Court papers that JPMorgan Chase fought to keep under seal claim that former Bear Stearns mortgage executives who now run mortgage divisions of Goldman Sachs and Ally Financial cheated and defrauded investors in mortgage-backed securities.
Teri Buhl has some of the colorful details:
Bear deal manager Nicolas Smith wrote an e-mail on August 11th, 2006 to Keith Lind, a Managing Director on the trading desk, referring to a particular bond, SACO 2006-8, as "SACK OF Sh** [2006-]8" and said, "I hope your [sic] making a lot of money off this trade."
It’s hard to believe that people on Wall Street still send those kind of emails. But apparently it is a Law of Bubbles: sales people will say stupid things about their products in internal emails.
The lawsuit makes some claims which—if true—seem almost criminal.
Buhl again:
According to the lawsuit, the Bear traders would sell toxic mortgage securities to investors and then sell back the bad loans with early payment defaults to the banks that originated them at a discount. The traders would pocket the refund, and would not pass it on to the mortgage trust, which was where it should have gone to be distributed to the investors who owned the bonds. The Marano-led traders also cut the time allowed for early payment defaults, without telling the bond investors. That way, Bear could quickly securitize defective loans, without leaving enough time for investors to do their own due diligence after the bonds were sold and put-back any bad loans to Bear.
The traders were essentially double-dipping—getting paid twice on the deal. How was this possible? Once the security was sold, they didn't have a legal claim to get cash back from the bad loans—that claim belonged to bond investors—but they did so anyway and kept the money. Thus, Bear was cheating the investors they promised to have sold a safe product out of their cash. According to former Bear Stearns and EMC traders and analysts who spoke with The Atlantic, Nierenberg and Verschleiser were the decision-makers for the double dipping scheme, and thus, are named as individual defendants in the suit.
If I understand this correctly, Bear was allegedly forcing mortgage orginators to buy back bad loans it had securitized, but then refused to buy similar loans out of the securitization pools.
Bloomberg has a good description of how this worked.
By the end of 2005, Bear Stearns had moved to making sure to securitize home loans before their early payment default periods ended, without informing investors and insurers of the switch, according to the complaint.
Then, if the loans went delinquent or were otherwise found defective, the company would seek settlements from lenders, rather than repurchases, which would have required the cash paid by originators to flow through to the securitization trusts so the debt could be passed back, according to the complaint.
The thing to keep in mind about this complaint is that it is highly unlikely that this tactic was confined to Bear. If it was happening there, it was probably also happening at Lehman Brothers, Merrill Lynch and Goldman Sachs.
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Companies mentioned in this post
Goldman Sachs
Bank of America
JPMorgan
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