Bank of America (BAC) is the target of a new lawsuit alleging the company misrepresented the quality of loans it sold to Fannie Mae and Freddie Mac. The suit, which seeks at least $1 billion in damages, is the latest in a string of suits brought against big banks in connection to loans underwritten during the financial crisis.
Preet Bharara, the U.S. attorney for the Southern District of New York, claims Countrywide, which was acquired by Bank of America in 2008, sacrificed quality control and other checks on loan quality in the name of speed as it tried to originate and sell as many loans as possible. The company then falsely claimed that all the proper procedures had been followed and the loans thus qualified for insurance from Fannie and Freddie, the suit says.
In particular, Bharara's suit claims the bank used a process known as “Hustle” which was specifically designed to avoid the checks that could disqualify certain borrowers in the name of originating and selling as many loans as possible. The suit claims that Countrywide's loan origination process was changed to put less qualified and inexperienced clerks in charge of the underwriting process, replacing trained mortgage underwriters. The company even changed its compensation plan so that bonuses were paid based solely on loan volume, removing a prior policy of reducing compensation for poor quality loans.
The company-wide rush to close loans resulted loans being closed while still missing important checks or documents, the complaint says. By February 2008, the defect rate had risen to 37%, well above the industry standard of 4% to 5%. The complaint says the company then initiated a bonus program for its quality-control staff that incentivized them rebut defect claims found by quality control. This program was apparently successful enough that the defect rate was lowered to 13%.
While some of the details may be shocking, there isn't really much new here. Loans originated by Countrywide and later Bank of America contributed greatly to the collapse of the financial system, Fannie Mae and Freddie Mac and the entire economy.
This isn't Bharara's first suit against a big bank. He's the guy behind the suit against Wells Fargo (WFC) filed two weeks ago that accuses that company of reckless underwriting and then leaving the Federal Housing Administration to clean up the mess.
Bank of America's stock lost some ground after the suit was announced, but was trading roughly in line with the broader market in mid-afternoon trading. The lack of reaction to a $1 billion lawsuit and allegations of severe institutional wrongdoing shows how little impact investors think this suit will have. Most of the big banks already have significant litigation reserves in addition to insurance policies for this kind of thing. Bank of America settled another $1 billion suit in February, without admitting wrongdoing. Last month the bank agreed to pay $2.43 billion over claims it mislead investors about the acquisition of Merrill Lynch.
This new suit will likely result in yet another settlement with no admission of wrongdoing. Everyone at the bank who got a bonus or was otherwise enriched by the program gets to keep their money. The only damage done is to taxpayers who had to bail out Fannie and Freddie and the homebuyers who haven't' defaulted, but are having to deal with the consequences of a poorly underwritten mortgage, which create headaches during refinancing or if they attempt to sell their homes.
This leaves a situation ripe for additional abuses in the future. Until actual people start to face lawsuits or criminal prosecution from these types of actions, there is no incentive for anyone to change. If the people who took advantage of the system never face consequences from their actions, there is no incentive not to do it again. Until the people, not the institutions, behind the financial crisis are taken to task, the potential for another crisis will always be right around the corner.
Bobby Raines is the Managing Editor of the Market Intelligence Center. He has degrees in Mass Communications and History from Emory & Henry College. Bobby worked at a mid-sized daily newspaper before making a switch to covering the financial industry full time in the years leading up to the financial crisis. He has been a member of the Fresh Brewed Media team since 2011 and has served as a writer and analyst. You can write to him at email@example.com.