The New York attorney general sued JPMorgan Chase on Monday, charging that the Bear Stearns brokerage it bought committed fraud in the sale of hundreds of billions of dollars in MBS on the eve of the housing crisis.
Bear Stearns abandoned its credit guidelines for reviewing borrowers whose MBS it sold to investors over a roughly five-year period beginning in 2003, New York Attorney General Eric Schneiderman charged in a civil lawsuit filed in Manhattan. JPMorgan acquired Bear Stearns in March 2008.
"Defendants led investors to believe that defendants had carefully evaluated — and would continue to monitor — the quality of the loans in their [residential mortgage-backed securities]," the suit says. "In fact, defendants systematically failed to fully evaluate the loans, largely ignored the defects that their limited review did uncover and kept investors in the dark about both the inadequacy of their review procedures and the defects in the underlying loans."
The case is the first to emerge from a joint federal-state task force formed in January to probe misconduct in the mortgage market. Schneiderman, who co-chairs the task force, said in September his office was poised to take action.
JPMorgan Chase said the suit concerns actions by Bear Stearns before it acquired the firm. "This complaint is entirely about historic conduct by that entity," spokesman Joe Evangelisti wrote in an email.
The case stems from activities by Bear Stearns and EMC Mortgage, its former mortgage underwriting subsidiary, which purchased and packaged home loans for sale to investors. Both subprime and Alt-A MBS, which later lost value as a result of borrowers' inability to repay their mortgages, fraud in the loan applications themselves and a lack of standards on the part of EMC and Bear Stearns, the lawsuit says. For example, securities backed by the mortgages allegedly lost about $22.5 billion, or 26% of their original value, in 2006 and 2007.
Prosecutors also charge Bear Stearns with failing to weed out problem loans that ended up in securities purchased by investors. Its "quality control department was so overwhelmed by the sheer number of defects in the underlying loans that it could not properly function," the lawsuit says.
The lawsuit demands that JPMorgan calculate the compensation it received from the allegedly illegal activities and repay investors.
JPMorgan Chase bought Bear Stearns at a steep discount days after creditors refused to advance the brokerage firm more money. Regulators provided $30 million in funding for the deal, which resulted in JPMorgan Chase's inheriting the potential for lawsuits from Bear Stearns.