Opinion

Alison Frankel

BofA, JPMorgan travel opposite roads to end MBS liability

By Alison Frankel
October 31, 2013

For a change, JPMorgan’s rollercoaster negotiations with state and federal regulators to resolve the bank’s liability for rotten mortgage-backed securities did not make news Wednesday. Has there ever been more public dealmaking between the Justice Department and a target? It feels as though the public has been made privy to every settlement proposal and rejection, as if we’re all watching a soap operatic reality show. Will there be a reunion episode if the bank and the Justice Department end up finalizing the reported $13 billion global settlement, with Eric Holder and Jamie Dimon shouting imprecations at each other?

Bank of America filled the MBS news vacuum Wednesday. Its quarterly filing with the Securities and Exchange Commission disclosed that the bank – under Justice Department investigation for its securitization practices – has bumped up its estimate of litigation losses in excess of its reserves to $5.1 billion. The filing also said that staff lawyers from the New York attorney general’s office have recommended a civil suit based on Merrill Lynch’s mortgage-backed securities.

BofA also had some good news, though. Late Tuesday, U.S. District Judge Mariana Pfaelzer of Los Angeles granted tentative approval to the bank’s $500 million Countrywide MBS class action settlement, despite objections to the deal from the Federal Deposit Insurance Corporation (on behalf of 19 failed banks that owned Countrywide MBS) and several other institutions. Perhaps even more importantly, on Wednesday, two significant objectors to BofA’s proposed $8.5 billion put-back settlement with private Countrywide MBS investors dropped their challenges to the deal. In separate letters to New York State Supreme Court Justice Barbara Kapnick, who has presided over a sporadic but nearly concluded trial on the settlement, three Federal Home Loan Banks and two Cranberry Park investment vehicles asked to withdraw from the proceeding. The remaining objectors, led by AIG, Triaxx and the FHLB of Pittsburgh, filed a strong post-trial brief summarizing their evidence that the proposed settlement was obtained through a “conflicted, back-room, closed-door process” and “cannot be endorsed without running roughshod over the absent certificateholders’ interests.” But the objectors’ ranks are dwindling, and late withdrawals by MBS certificate holders that actually helped try the opposition case has to increase the pressure on Justice Kapnick to bless the deal.

If you step back from all of these incremental developments, you see two banks traveling opposite roads to the same hoped-for final destination: a resolution of all their liability for deficient mortgage-backed securities. JPMorgan is concentrating first on a deal with regulators, not with private investors. BofA, meanwhile, is inching toward an end to claims by private investors but has balked at paying out more money to regulators. Last week, as you surely remember, Bank of America lost its gamble on a trial of Justice Department allegations that Countrywide’s short-lived, high-speed “Hustle” underwriting system defrauded Fannie Mae and Freddie Mac. A federal jury in Manhattan found the bank liable on one civil fraud charge; U.S. District Judge Jed Rakoff has yet to determine damages. BofA also hasn’t settled the Federal Housing Finance Agency’s securities suits before U.S. District Judge Denise Cote of Manhattan, unlike JPMorgan, which agreed last week to pay $5.1 billion to end the FHFA litigation against it.

To a large extent, these different approaches were forced upon the banks. Because of Countrywide’s egregious mortgage practices, Bank of America was an early magnet for MBS claims. Countrywide was first targeted in an MBS class action all the way back in 2007, before it was even acquired by BofA. MBIA launched its enormous litigation against BofA in 2008, and the Gibbs & Bruns institutional investor group that instigated BofA’s put-back settlement sent a demand notice to Countrywide MBS trustee Bank of New York Mellon in 2010 – two years before Gibbs & Bruns sent similar breach-of-contract notices to trustees for other banks that issued mortgage-backed securities, including JPMorgan. It’s hard even to remember now that Bank of America reached billion-dollar put-back deals with Fannie Mae and Freddie Mac on the last day of 2010. By the time state and federal officials finally got serious about MBS fraud in early 2012, BofA was already battered and bruised by private mortgage-backed securities litigation.

JPMorgan wasn’t, despite its acquisitions of Bear Stearns and Washington Mutual, which had their own MBS sins to answer for. JPMorgan was known as the bank that had best weathered the financial crisis, and though it had also been sued by bond insurers soon after the crisis and was later targeted in fraud suits by large individual MBS investors, the bank was a ripe target for government officials who wanted attention for their MBS efforts. The first MBS civil suit by the N.Y. AG, filed a year ago, was against JPMorgan. A month later, the bank was the first defendant (along with Credit Suisse) to settle SEC claims of systemic securitization failures. And when Judge Cote set a trial schedule in the FHFA securities suits, JPMorgan was in an early tranche, facing a June 2014 trial date. In contrast to BofA, JPMorgan was more swamped by regulatory concerns (MBS and otherwise) than by private MBS litigation.

JPMorgan is not ignoring claims by private investors. There have been reports, including one from my colleagues at Reuters, that the bank is close to a $6 billion put-back settlement with the Gibbs & Bruns institutional investor group. I doubt, however, that JPMorgan will be able to obtain the kind of global put-back deal with investors that BofA negotiated in its proposed $8.5 billion Countrywide settlement. When the Countrywide settlement was announced in June 2011, only one put-back suit had been filed on behalf of a Countrywide trust, by a single investor (the hedge fund Baupost, via an MBS vehicle called Walnut Place). JPMorgan, on the other hand, is facing multiple put-back suits by a range of certificate holders (including Baupost), in addition to the sweeping breach-of-contract case under way in federal court in Washington, in which WaMu MBS trustee Deutsche Bank has sued on behalf of about 100 trusts. Given the controversy over BofA’s attempt to resolve claims of absent certificate holders through its $8.5 billion settlement, I don’t see how JPMorgan can expect to push through a similar deal on repurchase claims.

I also don’t see much benefit to the bank in throwing a few billion dollars to private investors as part of the Justice Department settlement. (Both The New York Times and The Wall Street Journal have reported such a payment to be under discussion in the proposed $13 billion deal.) The Justice Department can’t settle investor claims it’s not a party to. JPMorgan might be able to buy a reduction in its payout to private claimants through the Justice Department settlement, but it can’t buy an end to private MBS litigation, whether it’s put-back claims or fraud suits.

So, as we move beyond the five-year anniversary of the financial crisis, JPMorgan seems to be on the verge of resolving its MBS regulatory exposure but probably faces a long slog with private investors. BofA appears to be closer than JPMorgan to wrapping things up with private investors but further from a final reckoning with the Justice Department.

And someday, when this is all over, we’ll know which strategy cost less.

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