National Credit Union Administration (NCUA) urged a federal judge here last week not to dismiss its claims against underwriters of more than $1 billion of MBS sold to WesCorp Federal Credit Union, as the regulator’s numerous legal claims in the corporate credit union failures appear to be slipping away.
In a response to the judge’s tentative ruling to dismiss its suit against RBS Securities, NCUA urged the judge to reject the Wall Street bank’s defense that more than $1 billion of WesCorp MBS it underwrote went bad because of the 2007-2008 meltdown of the mortgage market and not because of any of its own actions.
Rather, NCUA asserts the vast majority of the MBS losses occurred in 2006 and 2007 — “long before the U.S. economy began to decline.”
“Accordingly, the logical inference is that the high level of unexpected losses stemmed not from general economic conditions, but rather from the fact that bad loans were being made to borrowers who could not repay them and were secured by real estate whose value was inflated as compared to the representations in the Offering Documents,” NCUA told the judge.
NCUA’s response comes after the judge in the case, George Wu, issued a preliminary ruling last month that NCUA has failed to show that the Wall Street bank and related entities disregarded their own underwriting standards in the creation and sale of $1.1 billion of MBS to WesCorp, the one-time $34 billion corporate credit union that failed in 2009 amid some $7 billion in losses.
The preliminary ruling by Wu, who earlier rejected NCUA’s separate civil negligence claims against directors of WesCorp, casts doubt on several other suits NCUA has brought against Wall Street banks, including JPMorgan Chase, Goldman Sachs and Wachovia Securities (now part of Wells Fargo) in the failure of five corporate credit unions, including U.S. Central, Members United Corporate FCU, Southwest Corporate Federal Credit Union and Constitution Corporate Federal Credit Union – as well as WesCorp. NCUA claims the Wall Street banks ignored their own underwriting standards when they bought and packaged subprime loans for sale as MBS to the doomed corporates.
The stakes in the legal battle are enormous as dozens of other entities, including several Federal Home Loan Banks, Fannie Mae and Freddie Mac, have filed similar lawsuits against Wall Street banks who sold them billions of dollars of MBS that eventually went sour.
The gist of the plaintiffs’ claims are that the Wall Street banks sold trillions of dollars in MBS purportedly backed by solid mortgages which were instead, packages of subprime loans that were disguised by so-called credit enhancements; over-collateralization and private bond insurance. But when the subprime loans began to falter so did the over-collateralization, while the private bond insurance became an illusion, as all of the major bond insurers became insolvent, as a byproduct of the mortgage meltdown.
In his preliminary ruling Judge Wu said that NCUA relied too much on statistics showing how the investments failed following the collapse of the housing market, which the Judge described as “conclusory," Without additional information, he said, the suit would fail the pleading standards set forth in prior Supreme Court rulings. He also expressed doubts whether the relevant statute of limitations on the civil claims had expired on the sale of the MBS—some of which occurred as early as 2005 and 2006 – before NCUA filed its suit last July.
NCUA rebutted the statute of limitations claims in last week’s pleading, saying the clock did not start running on the relevant statutes until NCUA took WesCorp under conservatorship in March 2009 and thus was able to comprehensively review the records of the failed MBS in order to determine whether misrepresentations occurred in their purchase.
At the core of the numerous suits NCUA asserts the main purpose of RBS and the other Wall Street banks in securitizing mortgages originated by other lenders was the practice known as “originate-to-distribute,” with no concern by the Wall Street banks whether the mortgage loans were properly underwritten and would perform as advertised. “Not surprisingly,” says NCUA, “such “high OTD” lenders had little incentive to ensure that these loans were sound, as they would not be keeping them for long, but rather, would sell them immediately to Wall Street, which would in turn securitize them for sale to investors – thereby shifting like a hot potato the risk of default from the lenders to (residential) MBS investors.”
“Originators began to make loans to home buyers only to re-sell those loans to Wall Street banks, which made them more likely to disregard underwriting standards because they faced no risk if borrowers could not repay the loans,” argues NCUA, which said several courts have ruled that just a few of these factual allegations are sufficient to survive a motion to dismiss.
Throughout the numerous suits brought by NCUA the regulator has been careful not to allege fraud because the standards in proving fraud are much higher than simple misrepresentation, a major distinction in its legal case.
Lawyers for RBS did not return to phone calls seeking comment. NCUA said it does not comment on pending litigation.