Schneiderman Suit Against JP Morgan: A Rehash of Other Lawsuits, Likely to Produce Meager Settlement

It looks like Eric Schneiderman is living up to his track record as an “all hat, no cattle” prosecutor. Readers may recall that he filed a lawsuit against the mortgage registry MERS just on the heels of Obama’s announcement that he was forming a mortgage fraud task force. Schneiderman’s joining forces with the Administration killed the attorney general opposition to the settlement, allowing the Administration to put that heinous deal over the finish line. The MERS filing was a useful balm for Schneiderman’s reputation, since it preserved his “tough guy” image, at least for the moment, and allowed his backers to contend that he had outplayed the Administration.

By contrast, we were skeptical of the suit, both in timing and in substance, and thought it had substantial hurdles to overcome. Indeed, despite invoking an impressive-sounding $2 billion in lost recording fees and other harm, the suit settled for a mere $25 million (you have to love Schneiderman’s pushback; this was a “partial” settlement. Puhleeze. We’ve been told by lawyers who aren’t pro bank that the judge assigned the case was not buying what Schneiderman was selling, and the claim that he has residual claims he can pursue, while narrowly true, is pretty desperate).

Schneiderman has churned out another lawsuit that the Obama boosters and those unfamiliar with this beat might mistakenly see as impressive. It’s a civil, not criminal suit against JP Morgan he conduct of Bear Stearns in originating and misrepresenting $87 billion of mortgage backed securities (the link takes you to the court filing). And also notice no individuals are being sued. Being a banker apparently means never having to be responsible for your actions.

There is nothing new here; this claim is cobbled together from other litigation and investigations. And to add insult to injury, the damaging information has been in the public domain for years. There are two overlapping sets of issues described in the claim. First is that Bear was telling investors in its marketing materials and public filings that it had a robust due diligence process, when it in fact it purchased loans that were delinquent or otherwise failed to meet stipulated underwriting standards and sold them into securitizations. The filing depicts Bear as aggressively seeking to increase its origination volumes and regularly ignoring the findings of outside firms and its own quality control team regarding substandard loans. Well, take it back, there does seem to be something original here: Francine McKennal noted the complaint named the wrong auditor (hat tip Matt Stoller).

Second, rather than repurchase loans that should not have been included in securitizations, such as ones that defaulted early, Bear would instead extract settlements from originators, which it retained rather than pass them on to the securitization trusts. Note that while the filing discusses how this practice unjustly enriched Bear, it completely misses another motivation. It wasn’t just to “preserve its relationship” with these originators, it was to preserve them, period. Bear had warehouse lines with mortgage brokers and originators like New Century. If it put back too many loans, it would bankrupt them, exposing Bear to substantial losses on these loans. Effectively, Bear was in so deep that it had no way out other than to keep dumping toxic product into securitizations.

So what’s wrong with this suit? There is no reason it could not have been filed in 2011, if not sooner. The discussion of the fact that Clayton Holdings, the independent review firm for the major investment bank originator/packagers, routinely found significant levels of defects in the loans it reviewed, came out in the FCIC investigation and the evidence was made public on the FCIC website (as well as given considerable attention in the financial media). Representation and warranty suits against the major issuers have made similar claims. In particular, Ambac set forth the allegations that Bear and its subsidiary extracted concessions from originators for defective loans but pocketed them rather than passing them on in January 2011. Isaac Gradman of Subprime Shakeout wrote a compelling post on the “bombshell” of its amended complaint.

The delay considerably reduces the value of this suit. Schneiderman cites two causes of action, both of them subject to six year statute of limitations. This means that the only mortgages that would be eligible would be in deals from October 2006 to the end of the subprime mania, June-July 2007 (and recall that the market was deteriorating in January 2007, in free fall in February, and rebounded in March, so it isn’t even 9 months of origination, it’s more like 6). By contrast, the toxic phase of subprime started in third quarter 2005 and the complaint cites behavior dating back to 2005, and most laypeople would incorrectly assume that would assume mortgages originated then would also be included.

What makes this particularly galling, as MBS Guy points out, is the previous attorney general, Andrew Cuomo, was on this trail in 2008 and granted immunity to Clayton and conducted his own investigation. Cuomo chose to do nothing in the end. Schneiderman chose only to dust it off when it was politically useful and what value it has is largely dissipated. And notice despite the media spin that this action came out of the mortgage task force, none of the other Federal agencies involved (the DoJ and the SEC) are filing parallel actions. We were told by Administration loyalists that the fact that the statute of limitations for Federal securities law violations, which is five years (it’s a bit more complicated but that’s a not bad generalization) was not a big problem since the Feds had lots of other causes of action with 10 year statute of limitations, such as mail fraud and wire fraud. Hhhm, guess those aren’t as useful as the Administration’s defenders would have you believe.

However, the usual cheerleaders are touting this action as significant and anticipate other suits will follow. More cookie cutter suits of this order are nuisance-level for the banks and will be settled after the election, when voters hopefully won’t notice if the results fall short of the grandstanding. In many ways, filing suits that generate settlements vastly lower than the actual harm they did are worse than not acting at all. They will serve to reinforce the false Obama narrative that it’s just too hard to go after the banks, while the timing and the half-heartedness of the effort will correctly stoke criticisms by bank allies that this is just a politically motivated shakedown operation. As we’ve said before, Obama believes that every problem can be solved by better PR, and this looks like one in a long string of examples.

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  1. indio007

    Sarbanes-Oxley is the most useless words ever written on paper.

    All these scum bankers could be prosecuted under it but nothing happens. Has there ever been even one prosecution under the act?

    1. Gil Gamesh

      Yes, Richard Scrushy. The Feds lost, on venue grounds really. But they decided SOX was unprosecutable nonetheless.

  2. ZygmuntFraud

    I’ve read your post and clearly there’s an argument with facts to back it up. I see nothing of the sort in Tao’s reply.

    As an idea, I’ll throw out that State Attorney Generals probably have to work with the hand of cards they are dealt, for example how much manpower they are given.

    What stands out for me is the dog that didn’t bark on Monday. Upon belief, this is in contained in Bo’s dog diaries.

  3. Conscience of a Conservative

    I agree this is smoke and mirrors. Good stuff about Cuomo and Clayton, and if he didn’t persue MERS other than for a quick headline what can we expect here.. but where is the link or source to “MBS Guy”?

    More importantly so, what’s the “legal standard” or more correctly what is supposed to be the legal standard in deciding whether a financial fraud is criminal or civil.

    Also this appears to be a NY State suit, so where is the Lany Breuer in all this, or did those scary economists disuade him again? Seems this suit has nothing to do with the new get tough task force.

    1. Strangely Enough

      “…legal standard in deciding whether a financial fraud is criminal or civil.”

      It would appear the “legal” standard is actually a political one.

  4. John Glover

    There is no significant politician in the state of New York that isn’t in the pocket of the financial industry. The only person close to an exception to that rule was Spitzer, and look what they did to him. They all consider Wall Street to be the local business that needs to be protected at all costs….

    1. Ms G

      Grey area, unfortunately. FIRE is a big tend. Spitzer was very much part of the Real-Estate-Financial-Comples in NYC. If you look carefully at the cases he chose to bring, none targeted the mountains of Bankster frauds tied in to that industry.

  5. Susan the other

    JPMChase only commented that they wished they had been given a chance to explain things before they were sued. Implying they have a perfectly good explanation. Funny. But isn’t it true that the Fed guaranteed, indemnified, JPM against any losses associated with their takeover of Bear Stearns? Is this case about securitization fraud? Yes. Is it about uttering and misrepresentation? Yes. Is it about embezzling from investors all that clawback money? Yes. Why is it all being treated so gingerly? Because in the end JPM will not be held responsible. It almost sounds like Schneiderman is doing this for JPM, just to get it off their plate. And accountability? Please. If there were any justice, accounts would be settled both for duped borrowers and bilked investors.

  6. briansays

    but just in time for the debates
    most people won’t see the distinction
    civil vs criminal state vs federal
    and obama certainly not below trying to somehow take credit

  7. TC

    Kudlow asks, “Why are we still bashing banks?” Indeed. The Federal Reserve can do nothing but persist in telling one and all that, they’re all hopelessly insolvent. These weak PR “attacks” charging wrongdoing, but icing on the cake.

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