(Corrects to remove Las Vegas from 25th paragraph in story published yesterday.)
Bank of America Corp. (BAC:US)’s Countrywide unit was found liable by a jury for selling Fannie Mae (FNMA:US) and Freddie Mac (FMCC:US) thousands of defective loans in the first mortgage-fraud case brought by the U.S. government to go to trial.
A federal jury in Manhattan yesterday also found former Countrywide Financial Corp. executive Rebecca Mairone liable for defrauding the U.S. Mairone was the only individual named as a defendant in the government’s lawsuit.
U.S. District Judge Jed Rakoff, who presided over the trial, told lawyers he’ll determine the amount of any civil penalty at a later date. Assistant U.S. Attorney Pierre Armand asked the judge to impose a penalty of as much as $848 million, representing the gross losses to Fannie Mae and Freddie Mac. Armand said alternatively, Rakoff could fine Countrywide about $131 million, the estimated net losses to the two entities.
Rakoff set a Dec. 5 hearing for further arguments involving the penalty and said he would be ready to rule on those matters by Dec. 31. He said if he determines an evidentiary hearing is needed, lawyers should be prepared to proceed with expert witnesses during the first week in January.
Countrywide, based in Calabasas, California, was once the biggest U.S. residential home lender, originating or purchasing about $1.4 trillion in mortgages from 2005 to 2007. The bulk of them were sold to investors as mortgage-backed securities. Bank of America acquired Countrywide in 2008.
Bank of America (BAC:US) fell 31 cents, or 2 percent, yesterday to $14.21 in New York Stock Exchange trading. The shares fell 0.3 percent today.
Manhattan U.S. Attorney Preet Bharara, whose office brought the case, said Countrywide’s program “treated quality control and underwriting as a joke.”
“In a rush to feed at the trough of easy mortgage money on the eve of the financial crisis, Bank of America purchased Countrywide, thinking it had gobbled up a cash cow,” Bharara said in a statement. “That profit, however, was built on fraud, as the jury unanimously found.”
Prosecutors in Bharara’s Civil Fraud unit alleged that a division of Countrywide in August 2007 initiated a loan program called “High Speed Swim Lane,” or HSSL, that ran until 2008.
“The jury’s decision concerned a single Countrywide program that lasted several months and ended before Bank of America’s acquisition of the company,” Lawrence Grayson, a spokesman for the Charlotte, North Carolina-based bank, said in an e-mailed statement. “We will evaluate our options for appeal.”
Marc Mukasey, a lawyer for Mairone, said he would appeal.
“We are not going to stop fighting for Rebecca,” Mukasey said after court. “She’s a woman of integrity, ethics and honesty. She never engaged in any fraud because there was no fraud. We’re going to fight on.”
Following a four-week trial, the jury of six women and four men deliberated about five hours yesterday. After the verdict, a female juror said she and her colleagues on the panel agreed with the government’s view that Countrywide’s Full Spectrum Lending unit had shunted substandard loans to Fannie Mae and Freddie Mac under the HSSL program.
“I knew something about what was going on in the mortgage debacle but it was certainly interesting to see how this happened first-hand,” said the woman, who declined to be identified. She is a freelance writer who lives on Manhattan’s Upper West Side.
The juror cited the testimony of John Boland, a former Countrywide employee who said some loan specialists were told they wouldn’t be allowed to go home for the night unless they approved a loan. Jurors asked to re-hear Boland’s videotape deposition just minutes before announcing their verdict.
Boland testified he had complained to Countrywide superiors repeatedly about the loan approval process under HSSL and an earlier program. He said it was “mind blowing” to learn that two employees who he criticized “lost their authority” regarding loans because that hadn’t happened before.
“Boland’s testimony was shocking,” the juror said. “Those employees were told to do ‘30 in 30,’ or 30 loans in 30 days. I will say in my opinion the bank and these employees were just passing off unsatisfactory loans as prime loans and Fannie and Freddie got stuck.”
The juror also said she and her fellow panelists weren’t convinced by the lender’s argument that a computer-generated underwriting process called “CLUES” was a satisfactory method for evaluating the quality of loans.
“The defense seemed to be saying that with CLUES, the loan specialists didn’t need underwriters,” the juror said. “But we decided that there was no way that any machine could do that. You needed a human.”
Countrywide earned at least $165 million using HSSL, allowing the company to maintain revenue in a “cratering” market for subprime mortgages, prosecutors told the jury in closing arguments. Government-sponsored enterprises, or GSEs, such as Fannie Mae and Freddie Mac bought single-family mortgages from lenders.
The U.S. last year joined the whistle-blower action against Bank of America filed by former Countrywide executive Edward O’Donnell.
O’Donnell, who came to court yesterday morning after jurors began their deliberations, declined to comment after the verdict. Under whistle-blower laws, O’Donnell testified he could collect as much as $1.6 million of any monetary damages awarded to the U.S.
Under the HSSL program, prosecutors said, the time in which more than 28,800 loans were processed was reduced to as little as 10 days from 60 days and safeguards were lifted to boost the number of loans the lender completed and sold to GSEs. Brendan Sullivan, a lawyer for Countrywide, said just 11,000 HSSL loans were sold to Fannie Mae and Freddie Mac and quality wasn’t compromised.
Prosecutors said some Countrywide supervisors promised loan specialists trips to casinos as incentives for reducing errors. Sullivan said the incentive program rewards were often no more than a $50 gift certificate to the Outback Steakhouse.
In internal Countrywide e-mails shown to the jury, supervisors urged loan specialists to increase the speed and volume of their work. They also held contests that promised rewards and “casino” nights with poker games.
In another e-mail, dated Dec. 20, 2007, one of Boland’s colleagues questioned a decision under HSSL to eliminate a review of loans by underwriters and shift the focus from ensuring quality loans to speed.
“How does a policy where branches clear everything and underwriting is virtually no longer required, improve our position in an industry accused of low underwriting standards and shady lending practices?” the employee, Neal Ballance, wrote. “This mentality will eventually lead us down the same road as subprime. When did erring on the side of caution ever become a bad thing?”
‘Greed and Lies’
In closing arguments on Oct. 22, Assistant U.S. Attorney Jaimie Nawaday said the case was “about greed and lies.” She cited e-mails in which Countrywide employees described some HSSL loans as “loser loans.” While some employees said the loans’ quality was “in the ditch,” they still sold them to Fannie Mae and Freddie Mac “for a quick profit,” she said.
Sullivan told jurors in his closing arguments that the U.S. failed to prove any fraud occurred and evidence provided by the lender showed that only about 11,000 loans were processed under the HSSL program.
“The government is wrong,” Sullivan told jurors. “There is no fraud, no misrepresentations and no violations of law.”
Messages sent by O’Donnell during HSSL’s tenure show him lauding colleagues’ efforts on the program, endorsing it and supporting implementation of new measures, Sullivan said.
O’Donnell testified during the trial, which began Sept. 24, that he warned Countrywide executives including Mairone about the failure rate of HSSL loans. He read jurors a letter of resignation he drafted and read to superiors in 2008, complaining about the “continued deterioration” of loan quality and describing Mairone’s tenure as “operational negligence.”
Under the program, Countrywide shifted the job of approving loans from trained underwriters to “loan specialists,” or clerks who lacked sufficient training, Nawaday said.
“The HSSL program was all about speed and volume and not about quality,” Nawaday said. “Quality was no more than a distraction.”
Mairone took the stand in her own defense and told jurors she wasn’t part of a scheme to defraud Fannie Mae and Freddie Mac. She said Countrywide considered risks before instituting HSSL and came up with plans to deal with them.
Jurors sent a note yesterday asking Rakoff why other Countrywide officials weren’t sued with Mairone. The judge told jurors they weren’t to speculate on why others weren’t part of the case.
After the jury left the courthouse, Rakoff asked lawyers how he should calculate a penalty.
Armand said the government calculated that all the HSSL loans cost Fannie Mae and Freddie Mac more than $840 million, regardless of whether they were defective. He said the two GSEs sustained gross losses of about $500 million from defective HSSL loans, with about $130 million in net losses after funds were recouped from the defective loans.
Kenneth Smurzynski, a lawyer for the bank, said the defendants disagreed with the government’s calculation. They also disputed the number of HSSL loans sold to Fannie Mae and Freddie Mac that weren’t of investment quality. The banks also argued that Rakoff has discretion on placing a cap on penalties.
Rakoff agreed to review the matter. “It seems to me that I don’t see how I could hold an evidentiary hearing that would be useful until I resolve all these legal issues that have now surfaced,” the judge said.
The case, brought under the Financial Institution Reform, Recovery and Enforcement Act of 1989 or FIRREA, has been used by Bharara’s office at least six times. The office has used the statute and another law to obtain almost $500 million in mortgage fraud recoveries.
The case is U.S. v. Countrywide Financial Corp., 12-cv-01422, U.S. District Court, Southern District of New York (Manhattan).
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