Bank of America (BOA) was sued in Federal Court today for civil mortgage fraud in a complaint seeking civil penalties as well as treble damages and penalties.  The suit alleges that Fannie Mae and Freddie Mac lost over $1 billion because of defaulted loans fraudulently sold them by Countrywide Mortgage and BOA.

The suit alleges the from at least 2007 through 2009 implemented a new loan origination process called the "Hustle," which was intentionally designed to process loans at high speed and without quality checkpoints, and which generated thousands of fraudulent and otherwise defective residential mortgage loans sold to Fannie Mae and Freddie Mac (the GSEs) that later defaulted.  The Hustle continued under the ownership of BOA.

The suit was brought by Preet Bharara, U.S. Attorney for the Southern District of New York and is the first civil fraud suit that the Department of Justice has filed on behalf of Fannie Mae or Freddie Mac.  Joining Bharara in the Compliant were Steve A. Linick, the Inspector General of the Federal Housing Finance Agency ("FHFA"), and Christy L. Romero, the Special Inspector General for the Troubled Asset Relief Program ("SIGTARP").

The Complaint charges that, in buying loans from Countrywide and BOA the GSEs relied on the lenders' representations and warranties that the loans complied in all respects with the standards outlined in the GSEs' selling guides and lenders' sales contracts.  Because they do not do a pre-purchase review these representations and warranties are central to the GSEs purchase decisions.

Countrywide initiated the High-Speed Swim Lane (HSSL or "Hustle") in 2007 just as loan default rates were increasing and the GSEs were tightening their purchase requirements. Hustle sought to maintain high speed and high volume in loan processing.  To this end, quality control "toll gates" were removed.  Underwriters were eliminated from loan production in favor of unqualified and inexperienced clerks or loan processors.  Hustle also did away with compliance specialists who were supposed to insure that any conditions attached to an approval were satisfied.  Other shortcuts included reducing the guidance previously given processors, providing financial incentives for volume rather than quality and discontinuing financial penalties for poor loan quality.

The Hustle operated within Countrywide's Full Spectrum Lending Division where senior management was repeatedly warned that Hustle's shortcuts would yield disastrous results.  By February 2008, post-closing quality reviews showed defect rates of approximately 37%, far above the industry standard defect rate of 4 to 5%.  One pre-funding quality review in early 2008 showed an overall defect rate of 57 percent rising to nearly 70 percent of stated income loans.  Full Spectrum senior management, however, made to changes to the Hustle, restricting dissemination of the review instead.

Instead of notifying the GSEs that they had been purchasing large volumes of fraudulent and otherwise defective loans that did not meet GSE guidelines, Countrywide concealed the defect rates and continued the Hustle. In addition, Full Spectrum Lending initiated a one-time bonus to its quality control personnel to "rebut" the defect rates found by corporate quality control after which the final defect was revised down to 13%. Countrywide concealed this bonus plan from the GSEs as well.

In July 2008 BOA acquired Countrywide but the suit charges that the Hustle continued unabated through 2009 and at no time did BOA take any steps to disclose the program to the GSEs.  Throughout the time it was in operation Countrywide and BOA sold thousands of Hustle loans to the GSEs that they knew did not meet their representations and warranties of quality and after the loans defaulted, BOA resisted buying many of them back, despite the presence of fraud, misrepresentation, and other obvious violations of GSE requirements.

Manhattan U.S. Attorney Preet Bharara said: "For the sixth time in less than 18 months, this Office has been compelled to sue a major U.S. bank for reckless mortgage practices in the lead-up to the financial crisis. The fraudulent conduct alleged in today's complaint was spectacularly brazen in scope. As alleged, through a program aptly named 'the Hustle,' Countrywide and Bank of America made disastrously bad loans and stuck taxpayers with the bill. As described, Countrywide and Bank of America systematically removed every check in favor of its own balance - they cast aside underwriters, eliminated quality controls, incentivized unqualified personnel to cut corners, and concealed the resulting defects. These toxic products were then sold to the government sponsored enterprises as good loans. This lawsuit should send another clear message that reckless lending practices will not be tolerated."

SIGTARP Special Inspector General Christy Romero said: "The complaint filed today alleges serious and significant misrepresentations that Bank of America made before and during the time taxpayers invested $45 billion in TARP funds in the bank. SIGTARP and its law enforcement partners will investigate allegations of wrongdoing by TARP recipients; particularly conduct that results in substantial losses to the government and taxpayers."