The losses are alleged to amount to over $20bn, on a total of $87bn of subprime bonds sold in 2006-2007. Bear Stearns, you will recall, was the failing investment bank hastily acquired by JP Morgan over the course of a hectic weekend back in 2008. Since the deal amounted to a rescue and was rushed through with the express encouragement of the US financial authorities, bosses at JP Morgan could be forgiven for feeling rather aggrieved at the decision by the state prosecutor to press charges. A lot can change in 4 years…
New York Attorney General Eric Schneiderman said that Bear Stearns ‘committed multiple fraudulent and deceptive acts’ whilst selling mortgage backed securities – the CDOs, CDSs and CDOs of CDSs which we used to hear so much about back in the dark days at the height of the financial crisis.
The case rests largely on claims that Bear Stearns failed to honour due diligence obligations to ensure that the quality of loans used to create its mortgage backed securities were reasonable. It is also reckoned not to have kept up a commitment to remove loans that went into arrears and replace them with better ones. The allegation is further that these failures were sins of commission rather omission - that Bear Stearns consciously flouted due diligence rather than simply cocking it up.
The case opens up a fresh window into the frenzy of debt securitisation that was going on in the lead up to 2008, with subprime mortgages being bundled up and flogged off for huge profits as fast as humanly possible, regardless of the chances of the original debt ever being paid off. In one case cited, an internal Bear Stearns email from June 2006 apparently states that no less than 60% of loans bought from one provider, AHM, were in arrears by 30 days – but that despite the toxic nature of the loans the bank went on to issue securities backed by them regardless.
The reminder of the kinds of odious shenanigans that banks got up to not so very long ago is unlikely to be welcomed either by JP Morgan or the whole industry, which has been vigorously attempting to distance itself from its own past. If they could pull this sort of stunt once, what’s stopping them from doing it again is the subtext here. For its part JP Morgan has expressed disappointment at not being given a chance to refute the allegations, and has said that will contest them.
It is possible that Schneiderman may be using the case as a lever to extract more financial support for borrowers who lost out as a result of the subprime crisis. Earlier this year a multibillion deal was reached between the authorities, JP Morgan and four other large banks, and this action may be a case of more of the same.
It’s also quite possible that further actions may be brought against other banks – Bear Stearns was hardly likely to be alone in acting this way after all. So plenty more fun and games to come…