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JP Morgan Mortgage Fraud: Comments and Questions

Posted by Larry Doyle on October 2, 2012 8:58 AM |

Is yesterday’s announcement that the New York Attorney General (on behalf of the President’s Residential Mortgage-Backed Securities working group) is suing JP Morgan for fraud in selling mortgage-backed securities during 2006 and 2007 America’s long overdue call for justice?

Here is a copy of the suit. A few comments and questions.

First off, the activity in question occurred at Bear Stearns and not JP Morgan. JPM purchased Bear in the spring of 2008. I have long believed that selected parts of the mortgage origination process on Wall Street rose to the level of a racketeering enterprise. 

Although widely promoted as a charge against JPM (Bear Stearns), the suit also specifies the mortgage origination unit at Bear, an entity known as EMC located in Texas.

Why is this merely a civil suit? In reviewing the suit and in light of all that we know occurred in the origination and sales of mortgages during this time period, one is hard pressed to believe that there was not very real criminal activity involved in these operations. Not one single individual is named on the defendant’s side of this suit.

The suit lays out in spades the amazing lack of due diligence and real quality controls in place at EMC. Additionally, the suit highlights the pressure placed on the originators at EMC by New York based executives thirsting for more and more volume seemingly with little regard for quality in the process.

What do I see as the most serious allegation in this suit? Starting on page 26, we learn the following:

Defendants Breached Their Obligations to Repurchase Defective Loans From Securitizations While Secretly Settling Claims with Originators and Pocketing Recoveries

Although loan originators were contractually required to buy back defective loans at an agreed-upon repurchase price, Defendants routinely permitted them to avoid this obligation by extending cheaper or otherwise more appealing alternatives. Specifically, Defendants offered substantial concessions to originators in order to preserve Defendants’ relationships with them and to ensure the continued flow of loans.

For example, “in lieu of repurchasing the defective loans,” originators were permitted by Defendants to confidentially settle EPD and other claims by making cash payments that were a fraction of the contractual repurchase price. Defendants’ other concessions included agreements to cancel or waive entire claims against originators, and the creation of “reserve programs” under which Defendants used funds collected from these originators towards future
loan purchases.

According to an internal presentation, during the period May 2006 to April 2007 alone, Bear Stearns resolved $1.9 billion worth of claims against sellers relating solely to EPDs (early payment defaults). As a further accommodation to originators, Defendants also agreed to extend the EPD period so that already-securitized loans that had defaulted during the designated EPD period, and then started paying again, could remain in the securitization. This allowance was made despite defendants’ recognition that an EPD is a strong indicator not only of a borrower’s inability to repay but also of fraud in the origination. Notably, Defendants’ extension of the EPD period applied only to securitized loans; extensions of the EPD period for loans in Defendants’ own inventory were expressly forbidden.

Defendants were contractually obligated to give prompt notification to investors of any breach that materially and adversely affected investors, such as fraud in connection with loan origination or the failure to underwrite a loan in accordance with underwriting guidelines. Defendants were also required to repurchase defective loans from securitizations. Defendants not only failed to fulfill their contractual obligations; according to the testimony of one senior Bear Stearns manager, Defendants collected and retained the recoveries they obtained from their undisclosed settlements with originators.

Defendants kept settlement amounts for themselves rather than depositing the settlements into the relevant RMBS trusts, and failed to disclose that they were recovering and pocketing money from originators for settled EPD claims on loans that remained in their RMBS Trusts.

Would an intelligent individual define this activity as anything more than out and out theft? One does not need more than a high school equivalency to understand that activity as blatant theft.

One final question. Why now? Why is this suit brought at this juncture?

I personally believe the Feds are pursuing these cases at this juncture in a very coordinated fashion with the recently announced program to pump $40 billion per month into the market via the Federal Reserve’s QE3 program. The banks are benefiting from that program because the prices for mortgage securities sold to the Fed have soared while rates to the borrower have barely budged. Cha-ching, cha-ching for the banks. Just in time to increase revenues and settle this suit and the inevitable other suits to follow.

The rackets continue but will there be real justice. Or will this suit and these charges be just another day in The Twilight Zone.

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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