AIG isn’t only megabucks case uncovering new facts about 2008 bailouts

October 6, 2014

Former AIG honcho Maurice “Hank” Greenberg’s $50 billion Fifth Amendment claims against the U.S. government may be, as New Yorker writer John Cassidy recently said, more of a comic extravaganza than a legitimate case, but there’s no doubt that the Greenberg trial underway in the U.S. Court of Federal Claims will contribute to the historical record of the government’s response to the 2008 economic crisis. Former U.S. Treasury Secretary Hank Paulson testified Monday, and his successor, Tim Geithner, and former U.S. Federal Reserve Chairman Ben Bernanke are also on Greenberg’s witness list. We can all thank Greenberg for muscling their sworn testimony into public, regardless of the crotchety old rich guy’s gall and his long odds of actually winning.

Meanwhile, there’s a much less celebrated case over the 2008 economic crisis underway in federal district court in Washington, D.C. It doesn’t have the glamour of David Boies of Boies, Schiller & Flexner (Hank Greenberg’s lawyer) grilling former Cabinet officials over the AIG bailout, but it involves between $6 billion and $10 billion in real money — and it’s also contributing real facts to what we know about how government officials in the thick of bailout frenzy implemented policies set at the highest levels.

I’m talking about litigation between JPMorgan Chase and the Federal Deposit Insurance Corporation over which of them was left holding the scorching hot potato of liability for Washington Mutual’s misrepresented mortgage-backed securities. As you may recall, as WaMu was collapsing in 2008, the federal government pushed JPMorgan to acquire the Seattle-based bank. One of the many branches of subsequent litigation over WaMu’s failure was a suit by Deutsche Bank, as the trustee overseeing many WaMu MBS, against JPMorgan, asserting that JPMorgan was on the hook to MBS investors for breaches in contractual representations and warranties about the securities. Deutsche Bank said JPMorgan owed WaMu MBS investors as much as $10 billion for their put-back claims.

JPMorgan and its lawyers at Sullivan & Cromwell countered that the FDIC – and not the bank – was liable for put-backs on private-label mortgage-backed securities. It sued in Washington federal district court for a declaration that when the bank paid $1.89 billion to take WaMu off of the FDIC’s hands in late September 2008, liability for MBS representations and warranties was not part of the deal. Those obligations, according to JPMorgan, stayed with the FDIC.

Last Friday, the two sides filed mostly unredacted summary judgment briefs with U.S. District Judge Rosemary Collyer, adding layers of detail to what was previously known about JPMorgan’s WaMu acquisition. Obviously, the briefs center on the limited contractual question of whether the FDIC ditched put-back liability in the WaMu sale, but the hundreds of pages JPMorgan and the FDIC’s lawyers at Hughes Hubbard & Reed have generated on this seemingly straightforward contract interpretation show the loopholes that open when economic chaos looms, as it did when the WaMu deal was being negotiated.

Three of the most interesting revelations involve emails within the FDIC about whether put-back obligations would transfer to JPMorgan, a seemingly contradictory email from the FDIC to the bank, and evidence about the pressure Fannie Mae and Freddie Mac exerted on JPMorgan as the bank tried to make its investment in WaMu begin to pay off.

In mid-September 2008, with WaMu teetering on the brink of receivership, the FDIC reached out to several potential acquirers, offering a variety of deal options. The template purchase agreement, drafted by FDIC lawyers, said that the acquiring banks would assume at book value “all of the liabilities” of Washington Mutual. But according to JPMorgan’s summary judgment brief, an FDIC lawyer named David Gearin proposed changing the draft to assuage possible acquirers. The new version said successor banks would only assume liabilities “which are reflected on the books and records” of WaMu.

As JPMorgan moved closer to an agreement to take over WaMu, its lawyers at Sullivan & Cromwell wanted to be sure – in light of a different provision in which the FDIC agreed to indemnify JPMorgan for certain WaMu liabilities – that they understood what those assumed “books and records” liabilities were. An S&C lawyer asked Gearin for clarification, and on Sept. 23 Gearin emailed an in-house JPMorgan lawyer that the bank would only be assuming “booked liabilities.”

JPMorgan witnesses testified that they considered Gearin’s email a promise that the bank would be assuming only liabilities that were already on WaMu’s books – not undefined and as yet unasserted put-back obligations. JPMorgan also argues that Gearin’s actions when bank lawyers told him they were worried about post-deal claims that JPMorgan was responsible for additional WaMu contractual obligations are additional proof that Gearin believed put-back liability remained with the FDIC. Gearin didn’t say that the FDIC believed JPMorgan was already on the hook for WaMu contract breaches. Instead, according to the bank, he agreed to expand the draft agreement’s indemnification language.

The FDIC’s summary judgment brief, in contrast to JPMorgan’s, highlights internal emails amongst FDIC lawyers on Sept. 24, the day the WaMu deal closed. FDIC lawyer Rick Aboussie sent a note to Gearin and others at the FDIC stating flat out that WaMu receiver James Wigand, who had structured the transaction, specifically intended to pass reps and warranties liability to the acquiring bank. According to the FDIC, government officials said as much in a hypothetical Q&A they prepared for potential WaMu bidders, including JPMorgan. “The bank’s interests and obligations associated with the off-balance sheet credit card portfolio and mortgage securitizations pass to the acquirer,” the FDIC’s Q&A said. (I should note that the question in the FDIC hypothetical involved mortgage servicing obligations, not put-back claims.)

A hot point of contention between the FDIC and JPMorgan is whether JPMorgan’s concessions to Fannie Mae and Freddie Mac – which are newly disclosed in the summary judgment briefing – should be considered proof that the bank knew it was liable for WaMu put-backs. After its deal with the FDIC closed, JPMorgan was eager to begin collecting on and processing WaMu mortgage loans, a business it valued at nearly $6 billion. Fannie Mae and Freddie Mac, according to JPMorgan, said they would not permit the bank to begin servicing WaMu mortgages unless JPMorgan also agreed to assume put-back liability on loans securitized by the government sponsored entities. JPMorgan, which claims that the FDIC was secretly advising Fannie and Freddie on their demands, eventually agreed to a put-back settlement with the GSEs. The bank said, however, that its agreement with Fannie Mae and Freddie Mac should not be construed as an admission of responsibility for private-label put-backs, since MBS trust contracts don’t give trusts the same power to block mortgage servicing transfers.

The FDIC, however, said that JPMorgan’s deal with Fannie and Freddie is evidence that the bank knew it was assuming WaMu’s contract obligations to private-label MBS investors as well. Nothing in the WaMu acquisition agreement distinguishes between JPMorgan’s obligations to Fannie and Freddie and its liability to private MBS investors, according to the FDIC brief opposing JPMorgan’s summary judgment motion.

Like I said, these details don’t change history’s fundamental understanding of the frenzied days of September 2008. But they do show that tiny decisions about contract language, made under the extreme stress of a collapsing economy, can have multibillion-dollar consequences years later.

An FDIC spokesman and a lawyer for JPMorgan both declined to provide a statement.

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