RBS), and, surprisingly, General Electric.
Financial journalist Felix Salmon at Reuters said of the lawsuits, “They’re strong, and aggressive, and exactly what I’ve been looking for for a while. These banks lied to investors when they put together mortgage securitizations. And one way or another, they’re about to start paying for that. About time too.”
Representative Brad Miller, Democrat of North Carolina, said in a conference call, “I want our money back. If FHFA has legitimate claims...I want them to pursue legitimate claims to minimize taxpayer losses. I don't want them to look the other way and to provide a subsidy for that industry.”
While this story will keep developing, we break down eight things you should know about the suits, the banks involved, and the potential political and economic consequences.
1. Accelerating the Bank of America death spiral
Felix Salmon broke down the lawsuits into a table and pointed out that since Bank of America's two subsidiaries, Countrywide and Merrill Lynch, are named separately from B of A itself, the wobbly bank is by far the biggest loser in the lawsuit. Rep. Miller noted that nearly one quarter of the mortgage-backed securities in these lawsuits come from Bank of America.
B of A stocks are down almost to where they were before Warren Buffett put $5 billion into the bank, and it's got more layoffs coming—up to 30,000 jobs might be shed, which would be about 10 percent of the company's total employees.
The New York Times pointed out that while the total damages in the suit have yet to be determined, a similar lawsuit brought in July by the FHFA against UBS seeks to recover $900 million in losses on $4.5 billion in securities—or 20 percent. “A similar 20 percent claim against Bank of America could equal a $10 billion hit.”
And “Tyler Durden” at Zero Hedge thinks it could be even bigger:
“Alternatively, using generic cumulative loss thresholds of around 45% based on Fitch estimates for 2005-2007 vintages, and applying a conservative 60% loss severity to defective loans, implies $25.8 billion loans are defective, with total Bank of America umbrella losses of $15.5 billion.
This is virtually the entire worth of the company's stake in the China Construction bank. And this is to settle just with the FHFA alone!”
In other words: this is a big mess for all of the banks named, a potential long-lasting expensive legal battle, but for Bank of America, teetering on the edge of disaster already, it could wind up pushing them over. Rep. Miller argued that the potential collapse of Bank of America, though, was not a good reason to stop the lawsuit going forward. “I know that there would be a great sense of injustice if they were given a pass on their legal liabilities on that basis,” he said. “Every small business in America knows if they have harmed someone they'll get sued for it and they'll have to pay.”
And Forbes noted, “An analyst from the other side of the Hudson River said that Bank of America may very well prove that no bank is too big to fail.”
2. Opening door for more lawsuits
Whatever happens with the FHFA's lawsuits—whether they're settled or litigated—there's every potential here for private lawsuits against the same banks to follow. The FHFA snuck in right under the deadline for the statute of limitations, and this could spur other investors to try to recoup losses. For troubled banks like Bank of America or RBS, this could be a chain reaction difficult to recover from.
3. Banks declare total war...against Democrats
Which leads us to point number three: who's going to be the target of the banksters' ire at finding themselves the target of government lawsuits?
You guessed it: Democrats.
Ben White at Politico's Morning Money column wrote that banks are considering “Total War,” saying:
“M.M. hears that instead of contemplating settlements of the FHFA mortgage-backed securities lawsuits, big banks and their attorneys are more likely to pursue what insiders describe as an all out war strategy in which they go after Fannie Mae and Freddie Mac (and by default their Democratic supporters) in a scorched earth strategy to show the GSE’s took an active role in creating the very securities they are now suing the banks over.”
You can see the talking points already in several of the business press pieces on this story, which blame the subprime mortgage mess on lawsuits to prevent discrimination against poor people (usually people of color, who faced housing discrimination for oh, most of US history) or on Fannie and Freddie's lending itself.
Never mind that those arguments leave out the responsibility of the big banks to, you know, not commit fraud. Bad mortgages on their own would not have caused the current economic crisis. The securitization of that mortgage debt combined with speculation drove up the price of housing; the decline in real wages led more and more people to borrow against the value of their homes. Systematic attacks on the little wealth that most working people had by a small handful of ultra-wealthy suits on Wall Street and around the world created the crisis, not the desire of low-income folks to maybe have a nice house to pass on to their kids.
But as we see so often, the argument from the banksters and their apologists in politics will be that we all should have known better, that Fannie and Freddie were “sophisticated investors” and should have been able to foresee that bankers were lying to them.
Rep. Miller shrugged off this argument. “I would like to see the cases, the legal authority that makes that a defense to this lawsuit. The argument that he's a bad guy too doesn't strike me as a very strong legal defense.”
“There has been precious little interest on the part of Republicans to pursue any claims or to allow private litigants to pursue any claims,” he continued.
Of course, there's been precious little interest from many Democrats as well, as the Obama administration has joined in pressing for a sweetheart-deal settlement for the banks. The question then becomes, will lawsuits like this lead to the end of the romance between finance and at least certain parts of the Democratic party?
4. Suing Obama advisers: where does GE fit in?
General Electric? That's not a bank! Yet it is named in its very own lawsuit over mortgage securities—and its CEO, Jeffrey Immelt, is a top Obama adviser (on jobs, which requires more comment than I have room for here).
But among the many tentacles of the $739 billion conglomerate that is GE is GE Capital Services, otherwise known as GE Consumer Finance or GE Money, which is in turn the parent of GE Mortgage Holding or GE Holding. If you're confused, you're not alone. Suffice it to say that in addition to weapons, household appliances and NBC, GE has some significant money in mortgages—and like the other banks in the suits, was doing some shady things with them. (You can read the whole suit here [PDF].)
William Alden and Zach Carter at the Huffington Post explained the ongoing tensions between Obama and Edward DeMarco, acting FHFA director. “DeMarco, a holdover from the Bush administration, has rebuffed a push from Obama insiders to spur mortgage refinancing for underwater borrowers,” they wrote.
So is the inclusion of GE a sign that the Obama administration is willing to tackle even its buddies (and donors)? Or is it a Bush-administration holdover continuing to be at odds with the Democratic administration in charge? It seems clear that Obama doesn't want to take credit for the lawsuits—though Democratic Rep. Brad Miller has cheered them.
Either way, GE's involvement should remind us that we're not dealing with just financial institutions here—multinational corporations are wrapped up in this crisis on all sorts of levels.
5. Impact on the housing crisis
These lawsuits, like so much of the ongoing fallout from the economic crisis, are all about the housing industry. The New York Times noted:
“Buried in the filings themselves, however, is a damning portrait of the excesses of the housing bubble, when borrowers were able to obtain home loans without basic proof of income or creditworthiness, and banks appeared only too happy to mine profits taking the risky loans and assembling them into securities that could be sold to investors.”
So as we follow the fallout, it's important to remember that there were real people who bought homes under pressure from lenders desperate for more mortgages to sell as securities, or who refinanced their homes only to get foreclosed upon.
And the Housing Predictor blog wondered if there could be help for homeowners struggling with their loans or underwater on their mortgages in negotiations with the FHFA. Mike Colpitts wrote, “...according to two highly placed federal sources. Negotiations could include more than just big cash settlements with the lenders.”
Mortgage modifications have been part of every settlement or deal with the banks since the beginning of the crisis—and they've also nearly always been optional, and banks have actually done very little modifying. But, Colpitts argued, “BofA could presumably work out an agreement with the government that could reduce the amount the bank would have to pay in damages to the federal government, by increasing the amount it would reduce the principal of mortgages for at risk mortgage borrowers.”
It's an optimistic viewpoint, to be sure—as noted above, FHFA director DeMarco has shown little interest in mortgage modifications. Still, avoiding a protracted messy legal fight by helping struggling working families stay in their homes would be a real benefit for real people as well as for the economy—and for Obama. Colpitts pointed out:
“Some 73 million Americans are homeowners and about two-thirds are mortgage holders, representing a huge voting block for President Barack Obama. With little chance of the unemployment rate being reduced much before the next presidential election, the biggest way Obama could influence voters is through the housing mess....The FHFA...is sitting in a perfect place to negotiate those results and take the pain out of the foreclosure mess for millions of Americans.”
6. Attack on the great vampire squid
Goldman Sachs has been emblematic of the financial crisis since Matt Taibbi memorably described it as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” It's got its tentacles in both parties, from former New Jersey governor and former Goldman CEO Jon Corzine to bailout architect and former Goldman CEO Henry Paulson—and was the largest donor, through its employees, to President Obama. (Taibbi is actually quoted in the FHFA's lawsuit against Goldman, though not his best line.)
And Goldman takes it on the chin in the FHFA's lawsuits, accused of committing fraud directly as well as aiding and abetting fraud. The Times pointed out, “the suit says that 'Goldman was not content to simply let poor loans pass into its securitizations.' In addition, the giant investment bank 'took the fraud further, affirmatively seeking to profit from this knowledge.'”
Several executives are named in the lawsuit, but most prominently Daniel Sparks, former head of Goldman's mortgage department. Courtney Comstock at Business Insider noted, “Dan Sparks is full-on attacked in the lawsuit. The FHFA basically blames the rot of Goldman's mortgage business on him and his team's 'traveling the world' to 'make some lemonade from some big old lemons' (his words).”
Those big old lemons, of course, were mortgages that were not created by Goldman; they were simply repackaged and resold by the finance giant, preferably as quickly as possible, the lawsuit argues, to keep them off its own books because it knew they were likely to fail.
7. Global financial crisis, part 2
The banks named in the lawsuits aren't just US companies; three of them are based in the UK and one of those, RBS, is already majority-owned by the British government. The Telegraph noted “[T]hrough its US-based investment banking arm RBS Securities was hit with a $30.4bn claim, compared with $6.2bn for HSBC and $4.9bn for Barclays...For Barclays and HSBC the sums, while not small, would be far from existential, but for RBS the spectre of full-nationalisation remains a constant threat.”
The British, of course, are already suffering under an austerity regime that has yet to fix the economy even though working people are suffering and students are facing unprecedented costs for education.
Frankfurt, Germany-based Deutsche Bank is also a target of the lawsuits. The Eurozone is already in crisis, which pushed Deutsche Bank's stock down nearly 10 percent—a hit from the FHFA suit could be big trouble.
On Monday, Deutsche Bank's CEO Josef Ackermann gave a speech at a conference in Frankfurt where he said, “It is an open secret that numerous European banks would not survive” having to re-price the sovereign debt on their books at market prices (market price right now is, of course, rock-bottom).
Courtney Comstock said “The implication is that not just Eurozone countries are buckling under the pressure of Greece's, France's, and Italy's debts, but banks are too. It sounds like a desperate call for a bailout. Now.”
That's the problem—the financial system is global. Banks in Germany and the UK were buying mortgage-backed securities with mortgages across the US in them, and a debt crisis in Greece is making the markets shaky over here. It's a recipe for another round of financial crisis, but with austerity-mad governments in power in many countries (including our own) there's little appetite for more bailouts.
Ackermann said, "All this reminds one of the autumn of 2008."
8. More bailouts coming?
This seems fairly unlikely, but one extremely cynical take on the situation is that the suit is actually meant to be lost, providing a back-door bailout for the big banks by giving them legal precedent that can then be applied in all cases (including the 50-state settlement and Eric Schneiderman's investigation into Bank of America). This comes from Zero Hedge—or rather, one of Zero Hedge's readers, who suggests that this suit is to make Obama look like a crusader against the banks while making the case for more quantitative easing (printing money, the thing that got Ben Bernanke threatened by Rick Perry).
It's complicated, it's unlikely, and we should all really, really hope it's not what's happening. However, it's worth remembering that the “too big to fail” institutions that were bailed out the first time around have mostly, like Bank of America, only gotten bigger by purchasing other too-big-to-fail institutions with government cash. So if B of A or any of the others do fail, what happens?
Jeffrey Sica, who contributes to Forbes and runs a wealth management firm—no socialist, he—argued that the banks should be allowed to fail, pointing out their responsibility for the ongoing miserable economy:
“Banks used tax payer dollars given to them through government bailouts to sure up their balance sheets and have not contributed 1 penny to helping small businesses get on their feet and start hiring again. They have, however, contributed to our incredibly high unemployment rates since small businesses will not hire if they can’t borrow to grow.”
And Rep. Brad Miller argued, “The rule of law really does require that we pursue those claims, that people be able to pursue claims that they are harmed. To say that those claims should not be pursued or should be obstructed I think undermines the rule of law, which is more damaging to our economy than the solvency of any given bank. Our economy depends on people being able to contract and enforce their contractual rights in legal actions.”