FDIC is Unable to Skip Out on WAMU

Earlier this week, a Federal judge ruled that she would not dismiss a case brought by Deutsche Bank over the FDIC’s responsibility for billions of dollars in bad residential mortgages originated or purchased by Washington Mutual Bank in 2008 or earlier and later packaged into mortgage-backed securities.

In 2009, Deutsche Bank National Trust Company filed a lawsuit against the FDIC charging it with liability for losses from these bad mortgages up to US$10Billion.  The FDIC attempted to have the suit dismissed arguing that the plaintiff should be pursuing JP Morgan Chase & Co. which had acquired WAMU from the FDICThe FDIC had been appointed receiver for Washington Mutual in 2008, when the bank collapsed under the weight of the failure or its US mortgage business).  Not surprising that JPM argued that it had not assumed WAMU’s liabilities for these mortgages or the MBS structures.

Apparently, the judge seems to have agreed with JPM and the case against the FDIC will proceed in U.S. District Court.  This could turn out to be a very significant ruling and there are a couple of very interesting potential repercussions that come to mind.

1)  If we can take the judge’s ruling at face value then the FDIC’s liability will likely hinge on precisely what liabilities it agreed to retain in connection with the sale of WAMU to JPM.  We would suggest that it would not be unusual, particularly in the context of an asset sale (as this may have been structured), for the buyer and seller to agree upon some extensive “carve outs” for “pre-existing liabilities”.  How the the mortgage collateral was farmed and how these MBS securities were structured are good examples of the types of liabilities that a sharp buyer would be interested in avoiding.  If JPM is correct then it would seem that the FDIC is “left holding the bag”.

2)  Assuming that the FDIC is responsible and assuming that the plaintiff in the Deutsche Bank case prevails, we see the next milestone to be the determination by the FDIC of whether it will actually pay-up or not.  It may believe that it can fall back on Dodd-Frank or other pre-exiting laws and regulations  that would allow it to avoid liability for these bad loans.  We’re not yet exactly sure what their strategy might include but such a position seems logical, given their first reaction to point Deutsche Bank to JPM.  We believe that this strategy expose a long-held belief at the Agency that, while the FDIC can step in at anytime and take over an institution it oversees, it never takes on any liabilities for those actions, at least not to third-party mortgage-backed  investors.

If the FDIC is found to have assumed those liabilities then the good news for investors in securitization structures could be that the “liability chain” was not broken with the onset of FDIC receivership. 

Going further, if the plaintiffs in the WAMU case are able to recover all or a substantial percentage of their losses, might that not signal to the FDIC and the investor community that these structures must, in fact, be treated as off-balance sheet and, in effect, restore the concept of “perfection of security interest to where the vast majority of issuers and investors in securitized debt thought it was prior to 2008 and Dodd-Frank.

Wouldn’t that be something!!

About markferraris
Managing Principal Orchard Street Partners LLC

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