The Feds' Upcoming Suit on Major Banks Is Already Taking Its Toll

Banks stocks are getting killed

Late last night, The New York Times reported that the federal government is preparing to sue at least 12 major banks by Tuesday, and the news is already hammering bank stocks. The agency readying the suit, the Federal Housing Finance Agency, oversees the mortgage firms Fannie Mae and Freddie Mac and will likely seek billions in compensation from Bank of America, JPMorgan Chase, Goldman Sachs and others for peddling mortgage-backed securities that ended up being junk. The Times describes the suit as follows:

The suits will argue the banks, which assembled the mortgages and marketed them as securities to investors, failed to perform the due diligence required under securities law and missed evidence that borrowers’ incomes were inflated or falsified. When many borrowers were unable to pay their mortgages, the securities backed by the mortgages quickly lost value.

Fannie and Freddie lost more than $30 billion, in part as a result of the deals, losses that were borne mostly by taxpayers.

Here's how the banks' stocks are doing in early trading and how a pending suit could affect the banks' impending mortgage-bond settlement with investors:

Bank stocks are taking a big hit  In early morning trading, Bloomberg reports that Bank of America fell 7.5 percent, JP Morgan Chase dropped 2.1 percent and Deutsche Bank slipped 4.8 percent. "This market is all about credit and banks right now," a strategist for AMP Capital Investors, which manages almost $100 billion, told Bloomberg. He said a pending lawsuit "is an uncertainty that can go on for years -- that gets the market quite nervous. Bank of America, being at the epicenter of these problems, is going to get smashed."

The FHFA is hammering the banks on two fronts, writes Shira Ovide at The Wall Street Journal: "The Federal Housing Finance Agency wants the banks to compensate them for losses Fannie and Freddie took from investing in bad mortgage bonds, as the New York Times reported. The FHFA already has opposed Bank of America’s $8.5 billion mortgage-bond settlement with major investors — the bank’s big effort to move past its black eye of mortgages."

The combination of the settlement dispute and the impending lawsuits will drag this on indefinitely, writes Felix Salmon at Reuters:

The timing of the suit has nothing to do with the settlement talks, and everything to do with the statute of limitations. But once the suits have been filed, it’ll be hard to persuade the FHFA to drop them quietly — especially if it doesn’t get a large check as part of the settlement. So count this as one more thing which mitigates against any settlement from happening. The banks won’t agree to anything unless they get immunity from securitization-related suits, and the government won’t give them that immunity, not least because it’s a plaintiff in a lot of those suits itself. Expect this saga to drag on indefinitely, rather than being brought to some kind of artificial end through the settlement talks.

Still, it's unclear if the Feds have a strong case, write Caroline Bankoff and Chadwick Matlin at New York magazine:

Why this suit, and why now? It could be that the feds were simply running out of time. The Times reports that a three-year statute of limitations was set to expire Wednesday, so it was best to do it now rather than never. Until the suit is officially announced, it's tough to know whether the feds actually have a case, or if they rushed the action because of that deadline.