Cynicism aside, why the NY AG’s MBS suit vs JPMorgan matters

By Alison Frankel
October 3, 2012

It would be so easy to be cynical about the suit New York Attorney General Eric Schneiderman brought Monday night against JPMorgan Chase, seeking to hold the bank liable for the alleged mortgage securitization fraud committed by Bear Stearns before JPMorgan acquired Bear in March 2008. I could start with the political expediency of the 31-page complaint, which, on the eve of the first presidential debate, provides the Obama administration with an answer to critics who have accused regulators of going easy on big banks. Indeed, the case is so politically charged that, according to Reuters, Schneiderman’s federal colleagues on the administration’s mortgage fraud task force were peeved that the New York AG filed the suit Monday, ahead of a joint federal-state press conference Tuesday.

Then, of course, there’s the content of the complaint. I’ve been carping for a long time that regulators were years behind lawyers representing bond insurers and private investors in mortgage-backed securities. Beginning in 2008 and 2009, private lawyers marshaled evidence from their own discovery and, later, from Congress’s Financial Crisis Inquiry Commission Report and the Levin-Coburn Report to produce damning, detailed complaints against JPMorgan and the other banks involved in securitization. The New York AG’s new complaint cited the FCIC report and the JPMorgan suit filed in August 2011 by the Federal Housing Finance Agency, but the AG really owes his biggest debt of gratitude to the monolines Ambac, Syncora and Assured Guaranty and their counsel at Patterson Belknap Webb & Tyler. Patterson has been relentless in its pursuit of Bear Stearns and, by extension, JPMorgan. Just look at the amended complaint Ambac filed in New York State Supreme Court in February 2011 against JPMorgan and the Bear mortgage arm, EMC. It’s 160 pages of brutal accusation, documenting the same theories put forth by the New York AG — but in much more detail.

Those colorful quotes in the AG’s suit about Bear’s “sack of shit” and “shit breather” securitizations? They’re in the Ambac complaint. So are the AG’s allegations that PricewaterhouseCoopers, engaged in 2006 to offer an opinion of Bear’s put-back practices, told the bank to stop keeping the money it recovered from the originators of deficient mortgages for itself and to start passing on its put-back recoveries to MBS investors. The AG, in other words, did a lot of piggybacking on other people’s work. I didn’t see anything in Schneiderman’s complaint that I haven’t seen elsewhere in suits against Bear and JPMorgan.

So why do I believe the AG’s suit is so significant? Because Schneiderman is the first regulator to acknowledge in a legal complaint that the mortgage securitization process was rotten to its core. He is the first government official to stand up and demand legal accountability on behalf of the market and all of its participants, not just for investors in individual MBS deals like Goldman’s Abacus CDO or the Magnetar and Citigroup CDOs. “This action is brought by Attorney General Eric T. Schneiderman on behalf of the people of the State of New York,” his complaint said. “The Attorney General is charged by law with protecting the integrity of the securities marketplace in the state, as well as the economic health and well-being of investors who reside or transact business in the state.” You can read that as boilerplate, or you can think about what it means.

The attorney general doesn’t just represent a bond insurer or a major MBS investor like Dexia or the German regional banks or even Fannie Mae and Freddie Mac’s conservator. They’ve all got their own private lawyers pursuing federal securities claims on their behalf. He doesn’t only represent BlackRock or Pimco or any of the other institutional investor clients of Gibbs & Bruns who have asserted billions of dollars of put-back claims against JPMorgan. And he doesn’t merely represent the pension funds that have found MBS class action litigation to be such an exercise in frustration.

Schneiderman represents all of us — the people of New York and all of the investors harmed by the allegedly deceptive practices of mortgage securitizers. (I’m assuming that the JPMorgan suit is the first in a series of similar complaints against MBS issuers.) Everyone who lost even $1 of the $22.5 billion in losses suffered by Bear Stearns mortgage-backed notes in 2006 and 2007 has an interest in the AG’s case. Everyone whose pension fund or healthcare fund or retirement fund took a hit when the MBS market collapsed should be rooting for this litigation to succeed.

If you remember that Schneiderman seeks accountability on our behalf, his description of Bear’s alleged fraud sounds simple and elegant, not warmed over and rehashed: “The defendants’ misconduct in connection with their due diligence and quality control processes constituted a systemic fraud on thousands of investors,” the complaint said. “As a result of this fraudulent misconduct, investors were deceived about the fundamentally defective character of the mortgages underlying the RMBS they purchased. Mortgagors defaulted on their loans in exceedingly large numbers, causing the value of these securities to plummet, which in turn caused investors in RMBS to incur monumental losses.” On our behalf, Schneiderman is demanding that JPMorgan repay every penny that Bear unjustly derived from its alleged fraud.

I fervently hope that when Schneiderman talks about exacting justice, he means it. I hope that when he and the bank discuss a resolution of this case, he remembers the awesome responsibility he holds as our lawyer and his obligation to seek accountability on our behalf. I also hope that the AG’s JPMorgan suit is the beginning of a new era of MBS litigation, in which regulators target systemic flaws in the securitization process that sent housing prices to such unsustainable heights that the entire economy was wrecked when the balloon fell to earth. The AG’s suit asserts only state-law claims, under the plaintiff-friendly Martin Act, leaving plenty of room for the Securities and Exchange Commission and the Justice Department to bring federal securities cases or enforcement actions against JPMorgan and the other banks that allegedly profited from deceptive securitizations.

Only by acknowledging systemic wrongdoing and seeking systemic accountability can regulators restore confidence in the system. Cynicism aside, Schneiderman’s suit begins that process.

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