According to the court filings, those firms and others “falsely represented” the quality of the loans that were bundled into securities and sold to investors and “significantly overstated the ability of the borrower to repay their mortgage loans.” The result, the suits claim, were investments that were far riskier than the banks led taxypayer-backed Fannie and Freddie to believe, and the securities ultimately were worth a fraction of their original value.
Friday’s filings in New York and Connecticut represent an escalation in the government’s effort to recoup taxpayer losses incurred during the financial crisis. But the lawsuits also raised questions about the toll they might have on the health of the already struggling banking sector and the prospects for a housing market recovery.
The federal action also underscored the often contradictory relationship between the government and financial firms in the wake of the crisis. At times, government officials have come to the rescue of banks and counted on them to help accelerate the nation’s lagging economic recovery. But often, officials have derided the practices that fueled the financial meltdown and sought to keep banks in check, either through new regulations or negotiated settlements or, as on Friday, potentially costly litigation.
Some financial analysts said the lawsuits come at a particularly bad time because bank lending is already sluggish. They warned that the lawsuits could sap capital from banks, leaving them with even less money to lend, and further weaken the economy. Others argued that Fannie and Freddie were sophisticated investors who helped shape the very securities they purchased.
One former top executive at a financial institution that bought and sold mortgage securities, and who spoke on the condition of anonymity, criticized the suits, saying that “the whole thing has gotten ridiculous and out of hand. The banks are big boys. Fannie Mae and Freddie Mac are big boys. The people who invested in private securities are big boys.”
Added another bank official: “These are folks that were involved in creating these securities. The idea that Fannie and Freddie were victims in this, it defies credibility.”
But James Millstein, a former Treasury official who oversaw the reorganization of bailed-out insurance giant American International Group, said “the anti-fraud provisions of the securities laws don’t have a big boy exemption. There isn’t one rule for little investors and another rule for big investors.”
He added that the government had an obligation to pursue its claims. “I don’t think it’s going to do anybody any good if the price of getting banks to do what they’re supposed to do is giving them a pass on violating the securities laws,” he said, “particularly when it involves an entity currently being subsidized by the taxpayers.”