The federal housing finance agency’s complaints against seventeen banks

Author:Oonagh Anne McDonald
Position:Visiting Fellow, Institute of Banking and Investment, University of Leeds
Pages:22-44
SUMMARY

Purpose - The purpose of this paper is to examine the basis of the complaints against banks which sold private label securities to Fannie Mae and Freddie Mac before the financial crisis. The examination shows that all but one of the cases was settled out of court. Nomura and RBS went to court, but the case against them was based on dubious evidence and on strict liability which only enabled the judge to set aside relevant evidence. The Securities and Exchange Commission’s evidence against senior executives of Fannie and Freddie shows that they deliberately purchased PLSs based on subprime loans to meet the government’s housing targets. Design/methodology/approach - The research was based on... (see full summary)

 
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The federal housing nance
agency’s complaints against
seventeen banks
Oonagh Anne McDonald
University of Leeds, Leeds, UK
Abstract
Purpose – The purpose of this paper is to examine the basis of the complaints against banks which
sold private label securities to Fannie Mae and Freddie Mac before the nancial crisis. The examination
shows that all but one of the cases was settled out of court. Nomura and RBS went to court, but the case
against them was based on dubious evidence and on strict liability which only enabled the judge to set
aside relevant evidence. The Securities and Exchange Commission’s evidence against senior executives
of Fannie and Freddie shows that they deliberately purchased PLSs based on subprime loans to meet
the government’s housing targets.
Design/methodology/approach The research was based on publicly available documents,
including details of the Federal Housing Finance Agency’s (FHFA) complaints against the banks in
question, the settlement agreements published by the DoJ, FHFA and SEC. Furthermore, it includes
documentary evidence from the Financial Crisis Inquiry Committee and Senate Committees, the full
transcript of the trial, opinions of the judge for the trial and the judgement.
Findings – The ndings are that many have concluded that settlements out of court fail to satisfy the
demand for justice. They have been criticised as a trade-off between the prosecutor and the bank, with
a view that the imposition of large nes is to pay back taxpayers’ money spent on rescuing the banks,
rather than punishing those responsible. Such nes do little, if anything, to change the behaviour of
banks. As a result, the Department of Justice issued a memorandum on 9 September to focus on
individual accountability for corporate wrongdoing. It remains to be seen how many cases against
senior executives will result from the change in direction.
Research limitations/implications – The implications of the research are that it is important even
in the aftermath of such a serious if not devastating nancial crisis to ensure that the laws are properly
applied and can stand up to any challenge that it has been stretched to obtain the results the
administration of the day wants to see. In addition, care must be taken over both the imposition of large
nes and the use to which the monies should be put. All the parties involved in bringing about the crisis
should be held to account. The major cases against the banks have almost all been “resolved”. A change
in direction has now taken place.
Practical implications – The practical implications of holding individuals to account should now be
tackled. It requires a careful examination of the laws and regulations already in place to ensure that it
is clear within a bank as to who is responsible for what. It will only be possible to hold senior individuals
to account if the laws are clear and if all the evidence is not hidden. It may also require a review of the
contracts under which senior executives are employed, because to remove a person from his post and
then nd that he still has a large pension pot and bonuses due may not result in justice either. A delicate
balancing act is required because banks require highly competent and motivated individuals to run
them.
Social implications – If a very large ne is imposed on a bank, the shareholders and customers
pay. The shareholders will mostly own the shares through their pensions and their savings in
mutual funds.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1359-0790.htm
JFC
23,1
22
Journalof Financial Crime
Vol.23 No. 1, 2016
pp.22-44
©Emerald Group Publishing Limited
1359-0790
DOI 10.1108/JFC-09-2015-0047
Originality/value – There have been few studies of all the cases against the banks brought by the DoJ
and FHFA and still fewer have recognized the fact that government housing policy was the source of the
extent of the subprime mortgages.
Keywords Department of justice, Federal housing nance agency, Fines, Nomura,
Private label securities, USA banks
Paper type Research paper
Part I. The basis of the complaints
The cases against the banks made by the Federal Housing Finance Agency (FHFA) rely
on a different legal basis from those of the Department of Justice. The approach, as set
out below, is much more cautious in that it relies on strict liability, but this does allow for
the complaints to be made without regard to the context and, indeed, without regard to
conicting evidence. The cases brought by the SEC against chief executives and senior
executives of Fannie Mae and Freddie Mac were also settled out of court, but evidence on
which the SEC based its cases shows that Fannie Mae and Freddie Mac knew exactly
what the contents of the private label securities were and, indeed, that was the reason for
their purchase.
The complaints
These all follow a similar format, covering four areas that form the substance: the
underwriting guidelines, the occupancy status of the borrower, loan-to-value and the
credit ratings[1].
It is claimed that the originators of the underlying mortgage loans systematically
disregarded their underwriting guidelines. The collapse of the (MBS) certicates is also
taken to indicate that the mortgage loans were not originated in accordance with the
guidelines. This was further conrmed by the surge in mortgage delinquency and
default in 2008.
The full details of the data review and the evidence gathered to support the FHFA’s
complaint are not provided in the complaints. This is despite the fact that the FHFA has
subpoena powers, i.e. they have access to the underlying loan les without having le a
lawsuit and proceed through discovery. Because only the Nomura case went to trial, it is
not possible to gauge the strength of the evidence. However, in the case of Bank of
America, for example, the FHFA stated that an:
[…] industry standard automated valuation model was used to calculate the value of the
underlying property at the time the mortgage was originated. AVMs are routinely used in the
industry as a way of valuing properties […] AVMs rely on similar data as appraisers-primarily
county assessor records, tax rolls, and data on comparable properties. AVMs produce
independent, statistically-derived valuation estimates by applying modelling techniques to
this data.
The FHFA makes the same claim about the use of the automated valuation model (AVM) in
each case, an interesting claim, given the revelations about the use of the specially prepared
AVM in the Nomura trial[2]. This will be further explored in section 3.
The credit rating agencies
The rating agencies are criticised for their role in the nancial crisis. The complaints,
whilst relying on the evidence gathered during the Financial Crisis Inquiry Commission
(FCIC) for the issue of inated appraisals, sets aside the extensive evidence of the FCIC
23
Federal
housing nance
agency’s
complaints

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