BofA Mortgage Saga: Investors Prepare for a $6 Billion Fine

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“The government is watching the banks and if you make a wrong step you’re going to pay,” CLSA analyst Mike Mayo told the Financial Times, describing the commitment federal regulatory agencies have made to assigning blame to the institutions responsible for the late-2000s financial crisis. “It’s not clear where the boundaries lie in terms of who the government deals with, the ultimate amount, even — as shown during the crisis — which banks can get vaporized.”

Since JPMorgan Chase (NYSE:JPM) and now Bank of America (NYSE:BAC) have settled with several regulatory bodies, including the Federal Housing Finance Agency, regarding faulty mortgages made in the months and years leading up to the crisis, the federal government is a new stronger position to exact heavy penalties from small banks. Those institutions that have not yet made an agreement — like the Royal Bank of Scotland (NYSE:RBS) — will likely find it difficult to make a cheaper deal, which leaves banks the choice between a multibillion dollar fine or the risk of taking the accusations to court. “It’s the example of the new Big Brother banking,” added Mayo.

While the settlement between JPMorgan, the largest United States bank by assets, and the federal government has yet to be made public officially, the deal removes a huge hurdle from the path of regulators in their quest to punish those financial players who brought about the crisis. With claims against both JPMorgan and Bank of America now laid to rest, this could represent a watershed moment in the government’s efforts to prosecute banks that allegedly broke securities laws when selling home loans to the government-backed mortgage companies Fannie Mae and Freddie Mac.

The fines that have been levied thus far are part of an effort to recoup some of the losses that taxpayers covered when the government took control of those mortgage companies after they came close to failing in 2008. Together, Fannie Mae and Freddie Mac have taken $187.5 billion in federal aid since then. On September 2, 2011, the Federal Housing Finance Agency, the regulator that oversees Fannie Mae and Freddie Mac, filed lawsuits against 17 financial institutions, accusing them of violating federal laws and common law in the sale of residential private-label mortgage-backed securities.

“The complaints filed today reflect FHFA’s conclusion that some portion of the losses that fannie Mae and Freddie Mac incurred on private-label mortgage-backed securities (NYSE:PLS) are attributable to misrepresentations and other improper actions by the firms and individuals named in these filings,” noted the press release announcing the lawsuits. ”Based on our review, FHFA alleges the the loans had different and more risky characteristics than the descriptions contained in the marketing and sales materials provided to” Fannie Mae and Freddie Mac for those securities.

So far, UBS (NYSE:UBS), Citigroup (NYSE:C), and General Electric (NYSE:GE), which acquired WMC Mortgage in 2004 to capitalize on the home-loan boom, have settled with the FHFA. But the Royal Bank of Scotland faces a multibillion dollar fine unless it wins its court case, while Credit Suisse (NYSE:CS), Goldman Sachs (NYSE:GS), and Barclays (NYSE:BCS) have yet to settle.

JPMorgan Chief Executive Officer James Dimon spent two hours at the Department of Justice on September 26 to discuss the bank’s settlement with Attorney General Eric Holder, a source familiar with the negotiations told Bloomberg. The FHFA accused JPMorgan of making false statements and omitting key facts when it sold $33 billion in mortgage bonds to the government mortgage from September of 2005 to September of 2007. In papers filed in the federal court in Manhattan, acquired by the publication, regulators accused executives of JPMorgan and Bear Stearns, the brokerage acquired by the bank in 2008, of misrepresenting the quality of the loans underlying the bonds.

As first reported by the Wall Street Journal, the mounting litigation and regulatory investigations led the institution to making a $4 billion dollar settlement with the FHFA. In total, Dimon agreed to pay a total of $13 billion to a variety of U.S. state and federal agencies during a Friday phone call with Holder, ending government investigations into its mortgage-bond sales. If that penalty is finalized, it will be the largest imposed on a single company by U.S. authorities, and of that $13-billion, the largest slice went to the housing regulator, FHFA.

Under litigatory and regulatory pressure, JPMorgan took a $7.2 billion dollar charge in the second quarter, giving the bank its first quarter loss under the leadership of Dimon. However, through sources familiar with the private negotiations, Bloomberg learned that FHFA is seeking a much larger fine of $6 billion from Bank of America.

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 drawn into federal court for years regarding its mortgage business, proof of the Justice Department’s ongoing commitment to pursuing litigation with “any individual or if any institution” that damaged the U.S. financial markets.

Countrywide Financial has cost Bank of America more than $45 billion in settlements over the subprime lender’s allegedly fraudulent mortgages, and those costs have proved to be quite troublesome for the bank’s balance sheet. Chief Executive Officer Brian Moynihan has made it his expressed goal to clean up the institution’s legal docket, but that has been no easy task. Last year, the Department of Justice filed a $1 billion fraud complaint against the bank, which alleged that Countrywide sold Fannie Mae and Freddie Mac billions of dollars of toxic mortgage loans.

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.

Follow Meghan on Twitter @MFoley_WSCS

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