Judge Rakoff awards $90.1 million judgment to Assured Guaranty Corp
The legal press is abuzz with reports of a New York federal judge’s award of a $90.1 million judgment to mortgage insurer Assured Guaranty Corp. after a lengthy trial in its suit against Flagstar Bank FSB. The lawsuit arose from Assured’s claims that Flagstar had misrepresented the quality of roughly $900 million in residential mortgage-backed securities (“RMBS”) covered by an Assured insurance policy.
The length of the trial, size of the award, and prominence of the judge (U.S. District Judge Jed S. Rakoff) who issued the opinion after a bench (i.e., non-jury) trial all have many people thinking that this judgment will have a substantial ripple effect. Among the predictions are that the big banks will now be rushing to the “settlement table,” more eager than ever to avoid liability on claims by mortgage insurers against them.
Issues to consider:
Maybe so. But there are a number of issues to consider. Some of them indeed do weigh against the big banks, while other issues suggest that the mortgage insurers might not want to get too confident.
On the “plus” side for the mortgage insurers: first, needless to say, this is a useful precedent to which to be able to cite in future cases (unless it gets overturned on appeal). Second, there is definitely something to be said for the idea – not only in this case, but also in cases that big banks bring against correspondent lenders – that no one knew the banks’ loan products better than the banks themselves.
That means that the big banks who originated loans on a retail basis and/or acquired loans underwritten to their product specifications by correspondent lenders are in a tough position. They have a very difficult time claiming that their own representations and warranties (to mortgage insurers, to RMBS investors, or to Fannie and Freddie) about the high quality of loans they were peddling should not be enforced strongly against them whenever a misrepresentation can be proven.
Third, insurers are in a stronger position as plaintiffs to begin with than many RMBS investors, and certainly in a stronger position than the banks are when they try to force correspondent lenders to buy loans back. They are in a stronger position because case law holds that insurers typically need only show that their risk level increased because of the alleged misrepresentations. The banks themselves need to show significantly more when they make buy-back demands.
But there are some “minuses” for the insurers as well as more cases like this one get filed. One is that the big banks have generally been successful as defendants in defeating misrepresentation claims made against them. The main reason for this has been that they have been able to demonstrate that, essentially, everyone knew what they were getting into with regard to high-risk, reduced-documentation loan products (this argument very much works against the big banks when they demand repurchases by correspondent lenders, of course).
In other words, are the mortgage insurers seriously claiming that they had no idea that “stated income” or “no doc” loans were widely denigrated in the industry as “liar’s loans,” because they were loans made to borrowers based on little or no verified information about the borrowers’ ability to repay? What risks did the mortgage insurers think they were insuring against, if not the risk that many of these types of loans would go into default? Perhaps for this reason, banks have certainly been known to be the ones filing the lawsuits against mortgage insurers, rather than the other way around.
Moreover, not all insurance policies are alike. Banks negotiate particular policy provisions, and different carriers have different contractual rights and responsibilities. It is therefore difficult to simply assume that all disputes between banks and MI carriers will now tilt towards the carriers.
It’s not over yet..
Finally, Judge Rakoff’s decision rested heavily on his willingness to allow Assured’s expert to “sample” some of the many loans that had been insured, and make assumptions about what was in the rest of a very large pool. This part of the decision will be subjected to particularly strong scrutiny by an appellate court in all likelihood. All loan related claims of misrepresentations really are unique in most important respects. They involve different borrowers, different originators, different loan officers, different loan applications, different alleged errors, different means of proving those alleged errors, and different alleged losses (which may or may not have truly been “caused” by the alleged misrepresentation).
In other words, it may have been more convenient for the court and for the expert to limit themselves to analysis of a sampling of some loans from a much larger pool of loans, but convenience does not always equate with accuracy by any means. If the appellate court finds that this sampling process was unfair or inaccurate, this long legal battle between Assured and Flagstar may be headed right back to district court, with the award to Assured stricken.