In a bit of bad news for the largest global banks as they are working to resolve their mortgage-related woes from the economic downturn of 2008, Federal regulators are investigating whether the banks wrongly booked profits between 2009 and 2011 by mispricing mortgage-backed securities originated before the crisis.  The investigation could open yet another can of worms for the banks, who have already doled out billions of dollars over the last few years, to settle the numerous lawsuits that were spawned by their mortgage-related malpractices.
This investigation suggests that the banks’ misconduct may not have been confined to the years before the downturn. The legal mess from mortgage-backed securities could haunt the banks for much longer if the investigation brings up any evidence against them. This will certainly not help investor sentiment, which has been largely fueled in recent years by the belief that the banks are only dealing with “legacy” mortgage issues.
The banks under scrutiny include Barclays (NYSE:BCS), Citigroup (NYSE:C), Deutsche Bank (NYSE:DB), Goldman Sachs (NYSE:GS), JPMorgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS), RBS (NYSE:RBS) and UBS (NYSE:UBS).
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Global banks which had a major role in the mortgage-backed securities market in the wake of the economic crisis of 2008 have been under considerable scrutiny since then, for the unbridled manner in which they originated and sold these securities. Over the years, the banks have had to make considerable changes to their business models and capital structures to comply with stricter regulatory requirements, even as settlement and other litigation costs for all of them totaled more than $100 billion.
But it looks like there may be more to the story as far as banks’ misconduct is concerned. The Securities and Exchange Commission (SEC) and the special inspector general for the Troubled Asset Relief Program are looking into the possibility of the banks quoting a value for the hard-to-price mortgage securities that was either too high or too low so that they could profit in these deals. The investigation is in its preliminary stages, and several banks have been served subpoenas in this regard in addition to some hedge funds and large investment firms likely to be involved in such deals.
While the investigation could end with the banks being let off the hook if no dirt turns up against them, the possibility of a fresh new wave of mortgage-related lawsuits is daunting. In such a scenario, investor confidence in bank stocks would take yet another hit as banks scramble to reach settlements with regulators – costing them billions more over coming years.
A clear idea of the impact of this on UBS – one of the banks under the scanner – can be obtained by reducing the margins for its investment banking business for the future as shown in the chart below, as the higher legal costs will eat into profits from these operations.Notes: