The trial of the century—a long-awaited determination of the damage perpetrated by Wall Street institutions in the financial crisis—began Monday in New York. But it’s only happening because one bank—unlike Goldman Sachs, JP Morgan, Citigroup, and Bank of America—refused to settle out of court. The Japanese firm Nomura stands accused of lying to mortgage giants Fannie Mae and Freddie Mac about the quality of mortgages pooled into securities during the housing bubble. The case will finally reveal hard data on just how much money Nomura, and the rest of the industry, made through fraud.

The Federal Housing Finance Agency (FHFA), conservator of Fannie Mae and Freddie Mac, sued 18 of the biggest banks in the world in 2011. As an investor, Fannie and Freddie purchased $196 billion in mortgage-backed securities from 2005 to 2007, filled with loans that did not meet specific underwriting guidelines. Sixteen of the 18 banks settled with FHFA, netting the agency $18.2 billion. One suit with the Royal Bank of Scotland remains in limbo. Only Nomura pushed FHFA into trial.



FHFA purchased seven mortgage-backed security deals worth about $2 billion from Nomura, just 1 percent of the total mortgage-backed securities it purchased. But the trial will force the agency to actually show its work. Unlike in the settlements, which offered no details beyond the names of the securities, FHFA must explain why they’re asking for $1.1 billion in damages, over half of what it spent.

In its opening statement, FHFA alleged Nomura prospectuses about the quality of the mortgage pools were materially false. It stated that 68 percent of a sample of loans in Nomura securities had underwriting standards below what the bank advertised. That resembles the findings of Clayton Holdings, a third-party reviewer of mortgage pools for Wall Street banks (FHFA used Clayton estimates in their complaint). FHFA also charged that home appraisals were inflated by an average of 11 percent. Tellingly, Nomura tried to block John Kilpatrick, the FHFA’s expert witness on appraisals, from testifying.

This small set of facts brings sharper focus to the securitization scheme. For context, banks proffered over 1,800 mortgage-backed securities deals during the housing bubble. But all the securitizations were structurally, more or less, the same as Nomura’s; that’s why FHFA sued 18 banks. Under representation and warranty agreements, if the underwriting did not match the securities issuers’ claims, investors like Fannie and Freddie could demand that the bank repurchase the bad loans. That means that FHFA could have stuffed over two-thirds of its securities back into Nomura’s pockets. Federal judge Jed Rakoff made a similar determination in the Countrywide “Hustle” case last year when he ordered damages of $1.3 billion on defective mortgage sales to Fannie and Freddie, based on the percentage of loans that were poorly underwritten.