David McLaughlin, Bloomberg News
JPMorgan Chase & Co.’s rivals may face government lawsuits claiming tens of billions of dollars in damages tied to investor losses on mortgage bonds after New York’s attorney general filed a fraud lawsuit against the nation’s biggest bank by assets.
A state-federal task force set up this year to investigate misconduct in the bundling of mortgage loans into securities will bring other cases, according to New York Attorney General Eric Schneiderman. Investor losses in the JPMorgan case alone will be “substantially more” than the US$22.5-billion cited in his complaint, he said.
We’re looking at tens of billions of dollars, not just by one institution, but by quite a few
“We do expect this to be a matter of very significant liability, and there are others to come that will also reflect the same quantum of damages,” Schneiderman said in an interview yesterday with Bloomberg Television’s Erik Schatzker. “We’re looking at tens of billions of dollars, not just by one institution, but by quite a few.”
Schneiderman alleged that the Bear Stearns business that JPMorgan took over in 2008 deceived mortgage-bond investors about defective loans backing securities they bought. Bear Stearns “systematically failed” to evaluate loans, ignored defects uncovered and “kept investors in the dark” about review procedures and problems with the loans.
The Bear Stearns mortgage unit packaged US$212-billion in mortgage bonds from 2003 through 2006, according to the state’s complaint. Losses on US$87-billion of those bonds packaged during just two of those years total US$22.5-billion so far, it estimated.
The case targets mortgage securitizations between 2005 and 2007 involving Alt A and subprime mortgages, Schneiderman said in a conference call with reporters. It will take further investigation to determine the full extent of the losses, he said.
“There are further losses being incurred,” according to Schneiderman, who called the case a “template” for cases against other issuers of mortgage securities.
New York will use at least some of the money it collects from the suits to reimburse investors, Schneiderman said in the Bloomberg interview.
“The investors who were defrauded deserve to get money back,” he said. “I don’t think there’s any dispute about that. This is a matter of doing justice. If anything, most folks in the U.S. think there were too few strings on the banks that were the recipients of the bailout and the recipients of taxpayer- backed loans.”
Joe Evangelisti, a JPMorgan spokesman, said the New York- based bank would contest the state’s complaint, which is “entirely about” conduct by Bear Stearns. JPMorgan acquired Bear Stearns in March 2008 after a run on what was then Wall Street’s fifth-largest securities firm.
“We’re disappointed that the NYAG decided to pursue its civil action without ever offering us an opportunity to rebut the claims and without developing a full record — instead relying on recycled claims already made by private plaintiffs,” Evangelisti said in an e-mail.
The case is the first legal action by the state-federal task force set up by President Barack Obama this year to investigate claims related to packaging mortgage loans into securities. The group includes officials from the Department of Justice, the Securities and Exchange Commission and the Department of Housing and Urban Development.
“There are quite a few investigations under way and we will bring cases when they’re ready,” Schneiderman said on the conference call.
JPMorgan was sued by the Federal Housing Finance Agency last year over US$33-billion in mortgage securities sold to Fannie Mae and Freddie Mac. The bank is among more than a dozen financial institutions, including Bank of America Corp. and Goldman Sachs Group Inc., sued by the regulator over similar claims.
The JPMorgan case involves securitizations by JPMorgan, Washington Mutual and Bear Stearns, according to court papers. JPMorgan acquired Washington Mutual in 2008.
The top issuers of mortgage securities without government backing in 2005 included Bank of America’s Countrywide Financial unit, GMAC, Bear Stearns and Washington Mutual, according to trade publication Inside MBS & ABS. Total volume for the top 10 issuers was US$672-billion.
Countrywide ranked as the top issuer of the securities in 2005, 2006 and 2007, when the worst-performing debt was created, according to Inside MBS & ABS. The lender created US$405-billion of the US$3.04-trillion of bonds sold in those years.
JPMorgan, with Bear Stearns and Washington Mutual, are facing lawsuits and claims against mortgage-related deals totaling US$120-billion, the bank said in a regulatory filing. In the first quarter, JPMorgan had a US$2.5-billion pretax expense for additional litigation reserves, mostly mortgage-related, a charge that knocked 39 cents a share off its profit. The quarter’s actual litigation expense was US$2.7-billion.
As of March 31, the bank estimated its outstanding mortgage repurchase liability at US$3.5-billion, an amount already recognized in earnings, according to the quarterly filing. Litigation reserves may need to be increased, although probably not this year, the bank said.
Among JPMorgan’s competitors, Citigroup Inc., the third- biggest U.S. bank by assets, “continues to cooperate fully” with regulators and law enforcers in response to subpoenas and information requests related to its mortgage activities, the bank said in its latest quarterly filing. It didn’t specify the cases.
Goldman Sachs Group Inc., the fifth-biggest U.S. bank, has had subpoenas and requests for information from state and federal law enforcers and regulators over mortgage-related securitization and subprime mortgages and is co-operating in the inquiries, the bank said in its latest quarterly filing.
A Securities and Exchange Commission probe of US$1.3-billion of subprime residential mortgage-backed securities underwritten in 2006 by Goldman Sachs ended without enforcement action, the bank said.
Recent filings by Bank of America, the second-biggest U.S. bank, mention that the bank receives subpoenas without specifying from whom or what for.
Citigroup, Bank of America and JPMorgan each estimated their litigation liabilities might at worst exceed their estimates by US$4-billion to US$5-billion.
It may cost JPMorgan as much as US$3-billion to settle the New York case, although the cost could be higher depending on what the state ultimately requests, said Charles Peabody, a bank analyst with Portales Partners in New York.
“The language is so vague on what they’re defining in the way of damages, it’s so hard to know,” he said in an interview.
Peabody said his estimate is conservative and based on similar cases by private investors against Bank of America and other lenders, which have generally settled for about 2% to 3% of the original investment amount.
Since the state’s complaint doesn’t specify the timeframe, number of securities or amount of damages sought, Peabody based his estimate on the peak years of the housing boom from 2005 through 2007. Bear Stearns issued roughly US$162-billion in mortgage bonds over those three years, according to Peabody’s calculations.
“It’s very open-ended,” Peabody said. “Until you define it, everything is just that, an estimate.”
A settlement may be reached for as little as US$2-billion, Peabody said. He raised his estimate for JPMorgan’s third- quarter litigation costs to US$1.6-billion from US$500-million and cut his estimate for the bank’s earnings, which are scheduled to be released Oct. 12, by 17% to 95 cents a share.
The case is People of the State of New York v. J.P. Morgan Securities, 451556-2012, New York State Supreme Court (Manhattan).