More than a dozen of the world’s largest financial institutions conspired to fix the prices on more than $485 billion in bonds issued by Fannie Mae and Freddie Mac over a five-year period, according to a new blockbuster lawsuit.
The lawsuit was filed this week by the state of Pennsylvania, which claims that Bank of America; Barclays Capital; BNP Paribas; Citigroup; Credit Suisse; Deutsche Bank; Deutsche Bank Securities; First Tennessee Bank; FTN Financial Securities; Goldman Sachs; JPMorgan Chase; J.P. Morgan Securities; Merrill Lynch; and UBS Securities conspired to both overcharge and underpay investors on debt bonds issued by Fannie and Freddie between 2009 and 2014.
The lawsuit, filed by Pennsylvania Treasurer Joe Torsella, is a class action lawsuit that claims that the state invested in the bonds but was financially harmed by the financial institutions alleged actions.
The lawsuit seeks to have other aggrieved parties join it, but the lawsuit states that the groups’ supposed conduct may have harmed “at least thousands” of other investors.
It’s important to note that the bonds in question are not mortgage bonds. They are bonds issued by the government-sponsored enterprises to support their operations. The bonds are traded “over the counter,” which means that investors work with the bond trading desks at the named institutions to buy and sell the bonds.
Since the bonds are not traded on a public exchange, the broker wields more control over pricing, as comparative bond trading is not made public. Bond values must then be derived based on a price the buyer is willing to pay and what the seller is willing to sell for; known as derivative trading.
The lawsuit claims that the named institutions conspired to fix the prices on those bonds, which allowed them to underpay sellers and overcharge buyers.
“Because the FFB market is an opaque, OTC market, Defendants were able to charge fixed prices without revealing their conspiracy to their customers,” the lawsuit claims.
According to the lawsuit, the named financial institutions controlled more than 64% of the total underwriting of Fannie and Freddie bonds during the time in question, with each institution underwriting at least $28 billion in bonds.
“Defendants have consistently been the 10 largest FFB underwriters in the United States, and each underwrote more than $28 billion in FFBs during the Class Period,” the lawsuit claims. “Thus, Defendants as a bloc dominated control of FFB supply and were well-positioned to use that dominant position to fix the prices of FFBs charged to their customers, the Commonwealth Funds and the Class.”
And the lawsuit isn’t the only trouble those institutions are facing in this regard. According to the suit, the Department of Justice is also investigating the companies for price-fixing the GSE bonds, which was reported by Bloomberg last summer.
From the lawsuit:
On June 1, 2018, four confidential sources revealed that the DOJ Antitrust Division is conducting a criminal investigation into collusion among dealers to fix FFB prices.
These confidential sources revealed that the investigation concerns the prices that dealers in the FFB market charged to investors, such as the Commonwealth Funds and the Class. Specifically, the investigation focuses on illegal activities of bank traders suspected of coordinating to benefit the institutions they work for. Sources said prosecutors from the Justice Department’s antitrust division and criminal division are working on the investigation into the dealers’ behavior in the secondary market.
And the lawsuit states that market data shows conclusively that a conspiracy was indeed in effect.
“Consistent with the DOJ Antitrust Division’s investigation, empirical, economic price data and other market facts demonstrate that Defendants used their control over FFB supply to fix the prices of these instruments, causing the Commonwealth and the Class to pay too much (when buying FFBs) and receive too little (when selling FFBs) on their FFB transactions during the Class Period,” the lawsuit states.
According to the lawsuit, Torsella’s office obtained the pricing data for more than 13,117 unique FFBs and a total of 1.6 million FFB transactions. The lawsuit states that the data shows “highly anomalous” pricing on the Fannie and Freddie bonds, including highly inflated, “supracompetitive” prices on newly issued bonds.
Additionally, the lawsuit claims that the financial institutions inflated the prices of older bonds in the days leading up to the sale of new bonds to establish a higher benchmark, which then allowed them to sell the new bonds at higher prices to earn “excess, unlawful profits.”
Also, the lawsuit claims that evidence shows that the institutions, rather than competing with each other for Fannie and Freddie bond business, “agreed to inflate the prices at which they sold FFBs to investors (the “ask” price), or deflated the price at which they purchased FFBs from investors (the “bid” price), or both.”
According to the lawsuit, a comparison of the pricing of the bonds during the time period in question against the pricing of bonds after 2014 shows prices “markedly decreased” after that time “for no other apparent economic reason.”
The lawsuit claims that the questionable conduct appeared to “statistically diminish” in April 2014, when government regulators began looking into banks’ trading business after the LIBOR scandal first became public knowledge, wherein banks were accused of manipulating the LIBOR interest rate for profit.
According to the lawsuit, before April 27, 2014, the prices charged for new Fannie and Freddie bonds were eight times higher than what was charged after that date.
Torsella’s office claims that an initial analysis shows that four Pennsylvania Treasury funds lost “millions” as a result of the alleged price manipulation by the named institutions.
“Time and time again, we have witnessed Wall Street institutions enrich themselves at the expense of Main Street investors with little to no consequence,” Torsella said. “When I believe that Pennsylvania taxpayers have been taken advantage of, I intend to stand up and fight, and recover for Pennsylvanians what is rightfully theirs. It’s long past time that the big Wall Street institutions remember that the rules apply to them and that breaking them has consequences.”
To read the full lawsuit, click here.
