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Recently, nine banks were sued by the U.S. regulator for credit unions – National Credit Union Administration (NCUA) – over the sale of mortgage-backed securities (MBS) worth approximately $2.4 billion. The lawsuits filed in a U.S. district court in Manhattan accused the banks of misrepresentations related to the underwriting and sale of MBS.

The NCUA alleged that the banks, including Morgan Stanley (MS - Analyst Report) and Morgan Stanley Capital I Inc, Barclays PLC (BCS - Analyst Report), JPMorgan Chase & Co.’s (JPM - Analyst Report) Bear Stearns unit, Credit Suisse Group AG (CS - Snapshot Report), The Royal Bank of Scotland Group plc (RBS - Snapshot Report) and UBS AG (UBS - Analyst Report) sold these faulty securities to Southwest and Members United corporate credit unions.  

The Goldman Sachs Group, Inc. (GS - Analyst Report) and Wells Fargo & Company’s (WFC - Analyst Report) Wachovia Corp division, as well as Residential Funding Securities LLC, which is presently known as Ally Securities, were also included in the lawsuit.

The NCUA charged the banks for making misleading statements and omitting important facts in the offering documents of the securities sold to the plaintiffs. Due to the banks’ misrepresentations, the credit unions perceived the MBS to be less risky in nature when on the contrary, they were not so.

Moreover, the NCUA accused the banks of ignoring the underwriting guidelines specified in the offering documents. The credit unions paid roughly $416 million for the securities in the Morgan Stanley lawsuit and almost $1.9 billion for securities sold by the other defendants.

As a result, when these MBS lost their value due to defaults in the underlying assets, the value of investments by the credit unions in these securities also fell. Subsequently, the credit unions collapsed, triggering a crisis in the credit union industry.

Notably, this is not the first time that these major banks are embroiled in a legal hassle with the NCUA. Earlier, the U.S. regulatory body had sued Morgan Stanley and demanded the recovery of losses worth $566 million related to the sale of residential MBS to 2 corporate credit unions that have now collapsed.

Such cases will result in mounting litigation risks for these banks and dent its image as well as financials. On the other hand, recoveries by the NCUA will result in lowering of the losses that stemmed from the failure of the credit unions.

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