Some of the biggest players in banking's mortgage-finance assembly line — including JPMorgan Chase & Co., Citigroup Inc. and Credit Suisse Group — are asking a federal judge to dismiss a nearly $2 billion civil fraud lawsuit filed by the trustee of a defunct mortgage lender.
In a filing Tuesday in U.S. Bankruptcy Court in Baltimore, the banks asked Judge Duncan W. Keir to throw out the lawsuit filed by the trustee overseeing the liquidation of Thornburg Mortgage Inc. Among the other banks seeking dismissal of the suit are the Royal Bank of Scotland Group PLC and UBS AG.
Joel Sher — the court-appointed trustee overseeing the liquidation of Thornburg, once the nation's second-largest independent mortgage company — sued the banks earlier this year, claiming they engaged in series of "collusive" and "predatory" schemes taken by investment banks during the mortgage crisis in 2007 and 2008 that resulted in the lender's demise.
That scheme involved the banks demanding more than $700 million of margin and interest payments for which, Sher says, the Thornburg estate received no reasonably equivalent value. Bankruptcy law allows a trustee to unwind certain transfers as fraudulent transactions if they rendered the company insolvent and provided no benefit to the estate.
Prior to its collapse, Thornburg financed its business, including its purchase of mortgage-backed securities, through a series of repurchase agreements and swaps deals with the banks. Those mortgage-backed securities were typically then pledged as collateral in the deals.
The trustee's lawsuit alleges the banks improperly colluded to seize the property backing the deals and drive Thornburg into bankruptcy.
But the banks' lawyers argue that the trustee is simply "looking to 'finger-point,'" and the lawsuit engages in a "self-serving, revisionist story."
The real cause of Thornburg's demise was "the catastrophic decline in the domestic residential mortgage market" to which Thornburg, as one of the market's biggest players, was "inherently and acutely" vulnerable.
In any event, the banks say their actions in connection with their repurchase and swaps agreements with Thornburg were protected by the bankruptcy code's safe-harbor provisions.
Financial contracts like swaps and forwards have long been afforded a special exemption under bankruptcy law, providing counterparties a "safe harbor" from the automatic stay. The provision, a cornerstone of U.S. bankruptcy law, blocks creditors from immediately seizing property for payment of a debt.
Those exemptions were greatly expanded in 2005 to include a wide variety of other derivatives, including credit-default swaps and repurchase agreements involving residential mortgages, financial contracts that ironically were at the heart of the crisis. The thinking behind expanding the exemptions was to allow counterparties to cancel their contracts and seize their collateral if a major investment bank or hedge fund failed, which would prevent the financial system from seizing up.
Sher was named the Chapter 11 trustee of Thornburg, now named TMST Inc., in 2009, after it was discovered that former managers had used the lender's employees and assets to launch a new company.
He declined to comment on the banks' bid to dismiss the lawsuit.
However, earlier this month a different federal judge allowed Sher to proceed with a similar lawsuit against Barclays Capital Inc. over allegations that the bank made improper margin calls that helped drive the mortgage lender into bankruptcy.
Thornburg, a real-estate investment trust that specialized in making jumbo mortgage loans, was founded in 1993. While it avoided many of the excesses of the subprime-mortgage market during the real-estate bubble, Thornburg eventually succumbed to Chapter 11 as the value of the mortgage-backed securities the company packaged and sold to investors plummeted amid the worsening housing crisis.
The company tried to hang on, selling $21.9 billion in mortgage assets in 2007. But as prices for mortgage-backed securities continued to fall in 2008, Thornburg looked to buy a thrift to save the company's failing lending business.
Ownership of a thrift would have given Thornburg access to customer deposits — a cheaper funding source than credit from investment banks, which Thornburg had traditionally relied on to fund its lending business.
But the lender didn't get the necessary approval from its banks to go forward with a restructuring using the thrift strategy, and Thornburg, based in Santa Fe, N.M., filed for Chapter 11 protection in May 2009, listing assets of $24.4 billion and debts of $24.7 billion. The bulk of those assets — some $19.7 billion — were held in securitization trusts. Sher is winding down the company and seeking to recover assets for the benefit of creditors.
