New York Attorney General Eric Schneiderman reignited concerns about residential mortgage-backed securities by filing a multibillion lawsuit against JPMorgan Chase and the financial firms it acquired after the subprime crisis—namely Bear Stearns and EMC Mortgage Corp.

The suit claims the financial firms, which are now part of JPMorgan, are responsible for the underwriting, securitization and packaging of $87 billion in residential mortgage-backed securities that lacked proper oversight in terms of assessing and reporting the real risks tied to the underlying loans. Schneiderman alleges the parties misrepresented the loans’ qualities to investors as well as the strength of their due diligence.

Schneiderman on behalf of the state of New York claims the RMBS affiliated with the firms, which are all under the JPMorgan umbrella today, ended up creating $22.5 billion in investor losses.

The suit also alleges the parties used the Bear Stearns Residential Mortgage Corp. platform and Encore Credit Corp. to generate loans for securitization. In addition, the complaint says EMC purchased additional loans for securitization from other banks and secondary mortgage market sellers.

The suit claims the defendants did not report or accurately represent defects in many of the loans securitized and sold off to investors.

“According to a June 2006 internal Bear Stearns email, almost 60% of American Home Mortgage (AHM0 loans that were purchased through the conduit were 30 or more days delinquent,” the complaint says.

“After learning this information, defendants went on to issue over 30 subprime and Alt-A securitizations that included AHM loans. At least four of these securitizations contained 30% or more loans originated by or purchased from AHM, including SACO I Trust (“SACO”) 2006-8, Structured Asset Mortgage Investments II Trust (“SAMI”) 2007-AR4, SAMI 2007-AR6, and SAMI 2007-AR7. Other internal communications reflect Defendants’ awareness of the bad quality of loans that were being included in other securitizations.”

What due diligence did occur on the loans was ignored, according to the complaint.

“The due diligence providers, well aware of defendants’ need to maintain a relationship with the originators, conducted their loan review accordingly,” Schneiderman alleges. “In late 2006, for example, Clayton’s due diligence review determined that a pool of bad quality SunTrust loans had ‘an 86% reject rate due to missing docs.’ Despite the high defect rate, a Clayton manager told a representative of SunTrust that ‘our number one priority is to help you get this trade cleared up and funded’ – i.e., make sure defendants’ purchase of the loans went through.”

Schneiderman is suing the firms for two counts of fraud—one being securities fraud, the other a cause of action under the Martin Act, which gives government officials broader powers to fight financial crimes. 

Read the complaint here.

3d rendering of a row of luxury townhouses along a street

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