Mortgage-backed securities were misrepresented as highly valuable, helped trigger market crash
Oregon Treasurer Ted Wheeler and Attorney General John Kroger today announced a lawsuit against former financial giant Bear Stearns & Co. to recover losses that were directly attributable to misleading filings in connection with mortgage-backed securities.
Mortgage-backed securities are bundles of real estate obligations that are sold as an investment, and Bear Stearns, as a significant issuer and underwriter, resold such securities to investors such as the Oregon Public Employees Retirement Fund (OPERF).
When securities sold in 2006 and 2007 were found to be vastly exaggerated in value and quality – in some cases, they were worth only 10 percent of the reported value – investors lost substantial money. The proliferation of such overvalued securities helped to trigger the devastating market collapse of 2008.
Alleged misrepresentations by New York-based Bear Stearns and a subsidiary, Structured Asset Mortgage Investments II, Inc., directly smacked OPERF, which suffered losses estimated at $17 million. In addition, the economic crash of 2008, sparked by the fraud by once-trusted financial firms like Bear Stearns, caused profound financial harm to Oregon families.
"We believe that these junk investments were intentionally mislabeled and all Oregonians are still reeling from the economic fallout," said State Treasurer Ted Wheeler. "If you hurt Oregonians financially, we are coming after you."
"Oregon has zero tolerance for companies that deceive investors," said Attorney General Kroger. "I want to thank Treasurer Wheeler for his continued leadership on this issue."
With the filing, Oregon is joining an existing class action lawsuit which is pending in U.S. District Court in the Southern District of New York. The other plaintiffs are public employees' retirement funds in Iowa and Mississippi, the New Jersey Carpenters' Health Fund, the Boilermaker Blacksmith National Pension Trust, the City of Fort Lauderdale Police & Fire Retirement System, and the Police and Fire Retirement System of the City of Detroit.
The lawsuit is based on the sale of $17.5 billion in mortgage-backed certificates from 2006 and 2007. While those securities were sold as high-quality "investment grade" securities, they were actually part of a pool of 47,148 real estate loans that was largely made up of risky subprime and so-called "Alt-A" mortgages.
Mortgage-backed securities are ostensibly a "fixed income" investment, similar to bonds. Investors that buy the securities are then entitled to receive a predictable flow of income – the regular interest payments on the real estate debt. But that assumes the mortgages are being paid.
Many institutional investors such as pension funds can only purchase "investment grade" securities, so would not have been exposed to the risk if those mortgage-backed certificates were properly rated, the lawsuit says. However, the defendants misrepresented the quality of the loans in the loan pools and gave unjustifiably high ratings.
Since the securities were sold, the value of the investments has collapsed and the ratings on 99 percent of them were downgraded. Of the $17.5 billion in initial securities, rating firms downgraded $17 billion to "below investment grade."
Additionally, while $16.2 billion of the initial securities were once awarded the highest AAA rating, 95 percent of those were subsequently downgraded to "junk bond" status.
The Oregon Public Employee Retirement Fund purchased a total of 57,755,000 of the certificates in five different offerings in 2006 and 2007, at a price of $1 apiece – but the values of many of those securities dropped by more than half, according to the lawsuit.
The economic nosedive of 2007 and 2008 also ultimately led to the demise of Bear Stearns itself. Rather than fall into bankruptcy, Bear Stearns accepted a takeover bid by JP Morgan in 2008.
The Oregon Public Employees Retirement Fund, which had a value of $54 billion as of Sept. 30, is diversified and invested around the world. As a responsible investor, the Oregon State Treasury directly engages with corporations to encourage responsible practices and also takes legal action when companies fail to act in shareholders' best interests.
The lawsuit against Bear Stearns is Oregon's second this year in connection with losses from misreported values of mortgage-backed securities. In July, the State Treasury authorized a lawsuit against Countrywide Financial Corp.