Bank of America bought Countrywide Financial in 2008 and it’s fair to say that went poorly; the Wall Street Journal totted up total Countrywide losses at about $40 billion but that was in July so they’re probably, like, $80 billion by now. If you were trying to figure out the maximum past and future losses you might start with the fact that Countrywide Financial originated about $2.2 trillion of mortgages between 2003 and 2007; ignoring anything before that you might ballpark the upper bound at $2.2 trillion. Let me draw you a Venn diagram, because this is now that kind of blog:
Eventually that yellow circle can grow to the size of the blue circle, but no bigger: the absolute highest number of fraudulent mortgages that Countrywide could have written is “all of the mortgages it wrote.” Right? No, wrong, of course:
Federal prosecutors sued Bank of America on Wednesday, accusing the bank of carrying out a mortgage scheme that defrauded the government during the depths of the financial crisis.
In a civil complaint filed in New York, the Justice Department cited the bank’s home loan program known as the “hustle.” Prosecutors say the program, which Bank of America inherited with its purchase of Countrywide Financial during the crisis, was designed to churn out mortgages at a rapid pace without proper checks on wrongdoing. The bank then sold the “defective” loans to Fannie Mae and Freddie Mac, the government-controlled housing giants, which were stuck with more than $1 billion in losses and many foreclosures.
I think – could be wrong – but I think this is the first time somebody has sued Countrywide for selling fraudulent mortgages that somebody else was suing Countrywide over? The DOJ’s complaint is here, and it covers prime loans originated at Countrywide and sold to Fannie and Freddie between 2007 and 2009 (by which time it was BofA-owned). Meanwhile Fannie and Freddie are independently trying to get back money from BofA for what I’ll assume is a significantly overlapping pool of mortgages? Pretend there’s another Venn diagram here, or just read pages 61-62 of BofA’s 10-Q:
Our current repurchase claims experience with the GSEs is concentrated in the 2004 through 2008 vintages where we believe that our exposure to representations and warranties liability is most significant. Our repurchase claims experience related to loans originated prior to 2004 has not been significant and we believe that the changes made to our operations and underwriting policies have reduced our exposure related to loans originated after 2008.
Bank of America and legacy Countrywide sold approximately $1.1 trillion of loans originated from 2004 through 2008 to the GSEs. As of June 30, 2012, 12 percent of the original funded balance of loans in these vintages have defaulted or are 180 days or more past due (severely delinquent). At least 25 payments have been made on approximately 66 percent of severely delinquent or defaulted loans. Through June 30, 2012, we have received $39.1 billion in repurchase claims associated with these vintages, representing approximately three percent of the original funded balance of loans sold to the GSEs in these vintages. We have resolved $27.8 billion of these claims with a net loss experience of approximately 31 percent, after considering the effect of collateral.
So that’s vague and there’s probably some non-overlap – e.g. 2009 loans? – but, still, Fannie Mae seems to be trying to get money back on a lot of the same mortgages at issue here.
The DOJ lawsuit doesn’t contain much that will surprise anyone. Countrywide sold prime mortgages into GSE pools; starting in 2007 it saw the handwriting on the wall for the subprime business so shifted its focus into prime; it brought the same shoddy underwriting and desperate desire to incur liability1 to its rejuvenated prime business that had made it such a success in subprime; events transpired. Mostly it’s 46 pages of (1) everyone was incompetent, (2) nobody verified income in the no-income-verification loans, (3) when they found defects they hid them, and (4) there were some shifty-looking changes in procedures and compensation practices whereby Countrywide went from “try to originate lots of good mortgages” to “try to originate even more lots of mortgages with no quality standards whatsoever and also there’s a bonus for steamrolling quality-control checks.”
Also it’s got a terrible name. One of these days there’s going to be a lawsuit about a mortgage lender’s Fast Reply – Alternate Underwriting Data program, FRAUD for short, and we’ll all get a slightly bigger chuckle over that than we did over:
After a pilot test in 2006 led by two senior managers transferred from Countrywide’s Consumer Markets Division, FSL [CFC's "Full Spectrum Lending" division] fully implemented its new model for loan origination – the “Hustle” – in mid-2007. The Hustle (or “HSSL”) was the term for FSL’s new “High Speed Swim Lane”2 model for loan origination. Operating under the motto, “Loans Move Forward, Never Backward,” the Hustle aimed to reduce the amount of turn time on loans.
Why is the DOJ bringing this $1 billion case instead of just, like, handing off its Hustle info to Fannie and Freddie to use in their multi-billion dollar ongoing putback disputes? I mean, you can probably go ahead and count “grandstanding” on your list of reasons; everyone wants to have some mortgage lawsuits and Preet Bharara probably wants to have more than anyone else.
But also fun reasons! For one thing, the whole “leave it to Fannie to demand putbacks” route is somewhat complicated by the fact that BofA is being snitty about Fannie’s putback demands and has stopped selling it mortgages as revenge/sulking. “Good riddance” is I suppose one possible answer for Fannie? But apparently not? I dunno. Anyway the la-la-la-I-can’t-hear-you approach that BofA has adopted to putback claims probably works less well against federal prosecutors, so this suit at the very least puts more pressure on BofA to cough up some money.
Also: a lot of money. The DOJ is suing under statutes including the False Claims Act, which provides a penalty of “3 times the amount of damages which the Government sustains,” and the FIRREA, which provides penalties of up to $1 million per violation for crimes affecting federally insured financial institutions. This is important for your Venn diagram: not only might Countrywide have to pay twice for the same mortgage – once to Fannie/Freddie on a putback, once to the DOJ on this lawsuit – but this lawsuit itself might lead to triple damages plus $1 million per mortgage.3 If Countrywide was in fact massively fraudy in 2007-2009, there is good reason to make that massive fraud more costly than just buying back all the mortgages that it originated: because next time, someone contemplating cutting corners with the GSEs (or whoever the next victim is) will think “ooh that could lead to massive penalties” rather than “well, if I don’t get caught, I win; if I do get caught, I just go back to where I am now.” That’s how you learn, I guess.4
Most interesting to me though is this paragraph of the complaint:5
Relator Edward J. O’Donnell is a resident of the State of Pennsylvania. From 2003 to 2009, Relator was employed by Countrywide Home Loans, first as a Senior Vice President, and later as an Executive Vice President.
That dude’s gonna be rich! He seems to have been a risk management and quality control officer at Countrywide, and he seems to have brought this case as relator in February – probably miffed because Countrywide actually paid bonuses to originators who could refute quality-control checks! – and gotten the government to join it now. And relators get a cut of any money the government recovers in False Claims Act lawsuits.
One important reason for the DOJ to bring this case is just to reward Edward O’Donnell for his – not really that exciting but whatever – whistleblowing on Countrywide. Fannie and Freddie employees reviewing Countrywide loans and demanding putbacks are doing their jobs, but they’re not going to get rich doing so, and they can’t necessarily dig up all the finest dirt on Countrywide operations. Giving this guy a couple hundred million dollars for providing that dirt, as the DOJ basically can do, should get other disgrunted quality control officers to come forward with similar dirt on other fraudy situations. Though – won’t it also get them to sit on that dirt until it’s grown into a really valuable fraud?
Another day, another BofA mortgage suit [FTAV]
Federal Prosecutors Sue Bank of America Over Mortgage Program [DealBook]
U.S. ex rel. Edward O’Donnell v. Bank of America [via Reuters]
Manhattan U.S. Attorney Sues Bank Of America For Over $1 Billion For Multi-Year Mortgage Fraud Against Government Sponsored Entities Fannie Mae And Freddie Mac [DOJ]
1. This reminds me of my second-favorite motivational speech I’ve ever received from a boss – after of course “don’t fuck it up.” I was a young lawyer off to negotiate some contract and asked a partner if he had any advice for me. He thought for a while, then replied, “don’t incur any liability.” If only Countrywide had thought of that.
2. Also, um, “swim lane”?
3. I mean: it won’t. But whatever.
4. This deterrence argument is obvious but importantly wrong: the putback liability itself far outweighs Countrywide’s profits on originating a loan. Countrywide’s misbehavior was not primarily selling the loan to Fannie/Freddie; it was making the loan in the first place. And the cost of a putback is not primarily due to CFC’s fraud; rather, it’s due to the collapse in the housing market and the collateral’s loss of value. So you don’t actually need the treble-damages deterrence, though I guess that’s no reason to stop you from seeking it.
5. Also the paragraph before it which reads in its entirety “Plaintiff is the United States of America.” Perhaps you’ve heard of us?