Bank of New York: A Train Wreck Waiting to Happen?

Many readers no doubt know that the so-called $8.5 billion Bank of America mortgage settlement, which was between the Charlotte bank and the Bank of New York as trustee for 530 residential mortgage securitizations, had run into some very serious headwinds. The deal had to be approved in a so-called Section 77 hearing; a number of interested parties, including some investors, the attorneys general of New York and Delaware, and the FDIC, raised questions and objections to the deal, as well as to the use of a Section 77 hearing (which sets a very high bar for opposing an agreement). Although this saga has a quite a few more rounds to go, it looks likely that any settlement will be considerably delayed and will wind up costing Bank of America a good bit more than $8.5 billion.

What has gotten less attention is the implication of the probable derailment of this deal for the Bank of New York, and its vulnerability to mortgage litigation. If you think, as banking expert Chris Whalen does, that BofA is a goner by virtue of the odds of very large damages in the various mortgage cases that are in progress, Bank of New York is a goner even faster if (and we really mean when) investors start saddling up to target the bank.

The liability of trustees in mortgage securitizations is so obvious and comparatively easy to prove that I am surprised that no one has yet gone after it. However, investors are probably understandably cautious about filing suits that might expose widespread failures of originators and pacakgers to convey mortgage loans to securitizations, which would lead to lots of collateral damage (no pun intended). The Delaware filing on the BofA settlement highlights the issue, which is that the trustees had made multiple representations in securities filings that the mortgage trusts had the assets they said they did. From our post on the Delaware filing:

And it goes straight to an issue we flagged, that the trustee makes annual certification in SEC filings, and the bar for securities fraud is much lower than under contract law theories. Delaware’s securities laws follow SEC 10(b)5 language re disclosure (that it not merely be narrowly accurate, but that it be free of material omissions). Boldface ours:

The acts and practices ofBNYM alleged herein may have violated 6 Del. C. § 7303(2), in that BNYM may have made untrue statements of material fact and/or omitted to state material facts in order to make the statements made, in light of the circumstances under which they were made, not misleading. BNYM’s conduct as described above may have violated the Delaware Securities Act insofar as the Trust PSA requires the Trust annually to certify the following “servicing criteria”:

• “Collateral or security on mortgage loans is maintained as required by the transaction agreements or related mortgage loan documents.
• “Mortgage loan and related documents are safeguarded as required by the transaction agreements;” and
• “Any addition, removals or substitutions to the asset pool are made, reviewed and approved in accordance with any conditions or requirements in the transaction agreements.” [See generally, Trust PSA, [Ex W to NY Petition]].

The Delaware investors in the Trusts may have been misled by BNYM into believing that BNYM would review the loan files for the mortgages securing their investment, and that any deficiencies would be cured.

As we reported in September, lawyers had found evidence that Countrywide did not transfer the notes (the borrower IOUs) to the securitization trusts as stipulated in the pooling and servicing agreements…

Because those agreements had strict cut off dates as to when those transfers had to be completed, and governing law for the overwhelming majority of the trusts (New York law) is unforgiving on this matter (New York trusts are not permitted to deviate from their written directives) the failure to perform as stipulated cannot be remedied…Hence the widespread use of document fabrication to get around this mess.

Note that Biden is not going directly after Bank of New York. He is merely seeking to question and perhaps block the settlement with Bank of America. But the issue he raises is a nuclear weapon. Bank of New York was the preferred trustee for Countrywide. There is good reason to believe the Countrywide securitizations were a total fail as far as living up to the requirements of the PSA are concerned. Bank of New York nevertheless piously made multiple false certifications on which investors relied (if you doubt the evidence above, a Pacer scrape of foreclosures on Countrywide trusts will provide further support).

This liability would almost certainly wipe out Bank of New York, which has $34 billion in equity. But Bank of New York is too big to fail by virtue of playing a crucial role in settlement, transfers, and custody. But the real reason no one is likely to sue on this issue is that confirming that the transfers were not done correctly and that this impairs the value of residential mortgage securitizations on a widespread basis. It makes them, again per Levitin, at best “non mortgage backed securities” (as counterintuitive as it sounds, treating regular borrower payments as if the deal were done correctly may well be a viable legal position but the ability of the trust to foreclose would be hopelessly impaired).

Chris Whalen, in his current Institutional Risk Analytics newsletter, raises more ugly questions about Bank of New York. Although he refrains from using the expression “securities fraud”, any informed reader can see that it precisely the issue Whalen is raising. He argues that the bank failed to disclose its mortgage liability in its recent SEC filings. And this is for a bank whose auditor has already highlighted problems in its trustee operations. The bank’s defense no doubt would be that any liability is not material, but you can see Whalen thinks, as we do, that the downside is plenty large:

We wonder, does the auditor of record for BK, KPMG, understand that the NY AG has accused its client of a conflict of interest and a systemic failure to perform its role as trustee with respect to hundreds of billions of dollars’ worth of RMBS?…

Just when, we wonder, did the general counsel of BK bring the issue of potential trustee liabilities to the attention of the board of directors of BK? Has BK informed their liability insurance underwriters of the appearance of this large risk? Again, we note, there is no mention of the liability in the BK 2010 Form 10-K, this even though we understand that BK was aware of the NY AG’s investigation into possible trustee lapses with respect to RMBS even before the end of last year. Certainly such information is material to investors…

Under Sarbanes-Oxley, the general counsel of BK has an affirmative duty to make members of the board of directors aware of any failure in terms of internal systems and controls or future risks. Looking at the public record, it does not appear that BK has yet acknowledged the problems regarding trustee activities that have been made public by the State of New York.

The auditor of BK as well as the outside counsel to the bank also have affirmative duties to report to the SEC any failure to disclose such risks to investors in the event that the board fails to make such disclosure. Again, we see nothing in the public record indicating any disclosure by BK regarding these allegations by the State of New York. And is it not interesting that the New York AG was not represented at last Friday’s meeting of parties in the Countrywide put-back litigation? While the penalties for failure to disclose in the Sarbanes-Oxley law are bad enough, a litigation by the NY AG using the Martin Act is the big shoe waiting to drop on both BAC and BK. What will the NY AG do? Stay tuned.

No wonder New York Fed director and official friend of Bank of New York (by virtue of her not for profit having BoNY as a large donor) Kathryn Wylde has gone into aggressive overdrive to protect one of her meal tickets, attacking Eric Schneiderman for having the temerity to question the Bank of New York’s role. Modern attorneys general apparently are supposed to understand that banks are above the law and act accordingly.

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      1. Yves Smith Post author

        To other readers, the CB and Fraud Guy comments will seem cryptic because I deleted two spam comments.

        1. Sleeper

          So what many folks already know is that the mortgage securitization system produced fraud and clouded the title of many mortgages.

          But the game of extend and pretend continues – and it can be expected that with national elections coming up in 2012 the game will continue especially if it can be used to pry funding from the banking system.

          As much as I wish that a white knight will arrive on the scene to punish the wicked there is no hope. Perhaps open resistance is in the cards but I think not.
          I suppose that the choices are to quit reading this blog as interesting and intelleligent as it is, join the local militia, stock pile food and supplies (and of course gold) or turn off the computer and turn on the TV.
          I can’t decide so I’ll just keep muddling through so I’ll go back to bed and hope for better times.

  1. Linus Huber

    Thanks Yves

    I am continuously monitoring the safety at banks. This one made me inquire about the risks associated with my futures accounts.

  2. DP

    Bank of New York has been run by pigs. I recall them talking on a conference call several years ago, around 2005-06, about the cost savings generated by moving 400 IT/administrative jobs from NY/NJ to lower cost areas overseas. If they saved $40K per year on each one of those job relocations, total savings per year would be $12 million pre-tax. I looked in the proxy for that year and the total compensation of the top 5 executives was $60 million.

  3. rd

    MBS investors should be pushing really hard for the Administration and Congress to get a functional re-fi process in place with the banks. While there might still be some title issues that come out of it, it is likely that ripping up the existing mortgages by cashing them out with refinanced mortgages while also reducing the payments would start to dramatically reduce the risk of having “non-mortgaged backed MBS’s.”

    One of the key moves “for the good of the country” would be to allow the principal writedown to a reasonable street value of the house not be counted as a taxable event AS LONG AS the owner remains current on the new mortgage and would become a permanent non-taxable event if the mortgqage is paid off in full.

    They may need to take write-offs on principal on these mortgages, but that would probably be a small relatively well defined risk compared to having your entire MBS collateral structure go up in a puff of smoke.

    The potential litigation against the banks is critical for this to occur because the potential for $10s of billions of putbacks will be the only crowbar available to convince them to swap re-fis and principal writedowns in place of fees for foreclosures.

  4. mark

    Do New York’s securities laws follow SEC 10(b)5 language re disclosure (that it not merely be narrowly accurate, but that it be free of material omissions)?

    Last May we started arguing as an equitable defense to foreclosure in NJ that BONY lacks clean hands because it is a dishonest trustee.

  5. Fraud Guy

    Two important facts the post neglects to mention:

    1) The CEO of BK was fired at the end of August by the board.

    2) BK faces very large liability in its custody business for FX fraud against its pension fund clients. See:

    for a good discussion with Harry Markopolos, the guy who uncovered the Madoff fraud and who also uncovered this one. Settling this could easily cost close to a billion dollars.

    Now, was the CEO fired for the mortgage custody fraud, the FX fraud, both, or neither? That’s the question.

    1. Fraud Guy

      Or was he fired because they couldn’t sweep the BofA settlement under the rug fast enough to avoid scrutiny. It’s not the fraud that usually gets them, it’s being caught publicly for it.

      Have you decided on your new name yet?

  6. JayB

    “(as counterintuitive as it sounds, treating regular borrower payments as if the deal were done correctly may well be a viable legal position but the ability of the trust to foreclose would be hopelessly impaired)”

    Does “may well be a viable legal position” mean that if this failure-to-transfer issue is litigated, trusts can assert they still have a legal right to the stream of payments, and win on this assertion?

    If so, that appears, at best, to be a small temporary victory. That would clarify to people still making those regular borrower payments that their notes are being held by an an institution that already has been paid for the note. My understanding is those note-holders would have no legal ability to collect again for the note. (having suffered no loss, they would have no standing) Realizing that the trust had no ability to foreclose and the note holder had no right to collect, why wouldn’t the people who are still making regular borrower payments… stop paying and head to court to gain clear title to their home?

    Apparently I’ve misunderstood what you mean by “viable legal position.”

  7. Charles U. Farley

    Forget NY trust law. I’m surprised the IRS hasn’t gone after the note holders for taxes. After all, if the notes weren’t validly assigned to the trusts, then the notes aren’t exempt from the entity-level taxation.

  8. Shankara

    Whenever I hear someone say that we should act as if the laws were adhered to, my gead spins around like little Linda Blair, complete with spewed pea soup.

  9. DANI

    both bank of america and bank of new york are involved
    in fraud both against investors and homeowners.while all this gos on bank of america and bank of new york mellon are stealing homeowners home by fraud claiming they own mortgages that are owned by unkown investors[ without investors knowledge
    or approvals] and the sad story is judges all over america
    not doing their jobs and forcing them[the bank of new york mellon and bank of america] to prove their paper work and that they own the notes by showing clear chain of titles.
    wake up america judges, we the people demand due process of law and now

  10. Jmd

    Is anyone looking at Chris Ricciardi and Credit Suisse’s actions in the late 90s/early 00s? There was an enormous article on him in the WSJ a couple of years ago…he would be a great scalp.

  11. chris


    As Chuck U. Farley noted wouldn’t there be a large problem with Real Estate Mortgage Investment Conduits?

    Of course, dear Teleprompter or Eric BagHolder going after tax fraud seems to be about as likely as them becoming honorable.

  12. sgt_doom

    My question is this: the Bank of New York Mellon is really structured like a hedge fund, isn’t it?

    And, the Moore family married into the Mellon family some generations back, and when one looks closely on Timmy Geithner’s mother’s side of the family, one finds that Moore-Mellon connection, thusly making Treasury Secretary Geithner a descendant of another nefarious treasury secretary who wanted to end all capital gains taxes and corporate taxation, one Andrew Mellon.

    Is this innocuous or something we should be suspect of???

    Oh yeah, God bless Eric Schneiderman, one of the few honest people around (Phil Angelides, Neal Barofsky and Elizabeth Warren — although why anyone would ever waste any time on a consumer protection agency which would be shelved in the Federal Reserve is rather beyond belief!).

  13. Fraud Guy

    I have tried to be a constructive participant in this blog under the nomme de guerre of “Fraud Guy”. Now somebody else has appropriated that name (mine is only the first of three comments with that name attached).

    Yves, is there anything that can be done about this, since you should be able to see that the later comments aren’t associated with my email address?

    Very sad, or maybe I should be flattered.

    1. Fraud Guy

      Actually, I have been using this name here since about 2007, and actually researched its internet use before choosing it (and found no “blog name” use at that time). I do not wish to involve our host, nor lose my long established name (used here and elsewhere). I know that imititation is the sincerest form of flattery, and though we have had similar thought streams, they remain different enough that I ask that you refrain from using my chosen name in the future.

      Thank you,

      Fraud Guy.

  14. mark ferraris


    Another great example of you just throwing some crazy stuff out there and seeing if it sticks (or generates the desired number of clicks). Seems to be a habit.

    Your zany conclusions are only surpassed by your complete misunderstanding of the role of a trustee in a securitization. I suggest that you go back and do a little reading of a few pooling and servicing agreements, perhaps a few offering memorandums and a few deal opinions or so for good measure. Your “extraction” in the above article is completely out of context and shows that you really don’t understand how and when the trustee gets plugged into these transactions.

    I’d also point out that you should spend some time looking into the backgrounds of the current holders of these bonds that are making the biggest push and getting the AG’s to do their work for them. Safe to say that the most active ones came in late, as this is their business; buy for pennies and threaten to sue everyone to get a few more pennies added to each bond. Nothing new here.

    Mark F. Ferraris
    Managing Principal
    Orchard Street Partners LLC

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