BY Christopher Maag
If your retirement fund bought any mortgage-related investments during the housing bubble, now may be time for a little payback. In two separate announcements in recent days, federal officials announced they will make Wall Street investment houses answer for allegedly lying to investors about the quality of mortgage-backed securities sold right before the housing bubble burst.
In the first case, a U.S. District judge in Manhattan approved a class action lawsuit against Merrill Lynch, alleging that the firm hid basic facts concerning $16.5 billion worth of mortgage-backed securities sold to unions and public employee retirement funds. The documents contained untrue statements, including promises that all the underlying mortgages met underwriting requirements when in fact they didn’t, according to the complaint.
“After careful consideration, and for reasons that will be stated in a forthcoming written opinion, the court hereby grants both motions,” Judge Jed S. Rakoff of the U.S. District Court of Manhattan said in his opinion, according to Bloomberg.
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The lawsuit was filed by organisations including the Los Angeles County Employees Retirement Association, the Connecticut Carpenters Pension Fund and the Mississippi Public Employees’ Retirement System.
The second case was announced and settled on the same day. In that one, the Securities and Exchange Commission charged JP Morgan Securities LLC with selling $150 million worth of mortgage-based investments on the promise of rising returns, even as the investments themselves were chosen by a hedge fund with $600 million riding on the bet that they would fail, according to the complaint.
JP Morgan agreed to pay $153.6 million in fines and compensation to the victims.
“With today’s settlement, harmed investors receive a full return of the losses they suffered,” Robert Khuzami, director of the SEC’s enforcement division, said in a press release.
The investors included retirement funds with hundreds of thousands of members, including General Motors Asset Management, which manages GM pension plans, and Thrivent Financial for Lutherans. The investors received marketing materials stating that the investments were organised by GSC Capital Corp., which was experienced in analysing the risk involved in such products.
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What the investors never learned was that Magnetar, a hedge fund, played a major role in selecting what would go into the portfolio. By the time the deal closed in May 2007, Magnetar had bet $8.9 million that the portfolio would grow in value.
But that “long” bet was dwarfed by Magnetar’s “short” bet, in which the hedge fund wagered $600 million that the portfolio’s value would plummet once the mortgages upon which it was based started to default.
Nor was J.P. Morgan blind to its partner’s conflict of interest, or the spreading belief that the mortgage market was about to implode. As one J.P. Morgan salesperson wrote in an internal email three months before the deal was finalised, “We all know [Magnetar] wants to print as many deals as possible before everything completely falls apart,” according to the SEC complaint.
The top investors in the problematic portfolio will get $125.87 million back from J.P Morgan. The rest of the settlement money, $27.73 million, will be paid as fines to the U.S. Treasury.
Christopher Maag is Credit.com’s Staff Writer. Chris graduated with honours from the Columbia University Graduate School of Journalism, and has reported for a number of publications including The New York Times, TIME magazine and Popular Mechanics.
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