Banks facing a mortgage securities lawsuit filed by the Federal Housing Finance Agency lost their chance to enact a defense that could limit their potential liability.

The case — FHFA v. HSBC (and others) — is over loans packaged into securities that were sold off by the defendant banks to Fannie Mae and Freddie Mac.

After it was determined the mortgages contained potential misrepresentations as to the loan quality, the FHFA – as conservator of the GSEs – sued the banks on behalf of Fannie Mae and Freddie Mac.

The case and the most recent decision by U.S. District Court Judge Denise Cote is highly technical and exemplifies how MBS litigation often turns on specific points of law.  

The defendant banks asked the court to consider allowing them to assert the defense of loss causation – a strategy that would allow the firms to lean on the financial crisis or the natural loss of value in a down market as a defense to the FHFA’s claims.

However, FHFA pushed back, claiming this defense only applies to federal securities laws and should not apply to securities claims made under the umbrella of District of Columbia and Virginia blue-sky laws.

After hearing both sides of the debate, the district court refused to sign off on the banks' ability to cite loss causation as a defense in the two jurisdictions.

The case is cited by Reuters as one that could give the FHFA more leverage as it attempts to persuade the banks into settling these claims.  

But more than anything it takes away an avenue of defense, leaving the banks on the hook to challenge claims under both state and federal securities laws.