This is the second in a series examining some $65 billion of penalties paid by banks to U.S. regulators over mortgage-related abuses.
NEW YORK (TheStreet) -- Florida and Nevada have seen the largest home price declines since the housing market peaked in 2006, but when Citigroup (C)C paid $7 billion in fines in July and JPMorgan Chase (JPM)JPM paid $13 billion in fines in November to settle mortgage-related lending abuses, neither was among the five states that got individual cash payouts.
Also left out were Arizona and Michigan, two other states particularly hard hit by the housing crisis, according to data on foreclosures and home price declines from CoreLogic and RealtyTrac.
Instead, sizeable cash payments went to five states: New York, Massachusetts, Illinois, California and Delaware. Those states have attorneys general who have been particularly aggressive in going after the banking industry for the mortgage abuses that ultimately led to the worst financial crisis since the Great Depression.
In the latest such case, Morgan Stanley (MS)MS disclosed in its quarterly filing Tuesday that the California attorney general's office may seek damages against the company alleging "knowing and material misrepresentations" regarding residential mortgage backed securities it sold to the California Public Employees Retirement System. The California attorney general's office declined requests for comment.
Both the JPMorgan and Citigroup settlements were obtained by the Residential Mortgage Backed Securities (RMBS) Working Group, established by President Obama in 2012 as a collaboration between numerous state and federal authorities. Led by the U.S. Justice Department, the group is working on at least a dozen other cases including a potential $17 billion deal with Bank of America, and it offers a unique window into the peculiar way justice is being meted out some six years after the crisis began.
The RMBS Working Group was created "to investigate those responsible for misconduct contributing to the financial crisis through the pooling and sale of residential mortgage-backed securities" -- bonds backed by pools of individual mortgages.
President Obama created the group in January 2012 just as state and federal authorities were wrapping up the so-called "National Mortgage Settlement" -- a $25 billion settlement with the five largest collectors of mortgage debt at that time -- Bank of America (BAC)BAC, Citigroup, JPMorgan, Wells Fargo (WFC)WFC and Ally Financial (ALLY)ALLY (formerly GMAC) -- regarding abuses tied to foreclosures and mortgage debt collecting practices. Several attorneys general who eventually signed onto that settlement, including New York Attorney General Eric Schneiderman, Massachusetts Attorney General Martha Coakley, California's Kamala Harris, Delaware's Beau Biden and Lisa Madigan of Illinois, successfully argued at the time that the National Mortgage Settlement should not protect the banks from inquiries tied to the packaging and sale of mortgages.
Indeed, it's unlikely the settlement could have been reached without the creation of the working group, which held out the possibility of additional mortgage-related punishment for banks.
Still, when Obama created the group, there was considerable skepticism it would amount to anything. More than two months after the president first mentioned the group in his State of the Union speech, Schneiderman, a co-chair who was in charge of leading the state-level inquiries, "had no office, no phones, no staff and no executive director," according to a pair of housing-rights activists writing in the New York Daily News who cited conversations they'd had with Schneiderman. The two writers added that "none of the 55 staff members promised by [U.S. Attorney General Eric] Holder had materialized."
Zero to Hero
Despite that inauspicious start, the group now looks like a powerhouse. Justice Department press releases now assert that the group includes "more than 200 attorneys, investigators, analysts and staff." It is also said to include "more than 10 state Attorneys General offices around the country." U.S. Justice spokeswoman Ellen Canale would only disclose six states, however, which she said had "made their participation public."
Those are New York, Massachusetts, Illinois, California, Delaware and Maryland. Connecticut and Kentucky confirmed their involvement to TheStreet. The other group members are West Virginia, New Jersey and Missouri, according to a person who works in an office involved in the group, citing a document related to its work.
Beth Ryan, spokeswoman for West Virginia Attorney General Patrick Morrisey, Jeff Lamm, spokesman for acting New Jersey Attorney General John Hoffman and Nanci Gonder, spokeswoman for Missouri Attorney General Chris Koster, all declined to comment.
It's not necessarily a requirement that a state attorney general be an official group member to receive a cash payout from one of the group's settlements, but so far, at least, the only states that have received such payouts are indeed group members.
The winners and losers among the states are separated by the savvy of their attorneys general. Some state attorneys general were better prepared and more determined than others when it came to seeking damages from banks over their conduct during the subprime housing boom. Paradoxically, many of the hardest hit states were among the worst equipped and least willing to punish the banks for their misconduct.
The five states that did get payouts from JPMorgan and Citigroup obtained them and are likely to receive even more because they pursued their own investigations into banks' potential RMBS fraud. Occasionally, these cases are announced publicly and filed in court, though in many instances they aren't. Nonetheless, pursuing a case against a bank allows a state attorney general to gain a privileged seat at the RMBS working group negotiating table alongside the Justice Department, potentially leading to a cash payout.
The remaining 45 states are eligible to benefit from the two settlements, but they won't get cash. Instead, as in the 2012 National Mortgage Settlement, banks pay off a big portion of their fines by earning credits for modifying mortgages. TheStreet explains the credit system in more detail in part one of this series.
The Justice Department press releases announcing both the Citigroup and JPMorgan deals state that the penalties are "for misleading investors about securities containing toxic mortgages." They make little if any mention about harm done to consumers or home owners, even though both settlements include billions in consumer relief such as mortgage modifications.
Indeed, when asked by TheStreet why they weren't getting cash settlements, the initial reaction of Florida, Michigan and Nevada was that they had no losses in their pension funds tied to RMBS. But neither did New York, which has received $705 million in cash between the two settlements, more than any other state. Where other states focused on the impact to their investments, New York successfully interpreted the potential for a settlement more broadly.
"Investors have brought their own private actions on the mortgage-backed securities cases," Matt Mittenthal, spokesman for New York Attorney General Schneiderman, wrote in an e-mail message. "We filed our complaint against JP Morgan on behalf of the people of the State of New York. (Of course, those people include homeowners)."
Other states, such as Illinois, showed losses in their pension funds, but saw some cash go to consumer relief.
"Every negotiation is different, and I would refer you to DOJ for more specifics," wrote Maura Possley, spokeswoman for Illinois Attorney General Lisa Madigan.
U.S. Justice Department spokeswoman Ellen Canale was similarly opaque.
"Settlement allotments are unique to each case and the department works with State Attorneys Generals and federal partners to negotiate and come to a fair and proportionate resolution. States involved in the negotiations determine the value of their investigation, accounting for the quality and quantity of the evidence, and the losses suffered within their respective states," she wrote via email.
Ernest Figueroa, Nevada's chief deputy attorney general, said state AGs finding pension-fund RMBS exposure were able to get a seat at the RMBS Working Group negotiating table, which then allowed them to recoup pension fund losses, and in some cases get relief for consumers. Figueroa said AGs in other states, particularly New York with its powerful Martin Act, had tools that weren't available to Nevada.
"We looked at our statutes; we looked at our jurisdiction, but our pension fund had minimal exposure to residential mortgage backed securities. That kept us from participating in these settlements. To the extent that our policymakers wish to broaden our ability to go after potential wrongdoers in this arena, the office would have additional tools to evaluate similar cases," Figueroa said.
New York clearly has a better toolkit for bringing cases than other states, even putting aside the fact that Attorney General Eric Schneiderman is the only state government official among the five co-chairs of the RMBS working group. New York's Martin Act, originally passed in 1921, gives its attorney general broad latitude in bringing securities fraud cases. Schneiderman used it to bring fraud charges against JPMorgan in October 2012.
Schneiderman spokesman Matt Mittenthal cited that case as an important reason New York got a whopping $613 million payout from the $13 billion JPMorgan settlement in November, more than double what any other state received. The money is stuck in political limbo, however, as New York Governor Cuomo and the New York State Legislature have taken control of the bulk of the funds and need to agree on how to spend them.
"There are no specifics for us to point you towards at this early stage in the process," wrote Morris Peters, a spokesman in the New York State Budget Office.