A regulator sued 17 large banks and financial institutions on Friday over losses on about $200 billion of subprime bonds, which may hamper a broader government settlement of the mortgage mess left over from the housing crisis.
The lawsuits by the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, surprised investors, dragging down bank shares and could add billions of dollars of legal costs at perhaps the worst possible time for the industry.
Friday's lawsuits reflects how different parties, including investors, banks and different government groups are fighting over who should bear losses from a housing crisis that in 2008 drove the economy into its worst recession in decades.
The FHFA accused Bank of America Corp and its Countrywide and Merrill Lynch units, Barclays Plc, Citigroup Inc, Goldman Sachs Group Inc, JPMorgan Chase & Co, Royal Bank of Scotland Group Plc and others of misrepresenting the checks they had done on mortgages before bundling them into securities.
According to the lawsuits, the securities should have never been sold because the underlying mortgages did not meet investors' criteria. As more borrowers fell behind or went into foreclosure, the securities' value fell, causing losses.
Nearly all the banks that were sued declined to comment or were not immediately available for comment. Others called the charges unfounded.
Fannie Mae and Freddie Mac are the epitome of a sophisticated investor, having issued trillions of dollars of mortgage-backed securities and purchased hundreds of billions of dollars more, said Mayura Hooper, a spokeswoman for defendant Deutsche Bank AG, in a statement.
A Bank of America spokesman said Fannie Mae and Freddie Mac are trying to shift responsibility to banks after earlier blaming losses on other factors. A spokesman for Ally Financial Inc, once known as GMAC, called the FHFA claims meritless.
Bank of America faces three FHFA lawsuits, covering losses on more than $57 billion of securities. JPMorgan faces claims related to $33 billion of securities and Royal Bank of Scotland was sued over $30.4 billion of securities.
Several large banks are also negotiating with all 50 U.S. state attorneys general on a comprehensive settlement to address mortgage abuses and limit future mortgage litigation.
This new litigation could disrupt the AG settlement, said Anthony Sanders, finance professor at George Mason University and a former mortgage bond strategist.
Banks might resist settling if they knew litigation from other regulators could deplete capital, he said.
Before the FHFA lawsuits had even hit a court docket, financial experts offered blunt expectations for the outcome.
The lawsuits will be settled, said Sean Egan, managing director of Egan-Jones Ratings Co, an independent credit ratings firm. The end result will be a further outflow of cash from the banks, and more importantly an additional black eye.
FHFA director Edward DeMarco is looking to minimize future losses for Fannie Mae and Freddie Mac, which are owned by the government after being seized on September 7, 2008.
The FHFA filed the suits before a three-year statute of limitations expired. Fannie Mae and Freddie Mac are pillars of U.S. mortgage finance.
Wells Fargo & Co, the largest U.S. bank not sued by the FHFA, entered a tolling agreement waiving its right to claim the FHFA waited too long to sue, a person with knowledge of the matter said. The bank said Wells Fargo might have done this to give it time negotiate its own settlement, the person added.
FHFA spokeswoman Corinne Russell and Wells Fargo spokeswoman Mary Eshet declined to comment.
The KBW Bank Index closed down 4.5 percent on Friday, nearly doubling the losses of the broader market. Bank of America led the index lower, dropping 8.3 percent.
Bank shares also came under pressure from signs the Federal Reserve could start selling short-term debt on its books and buy long-dated bonds to push longer-term yields lower.
Such a move, known as operation twist, would hurt banks whose profit margin is tied to the short-term rates at which they fund and the longer-term rates at which they invest.
Major banks already face potential payouts of tens of billions of dollars to settle regulatory charges of abusive mortgage lending and foreclosure practices, and other investor lawsuits over mortgage debt losses.
Such payouts would reduce earnings and weaken capital levels, perhaps harming the ability of banks to lend money and provide much-needed life to a stalled housing market and weakened economy.
Whether to take action for mortgage bond problems had been under discussion since Fannie Mae and Freddie Mac were placed in conservatorship, a person familiar with the matter said.
While the ultimate amount FHFA will seek is still unclear, that person said it could top the $20 billion settlement being discussed by the banks and the state attorneys general.
Arthur Wilmarth, a George Washington University law professor, said the banks might argue Fannie Mae and Freddie Mac knew how risky the securities they bought were.
If the companies had reason to know mortgages were essentially being given to anyone with a pulse, then banks could argue they were at least partially at fault, he said.
The blizzard of litigation against banks is hurting share prices because investors are unable to estimate the ultimate scope of a given bank's legal liabilities.
Bank of America, for example, had intended its proposed $8.5 billion settlement in June with investors in Countrywide mortgage securities to resolve most litigation tied to its disastrous 2008 takeover of that home loan provider.
But many parties are objecting, and that settlement did not stop insurer American International Group Inc from suing the bank for $10 billion over its own alleged losses.
Nor did it stop Nevada's attorney general from threatening to withdraw from an $8.4 billion nationwide settlement with the bank. The AG now wants to sue the bank, accusing it of reneging on promises to modify mortgages.
Meanwhile, the U.S. Justice Department in May sued Deutsche Bank, accusing it of misleading a U.S. housing agency into believing loans it made qualified for federal insurance.
The FHFA's lawsuits follow an initial lawsuit in July against UBS AG seeking to recover $900 million of losses incurred on $4.5 billion of debt.
One legislator praised the expected FHFA lawsuits.
Brad Miller, a Democratic congressman from North Carolina, said: Not pursuing those claims would be an indirect subsidy for an industry that has gotten too many subsidies already.
Since Fannie Mae and Freddie Mac were seized, taxpayers have spent more than $140 billion to keep them afloat.