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In August, Bank of America Corp. made history by agreeing to the largest civil settlement a company has ever made with the U.S. Department of Justice. Bank of America and its subsidiaries agreed to pay $16.5 billion to put an end to the department's investigations into the company's fraudulent lending, underwriting and loan-originating practices.
In the years leading up to the 2008 financial crisis, and during the crisis itself, employees at Bank of America and its subsidiaries went to great lengths to skirt rules and compliance regulations designed to prevent bad loans, according to the settlement. These tactics included deceiving automated underwriting systems, making exceptions to underwriting guidelines, and endorsing loans for borrowers without verified incomes or jobs.
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What did Bank of America and its affiliates do to get hit with the largest civil settlement -- $16.5 billion -- the U.S. Department of Justice (DoJ) ever signed?
Much of what got Bank of America and its affiliates into trouble had to do with the way they handled residential mortgage-backed security certificates during the financial crisis and the years leading up to it. Just about everything they did with these products -- creating, originating, pooling, structuring, arranging, forming, packaging, marketing, underwriting, selling and issuing them -- bent or broke the compliance rules.
Merrill Lynch, a subsidiary of Bank of America, knew from due diligence reports that many of these loans did not comply with underwriting guidelines, were not originated according to laws and regulations, or had incomplete files. Some in this subcategory of loans, known as EV3 loans, were given to people who claimed unreasonable incomes or to people who had declared bankruptcy not long before. Despite knowledge regarding the defects, Merrill Lynch waived underwriting guidelines and purchased the loans.
Countrywide Financial Corp., another Bank of America subsidiary, originated a number of loans that required guideline exceptions even as employees learned of rising risk in some mortgage programs and other products. A Countrywide executive wrote to employees informing them that they could expand these loan programs, and that'"[t]o the widest extent possible, we are going to start allowing exceptions on all requests, regardless of program, for all loans less than $3 million, effective immediately."
What Bank of America loan programs, other than the residential mortgage-backed security programs, did the DoJ investigate for fraudulent lending practices?
In addition to the problems with the residential mortgage-backed security programs, Bank of America did not comply with rules for underwriting Federal Housing Administration (FHA) loans to low-income and first-time home buyers. The bank is required to determine whether potential borrowers meet minimum credit standards, but Bank of America endorsed FHA insurance loans to many who did not.
In one instance, Bank of America underwrote a $314,204 FHA loan for someone who lived with a relative and had never paid rent. The borrower had opened a bank account just 12 days before closing the loan, although Bank of America was required to verify two months' worth of bank account statements. The bank also did not verify the income of the borrower, who was put on a leave of absence from their place of employment eight days before closing the loan. The borrower made four payments on the loan before defaulting.
At Countrywide, if the company's automated underwriting system rejected a prospective FHA loan, underwriters tried to game the system by changing the applicant's financial data and resubmitting applications in an attempt to get the system to accept it. One underwriter tried more than 40 times to get the system to accept a particular loan application.
Why didn't compliance officials realize Bank of America and its subsidiaries were breaking loan rules, regulations and laws?
At Merrill Lynch, the Whole Loan Trading Desk was responsible for conducting due diligence on loans to be acquired, with assistance provided by an outside company. During the due diligence process, a sample of loans was evaluated to determine, among other stipulations, whether they complied with underwriting guidelines, laws, rules and regulations. Evaluations were reported to Merrill Lynch's subprime due diligence manager, some employees on the trading desk and others in the securitization division.
When due diligence revealed non-compliant loans -- such as those that did not comport with underwriting guidelines or were not originated according to laws and regulations -- many were approved for purchase anyway. Evidently frustrated by the process, one consultant in the due diligence department wrote: "[H]ow much time do you want me to spend looking at these [loans] if [the co-head of Merrill Lynch's RMBS business] is going to keep them regardless of issues? … Makes you wonder why we have due diligence performed other than making sure the loan closed."
Merrill Lynch's own due diligence manager told the head of its Whole Loan Trading division in late 2005 that some of its loan originators were using more lenient underwriting guidelines. The company kept purchasing loans from some of these originators and did not make substantial changes to its disclosures. In late 2006, the due diligence manager raised the issue again, but Merrill Lynch still continued its practices.
Did Bank of America have to admit wrongdoing to settle with the DoJ?
As part of the $16.5 billion Bank of America settlement, the company and its subsidiaries acknowledged knowing that many mortgage loans were defective and that it made inaccurate representations about the loans. They also admitted to originating risky mortgage loans and not being truthful with Fannie Mae, Freddie Mac and the Federal Housing Administration about the quality of those loans.
Merrill Lynch acknowledged that, telling investors that its securitized loans were given to borrowers who were able and likely to pay them back, despite knowing many of the loans were defective. What's more, Merrill Lynch rarely examined the majority of loans to make sure they did not contain defects.
Countrywide conceded that it told investors it originated loans using standards to ensure repayment even though it knew borrowers were likely to default. Additionally, Countrywide hid from investors that it was ignoring guidelines and providing loans to high-risk borrowers.
Who gets the $16.5 billion that Bank of America must pay under the settlement?
Bank of America will pay nearly $10 billion to settle a variety of federal and state lawsuits, including a $5 billion claim brought by the Justice Department under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). The company also settled claims brought by the Federal Deposit Insurance Corp., the Securities and Exchange Commission, and the attorneys general of California, Delaware, Illinois, Kentucky, Maryland and New York.
An additional $7 billion is earmarked for consumer relief through loan modifications, new loans, donations to communities, funds for affordable rental housing and tax relief.
As Bank of America is fined billions for mortgage fraud, who gets the settlement money? (TIME)
State of Illinois to receive $300 million as part of Bank of America settlement with DOJ (Chicago Tribune)
About the author:
Caron Carlson is a freelance writer and editor based in the Washington, D.C. area. Having covered technology and telecommunications for more than 15 years, Caron has contributed to a wide variety of tech and business publications and websites. She has also moderated webinars, spoken at industry conferences and been a guest commenter on radio shows. Caron holds a master's degree in journalism from the University of Missouri and a bachelor's degree from Georgetown University.