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Wells Fargo Must Answer for Failed Home Loans, U.S. Says

May 13 (Bloomberg) -- Wells Fargo & Co.’s $5 billion payment two years ago in a national mortgage settlement was for servicing abuses, and the bank still needs to answer for making bad government-insured loans, a U.S. Justice Department lawyer told a federal appeals court.

The court should reject the bank’s arguments that the national agreement limits new claims by the U.S., department attorney Lindsey Powell said. Wells Fargo’s attempt to fend off a New York lawsuit that accuses the bank of reckless loan origination mischaracterizes issues it raises as covered by the national settlement, Powell said.

“All of the loans at issue in that case contain material violations” of underwriting standards and other mortgage regulations and are fair game for the government, Powell told a three-judge panel of the U.S. Court of Appeals today in Washington.

Douglas Baruch, an attorney for Wells Fargo, disputed Powell’s assertion, arguing that the government’s case turns on compliance reports to federal agencies for which the bank received immunity from further suits.

“They’re seeking to impose liability on Wells Fargo based solely on annual certifications,” Baruch said.

He urged the panel to order U.S. District Judge Rosemary Collyer, who is overseeing the national settlement, to reconsider her ruling that it doesn’t offer protection against the allegations in the New York case, which was filed in Manhattan federal court in October 2012.

Harm’s Cause

The judges repeatedly questioned the lawyers on how much harm resulted from misconduct in processing individual loans and how much resulted from reliance on fraudulent Wells Fargo compliance reports, in which the bank told the government it had safeguards in place to properly run a program for Federal Housing Administration-insured loans.

Wells Fargo was one of five banks that agreed in 2012 to the $25 billion nationwide settlement with the Justice Department over mortgage-related claims that included botched foreclosures. The FHA then took additional action against four of the banks, including Wells Fargo, for related housing-crisis wrongdoing.

Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. decided to settle those matters. San Francisco-based Wells Fargo chose to fight.

‘Down Swinging’

“You go back to their DNA,” said Paul Miller, a banking analyst at FBR Capital Markets Corp. in Arlington, Virginia. “They fight things. They always go down swinging,” he said. The size of a potential settlement is likely to be “a rounding error” for the bank, he added.

Ancel Martinez, a spokesman for Wells Fargo, declined to comment on the case.

In the FHA lawsuit, the agency, which insures loans to help lower-income individuals buy homes, said it paid hundreds of millions of dollars on defaulted mortgages because Wells Fargo didn’t properly vet the origination of individual loans.

The bank turned to Collyer, asking her to block the FHA suit in New York. Collyer refused, holding that while the language in the settlement protects banks against some FHA lawsuits, it doesn’t cover the allegations made in that case.

Wells Fargo’s release from suits linked to its annual regulatory reports didn’t extend to alleged violations of FHA or Department of Housing and Urban Development rules on vetting or originating individual loans, Collyer said.

Countrywide Unit

Charlotte, North Carolina-based Bank of America and its Countrywide unit agreed to pay $1 billion in February 2012, while New York-based Citigroup resolved its FHA suit the same month by paying $158.3 million.

In February, New York-based JPMorgan agreed to pay $614 million to settle claims that it improperly approved FHA and Veterans Affairs Department loans.

If Wells Fargo, which had $21.9 billion in net income last year, eventually does negotiate an end to the FHA case, the size of the settlement may resemble the JPMorgan deal, Miller said.

There’s relatively little risk in the strategy, said Peter Henning, a former lawyer with the Securities and Exchange Commission and a professor at Wayne State University Law School in Detroit.

“If you win, you save a lot of money,” Henning said. “And if you lose, you do what you would have done anyway.”

In today’s hearing, U.S. Circuit Judge Thomas Griffith said that according to the government, the banks would have had to pay more in the national settlement to get broader protection against additional litigation.

“We’ve paid a lot of money already,” Baruch replied.

The case in Washington is U.S. v. Bank of America, 13-5112, U.S. Court of Appeals for the District of Columbia (Washington).

To contact the reporter on this story: Andrew Zajac in Washington at azajac@bloomberg.net

To contact the editors responsible for this story: Michael Hytha at mhytha@bloomberg.net Fred Strasser, David Glovin

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