Preet Bharara’s breathtaking case against Countrywide and BofA

By Alison Frankel
October 24, 2012

What a complaint U.S. Attorney Preet Bharara filed against Countrywide and Bank of America on Wednesday!

Earlier this month, when the New York Attorney General filed accusations of securitization fraud against JPMorgan Chase, I said we should put aside cynicism about the AG’s copycat allegations and be grateful that, at last, a government official was demanding accountability for systemic corruption in the mortgage-bundling business. The new complaint against BofA demands no such nose-holding: It asserts powerfully detailed — and original — accusations of billion-dollar fraud in the way Countrywide approved mortgages destined for purchase by Fannie Mae and Freddie Mac, and in Countrywide’s and BofA’s subsequent (alleged) refusal to repurchase defective loans.

To be sure, the U.S. Attorney had help from a whistle-blower, a former Countrywide Home Loans executive vice president named Edward O’Donnell. O’Donnell filed a relatively bare-bones False Claims Act complaint last February. As always in FCA cases, the complaint was sealed as the Justice Department checked out the allegations and deliberated whether to intervene in the case. Those deliberations can take years, but not in this case, when the government is under intense pressure to make good on promises of fighting mortgage fraudsters. Eight months after O’Donnell initiated his action in federal court in Manhattan, the U.S. Attorney’s office intervened, making the suit public.

The result is a complaint that features inside allegations from O’Donnell about Countrywide’s so-called “Hustle” program to funnel increasingly deficient loans to Fannie Mae and Freddie Mac alongside inside information that government investigators presumably obtained from Fannie and Freddie officials. The combination makes for a compelling case that Countrywide systemically deceived the government-sponsored entities about the loans it was selling them, then refused to live up to contractual obligations to repurchase deficient loans. (As Reuters reported Monday, Bank of America said accusations that it failed to repurchase loans are “absolutely false.”)

The U.S. Attorney’s allegations go much deeper than O’Donnell’s initial suit, which suggests that the government has been busily investigating in the months since O’Donnell initiated the case. According to the complaint filed Wednesday, in 2007 — with fewer MBS sponsors in the market for the subprime loans that had been Countrywide’s specialty — the bank was increasingly desperate to sell supposedly better-quality mortgages to Fannie Mae and Freddie Mac. To speed up the process of approving loans, Countrywide’s Full Spectrum Lending unit instituted “the Hustle” (or HSSL, for High Speed Swim Lane) program, which stripped away underwriter review for loans that were deemed acceptable by the bank’s automated mortgage review system. But that automated system, according to the complaint, depended on information supplied by the borrower and input by a loan processor. There were few to no controls in the Hustle approval process; according to the feds, even loans in which the borrower’s income wasn’t independently verified went unreviewed by underwriters.

Countrywide assured Fannie and Freddie that it had tightened its underwriting standards, but at the same time, the complaint asserts, it changed its bonus system to reward loan-level employees based only on the volume of mortgages they wrote, not on the quality of the loans. The result, according to the complaint, was that loan processors were induced to feed false information into the automated mortgage review system. The U.S. Attorney claims that processors would keep changing information until the system approved a loan and it could be fed into the High Speed Swim Lane.

The complaint names names (though not as defendants). The whistle-blower O’Donnell warned two high-ranking Full Spectrum Lending officials, President Greg Lumsden and COO Rebecca Mairone, that the Hustle program added multiple layers of risk to the mortgages Countrywide was selling to Fannie and Freddie. According to the complaint, Mairone permitted O’Donnell to oversee a quality check of Hustle loans by underwriters (but only as the loans were simultaneously being processed). O’Donnell found a “staggering” rate of defects in the approved loans.

Countrywide, however, hid its 40 percent defect rate from Fannie and Freddie, according to the U.S. Attorney. The complaint quotes former officials saying that they were not informed of the rate, and, if they had been, would have immediately begun asking questions about Countrywide’s processes.

Instead, Fannie and Freddie began demanding that Countrywide buy back loans that went into default, asserting after the fact that Countrywide had breached representations and warranties about the quality of the mortgages. And according to the complaint, Countrywide and its acquirer, Bank of America, “thwarted” the repurchase process, refusing to buy back obviously deficient loans. The result, according to the complaint, is that Fannie and Freddie, their shareholders and the U.S. government were defrauded to the tune of $1 billion.

It’s exceedingly rare for defendants to go to trial in False Claims cases in which the government has elected to intervene, and the whistle-blower O’Donnell, who is represented by lawyers at The Wasinger Law Group, will recover a percentage of whatever the government ends up collecting in the case.

Bank of America, you may recall, has already settled one billion-dollar False Claims Act case, in which the U.S. Attorney in Brooklyn claimed the bank deceived the Federal Housing Administration about the quality of mortgages that FHA insured. But in my estimation, the new suit could have far more serious implications for BofA. There are two primary reasons: BofA’s long-running tussle with Fannie Mae over put-backs; and the U.S. Attorney’s analysis of BofA’s successor liability for Countrywide.

Bank of America, according to its third-quarter earnings’ presentation to analysts, is facing more than $12 billion in outstanding repurchase claims from Fannie and Freddie (the vast majority of claims are from Fannie, since BofA settled future claims with Freddie in 2011). It’s not clear from the presentation how many of those billions of dollars in claims derive from loans originated after the Hustle program began. But Bank of America has to be worried about prosecutors in Manhattan developing a record that supports Fannie Mae’s assertions of deficient underwriting. It’s a lot harder to argue that Fannie isn’t entitled to put-backs in the face of evidence that Countrywide lied about the loans.

BofA has also argued in all of the put-back cases against Countrywide that it is not liable for Countrywide’s breaches. That assumption limited its proposed settlement with private investors in Countrywide mortgage-backed securities, since what remains of Countrywide has less than $5 billion in assets. BofA’s pursuers, particularly the bond insurers, are eager to pierce what they regard as a tissue-paper division between Countrywide and BofA in order to foist Countrywide’s liabilities onto its parent. The U.S. Attorney’s office sides squarely with BofA’s foes, making precisely the same arguments for BofA’s successor liability as MBIA’s lawyers at Quinn, Emanuel, Urquhart & Sullivan made in a summary judgment brief they filed earlier this month in MBIA’s fraud and put-back case in New York State Supreme Court.

And here’s one other nagging concern for BofA: The U.S. Attorney’s suit is before District Judge Jed Rakoff, who’s known for pushing cases along at a speedy clip. He’s also quite familiar with MBS put-back litigation, since he’s in the midst of a bench trial of Assured Guaranty’s claims against Flagstar Bank. How willing is BofA to bet on its defense in Rakoff’s court, when his rulings could resound so loudly in other cases?

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