MANHATTAN (CN) – Fannie Mae executives cannot dismiss claims that they understated their liabilities by hundreds of billions before the housing market crashed, a federal judge ruled.
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Daniel Mudd headed the Federal National Mortgage Association, better known as Fannie Mae, from June 2005 to September 2008.
Financial regulators say that Mudd adopted increasingly strained euphemisms to describe subprime mortgages, defining them first as loans to borrowers with “damaged credit,” then to those with “weaker credit histories” and finally to ones who “had a credit problem in the past.”
In an Aug. 20, 2008, radio interview, Mudd allegedly insisted that such loans posed “about zero percent” exposure to Fannie Mae.
Mudd took a similarly rosy view toward the risks of Alt-A loans, eventually called “fast and easy” loans because they required less documentation, the Securities and Exchange Commission says.
Fannie Mae allegedly processed these loans under programs called Expanded Approval/Timely Payment Rewards, or EA, and MyCommunityMortgate, or MCM, and left both types of loans out of its subprime calculations.
This maneuver could leave Mudd and others liable to securities fraud claims, U.S. District Judge Paul Crotty ruled Friday.
“The SEC has adequately alleged that FNMA’s quantitative subprime and Alt-A disclosures were false because they failed to include all loans that fell within FNMA’s subprime and Alt-A description,” the 26-page order states.
Regulators claim that Fannie Mae’s failure to include EA loans understated subprime exposure by $60 billion, and that the omission of MCM loans left out an additional $41.7 billion exposure.
“FNMA’s failure to include lender-selected low-documentation loans understated its Alt-A exposure by $341 billion,” Crotty wrote, summarizing the SEC’s complaint.
But Fannie Mae countered that the information was not material since the market did not react when it corrected these alleged omissions.
Though this a “plausible” defense, Crotty said it was not enough to thwart the lawsuit at this stage of the proceedings.
“In sum, the court cannot say at this juncture that FNMA’s failure to include approximately $100 billion of EA and MCM loans in its subprime exposure calculations, and approximately $341 billion in lender-selected low-documentation loans in its Alt-A exposure calculations was immaterial,” Crotty wrote.
The regulators can also pursue charges that Mudd and fellow high-ranking executives Enrico Dellavecchia and Thomas Lund intentionally misled investors.
“Given what defendants knew about EA, MCM, and lender-selected low-documentation loans, as detailed above, they must have known that FNMA’s disclosed subprime and Alt-A exposure calculations were materially misleading,” the order states. “Defendants’ conduct in making, or aiding others that made, these misstatements constitutes an extreme departure from the standard of ordinary care.”
All three face another count of aiding and abetting a securities law violation.
Mudd and Dellavecchia, in particular, will face an additional Securities Act charge for alleging making bonuses based on false statements.