Are Government Lawyers Dragging BofA Down the Rabbit Hole?

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Bank of America (NYSE:BAC) has “been dragged down the rabbit hole into Alice in Wonderland,” company lawyer Brendan Sullivan told Reuters reporters following the end of the institution’s four-week long trial over the alleged mortgage fraud committed by its Countrywide Financial unit during the months and years leading up to the financial crisis. Sullivan’s literary reference is appropriate for the argument he is making as the story is a tale that plays with logic. The bank’s legal team has claimed that the evidence shows that the brokerage had been focused on improving the quality of the mortgages it originated prior to the meltdown, and the government’s assertions to the contrary are blatantly illogical, much like the adventures Alice stumbles into during her trip through Wonderland.

More than five years have passed since the housing market bubble burst — causing a credit crisis and leaving financial institutions stuck with securities that had lost much of their value — and the federal government is still attempting to assign responsibility for the problems that drove the mortgage boom and the subsequent collapse of the housing market. Thanks to its 2008 acquisition of Countrywide Financial, Bank of America has been a key player in the government’s quest.

It has been drawn into federal court for years regarding its mortgage business, and while the government’s latest allegation of fraud was made last October, the lawsuit switched into high gear last month, proof of the Department of Justice’s ongoing commitment to pursuing litigation with “any individual or if any institution” that damaged the U.S. financial markets.

To settle claims of a wide range of financial misconduct perpetrated by Countrywide Financial alone, Bank of America has spent more than $45 billion. The purchase cost of that brokerage was just $2.5 billion. Those costs have proved to be quite troublesome for the bank’s balance sheet. Even as recently as the third quarter, the bank reported it had set aside $300 million for mortgage litigation.

Chief Executive Officer Brian Moynihan has made it his expressed goal to clean up the institution’s legal docket, but the bank’s efforts to dismiss the government’s latest accusations of fraud at Countrywide failed and the subsequent lawsuit, which began in late September, became the only government case linked to crisis-era financial misconduct to reach the trial stage. It also was the first civil fraud suit brought by the Department of Justice concerning mortgage loans sold to Fannie Mae (FNMA.OB) or Freddie Mac (FMCC.OB).

The federal government has alleged that Countrywide sold the Federal National Mortgage Association, Fannie Mae, and Freddie Mac billions of dollars of toxic mortgage loans, and in October of last year, the Justice Department joined a whistleblower lawsuit that was initially brought by Edward O’Donnell, a former Countrywide executive.

Specifically, the complaint claims that between “at least 2007 through 2009,” Countrywide, and later Bank of America, implemented a new loan origination process — known as the “Hustle,” the “High Speed Swim Lane,” or HSSL — which was “intentionally designed“ to process loans quickly and without quality checkpoints.

This process allegedly generated thousands of fraudulent and otherwise defective residential mortgage loans that were sold to the government-owned mortgage financiers and subsequently defaulted. The government seeks damages and civil penalties under the False Claims Act and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 for “engaging in a scheme to defraud the Federal National Mortgage Association [Fannie Mae] and the Federal Home Loan Mortgage Corporation [Freddie Mac].”

In the press release announcing the lawsuit, Manhattan U.S. Attorney Preet Bharara said that, “For the sixth time in less than 18 months, this Office has been compelled to sue a major U.S. bank for reckless mortgage practices in the lead-up to the financial crisis.” However, in court papers seen by Reuters, Bank of America said that HSSL was a “legitimate and good-faith effort” to develop a system for making prime loans after the subprime mortgage market collapsed. “This program ended before our purchase of Countrywide, as the government acknowledges,” Bank of America spokesman Lawrence Grayson told Reuters following U.S. District Judge Jed Rakoff’s decision to deny the company’s request that the court drop the charges. “We believe there was no fraud,” Grayson added.

In comparison, in closing arguments, Assistant U.S. Attorney Jaimie Nawaday asserted that Countrywide had put speed ahead of quality, a practice that was evident in the size of bonuses received by employees and the elimination of underwriters who had assured loan quality. “After four weeks of evidence and testimony, this is still a case about greed and lies,” she said, according to Reuters.

“Quality had become a joke,” she added. As part of her argument, the attorney noted that Rebecca Mairone, the former chief operating officer of Countrywide’s Full Spectrum Lending division and a co-defendant in the trial, “didn’t want to hear the process wasn’t working.”

The Department of Justice has claimed that Countrywide sold approximately 28,000 toxic loans to the government-owned mortgage financiers, while Sullivan has said that the total improperly included about 17,000 loans that were originated by the brokerage’s field offices, which were not part of the “Hustle” program. Furthermore, the evidence shows that employees were improving the quality of the mortgages and making corrections to that program. “I don’t think a fraud case should be an Easter Egg hunt,” Sullivan said, according to the publication.

Complicating the case is the fact that  O’Donnell stands to earn as much as $1.6 million if the Justice Department wins the lawsuit, Reuters reported. He now works at Fannie Mae, as Mairone’s lawyer Michael Hefter of Bracewell & Giuliani told the court. He also argued that O’Donnell “had it out” for Mairone, who now is employed by JPMorgan Chase (NYSE:JPM), because he blames the former COO for minimizing his role in the company following a division reorganization. “Mr. O’Donnell came into this court with a grudge and a mission,” Hefter said.

The Justice Department has said it is seeking a penalty equal to either Fannie Mae and Freddie Mac’s losses or the defendants’ gain, whichever amount was greater, and it has estimated the “gross loss” on the toxic loans was $848.2 million while the “net loss,” or the amount due to the portion of the loans that the government said were materially defective, amounted to $131.2 million. Jurors began their deliberations on Wednesday morning

Follow Meghan on Twitter @MFoley_WSCS

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