The company must go to trial on allegations by the Federal Housing Finance Agency of wrongdoing in the sale of securities backed by residential mortgages, U.S. District Judge Denise Cote ruled Monday.
The FHFA filed the lawsuit in December 2011 in its role as conservator for Fannie Mae and Freddie Mac. It has brought 16 actions in district court in Manhattan that charge underwriters of securities backed by residential mortgage loans with misconduct in the offering and sale of securities purchased by Fannie and Freddie over a roughly two-year period beginning in 2005.
The FHFA alleges that JPMorgan and other defendants represented falsely that the underlying mortgages complied with certain underwriting guidelines and standards, including representations that the borrowers had the ability to repay their loans.
In its motion to dismiss the case, JPMorgan charged the FHFA with failing to support its claims that the loans underlying the securitizations departed from the guidelines described in offering documents. The company also contended that downgrades of the securities by ratings agencies put Fannie and Freddie on notice of their concerns as early as September 2007 and that the FHFA’s claims amounted to what JPMorgan charged was fraud by hindsight.
Judge Cote allowed the case to proceed but winnowed the claims.
While Fannie and Freddie "were certainly aware that they were purchasing securitizations backed by subprime loans," there is nothing in court papers to "establish that they knew that the loans supporting these particular securitizations were so haphazardly originated as to put in jeopardy even the AAA-rated certificates they purchased," the judge wrote in her opinion.
As for the JPMorgan Chase’s argument that Fannie and Freddie waited too long to file their suit, "there is little, if any reason to believe that the downgrade of those tranches should have led the [government-sponsored entities] to discover that the underlying mortgages were not simply risky, but so poorly underwritten as to put at risk even the most senior certificates," Cote added.
A JPMorgan spokesman declined to comment on the ruling.
The FHFA contends that Fannie and Freddie purchased roughly $33 billion in residential mortgage-backed securities sponsored or underwritten by JPMorgan, Bear Stearns or Washington Mutual over a roughly two-year period beginning in September 2005. JPMorgan acquired Bear Stearns and Washington Mutual following their failures in 2008.
The securities were backed by the underlying mortgages. Their value depended on the ability of the borrower to repay the loan principal and interest and the adequacy of the collateral in the event of default.
In all, the case concerns 103 securitizations. JPMorgan served as lead underwriter for 30 out of the 103 securitizations at issue in the case. Bear Stearns served as lead underwriter for 38 of the securitizations. Other underwriters included RBS Securities, Citigroup and Goldman Sachs.
The court said it expects depositions in the case to take place next year in anticipation of a trial date set for June 2014.
Several large financial institutions have begun to push back against mortgage-related claims. Goldman Sachs recently asked the U.S. Supreme Court to overturn a lower-court decision involving securities backed by residential mortgages that the company says would cost financial firms tens of billions of dollars. Wells Fargo is contending that a federal lawsuit over its lending practices before and after the housing crisis contravenes the terms of the multistate mortgage settlement.