The U.S. credit union regulator, the National Credit Union Administration (NCUA), sued JPMorgan Chase & Co. (JPM) and Royal Bank of Scotland PLC (RBS) on Monday alleging that these banks had deceived five large credit unions by selling more than $3 billion high-risk mortgage-backed securities that were expected to underperform.The NCUA seeks to recover about $840 million in losses at five wholesale credit unions through these lawsuits.
What Went Wrong?
At the time of selling investment vehicles backed by mortgages to these corporate credit unions, JPMorgan and Royal Bank of Scotland made several misrepresentations in the offer documents to make them believe that these investments are attractive and less risky. In reality, however, these securities were laden with heavy risks.
Also misleading were the AAA investment grade given to the securities at the time of selling. This was most inappropriate given the latent risks.
Subsequently, shortly after buying these securities many of borrowers faced a default and the five credit unions collapsed. The NCUA seized two of the five credit unions in 2009 and the remaining three in 2010.
Looking back, the problem was far worse for the corporate credit unions that provide financing and investment services to retail credit unions. Unlike retail credit unions, restrictions on permitted investments were less for corporate credit unions. As a result, corporate credit unions suffered huge losses during the financial crisis.
Of the total 7,000 U.S. credit unions, a significant number of institutions are victims of the mortgage crisis. Since 2009, more than 40 credit unions have failed and several others are struggling to survive.
Basis of Allegation
The NCUA, which guarantees funds to credit unions, is taking legal actions based on its investigations on banks that twisted the details of the high-risk securities to suit their own interests.
The five corporate credit unions, namely U.S. Central, Western Corporate, Southwest Corporate, Members United Corporate and Constitution Corporate are not the only entities under the agency’s scanner.
The NCUA has been trying to spot and take necessary action on many other banks that were responsible for the collapse of credit unions by selling risky mortgage securities. A few more lawsuit filings against Wall Street firms by the NCUA are expected in the upcoming weeks.
Recovery: To What Extent?
The lawsuit against RBS could be settled for about $565 million, while JPMorgan will be forced to pay about $278 million. These proceeds would beef up NCUA's insurance and emergency support funds to some extent.
In another corrective move last year, Goldman Sachs (GS) was charged by the Securities and Exchange related to the sale of mortgage-backed products. The bank settled the case for $550 million. This was the most high profile lawsuit so far, following the recession.
A Step in the Right Direction
In the short run, the ongoing recovery by the lawsuits would reduce the cost of failed credit unions.
We are not sure how things will change with these lawsuits. But these measures are somewhat reassuring as they are aimed at resisting malpractices related to selling mortgage-backed securities.
Moreover, punishments to the culprits should also be well remembered in the years to come. Not only will the penalties come as a big price, they would also tarnish the image of some very big banks.
Most importantly, such measures would enforce the much needed transparency to banking procedures at the time of selling mortgage-backed securities.
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