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FDIC Says Wall Street Banks Defrauded Colonial

On August 10 the Federal Deposit Insurance Corp. filed suit in federal court for the Southern District of New York and in state court in Montgomery against eight of the largest international investment banks alleging securities fraud that contributed to the 2009 collapse of Colonial BancGroup.

Named as defendants in the complaint by the FDIC are Bank of America, Merrill Lynch, Citicorp Mortgage Securities, Citigroup Financial Products, Credit Suisse Securities (USA) LLC, J. P. Morgan Securities, RBS Securities, UBS Securities, HSBC Securities and a host of mortgage servicing companies, including Countrywide.

The three suits allege that 31 mortgage-backed securities sold to Colonial were sold in criminal violation of the Alabama Securities Act and the U.S. Securities Act of 1933. The complaints say the defendants lied about the credit quality of the loans that back the securities, including loan-to-value ratios and the number of properties that were not primary residences.

The 31 securities, says the FDIC, were worth a total of $816 million and says it can prove that over 50 percent of the mortgages that backed them were fraudulently represented. The three suits together call for damages of not less than $425.5 million.

Colonial BancGroup was put into receivership by the FDIC in 2009, shut down with $25.4 billion in assets. It is the third largest bank failure in the U.S. since 2008, the first full year of the financial crisis.

Allegations of fraud by the FDIC, are cited as misrepresentations and omissions of material facts. The more comprehensive list of these alleged actions include the following: the loan to value ratios (LTV’s) of the mortgages in the pool were represented as being lower than they in fact were (the lower the LTV’s the less risky the loans, for example a down payment of $20,000 on a $100,000 home equals an 80% LTV and shows $20,000 equity in the home); the values of the home appraisals for the homes in the pool were overstated (fraudulent and overstated home appraisals will result in lower LTVs and make an unattractive borrower appear to be an acceptable credit risk); homes within the mortgage pools reported only first mortgages rather than both the first and the second mortgages (additional liens reduce the owner’s equity in the property thus increasing the likelihood that the owner will walk away from the home if the value of the property falls below the combined values of the loans); the percentages of owner occupied homes in the mortgage pools were overstated (an owner is thought to be less likely to walk away from his family’s dwelling than a vacation home, or a home bought for speculation); compliance with underwriting guidelines is claimed to have been misstated (it is claimed that the correct number of early payment defaults – those homeowners who become delinquent on mortgages within the first six months was not disclosed); and, it is also claimed that the high delinquency rate of the loans in the pool indicate that the underwriting guidelines were not followed.

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