The Department of Justice filed a civil fraud complaint against Bank of America yesterday based on fraudulent underwriting practices at Countrywide from 2007 to 2008 (a period that includes the involvement of B of A). The gist of the suit is that Countrywide knowingly sold securities that didn’t meet the standards of Fannie Mae and Freddie Mac, leading to major losses for the Agencies and other federal institutions. The basics:
- The complaint covers a specific program called HSSL or “Hustle” that ran from 2007 to late 2008, rather than all of Countrywide’s lending
- The program in question was the underwriting version of robo-signing, with the least-qualified employees tasked with delivering loans in volume while any roles or procedures that might get in the way of that volume were removed.
- Countrywide is charged (based on evidence that must have been supplied by the “relator” named in the suit, a former executive) with undermining its own quality controls to produce loans that didn’t meet the quality standards required by Fannie Mae.
- Faced with declining profit opportunities and an increasingly conservative client, Countrywide opted to assure Fannie Mae that it was tightening its lending standards even as it was aggressively doing the opposite, ultimately producing loans that defaulted at 10x the national average rate. That information was hidden from Fannie Mae.
- In contravention of the terms of their relationship with Fannie, Countrwide/BofA have also refused to buy back the faulty loans they sold, following a pattern that predated the HSSL program.
The details of the complaint make for interesting (if infuriating) reading. The genesis of the misbehavior was the collapse in home prices and rising defaults that began in late 2006 and accelerated sharply in 2007, leading to the implosion of several smaller institutions and a collapse in underwriting. This collapse left Fannie and Freddie somewhat isolated in providing liquidity to the mortgage market, and made them effectively the only investors in the market to buy mortgage loans due to their government mandate to support that market.
The Agencies’ concerns about credit quality led them to tighten the standards that govern the types of mortgages they were willing to buy from lenders in 2007. This is where Countrywide comes into the picture. Like most private lenders, the firm’s business model from inception was reliant in large part on packaging and servicing loans for the GSEs, though in later years it followed the profit opportunities available in subprime by becoming a dominant player there as well. With so many lenders collapsing or withdrawing from the market in 2006 and 2007, Countrywide was one of the last left standing with the resources to produce loans in the scale needed to support the Agencies’ objective of supporting the market, and by 2007 the firm accounted for a third of all loans sold to Fannie Mae.
With Fannie tightening its credit standards, and Countrywide forced to rely on selling loans to this increasingly important client, Countrywide chose to double down on a rapid-underwriting program called HSSL, or “High Speed Swim Lane” that it had piloted in 2006. The program involved a radical shift in the firm’s already-dodgy underwriting practices, and echoes the approach taken by servicers to robo-signing foreclosure documents. Previously, Countrywide’s subprime underwriting process involved four functions involved in successive stages of entering, verifying, correcting and finally approving borrower files into the firm’s automated underwriting system, known as CLUES. In normal times, CLUES would render a verdict of either “accept,” leading to a loan, or “refer,” leading to a review by a more qualified underwriter of the file.
Under HSSL, Countrywide eliminated nearly every check on the process by removing underwriters, compliance, and procedural checks from the flow of work, leaving only the most junior loan processors (essentially data entry clerks) to manage the process. The firm also changed the compensation incentives in two key ways. First, the processors were compensated purely on volume, with considerations of quality eliminated from the bonus calculation. Second, in cases where ex-post quality control identified problems in the loans, the processors were given bonuses for rebutting the findings, in many cases successfully arguing that information they had made up was “reasonable,” whatever that means.
Ultimately, the processors ended up redoing files and adjusting data repeatedly until they could get the CLUES system to an “accept” verdict, regardless of the truth. The suit finds evidence of this in multiple loans, which in some cases required dozens of actions on the system before they were approved.
The results were as predictable as they were damaging. In the short term, Countrywide managed to crank out and sell $3 billion in faulty mortgages. But with so few constraints, defaults and defects in the loans soared to 40%, or ten times the national average. Countrywide knew this, and withheld the information from Fannie Mae, which is half of the suit. The other half is based on the misrepresentations regarding the underwriting processes followed by Countrywide, which told Fannie Mae that it had strengthened its quality controls rather than the truth that it had eviscerated them.
There’s a lot more in the complaint but this is long enough so I will leave it here. Hopefully Bharara will see this one through, though it’s hard to imagine even $1 billion in settlement making much of a dent in Bank of America.
Edit 10/25: adjusted title