But on Monday, in the starkest of terms, a federal judge dealt a strong blow to that version of history. She ruled that two banks misled Fannie Mae and Freddie Mac in selling them mortgage bonds that contained numerous errors and misrepresentations.
“The magnitude of falsity, conservatively measured, is enormous,” Judge Denise L. Cote of Federal District Court in Manhattan wrote in a scathing 361-page decision.
The ruling came in a closely watched case brought by the government against the Japanese bank Nomura Holdings and Royal Bank of Scotland. They were the only two of 18 financial firms that took their case to trial, arguing that it was the housing crash, and not deceptive loan documents, that caused the bonds to collapse.
The government, under pressure to hold Wall Street accountable after the crisis, has pursued a wide range of actions against domestic and foreign banks. Agencies including the Justice Department and the Securities and Exchange Commission have reached multibillion settlements.
But some of the government’s biggest wins — including its victory on Monday — have come from an unlikely source: the Federal Housing Finance Agency, a relatively obscure Washington entity set up to oversee Fannie Mae and Freddie Mac, the beleaguered government-sponsored enterprises rescued by taxpayers in September 2008.
The agency’s lawyers have aggressively pursued the banks, helping the government secure big-dollar settlements. But unlike the relatively opaque settlements, the trial against Nomura and R.B.S. opened a window into the behavior of banks heavily involved in subprime mortgages at the peak of the housing boom.
Judge Cote, and not a jury, decided the case, after the government dropped a claim that would have entitled the banks to a jury. After that, legal experts became more pessimistic about the banks’ chances: Judge Cote has a reputation for taking a hard line against the banks. They also expressed surprise that the Nomura and R.B.S. did not settle, though some suspected that as foreign banks, they were less concerned with risking their reputations in the United States.
Judge Cote has asked the F.H.F.A. to submit a proposal for damages, which are expected to be about $500 million. “It is clear the court found that the facts presented by F.H.F.A. were convincing,” Alfred M. Pollard, the agency’s general counsel, said in a statement.
A Nomura spokesman, Jonathan Hodgkinson, said the bank plans to appeal the decision. “Nomura is confident that it was consistently candid, transparent and professional in all of its dealing with Fannie Mae and Freddie Mac,” he said. A spokesman for R.B.S. could not immediately be reached for comment.
Some financiers and housing industry analysts have since asserted that, while Wall Street was acting out of greed and with a cavalier disregard for risk, it did not act deceptively. But Judge Cote, in her order, took a dim view of the banks’ conduct. She said that loan guidelines were “systematically disregarded” and found “disturbing examples” showing that Nomura was willing to package and sell defective loans.
“This case is complex from almost any angle, but at its core there is a single, simple question. Did defendants accurately describe the home mortgages in the offering documents for the securities they sold that were backed by those mortgages?” she wrote in her decision. “Following trial, the answer to that question is clear. The offering documents did not correctly describe the mortgage loans.”
Judge Cote described Nomura as a late-to-the-party participant in the mortgage boom that cut corners to win business, which, she asserted, led the bank to stuff the pools of mortgages that it sold to Fannie Mae and Freddie Mac with defective loans. The Federal Housing Finance Agency, which was represented by Quinn Emanuel Urquhart & Sullivan, said two-thirds of the mortgage loans underlying the securities had underwriting defects.
“As its witnesses repeatedly described and as its documents illustrated, Nomura’s goal was to work with the sellers of loans and to do what it could to foster a good relationship with them,” the judge wrote. “Given this attitude, it is unsurprising that even when there were specific warnings about the risk of working with an originator, those warnings fell on deaf ears.”
During the trial, expert witnesses performed analyses of some of the loans backing the disputed bonds. The experts brought in by the housing finance agency said far more of the loans than the documents stated had characteristics that made them much more likely to default.
Lawyers for Nomura and R.B.S. argued that those experts’ analyses were seriously flawed. In his closing argument last month, David B. Tulchin, a lawyer for Sullivan & Cromwell, representing Nomura, called the experts’ methodologies “entirely artificial in the extreme.”
The banks’ lawyers could argue on appeal that even though Fannie Mae and Freddie Mac took steep paper losses on the bonds, their actual losses have been small. All payments on the roughly $2 billion in bonds have been made, except for about $25 million, according a member of Nomura’s legal team, who spoke on the condition of anonymity.
More broadly, Nomura, in its appeal, will most likely continue to argue that the government’s losses on mortgage bonds were caused by the wider housing crash, making it a legal stretch to tie the losses on those bonds to flaws in the underlying loans.
Judge Cote, however, said that the banks’ misconduct exacerbated the collapse in the mortgage market.
“The origination and securitization of these defective loans not only contributed to the collapse of the housing market, the very macroeconomic factor that defendants say caused the losses,” she wrote, “but once that collapse started, improperly underwritten loans were hit hardest and drove the collapse even further.”