If there were any doubts about whether or not many banks broke the law while selling bad mortgages to investors or if their clients were merely victims of bad timing, Manhattan Federal Court Judge, Denise L. Cote, would like to eliminate them. Finding Japanese bank, Nomura Holdings and the Royal Bank of Scotland (RBS) liable of selling fraudulent mortgage-based securities to Fannie Mae and Freddie Mac, Cote wrote Tuesday, May 11th in a comprehensive 361-page ruling, “The magnitude of falsity, conservatively measured, is enormous.” The claims against the two banks were filed by the obscure, but surprisingly effective agency created in 2008 to oversee Fannie Mae and Freddie Mac, the Federal Housing Finance Agency (FHFA). The two banks are the first of 18 that the agency targeted since 2011 to bring their cases to trial. The FHFA and its aggressive litigators have already achieved settlements with Bank of America, Goldman Sachs, and JP Morgan Chase, among others, totaling roughly $17.9 billion of the estimated $200 billion of the mortgage-backed securities purchased by Fannie Mae and Freddie Mac. RBS was accused of underwriting 4 of the 7 Nomura securitizations that are the center of the case. Many were surprised to see the banks bring the case to trial as Judge Cote has taken a notoriously harsh stance against sellers of the mortgage-backed securities largely responsible for the Great Recession. The banks will now have to pay the FHFA $805 million, however, the mortgage bonds will be returned to them, with an estimated value between $434 and $479 million.
Judge Cote cited several pieces of evidence to illustrate Nomura’s level of complicity, countering the bank’s argument of unfortunate circumstances. Included in the evidence were emails from executives calling certain securities “crap,” and another ignored a warning of “Danger Batman.” Writing that “The reason for Nomura’s lackluster due diligence program is not hard to find,” Cote also noted 184 of 672 sample loans in which appraisers believed that home values were incorrect and inflated as well as several other “disturbing examples.” Answering her own question with an emphatic “no,” Cote summarized her ruling by asking, “This case is complex from almost any angle, but at its core there is a single simple question. Did defendants accurately describe the home mortgages in the offering documents for the securities they sold that were backed by those mortgages?” Nomura U.S. spokesperson, Jonathan Hodgkinson wrote in an e-mailed statement that, “Nomura is confident that it was consistently candid, transparent and professional in all of its dealings with Fannie Mae and Freddie Mac.” In closing arguments, lawyers for Nomura and RBS called the expert’s findings “entirely artificial in the extreme.” Nomura intends to appeal the decision while RBS could not be reached for comment. The latter bank faces a separate FHFA case headed to trial in Connecticut federal court next year.
The grim language and the thoroughness of Judge Cote’s ruling mixed with the effectiveness of the FHFA lawyers will likely dim Nomura’s chances for success upon appeal as well as encourage future FHFA targets to settle cases and avoid the court system altogether. Cornell law professor, Robert C. Hockett reacted in a Bloomberg interview to Nomura’s decision to bring the case to trial instead of settle saying, “They look pretty bad. They look like the strategy has blown up in their faces.” It will be curious as to whether or not RBS will settle the other case, although having a different venue will mean avoiding Judge Cote, but not the FHFA attorneys. In that case, the FHFA is accusing RBS of selling $32 billion of its own mortgage-backed securities to Fannie Mae and Freddie Mac in a trial that could dwarf the Nomura challenge. The Edinburgh-based company may find that the cost of an adverse judgment, litigation, and the publicity hit may be worth a negotiated sum before next year’s trial is set to begin.
Bloomberg Business – Bob Van Voris
New York Times – Peter Eavis
Reuters – Nate Raymond