Tag Archives: FIRREA

Reiss on Snuffing out FIRREA

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Law360 quoting me in BofA Fight Won’t Blunt DOJ’s Favorite Bank Fraud Weapon (behind a paywall). It reads in part,

A federal magistrate judge on Thursday put a Justice Department case against Bank of America Corp. using a fraud statute from the 1980s in peril, but the case’s limited scope means the government is not likely to abandon its favorite financial fraud fighting tool, attorneys say.

Federal prosecutors have increasingly leaned on the Financial Institutions Reform, Recovery and Enforcement Act, a relic of the 1980s savings and loan crisis, as a vehicle for taking on banks and other financial institutions over alleged violations perpetrated during the housing bubble years.

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Some banking analysts hailed the ruling as potentially the beginning of the end of the government’s pursuit of housing bubble-era violations.

“If the judge’s recommendation is accepted by the federal district court judge, then this development will represent a significant setback for the government’s legal efforts and likely mark the beginning of the end for crisis-era litigation,” Isaac Boltansky, a policy analyst at Compass Point Research & Trading LLC, said in a client note.

However, others say the government’s case was brought under relatively narrow claims that Bank of America did not properly value the securities to induce regulated banks to purchase securities they otherwise might not have.

That is a tougher case to bring than the broad wire fraud and mail fraud claims that were available to the government under FIRREA. The government has employed those tools with great success against Bank of America and Standard & Poor’s Financial Services LLC in other cases in far-flung jurisdictions, said Peter Vinella, a director at Berkeley Research Group.

“There was no issue about whether BofA did anything wrong or not. It’s just that the case was filed incorrectly. It was very narrowly defined,” he said.

It is not entirely clear that Bank of America is in the clear in this case, either.

U.S. district judges tend to give great deference to reports from magistrate judges, according to David Reiss, a professor at Brooklyn Law School.

But even if U.S. District Judge Max O. Cogburn Jr. accepts the recommendation, the Justice Department has already lodged a notice of appeal related to the report. And in the worst-case scenario, the government could amend its complaint.

A victory for Bank of America in the North Carolina case is unlikely to have a widespread impact, given the claims that are at stake. The government will still be able to bring its broader, and more powerful claims, under a law with a 10-year statute of limitations.

“It is one opinion that is going against a number of FIRREA precedents that have been decided in others parts of the country,” Reiss said. “It also appears that this case was brought and decided on much narrower grounds than those other cases, so I don’t think that it will halt the government’s use of the law.”

Duties to Serve in Housing Finance

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Adam Levitin and Janneke Ratcliffe have posted Rethinking Duties to Serve in Housing Finance to SSRN (also on the Harvard Center for Housing Studies site here). The paper states that

an important question going forward concerns the role of duties to serve (DTS) — obligations on lending institutions to reach out to traditionally underserved communities and borrowers. Should there be DTS, and if so, who should have the responsibility to serve whom, with what, and how? (2)

These are, indeed, important questions as regulators chart a course between requiring safe underwriting by lenders and ensuring access to credit for communities that have historically had little access to sustainable credit. The authors distinguish fair lending from duties to serve, with the former being an obligation not to discriminate and the latter being an affirmative duty to address the “disparity of financial opportunity.” (2) The paper describes two main DTS regimes,the Community Reinvestment Act and the Fannie/Freddie housing goals, as well as their limitations.

The paper concludes that the “aftermath of the housing bubble presents an opportunity to rebuild DTS” and proposes a set of reforms. (29) I highlight the first two here:

  1. “DTS should apply universally to the entire primary market,” covering both depositories and non-depositories in order to avoid incentives to engage in regulatory arbitrage. (30)
  2. “DTS should apply equally for all secondary market entities,” not just the Fannies and Freddies of the world. (30)

This paper has a lot to offer thoughtful policymakers. As with everything to do with our massive housing finance system, however, the devil is in the details of any regulatory regime. Mandatory duties to serve must be drafted to so that they are consistent with safe underwriting practices. This paper starts a conversation about doing just that.

FIRREA Does the Hustle

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Judge Rakoff has issued another Opinion in U.S. v. Countrywide Fin. Corp. et al., 12 Civ. 1422 (Feb. 17, 2014).  Rakoff reconfirms his broad reading of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which covers fraudulent behavior that is self-affecting; that is, where the perpetrator and victim of the fraud are one and the same financial institution. This Opinion goes further, however, based on on developments in the litigation since that earlier opinion.

The Opinion notes that the defendants were found liable at trial and finds that

Based on the charge as given to the jury, the jury, by finding liability, necessarily found that the defendants intentionally induced two government-sponsored entities, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), to purchase from the Bank Defendants thousands of loans that Fannie Mae and Freddie Mac would not otherwise have purchased. The defendants did so, the jury necessarily found, by misrepresenting that the loans they were selling were “investment quality” and that they knew of nothing that might cause investors to regard the mortgages as poor investments, when in fact the defendants knew that their underwriting process, known as the “High Speed Swim Lane,” “HSSL,” or “Hustle,” was calculated to produce loans that were not of investment quality. (3)

The Court had previously found that “the fraud here in question, perpetrated by the Countrywide defendants and Ms. Mairone, had a huge effect on Bank of America defendants, which, as a result of Bank of America’s purchase of Countrywide, paid, directly or through affiliates, billions of dollars to settle repurchase claims brought by Fannie Mae and Freddie Mac.” (4) The opinion concludes that

It is highly improbable that Congress would have intended to place beyond the reach of FIRREA those defendants whose misconduct “affects” federally insured banks that have the great fortune to be fully insured [by their affiliates] for such losses. Even less so can it be imagined that the device of having BAC [the BoA parent holding company] indemnify BANA [the BoA federally insured bank] for losses that otherwise would result from Countrywide’s fraud immunizes Countrywide from liability under FIRREA. Indeed, defendants’ labeling of this theory of liability as the “self-affecting” theory is something of a misnomer; Countrywide’s fraud, which culminated before the merger with BANA, directly affected, not just Countrywide, but its merger partner, BANA, as well. While the effect on Countrywide might be “self-affecting,” the effect on BANA was not. (5)

This Opinion seems to bolster Rakoff’s broad reading of FIRREA.  As of now, FIRREA gives the federal government a powerful tool to pursue alleged wrongdoing affecting federally insured financial institutions.  The caselaw reads FIRREA broadly and the statute’s ten-year statute of limitations means that additional suits may still be coming down the pike.

S&P’s Fightin’ Words

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S&P filed a memorandum in support of its motion to compel discovery in the FIRREA case that the United States brought against S&P last year. S&P comes out fighting in this memorandum, arguing that the “lawsuit is retaliation for S&P’s decision to downgrade the credit rating of the United states in August 2011.” (1)

S&P argues that the “most obvious explanation” for the United States’ “decision to pursue a FIRREA action against S&P alone” among the major rating agencies “is apparent:”   “S&P alone among the major rating agencies downgraded the securities issued by the United States.” (17) This is not obvious to me, particularly given the various explanations for this disparate treatment that have appeared in outlets like the WSJ over the last couple of years. But it may be true nonetheless.

In any case, I do not find the “chronology of events relating to the downgrade and the commencement of this lawsuit” to provide “powerful evidence linking the two.” (17) The chronology ends with the following entries:

  • S&P’s downgrade of the United States occurred on Friday, August 5, 2011. That Sunday, August 7, Harold McGraw III, the Chairman, Chief Executive Officer and President of McGraw Hill (of which S&P was a unit), received a telephone message from a high-ranking official of the New York Federal Reserve Bank; when the call was returned, the official conveyed the personal displeasure of the Secretary of the Treasury with S&P’s rating action.
  • This was followed on Monday by a call to Mr. McGraw from the Secretary of the Treasury, Timothy Geithner, in which Secretary Geithner stated that S&P had made a “huge error” for which it was “accountable.” He said that S&P had done “an enormous disservice to yourselves and your country,” that S&P’s conduct would be “looked at very carefully,” and that such behavior could not occur without a response.
  • The McClatchy Newspapers subsequently reported in a piece authored by Kevin G. Hall and Greg Gordon that while the United States’ original investigation included S&P and Moody’s, “[i]nvestigator interest in Moody’s apparently dropped off around the summer of 2011, about the same time S&P issued the historic downgrade of the United States’ creditworthiness because of mounting debt and deficits.” A source familiar with the investigations was quoted as stating: “After the U.S. downgrade, Moody’s is no longer part of this.”
  • In the year preceding S&P’s downgrade of the United States, two states, Mississippi and Connecticut, had initiated proceedings alleging deceptive practices based specifically on an alleged lack of independence. Each of those states named both Moody’s and S&P as defendants. After the downgrade, additional state lawsuits were commenced, with allegations nearly identical to those of the Connecticut and Mississippi complaints. Drafted after coordination and consultation with the U.S. Department of Justice, none of those lawsuits named Moody’s. (19, footnotes omitted)

This is surely no smoking gun and lots of dots remain to be connected.  How did DoJ get involved? Are the state Attorneys General in on the conspiracy? Why would DoJ stop an investigation of Moody’s to punish S&P? Sounds a bit like cutting off your nose to spite your face?

That being said, S&P might be right about the motivation for this suit and their allegations may be enough to win this motion to compel discovery. But whoever wins this round, this should be a fight worth watching.

Is Banks’ $200 Billion Payout from RMBS Lawsuits Enough?

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S&P issued a brief, The Largest U.S. Banks Should Be Able To Withstand The Ramifications Of Legal Issues, that quantifies the exposure that big banks have from litigation arising from the Subprime Crisis:

Since 2009, the largest U.S. banks (Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo) together have paid or set aside more than $45 billion for mortgage representation and warranty (rep and warranty) issues and have incurred roughly $50 billion in combined legal expenses .  . . This does not include another roughly $30 billion of expenses and mortgage payment relief to consumers to settle mortgage servicing issues. We estimate that the largest banks may need to pay out an additional $55 billion to $105 billion to settle mortgage-related issues, some of which is already accounted for in these reserves. (2)

S&P believes “that the largest banks have, in aggregate, about a $155 billion buffer, which includes a capital cushion, representation and warranty reserves, and our estimate of legal reserves, to absorb losses from a range of additional mortgage-related and other legal exposures.” (2) As far as their ratings go, S&P has already incorporated “heightened legal issues into our ratings, and we currently don’t expect legal settlements to result in negative rating actions for U.S. banks.” (2) But it warns, “an immediate and unexpected significant legal expense could result in the weakening of a bank’s business model through the loss of key clients and employees, as well as the weakening of its capital position.” (2) S&P also acknowledges that there are some not yet quantifiable risks out there, such as DoJ’s FIRREA suits.

As the endgame of the financial crisis begins to take shape and financial institutions are held accountable for their actions, one is left wondering about a group who is left relatively unscathed: financial institution employees who received mega bonuses for involving these banks in these bad deals. As we think about the inevitable next crisis, we should ask if there is a way to hold those individuals accountable too.

Reiss on Countrywide Verdict

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Law360 interviewed me in DOJ’s Countrywide Win Could Force More Bank Settlements (behind a paywall).  The story opens

The U.S. Department of Justice’s victory in a case against Bank of America Corp.’s Countrywide subsidiary over a housing-bubble-era mortgage program shows the power of a 1980s fraud statute, and could further encourage banks to settle future financial crisis cases, attorneys say.

A federal jury in New York on Wednesday unanimously found that Countrywide Financial Corp. and one of its former executives defrauded Fannie Mae and Freddie Mac through a program designed to speed up mortgage issuing in 2007 and 2008.

The court victory was significant in part because of U.S. Attorney Preet Bharara’s use of the Financial Institutions Reform Recovery and Enforcement Act, a law that grew out of the 1980’s savings-and-loan crisis, to bring a case over the 2007-09 financial crisis. With a fairly low standard of proof and a 10-year statute of limitations, a jury’s verdict based on FIRREA bodes well for future government cases, said Brooklyn Law School professor David Reiss.

“This successful use of FIRREA makes it much more likely that financial institutions are going to settle with the government,” he said.

Judge Rakoff Is All FIRREA-ed Up

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Law360 quoted me in a story, Rakoff Gives DOJ License To Be Bold In Bank Crackdown (behind a paywall), that reads in part,

U.S. District Judge Jed S. Rakoff’s expansive Monday opinion backing the federal government’s $1 billion mortgage fraud suit against Bank of America Corp. leaves the U.S. Department of Justice wide latitude to use its favorite financial fraud tools in cases linked to the recent financial crisis.

Judge Rakoff’s opinion expanded his May decision allowing the Justice Department’s October suit against Bank of America over lending practices during the housing bubble and financial crisis to move forward under the Financial Institutions Reform Recovery Enforcement Act, while also explaining why portions of its case using the False Claims Act failed.

The ruling, which accepted the government’s broad view of which federally insured financial institutions can be sued under FIRREA and on what grounds, gives the government further ammunition to bring such cases in the future, said Brooklyn Law School professor David Reiss.

“The federal government has taken an expansive view of this phrase, and Judge Rakoff agrees that it can be read broadly in certain circumstances, such as when the affected federally insured financial institution is the alleged wrongdoer itself,” he said.

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[T]he Second Circuit will look closely at other appellate rulings related to interpreting congressional intent, as well as any rulings dealing specifically with FIRREA should an appeal come its way, as many observers expect.

However, it is likely to look closely at Judge Rakoff’s opinion when rendering an ultimate decision, which is why he considered those issues, Reiss said.

“Judge Rakoff stated that this result clearly flowed from the plain language of FIRREA, so the defendants may have a hard time on appeal,” he said.