Mortgage Bond Insurer's Suit Suggests Bank Secretly Pocketed Payments On Sour Loans Prior To Default

The New York Times reports:

• Banks have been fighting with disgruntled bond investors and insurers for months, arguing that they do not need to buy back soured mortgages they placed inside securities before the financial crisis. Now, it turns out, some of those banks may have secretly collected partial payments on those same mortgages several years ago and pocketed that money.

• At least that is a theory being pursued by plaintiffs’ lawyers in some of the largest mortgage bond lawsuits, in which banks are accused of filling mortgage bonds with loans that did not belong there. The theory surfaced in a recently unsealed lawsuit against a mortgage unit at Bear Stearns, the failed investment bank that is now part of JPMorgan Chase.

• In the suit, the Ambac Assurance Corporation, which insured some mortgage bonds created by Bear Stearns, contends that the bank was partly compensated by loan originators for mortgages that became delinquent shortly after they were packaged into securities. Bear Stearns’s mortgage desk kept the payments, according to the suit, rather than apply them to the bonds that contained the delinquent loans.

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• At Bear Stearns, there seems to have been some knowledge of the failing loans, according to the Ambac case. Ambac says there is evidence of more than 100 early-default settlements for batches of loans that soured quickly. An example in that case describes an $11 million payment for one batch of loans. For another batch of “at least 12 loans,” there was a $2.6 million payment.

• Ambac’s case was filed in federal court, but a judge there ruled this week that the case belonged in a different jurisdiction. Erik Haas, a lawyer for Ambac, said the company planned to refile in state court.

• JPMorgan Chase, which bought Bear Stearns three years ago, said Ambac was a sophisticated investor that knowingly took risks in its deals.

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• Tracing such payments is tricky because of the large number of players in the mortgage machine: mortgage originators sold loans to banks, and then the banks packaged them into mortgage bonds to sell to mortgage investors. The originators did not generally communicate with mortgage investors, so neither side knows exactly what Wall Street’s middlemen did with the money or side agreements.(1)

For more, see New Questions Raised in Mortgage Financing.

(1) According to the story, Ambac’s lawyers at first did not know the extent of the payments at issue, but the company filed an amended complaint describing them after learning some new information from the producer of a coming documentary about Bear Stearns, "Confidence Game" (go here to watch the movie trailer).