On November 21, 2007, plaintiffs’ lawyers initiated separate securities class action lawsuits against the Federal Home Loan Mortgage Corporation (better known as Freddie Mac) and against bond insurer ACA Capital Holding. Both of these lawsuits reflect the deepening seriousness of the credit problems arising from the subprime lending meltdown, and the problems besetting these companies suggest even larger problems ahead.
defendants concealed the following information, which caused their statements to be materially false and misleading: (a) defendants were not implementing sufficient risk management controls to protect the Company from acquiring billions of dollars worth of mortgages with poor underwriting standards, causing the Company to have an untenable amount of risky loans; (b) defendants were not implementing controls to ensure that appraisals were done appropriately and to prevent collusion between lenders and appraisers, increasing the risk of defaults; (c) the Company was not adequately reserving for uncollectible loans, causing its financial results to be misleading; and (d) the Company had billions of dollars of bad loans which it would eventually have to write off, causing losses and capital deficiencies.
The problems at the heart of this lawsuit bespeak the fundamental problems afflicting the U.S. residential real estate market. Just since the end of October, problems stemming from these issues have led to lawsuits against some the country’s largest financial institutions, including Citigroup, Merrill Lynch, Washington Mutual – and now Freddie Mac. But the problems leading up to the lawsuit against relatively small ACA Capital hint at even more complicated problems that may yet arise, and may lead to even larger problems outside the residential real estate sector.
Analysts are feeling abused and embarassed. One muttered that such losses evidently were not unforseeable to the people who bought the insurance. Another suggested that perhaps this would become an issue for whatever company provides directors and officers insurance for the people who run Swiss Re, and asked what company had taken on that risk.
Swiss Re would not answer that question.
Special thanks to alert reader Matt Rossman at Citigroup for links to the Swiss re articles and the Floyd Norris blog post.