“The Obama Administration has had a high old time forcing big banks into big-dollar settlements without ever going to trial. So it’s worth paying special attention to the executives of the U.S. unit of Japanese bank Nomura who are refusing to settle a similar case they believe is bogus…

…Don’t they know this isn’t the way Washington shakedowns are supposed to work? The claim is that Fan and Fred—the government-created dominators of the mortgage market—were unwitting victims of the banks. To believe this fairy tale, you have to ignore the findings of a bipartisan congressional inquiry, as well as separate federal lawsuits in which the government is arguing that Fan and Fred did the misleading…..Yet regulators figured that the banks would probably cave to avoid unpleasant publicity and a juror pool angry about bank bailouts. And 17 banks did cave, paying the Beltway bandits nearly $18 billion to make these Little Orphan Fannie claims disappear. Firms like Bank of America , Deutsche Bank, Goldman Sachs and J.P. Morgan all wrote checks to buy peace with the politicos. Bankers knew that Fan and Fred understood they were running risks when they bought mortgage-backed bonds. But the bankers settled because they want to be able to say that their crisis-era litigation is over.”, “The Bank That Won’t Buckle”, The Wall Street Journal Editorial Board

Review & Outlook

The Bank That Won’t Buckle

Nomura goes to court over the Fannie Mae mortgage fairy tale.

The Obama Administration has had a high old time forcing big banks into big-dollar settlements without ever going to trial. So it’s worth paying special attention to the executives of the U.S. unit of Japanese bank Nomura who are refusing to settle a similar case they believe is bogus. Don’t they know this isn’t the way Washington shakedowns are supposed to work?

In 2011 the Federal Housing Finance Agency (FHFA) sued Nomura and 17 other financial institutions for allegedly misleading Fannie Mae and Freddie Mac about the risks in mortgage-backed securities prior to the financial crisis. The claim is that Fan and Fred—the government-created dominators of the mortgage market—were unwitting victims of the banks. To believe this fairy tale, you have to ignore the findings of a bipartisan congressional inquiry, as well as separate federal lawsuits in which the government is arguing that Fan and Fred did the misleading.

Yet regulators figured that the banks would probably cave to avoid unpleasant publicity and a juror pool angry about bank bailouts. And 17 banks did cave, paying the Beltway bandits nearly $18 billion to make these Little Orphan Fannie claims disappear. Firms like Bank of America , Deutsche Bank, Goldman Sachs and J.P. Morgan all wrote checks to buy peace with the politicos.

Bankers knew that Fan and Fred understood they were running risks when they bought mortgage-backed bonds. But the bankers settled because they want to be able to say that their crisis-era litigation is over.

Except at Nomura, which is more interested in establishing what really happened at Fan and Fred. With a March 16 trial date approaching, Nomura’s willingness to go to court is giving the government’s lawyers a case of the yips. In January the feds dropped their claims for damages. The government claims it can recover as much or more from the “equitable” claims, in which Nomura would merely be required to buy back the securities it sold to Fan and Fred. But Nomura says the damage claims were the most lucrative part of the case.

Why would the government want to limit its potential winnings shortly before the trial? Well, because abandoning damage claims lets the government avoid a jury trial. That means leaving it all to federal Judge Denise Cote, who is well known for tilting toward the government against business and has been siding with the feds in pre-trial rulings.

FHFA’s lawyer explained in a recent filing that a “bench trial clearly would conserve time and assets.” That may be true. But when the defendant is a large multinational bank and the government doesn’t want to face a jury in this era of public anger at big banks, that tells you how much confidence the feds have in their case.

They’re right to be worried. In a filing last fall, counsel for Nomura said that Fan and Fred not only went shopping for pools of mortgages. Nomura offered evidence that the politicized twins sought to ensure that the particular mortgages in the pools would help them meet affordable housing goals set by the federal Department of Housing and Urban Development.

In other words, while many investors might try to avoid risky loans to people with low credit scores, Fan and Fred were doing the opposite. They sought risky loans to please their political partners, even as they enriched themselves with fat interest-rate yields.

According to the Nomura filing, “To enable Freddie Mac and Fannie Mae to meet HUD’s requirements, broker-dealers provided them with loan-level information about the pools of loans from which private label securitizations were to be created. As Fannie Mae’s Paul Norris explained, ‘the whole collateral pool was ours to carve out.’”

It’s even possible that Little Orphan Fannie and her cousin Freddie knew more about the risks of such loans than the banks assembling them into securities. According to Nomura’s lawyers, “In selecting the loans that would be included in the loan groups supporting tranches they intended to purchase, Freddie Mac and Fannie Mae carefully analyzed loan-level data, including property addresses, to ensure that the loan pools underlying their certificates included as many goal-qualifying loans as possible.”

Nomura’s experience wasn’t unique. According to a 2011 Journal report, Deutsche Bank said before it settled that Fan and Fred bought mortgage-backed securities “often after hand-picking the loans they now claim should not have been included in the offerings.” We have heard the same from other banks.

It’ll be a shame if Judge Cote treats Fan and Fed as mom-and-pop investors who were naive about mortgage risks, even when they were the world’s leading experts on such risks. But on the evidence you can see why the government doesn’t want to try selling that fantasy to a jury.

Posted on March 9, 2015, in Postings. Bookmark the permalink. Leave a comment.

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