Deja Vu All Over Again

Banksters may want to put that cigar away.

News that rocked the financial world four years ago is about to be recycled.  Last night came word that New York Attorney General Eric Schneiderman has filed a civil suit against one of Wall Street's biggest banks, JP Morgan Chase & Co., for "multiple fraudulent and deceptive acts" in peddling residential mortgage-backed securities (RMBS) to investors from 2005 to 2007.  The fraud was actually perpetrated by Bear Stearns, which was close to bankruptcy when JP Morgan Chase took it over in May 2008, thereby inheriting the legacy liability.

The takeover had started with a low-ball bid from Morgan of a scant $2 a share.  Once the U.S. Federal Reserve agreed to offload $29 billion in toxic assets from Bear's balance sheet, the deal got done at $10 a share.  As Bear was going under, I was following the action here and asking whether two other investment banks, Lehman Brothers and Merrill Lynch, might be next.  Their turn came several months later ("Merrill, Lehman Are Goners").  Lehman was simply allowed to fail.  Merrill Lynch was "saved" by a shotgun wedding with Bank of America.

In taking on Merrill Lynch, BofA overpaid.  Taxpayers took some of the sting away (you remember agreeing to this, right?) by offering two tranches of TARP money adding up to $45 billion.  But even those sweeteners could not offset the deficiencies on Merrill's balance sheet, which were hidden from BofA shareholders until after they were coaxed by management to approve the merger ("Good Money After Bad").  BofA was eventually sued for the lack of disclosure, and in February 2010 the Securities and Exchange Commission settled with the company for $150 million.

Peanuts, said federal district judge Jed S. Rakoff, who, even as he approved the settlement, chastened the SEC for not extracting more.  Well, BofA shareholders have picked up where the regulators left off.  Last Friday the company settled a class-action suit over the Merrill Lynch acquisition for $2.43 billion (the N.Y. Times has the lowdown and a look-back here).  Upon the announcement, a loud "That's what I'm talking about!" echoed through the canyons of Lower Manhattan, originating apparently from the Pearl Street address where Judge Jed holds court.

But that will not be the end of the litigation for BofA.  The NY AG warns [see Schneiderman's interview with Bloomberg TV here] that the new charges against Morgan will be replicated against those of Morgan's peers who were also playing fast and loose with RMBS in the go-go aughts.  If the charges stick, settlements could run in the tens of billions to cover investors' losses.  Either that, or, as Christopher Whalen suggests, the banks will have to buy back the tainted securities:

"So what happens with JPM and Bear?  One word: rescission.  My guess is that the fraud perpetrated by Bear Stearns in creating these rancid securities will eventually force JPM to repurchase some of the bonds from investors.  That is tens or even hundreds of billions of dollars of face amount of bad securities." 

[update 10-10-12--]

A U.S. district attorney in New York has just sued Wells Fargo for mortgage fraud, issuing a statement that "yet another bank has engaged in a longstanding and reckless trifecta of deficient training, deficient underwriting and deficient disclosure, all while relying on the convenient backstop of government insurance."  Earlier this year the same office settled three similar suits against other banks for a total of almost a half-billion dollars.  [Story here.]