Every now and then, a lawsuit or legislative report emerges to remind us just how out-of-control the U.S. mortgage business was in the years leading up to the financial crisis, and a civil tort filed today by the New York State Attorney General Eric Schneiderman is a fine example. (A congressional investigation into Countrywide’s program to provide discounted loans to lawmakers, the results of which were published in July, also comes to mind.)
Mr. Schneiderman’s suit brings fraud charges against JPMorgan with widespread misconduct in the packaging and sale of mortgage securities committed by Bear Stearns. These practices, of course, helped sink Bear Stearns, leading the investment bank to be acquired by JPMorgan in 2008, and the broad details—that Bear so coveted the profit available by selling mortgage-backed bonds that it became indiscriminate in the loans it purchased for securitization—are well known, and were common to any number of Wall Street banks. For all the ubiquity of the alleged practices, Mr. Schneiderman’s complaint still makes for a shocking read:Bear Stearns was buying junk … “… numerous originators who were top contributors to Defendants’ RMBS were on the Comptroller of the Currency’s ‘Worst Ten’ mortgage originators in the ‘Worst Ten’ metropolitan areas due to their loans’ high rate of foreclosures during the period 2005 to 2007.”
… in no small measure, because it residential mortgage-backed securities business was growing so fast … “In 2003, EMC securitized 86,000 loans valued at approximately $21 billion. That number nearly tripled in 2004, to approximately 231,000 loans valued at $48 billion. In 2005, the number jumped to approximately 389,000 loans valued at nearly $75 billion. Finally, in 2006, EMC securitized over 345,000 loans valued at $69 billion. From 2003 through 2006, EMC securitized over one million mortgage loans valued at the time in excess of $212 billion.”
… and which rapid mortgage acquiring led to lapsed quality control standards … “To accommodate this massive volume of loans, Defendants’ due diligence process abandoned certain basic inquiries—such as determining the reasonableness of income in a ‘stated income’ loan. According to dozens of former due diligence firm employees and EMC underwriters, the very high volume of ‘stated income loans,’ and their limited ability to probe the reasonableness of the income stated, was one of the greatest challenges of the due diligence review.”
… which was plain enough to those involved … “Defendants were aware that many of their loan originators were selling defective loans but continued to buy and securitize those loans. For example, according to a June 2006 internal Bear Stearns email, almost 60% of AHM loans that were purchased through the conduit were 30 or more days delinquent. After learning this information, Defendants went on to issue over 30 subprime and Alt-A securitizations that included AHM loans.”
… even if the lapses were expedient to ignore … “Indeed, far from making an effort to improve their due diligence review—and thereby improve the scrutiny of the loans they were purchasing—Defendants, as early as February 2005, began to reduce the amount of due diligence conducted ‘in order to make us more competitive on bids with larger sub-prime sellers.’ As one senior executive acknowledged in testimony, the ‘reduction in due diligence could be a response to a request from a seller.'”
… ok, we can’t resist, one more … internal communications reflect Defendants’ awareness of the bad quality of loans that were being included in other securitizations. In connection with the Bear Stearns Second Lien Trust 2007-1 (‘BSSLT 2007- 1’) securitization, for example, one Bear Stearns executive asked whether the securitization was a ‘going out of business sale’ and expressed a desire to ‘close this dog.’ In another internal email, the SACO 2006-8 securitization was referred to as a ‘SACK OF SHIT’ and a ‘shit breather.'”
Of course, Mr. Schneiderman’s lawsuit is not mere historical relic. As The Wall Street Journal points out, the suit filed today is merely the first in what could be a series of actions against the banks, and which, if successful, could lead to another round of litigation costs weighing on the lenders’ bottom lines. In the meantime, though, we can only shake our heads at another chronicle of the housing bubble.