Goldman CEO Lloyd Blankfein testifies before a Senate panel in April 2010. (Photo: Diego M. Radzinschi)
Did Fannie Mae and Freddie Mac know what they were getting into?
That’s been the big lingering question in Federal Housing Finance Agency’s lawsuits against banks that sold residential mortgage-backed securities to Fannie and Freddie in the run-up to the subprime meltdown. Now U.S. District Judge Denise Cote in Manhattan has answered with a forceful “no,” handing a victory to the FHFA and its lawyers as trial approaches against the remaining defendants—Goldman Sachs & Co., Royal Bank of Scotland plc, Nomura Holding America Inc. and HSBC Holdings plc.
Cote on Friday granted summary judgment to the FHFA on the defendants’ so-called knowledge defense: the argument that even if the banks made misleading statements about billions of dollars in mortgage-backed securities, Fannie and Freddie were sophisticated investors that knew exactly what they buying. Cote ruled that the banks failed to show that Fannie and Freddie (the “government-sponsored entities,” or GSEs) willfully ignored false guarantees that were allegedly made to them about home loans underlying the securities at issue.
“Whatever the GSEs’ knowledge of general practices or trends, neither of them had access to the files or data that would give them knowledge that those detailed representations about the mortgage loans … were false,” Cote ruled. “The defendants have identified no evidence—either direct or circumstantial—of the extremely improbable scenario they posit: the GSEs, when investing billions of dollars in securities, knew of the falsity of defendants’ specific representations.”
The FHFA’s lawyers at Quinn Emanuel Urquhart & Sullivan and Kasowitz Benson Torres & Friedman sued 18 big banks in the summer of 2011, alleging that they duped Fannie and Freddie into investing in securities backed by shoddy home loans. From the get-go, the defendants have pointed out that the GSEs’ “single family” units were competing with the banks to securitize home loans from the very same originators during the same period. In a March 2013 petition to the U.S. Court of Appeals for the Second Circuit, the banks argued that “the GSEs either knew the extent to which those mortgage originators had abandoned their guidelines or, more likely, had concluded that originators did not materially deviate from the guidelines disclosed in petitioners’ offering documents.”
Most of the defendants have settled, including Bank of America Corp., JPMorgan Chase & Co. and UBS AG. In March, FHFA’s total haul from settlements has eclipsed $20 billion. In court filings, the banks have argued that Cote left them little choice but to settle by limiting their discovery into the business dealings of Fannie and Freddie’s single family units.
In Friday’s ruling, Cote rejected both the banks’ knowledge defense and the notion that she’d limited their ability to make it. She observed that the FHFA has turned over 19 million pages of documents and that the defendants deposed 29 GSE and FHFA witnesses over 46 days. “None of that testimony so much as suggested actual knowledge that defendants’ representations were false,” she wrote.
While Cote’s ruling is undoubtedly a blow to the remaining defendants, it’s not game over. Up until now, the defendants have been pressing a complex and contradictory two-part argument: We didn’t try to mislead the GSEs, but if we did, they were in on the game anyway. As Cote put it in Monday’s ruling: “It cannot both be the case that representations were true and that the GSEs had actual knowledge of their falsity.” By shutting down one line of defense, Cote has arguably simplified things for the banks as they contemplate facing the jury.
Lawyers at Sullivan & Cromwell represent Nomura and Goldman Sachs. According to The Wall Street Journal and other outlets, Goldman and the FHFA have held talks about a possible settlement that could top $1 billion.
HSBC has long been represented by attorneys at Mayer Brown, including Mark Hanchet and John Conlon. Famed trial lawyer David Boies of Boies, Schiller & Flexner made an appearance for HSBC late last year, as the prospects of a pretrial victory for the banks grew dimmer.
Thomas Rice of Simpson Thacher & Bartlett is lead counsel for RBS. The bank has settled with FHFA, but still faces some potential exposure for its role as an underwriter for home loans securitized by Nomura.
FHFA’s lead counsel is Philippe Selendy of Quinn Emanuel. He didn’t immediately return a call seeking comment.