New York Lawsuit Against JPMorgan Chase to Set Example

October 5, 2012

In the case of The People of the State of New York v. J.P. Morgan Securities, 451556-2012, New York State Supreme Court (Manhattan), the city of New York sued the biggest bank in the United States, over mortgage-backed securities.  According to New York Attorney General, Eric Schneiderman, this lawsuit will serve as an example and a template for other lawsuits against other issuers.

According to the complaint filed in New York Supreme Court on Monday, the Bear Stearns business that JPMorgan Chase took over in 2008 had deceived mortgage-bond investors about the defective loans backing securities that they bought, which lead to “monumental losses”.  Bear Stearns failed to abide by claims that they were ensuring the quality of loans backing the securities and “routinely overlooked defective loans” identified during due diligence reviews. The misconduct in due diligence and quality control “constituted systemic fraud on thousands of investors”.  The mortgage unit packaged over $200 billion in mortgage bonds from 2003 to 2006 and the losses on over $85 billion of those bonds packaged during just two of those years totaled over $22.5 billion so far.  There are still more losses to be identified, according to Schneiderman.

Schneiderman wants the bank to pay out all of the money it obtained in connection with or as a result of the alleged fraud.

Joe Evangelisti, a spokesman for JPMorgan, stated that the New York-based bank would contest the complaint, stating that this issue is about the conduct by Bear Stearns, not JPMorgan, who acquired Bear Stearns in March 2008.  “We’re disappointed that the New York Attorney General 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,” stated Evangelisti.

JPMorgan is among 17 financial firms sued last year by the Federal Housing Finance Agency over losses incurred by Fannie Mae and Freddie Mac on mortgage securities.  “Fannie Mae and Freddie Mac purchased residential mortgage-backed securities from the defendants and were allegedly misled about the quality of the loans supporting those securities, “said FHFA Inspector General Steve Linick in a statement released by Schneiderman’s office.  “Actions like this contributed to the financial crisis and those who engaged in such activities should be held accountable.”

Schneiderman is the co-chairman of a state-federal group formed to investigate misconduct in the bundling of mortgage loans into securities leading up to the financial crisis. The group includes officials from the United States Justice Department, the Securities and Exchange Commission, the Federal Investigation Bureau and other federal and state officials.  Earlier this year, Schneiderman sued JPMorgan, Bank of America Corp. and Wells Fargo & Co. over their use of MERSCORP Holdings, Inc. owned MERS® System, a national electronic registry system that tracks the changes in servicing rights and beneficial ownership interests in mortgage loans that are registered on the registry.

According to an estimate from bank analyst, Charles Peabody of Portales Partners, if JPMorgan seeks to settle Schneiderman’s claims, the bank may pay out as much as $3 billion.  “Litigation costs are likely to remain high for the foreseeable future.  A settlement could be reached for as little as $2 billion.”

JPMorgan initially said that the bank would set aside $6 billion for potential legal costs and losses that could come from Bear Stearns’s assets. This was how the bank explained paying $1.5 billion for a company that had $11 billion of common equity on its books. In JPMorgan’s annual report at the end of that year, all of the equity in Bear Stearns had been used up by litigation costs and losses from legacy assets bought from the smaller firm. Because such losses exceeded the equity of the purchased entity, JPMorgan booked losses on its second half income statement related to Bear Stearns.

JPMorgan, with its Bear Stearns and Washington Mutual acquisitions, are facing an estimated $120 billion of lawsuits and claims against mortgage-related deals.

“This is a workable template for future actions against issuers of residential mortgage-backed securities that defrauded investors and cost millions of Americans their homes,” Schneiderman said in a statement. “We need real accountability for the illegal and deceptive conduct in the creation of the housing bubble in order to bring justice for New York’s homeowners and investors.”

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