Major Banks Accused of Fixing Prices for Fannie Mae, Freddie Mac Bonds on Secondary Market

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A proposed class action lawsuit has been filed in New York over the allegedly anticompetitive practices of financial institutions who bought and sold bonds issued by the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). According to the lawsuit, the defendants, a group of 17 major banks, conspired to artificially raise prices of Fannie Mae and Freddie Mac bonds (FFBs) issued on the secondary market between January 1, 2009, and April 27, 2014.

Fannie Mae and Freddie Mac, the case explains, are government-sponsored entities that issue unsecured bonds to fund a range of operations “for a public purpose.” Because the bonds are associated with the government, though not backed by it, they are generally regarded as secure investments, the suit says.

“Investors typically were drawn to FFBs for their safety and liquidity,” the complaint reads. “FFBs are not perceived to be risky investments, and their returns to investors reflect this fact. Investors did not bargain for the overcharges and underpayments that the Defendant banks caused.”

The lawsuit explains that the secondary market in which FFBs are sold is an “over-the-counter” (OTC) market whose structure provides a prime opportunity for collusion. The case explains that the banks who sell bonds on the secondary market are the very entities who underwrite the FFB issuances, and are therefore privy to confidential pricing information that remains largely inaccessible to investors.

The bonds themselves, the lawsuit goes on, are unlike stocks in that they are not traded on a national exchange. The opacity of the market, which the case depicts as a “dark market” that caters to “a few select, knowledgeable, and privileged dealers,” allowed the defendants, the lawsuit alleges, to manipulate bond pricing without detection. This went on unnoticed, according to the case, because investors in the secondary FBB market typically communicate directly with the banks’ representatives to receive price quotes rather than view price data across the entire market.

The defendants’ alleged scheme was supposedly two-fold: After acquiring bonds from Fannie Mae and Freddie Mac, the banks, the case says, sold the newly issued bonds to investors at artificially high prices in the week following the new issuance. In the days prior to each new issuance, the defendants, the lawsuit alleges, colluded to raise the prices of older FFBs, which thereby set a higher benchmark for FFB pricing and allowed the banks to earn “excess, unlawful profits” on the new FFB inventory.

When investors purchase or sell FFBs, the suit explains, the price is typically quoted in the form of a bid-ask spread, which captures the difference between how much a dealer is willing to pay for a bond—the bid price—and how much it’s willing to sell the same bond for—the ask price. According to the lawsuit, the defendants’ anticompetitive behavior is evidenced by the high “bid-ask spreads” during the class period.

“For example,” the complaint reads, “a Defendant might quote a bid-ask spread of $99.90/$100.10 for a given FFB. $99.90 is the bid price, or the price at which the Defendant is willing to purchase the FFB from the customer, and $100.10 is the ask price, or the price that the Defendant is willing to accept for selling the FFB. The bid-ask spread in this example is $.20, or 20 basis points.”

The wider the bid-ask spread, the greater the profit for the bank, the suit says. During the class period, bid-ask spreads were statistically wide, according to the lawsuit, yet began to decrease after April 2014, for seemingly “no other apparent economic reason” than the banks ceasing their alleged price-fixing practices. In fact, the case states that defendants’ patterns of collusive behavior all began to “statistically diminish” after April 2014, when government regulators reportedly began to significantly increase oversight and scrutiny of banks’ operations.

The lawsuit notes that the U.S. Department of Justice is currently conducting an investigation into price-fixing in the secondary FFB market.