The Fraudulent Sale of Financial Institutions

In the early spring and early summer of 2007, the subprime mortgage industry, and the value of subprime securities collapsed.

Certainly by December 2007, it was widely known and widely reported, that the widespread dispersion of credit risk related to mortgage delinquencies and defaults was expected to have an very significant adverse impact on the performance of large banks, financial institutions, and the owners or originators of mortgage-backed securities.

Notwithstanding that many financial institutions became troubled or otherwise insolvent as a result their participation in the origination, trading and ownership of collateralized Debt Obligations ("CDOs"), Collaterialized Mortgage Obligations ("CMOs"), and other Asset Backed Securities ("ABSs") consisting primarily of subprime mortgage loans,1 many brokerage firms, including Merrill Lynch, Morgan Stanley, Citigroup, Wachovia Securities, and even E*Trade Securities, underwrote a series of preferred share offerings for financial instutions, i.e. for each other, totaling billions of dollars.

Many of these securities were sold to the investing public as if they were fixed income securities, targeting otherwise conservative-fixed income investors, baited stated yields, when in fact, preferred securities are still equities, they are still subject to market risk, and more importantly the dividend yield is merely precatory, meaning that if a dividend is ever declared, the preferred stock holders have preferential or cumulative rights to any dividends.

Most disturbingly, these securities offerings in the form of the common stock, preferred stock and structured notes, including the securities of AIG, Barclays Bank, PLC, Bear Stearns Cos. Citigroup, Deutsche Bank, Federal National Mortgage Association ("Fannie Mae") The Federal Home Loan Mortgage Company("Freddie Mac"), Merrrill Lynch, and Wachovia, were sold and offered to an unsuspecting investing public, after adverse information was widely disseminated in the investment media and in SEC Filings.

AIG

According to SEC filings, at all times relevant to this action, AIG engaged in the residential mortgage market in at least four significant ways. First, AIG acted as a mortgage originator through its subsidiary American General Finance, Inc., which originated mortgages, including first-lien and second-lien residential sub-prime mortgages. Second, AIG's insurance and financial subsidiaries invested in CDOs and mortgage-backed securities which utilize residential mortgage loans as collateral. Third, AIG acted as a securitizer of sub-prime mortgages, which it packages into various securities, including CDOs, that it marketed to investors . Fourth, AIG, through its subsidiaries, acted as an insurer for investors looking to hedge risk on debt instruments tied to the residential mortgage market.

For example, as early as the summer of 2007, MarketWatch reported that "AIG shares dropped more than 8% in July as investors worried the giant insurer could be hit by losses from declines in the value of subprime mortgages. Paul Newsome, an analyst at A.G.Edwards, observed that "AIG's shares have fallen significantly in past days. Why we don't exactly know, but investors are telling us that it has something to do with the potential for AIG to suffer significant losses from subprime mortgages."

Thereafter, on November 7, 2007, AIG filed its Form 10-Q for the third quarter of 2007 ("2007 Third Quarter 10-Q) after the close of the market. In the 2007 Third Quarter Form 10-Q, AIG disclosed that the credit and mortgage crises had resulted in a third quarter loss in its credit default swap portfolio of $352 million and projected higher losses during the fourth quarter of $550 million, of the company’s approximately $500 billion in total exposure.

At or about this same time, Robert Lewis, AIG’s Senior Vice President and. Chief Risk Officer, revealed to investors that: "As of June 30 this year, AIG had a total net exposure across all asset classes of $465 billion."

Subsequently, on December 5, 2007, AIG held an investor meeting for the purpose of discussing the Company’s exposure to the residential mortgage market. During this meeting, AIG disclosed that the value of its super senior credit default swap portfolio had declined between $1.05 and $1.15 billion since September 30, 2007.

These disclosures, together with the prior disclosures of losses in the 2007 Third Quarter 10-Q, revealed that the total decline in value of AIG's "super senior" credit default swap portfolio November 2007 was between $1.4 and $1.5 billion. AIG later confirmed this disclosure in its Form 8-K/A filed with the SEC on December 7, 2007.

As investors would eventually discover, AIG, through AIGFP, was the counterparty on credit default swaps hedging the risk of failure to pay or other credit condition for at least $527 billion in debt, including over $78 billion in CDOs as of December 31, 2007.

Bear Stearns

Bear Stearns, as an active participant in the $330 billion subprime mortgage industry, was not immune from this collapse, and as of the three month period ended February 28, 2007, the Company reported on SEC Form 10-Q, that it had suffered approximately $372 million in unrealized losses as a result of its derivative and non-derivative fixed income activities. The Company announced in connection with the release of its quarterly financial results that:

Although volumes were strong during most of the quarter, mortgage markets became more cWallenging later in the quarter as investor concern over the rising delinquency levels in the subprime mortgage market escalated.

During February 2007, the ABX subprime mortgage credit indices widened dramatically, reflecting investor concern due to increased delinquencies in subprime mortgages.

(Source: Bear Stears Co., SEC Form 10-Q, Feb. 28, 2007 "Management Discussion & Analysis ").

By July 2007, the extent of BSC’s exposure to the subprime crisis began to further emerge. As of May 31, 2007, the Company’s unrealized losses as a result of its derivative and non-derivative fixed income activities increased to approximately $597 million. The Company’s stock which has been as high as $187 per share decreased to a low of approximately $134 per share losing more than 28% of its value. On July 10, 2007, the Company announced that:

Challenging market conditions in the U.S. residential mortgage business were experienced in the 2007 quarter as difficulties in the sub-prime mortgage market continued to be a concern.

(Source: Bear Stears Co., SEC Form 10-Q, July 10, 2007).

As of August 31, 2007, according to the Company’s press releases and SEC filings, the Company had total ABS/CDO related exposures of approximately $2 billion. In August 2006, the price of the Company’s common stock decreased to less than $100 per share.

On November 14, 2007, the Company announced via SEC Form 8-K that as a result of its subprime exposure, "the Company will be taking a net write-down of approximately $1.2 billion on these positions and others in our mortgage inventory."

On December 20, 2007, the Company reported approximately $1.543 billion in unrealized losses as a result of its derivative and non-derivative fixed income activities, and on January 28, 2008, the Company reported that its "Mortgage-related revenues reflect approximately $2.3 billion in net inventory write downs in the second half of fiscal 2007."

In January 2008, the Company’s common stock, which had been as high as $187 a year earlier, lost more than 60% its value, and decreased to a low of approximately $68 per share. On January 28, 2008, the Company also reported that:

The current global credit crisis, inventory exposure, and potential counter party credit exposure, may continue to adversely affect our business and financial results.

During 2007, higher interest rates, falling property prices and a significant increase in the number of subprime mortgages originated in 2005 and 2006 contributed to dramatic increases in mortgage delinquencies and defaults in 2007 and anticipated future delinquencies among high-risk, or subprime, borrowers in the United States.

The widespread dispersion of credit risk related to mortgage delinquencies and defaults through the securitization of mortgage-backed securities, sales of collateralized debt obligations ("CDOs") and the creation of structured investment vehicles ("SIVs") and the unclear impact on large banks of mortgage-backed securities, CDOs and SIVs caused banks to reduce their loans to each other or make them at higher interest rates.

It is difficult to predict how long these conditions will continue, whether they will continue to deteriorate and which of our markets, products and businesses will continue to be adversely affected. As a result, these conditions could adversely affect our financial condition and results of operations. In addition, we may be subject to increased regulatory scrutiny and litigation due to these issues and events.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

(Source: Bear Stears Co., SEC Form 10-Q, Jan. 28, 2008).

On March 11, 2008, or less than two weeks later, Deutsche Bank AG reported that Bear Stearns will probably have $1.9 billion more write downs in the first half of 2008. Subsequently, Oppenheimer & Co. analyst Meredith Whitney wrote that "this investment simply is mired in too much risk," and that BSC shares "could become worthless'' if the company is forced to sell assets."

On March 14, 2008, the Company announced that its financial condition had "significantly deteriorated," and that absent additional capital the Company would be required to withdraw from its securities related activities.

Following this announcement and the merger of BSC with JP Morgan, on March 17, 2008, the price of BSC common stock opened at $3.17 per share.

Citigroup

It was widely reported, in the Fall of 2007, that Citigroup was "among banks that have suffered in the housing crisis as values have fallen and mortgages have gone unpaid."

Indeed in the first Quarter of 2008, Citigroup announced that the bank, which lost $5.1 billion in the first quarter and wrote down $12 billion in securities tied to debt, and that the Company expected an additional "$45 billion of losses and write-downs as a slowing economy hurts its customers’ ability to pay back everything from corporate loans to subprime mortgages."

Citigroup issued these preferred shares "to shore up its balance sheet after the largest U.S. bank recorded over $16 billion in write-downs and credit losses in the first quarter, thereby bringing Citigroup’s"total of capital raised since November to more than $36 billion to help offset more than $45 billion of losses and write-downs."

Deutsche Bank

Aas early as October 2007, Deutsche Bank disclosed to the investment community that the bank was experiencing substantial difficulties as a result of the "subprime\" crisis. On October 31, 2007, the company disclosed that "charges of € 603 million (net of fees) were taken against leveraged loans and loan commitments, over and above charges already taken in the second quarter 2007. Reflecting these charges, Origination revenues were negative € 120 million.

The bank also further disclosed that its "Performance suffered primarily from the rapid loss of liquidity in credit markets from August onwards. The substantial market turbulence caused breakdowns in relationships between credit securities and hedging instruments such as derivatives based on broad market indices. These together with the loss of liquidity negatively impacted credit trading positions in relative value trading, CDO correlation trading and residential mortgage-backed securities, even after taking into account significant gains on offsetting hedge positions." According to the bank, "Difficulties in the U.S. residential mortgage market may persist, impacting the wider economy."

Thereafter, in February 2008, just days prior to Binder’s purchases, Deutsche Bank announced that it anticipates first-quarter 2008 mark-downs in the region of € 2.5 billion in key areas, and that its "results for the fiscal year 2007 included losses relating primarily to the write down in the fair values of our trading activities in relative value trading in both debt and equity, CDO correlation trading and residential mortgage-backed securities and the leveraged loan book including loan commitments. We continue to have exposure to these markets and products and, therefore, could be required further to write down their carrying values and incur further losses. Any of these writedowns could have a material adverse effect on our results of operation and financial condition."

Federal National Mortgage Association ("Fannie Mae")

In September 2004, the Office of Federal Housing Enterprise Oversight ("OFHEO") announced that the Federal National Mortgage Association ("Fannie Mae") was under investigation for engaging in deceptive accounting practices. Subsequently, in December 2004, Fannie Mae announced a $6.3 billion restatement of its earnings, the largest restatement in American history, and in May 2006, announced a $400 million settlement with securities regulators and the OFHEO for violating certain accounting standards.

In November 2007, Fannie Mae announced its results of operations for the third quarter of 2007, and reported a loss of $900 million. Fannie Mae reported $56.2 billion in subprime and Alt-A loans, and for the period ended September 30, 2007, reported a $8.7 billion decline in the value of its assets.

In a November 9, 2007 conference call with securities analysts, Fannie Mae President and Chief Operating Officer, Daniel H. Mudd, told investors that the Company had approximately $3 trillion dollars at risk in residential home mortgages, and that the Company had reserves of approximately $41 billion.

On December 4, 2007, Fannie Mae announced that the Company would reduce its dividend, and in February 2007, the Company, citing continued deterioration in the housing market and an increase in its credit loss experience, reported a $7.1 billion decline in the value of its assets and a net loss of $2.1 billion.

In July 2008, several investment analysts reported that Fannie Mae would require an additional $46 billion in capital, following a report by the Federal Reserve that suggested that the company was insolvent. On September 7, 2008, federal regulators seized control of Fannie Mae, and notwithstanding that Claimants liquidated their Fannie Mae shares in July 2008, as of even date, these securities are also substantially worthless.

The Federal Home Loan Mortgage Company ("Freddie Mac")

However, as early as 2004, The Federal Home Loan Mortgage Company ("Freddie Mac") was the subject of warnings that the Company was taking on excessive risk in subprime and Alt-A loans. Both the Wall Street Journal and the New York Times reported that in mid 2004 it was widely known that Freddie Mac’s underwriting standards were becoming "shoddy" and that the Company’s lending practices "would likely pose an enormous financial and reputational risk to the Company."

In November 2007, Freddie Mac announced a third quarter loss of $2 billion due to the Company’s "deteriorating mortgage portfolio.\" In a November 20, 2007 conference call with securities analysts, the Company stated that it was expecting a $10 to $12 billion in credit losses in 2008 and 2009. Subsequently, OFHEO reported that Freddie Mac "had fallen below the capital level required to maintain safety and soundness and was in danger of being ordered to cease and desist buying mortgages until it replenished its capital base.

Lehman Brothers

In fact, prior to the release of the results of operations for the Lehman’s quarter ended February 29, 2008, it was widely anticipated, and widely reported on Bloomberg News and in the Financial Times, that Lehman was expected to lose up to $700 million dollars on its hedging positions. On June 9, 2008, Lehman reported a net loss of $2.8 billion.

On September 15, 2008, Lehman filed a voluntary petition to reorganize under Chapter 11 of the Federal Bankruptcy Code. As of even date, the preferred securities of Lehman Holdings are substantially worthless.

Wachovia Bank

On December 5, 2007, Wachovia disclosed that "the value of CDOs we have in our portfolio CDOs experienced declines and the Company’s third quarter 2007 market disruption-related losses totaling $1.3 billion pre-tax included $347 million of subprime-related valuation losses." The Company further disclosed that "due to the October market deterioration, these ABS CDOs experienced further declines in value in the month of October 2007 by an amount we currently estimate to be approximately $1.1 billion pre-tax."

On September 29, 2008, federal regulators announced that Wachovia was insolvent, and that Citigroup had agreed to purchase Wachovia’s banking operations for $2.1 billion in a deal arranged by federal regulators, making the Charlotte, N.C. based bank the latest casualty of the widening global financial crisis.

If you have suffered damages as a result of the purchase of the securities of any of these financial institutions, and were unaware that these were troubled institutions at the time of your purchases, particularly if your purchases were made in connection with the public offering of these securities, contact us for a free evaluation of your claim.

Subprime loans are not guaranteed by the U.S. Government or its agencies, and these assets consisting of mortgages typically come from unregulated mortgage wholesalers, which are pooled and "securitized," to be sold off to investors in tranches, or pieces, sometimes with little or no due diligence with respect to the quality of the loans being placed in any particular portfolio. Sub-prime mortgage borrowers have a less than perfect credit history and are required to pay interest rates higher than what would be available to a typical agency borrower. These loans are often originated with less than complete information as to the borrower's net worth, employment, credit history or other areas where complete information had historically been required prior to a loan being made.

Sources/Additional Readings:

See, e.g. T. Sabarwal, "Common Structures of Asset-Backed Securities and Their Risks," Univ. Calif. Berkeley, (December 29, 2005);

"Asset Backed Securities: The Dangers of Investing in Subprime Debt,\" McLean, Bethany (April 19, 2007).