Federal task force brings suit in New York civil court over packages sold to investors during US housing boom

The federal mortgage task force that was formed in January by the justice department filed its first complaint against a big bank Monday, citing a broad pattern of misconduct in the packaging and sale of mortgage securities during the housing boom.

The civil suit against Bear Stearns & Co, now a unit of JP Morgan Chase, was brought in New York state court by Eric T Schneiderman, the state attorney general. Schneiderman is also a co-chairman of the task force, known as the Residential Mortgage-Backed Securities Working Group.

The complaint contends that Bear Stearns and its lending unit EMC Mortgage defrauded investors who purchased mortgage securities packaged by the companies from 2005 through 2007. The firms made material misrepresentations about the quality of the loans in the securities, the lawsuit said, and ignored evidence of broad defects among the loans that they pooled and sold to investors.

Moreover, when Bear Stearns identified problematic loans that it had agreed to purchase from a lender, it was required to make the originator buy them back. But Bear Stearns demanded cash payments from the lenders and kept the money, rather than passing it on to investors, the suit contends.

Unlike many of the other mortgage crisis cases brought by regulators such as the Securities and Exchange Commission, the action does not focus on a particular deal that harmed investors or an individual who was central to a specific transaction. Rather, the suit contends that the improper practices were institutionwide and affected numerous deals during the period.

A spokesman for Schneiderman declined to comment on the filing.

A representative of JP Morgan, which acquired Bear Stearns in a fire sale in March 2008, said it would contest the allegations.

''We're disappointed that the New York AG decided to pursue its civil action without ever offering us an opportunity to rebut the claims and without developing a full record – instead relying on recycled claims already made by private plaintiffs," said Joseph Evangelisti, the bank's spokesman.

He added that the allegations all predate JP Morgan's acquisition.

To be sure, the allegations in the suit against Bear and EMC are not new. The task force complaint closely echoes legal arguments made in recent years by numerous private litigants trying to recover losses in mortgage securities. Most of these cases continue to inch their way through the courts.

Late last week, for example, JP Morgan lost a round in one of these battles when Jed S Rakoff, a federal judge in Manhattan, rejected the bank's request to dismiss a complaint brought by Dexia, a Belgian-French bank. The European bank had bought $1.6bn in mortgage securities issued by Bear Stearns and Washington Mutual, another institution taken over by JP Morgan during the credit crisis.

Nevertheless, some lawyers who are battling the large banks and investment firms on behalf of mortgage investors said they welcomed the action by the task force.

Gerald H Silk, a lawyer at Bernstein Litowitz Berger & Grossmann in New York, said: "The government's action represents a complete validation of the cases brought by investors who were duped by the fraudulent sale of mortgage-backed securities by JP Morgan, WaMu and Bear Stearns."

The suit encompasses work begun by Schneiderman's office in the spring of 2011, according to people briefed on the investigation. The attorney general subpoenaed documents from JP Morgan Chase and from large mortgage insurers that had also brought cases against the banks for failing to live up to their promises about the types and quality of mortgages placed in loan pools and sold.

New York investigators also capitalized on a cooperation agreement struck by Andrew Cuomo, the previous attorney general, with Clayton Holdings, a major firm in the business of evaluating mortgages. The firm provided documents and emails showing that Bear Stearns routinely ignored major defects on loans it was purchasing and pooling so that it could preserve its relationship with mortgage originators.

After the mortgage fraud task force was created in early 2012, Schneiderman's office combined its efforts with the department of housing and urban development, the SEC, the inspector general of the federal housing and finance agency, the FBI and the department of justice.