Act III of “The Big Short” – A Fraud by Any Other Name Would Smell As Sour

U.S. Court of Appeals Totally Misses the Boat in an Important Mortgage-Fraud Case


An appeals court dealt the Obama administration a major setback in its efforts to levy tough fines on corporations and executives, overturning a civil mortgage-fraud case against Bank of America Corp. tied to the financial crisis.

The court on Monday also tossed out a $1 million civil penalty against Rebecca Mairone , a former executive at Countrywide Financial Corp., who was one of the few individuals fined for alleged misdeeds during the crisis.

The ruling by the Second U.S. Circuit Court of Appeals in New York raises the bar for the government to prove fraud against companies and individuals, weakening a weapon the Justice Department has used to push Wall Street to agree to big mortgage settlements.

If it stands, the three-judge panel’s unanimous decision could affect the remaining investigations into crisis-era mortgage securities, . . .

The appeals court panel threw out a $1.27 billion penalty against Bank of America over mortgages sold by its Countrywide unit, in what had become known as the “Hustle” case.

It revolved around a civil lawsuit that the U.S. attorney’s office in Manhattan filed against Bank of America in 2012. It alleged that a precrisis Countrywide program called Hustle had generated shoddy mortgages and then misrepresented those loans when selling them to Fannie Mae and Freddie Mac, which had to be bailed out by the government during the financial crisis.

The panel said the jury’s findings in 2013 that the loans sold to Fannie and Freddie were below the quality that had been promised might be considered an “intentional breach of contract.” But it said those transgressions didn’t constitute fraud, overturning the jury verdict that had been a signature win for government officials widely criticized for bringing few cases tied to the 2008 crisis. . .

“It is challenging to prove fraud,” said Brandon Garrett, a University of Virginia law professor who has studied corporate prosecutions. “Obviously, people don’t normally come out and admit that they know they were selling deceptive products. It’s hard to get smoking guns. And now the courts are saying, you need smoking guns at the beginning and end of the deal.”

The government could appeal the ruling to either the full appeals court or Supreme Court. . .

The issue, the court said, turned on the timing of any misstatements and whether at the time they were made, the bank or its employees knew they were false. In this case, the panel said, Countrywide entered into the contract to sell loans to Fannie and Freddie long before the alleged scheme to defraud the housing entities took place. . .

The Hustle penalty was relatively small compared with other fines paid by the bank, but it was an important step in the government’s efforts to push for bigger penalties against banks over related charges.

The charges and trial took observers deep inside Countrywide, which has been seen as a central player in the mortgage crisis. According to the government, the firm accepted borrowers’ applications without checking that income levels and other information were reasonable. It awarded bonuses to employees who could make the case that a loan deemed defective by corporate auditors was in fact eligible for sale to Fannie and Freddie, with little regard for whether customers would be able to repay them.

Ed O’Donnell, a former Countrywide executive who was the government’s star witness in the trial, testified that he was ignored when he alerted his bosses to deterioration in the quality of the mortgage loans.         — by ArunaViswanatha and Christina Rexrodet for the Wall Street Journal

Too bad the judge couldn’t have read the book—or at least seen the movie!



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