The Surprises in the $1 Billion Bank Suit

Housing construction in Illinois Photograph by Daniel Acker/Bloomberg

Among the many lessons of the financial crisis is that the real troubles may come once the music has already stopped, an idea that seems to be evident in the new civil suit by federal prosecutors alleging Bank of America perpetrated $1 billion in mortgage fraud. U.S. Attorney Preet Bharara said that Countrywide, and later Bank of America, had a loan-origination program called the Hustle, which allegedly tried to speed up the process of approving loans and selling them off to Fannie Mae and Freddie Mac, the quasi-governmental companies created to buy and guarantee loans from private lenders to help support the housing market. The Hustle, short for “High Speed Swim Lane,” removed some underwriting reviews even on high-risk loans, cut compliance checks, and compensated employees solely on volume, not quality, the complaint alleges. When there were early signs that many of the loans were quickly becoming duds, the bank ignored the red flags and didn’t let Fannie and Freddie in on their internal reports.

In commenting on the suit, Bank of America didn’t directly address the Hustle but did say, “The claim that we have failed to repurchase loans from Fannie Mae is simply false. At some point, Bank of America can’t be expected to compensate every entity that claims losses that actually were caused by the economic downturn.”

News of shoddy underwriting and misaligned incentives during the bubble is hardly shocking anymore. But two things are striking about this case. First, the Hustle wasn’t for subprime loans—it was for prime loans. Perhaps even more surprising is that Countrywide got the Hustle going in August 2007, when the party was already over. Subprime lenders started going belly up in mid-2006, and by mid-2007, investors had lost their appetite for mortgage-related securities.

While the subprime bubble was still growing, Countrywide could easily sell low-quality loans into the voracious private market for bonds backed by mortgages. Once that market went away, Countrywide created the Hustle to ramp up its origination of prime loans that could be sold to Fannie Mae and Freddie Mac. The suit charges that Bank of America kept the Hustle going through 2009.

The beginning of the housing bust saw other questionable activity. In 2007, Wall Street banks let Magnetar and John Paulson stuff crummy loans into collateralized debt obligations (CDOs) so the hedge funds could later sell them short. And banks started selling dubious debt to each other to keep sales rolling.

Several of those 2007 deals have already cost Wall Street banks dearly, including a $285 million settlement by Citigroup, a $153.6 million settlement by JPMorgan Chase, and a $550 million settlement by Goldman Sachs. (The banks neither admitted nor denied wrongdoing.)  Depending on where this new $1 billion suit goes, the Hustle may be one more example that some of the most costly actions came during the twilight of the boom, when desperation kicked in.

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