One of the major causes for the economic downturn and resulting Great Recession was the issues facing the real estate sector. Overinflated home prices, shadily-issued loans, hastily-packaged mortgage-backed securities and other problems compounded and created one of the worst catastrophes since the Savings and Loan scandal of the 1980s.
While the housing sector continues to grind forward from these events, federal investigators have been busy uncovering the reasons for the crisis. Mortgage fraud and programs designed to remove safety checks seem to be the common theme with the federal investigations. That's resulted in some very big lawsuits against the nation's three largest "Too Big To Fail" banks.
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Doing the Hustle
The latest lawsuit focuses on Bank of America's (NYSE:BAC) 2008 purchase of Countrywide Financial. The Justice Department accuses Bank of America of costing taxpayers more than $1 billion worth of losses by selling thousands of toxic mortgage loans to Fannie Mae (OTC:FNMA) and Freddie Mac (OTC:FMCC).
The issue stems from a Countrywide program - dubbed the Hustle - which was designed to speed up residential home loans. The scheme involved Countrywide eliminating the various checks and balances designed to ensure that loans were sound and not tainted by fraud. Under the program, various underwriters were removed and replaced with loan specialists. Without the program, these specialists were previously considered unqualified even to answer borrower questions. Under the Hustle, however, they were put in the front seat to make decisions on borrowers' worthiness.
The "High Speed Swim Lane" made the bulk of Countrywide mortgages dangerous, a fact that investigators say it hid from Fannie and Freddie. Overall, the Hustle led to defect rates in the 40% range - well above the industry norm. At the same time, Countrywide - later via Bank of America - awarded various bonuses to staff under the program as well as resisted buying back many of the defaulted loans underwritten by the scheme.
The Justice Department's lawsuit is looking to levy triple damages under the federal False Claims Act as well as a series of civil fines.
SEE: What Happened To The MBS Market?
Others Feel the Heat as Well
Bank of America, however, isn't the only big institution feeling the mortgage wrath these days. Back at the beginning of the year, Citigroup (NYSE:C), Flagstar Bancorp (NYSE:FBC) and Deutsche Bank (NYSE:DB) have all settled multimillion dollar claims. Yet, there still are some other big mortgage fraud lawsuits on the docket.
Also in October, U.S. prosecutors sued Wells Fargo (NYSE:WFC) based on its own issues with the quality of mortgages it sold under a federal housing program. Like Countrywide, prosecutors accused Wells Fargo of issuing suspect loans and defrauding the government for more than a decade. These loans would not have been eligible for government insurance and, like Countrywide's Hustle program, were issued under hyper-underwriting conditions.
Federal prosecutors have also gone after big bank JP Morgan (NYSE:JPM) for its role in fraud stemming from mortgage-backed securities created by Bear Stearns. JP Morgan bought Bear Sterns during the depths of the credit crisis. That lawsuit claims that Bear Sterns had failed to evaluate the loans that were packaged into mortgage-backed securities. This caused the direct inclusion of mortgages on which borrowers were more likely to default. All in all, investors lost roughly $20 billion, while Bear pocketed huge fees for creating the securities. Likewise, issues with Washington Mutual's lending practices have been a headache for JP Morgan after it also purchased that savings and loan during the credit crisis.
SEE: The Pioneers Of Financial Fraud
The Bottom Line
Investors can expect more of these sorts of lawsuits to spring up over the next few years as investigations continue to unravel the interworkings of the big banks just before the recession hit. All in all, I wouldn't be surprised if more institutions are tapped by the federal government for their roles in various mortgage fraud schemes.
At the time of writing, Aaron Levitt did not own any shares in any company mentioned in this article.