We expected that the lead story of this week would be the Congressional testimony of Countrywide Mortgage CEO Angelo Mozilo and other mortgage company executives about their high levels of compensation which continue despite the enormous loses their companies have suffered in the subprime mortgage collapse. While we will report on that hearing before the House Committee on Government and Oversight, other news over the weekend has served to overshadow that sideshow.

First, The Wall Street Journal reported that Countrywide Mortgage and Wells Fargo and Company were under investigation by the Attorney General of Illinois for having improperly steered minority borrowers into high-cost or inappropriate loans

Attorney General Lisa Madigan subpoenaed units of the two investment giants asking for detailed information about borrowers in Illinois including their race or ethnicity, their credit scores and debt-to-income ratios, details of the loans granted and other materials.

The Journal quoted a spokesman for the AGs office as saying "We want to drill down into the underwriting and look at the credit characteristics of these folks and see if [the lenders] are underwriting fairly."

Madigan had earlier investigated Countrywides origination of loans, including subprime mortgages and option adjustable-rate mortgages.

Then the Journal reported that the FBI too has eyes for Countrywide. They are supposedly also interested in Countrywide's origination policies and how commonly fraud might have played a role in originations, but more ominously they are focusing on securities fraud.

The newspaper said that the probe is looking into whether the companys management misrepresented the quality of its portfolio of mortgages when making routine securities filings. If such misrepresentation did occur it might have led investors to overvalue the loans when they were securitized and sold to investors during the years 2004 to 2007.

While any positive fraud findings in the probe could entail serious legal problems for Countrywide and its officers, the real danger is that it could derail a merger with Bank of America that was, at the time it was announced, widely regarded as the only thing standing between Countrywide and bankruptcy.

The bank has agreed to purchase Countrywide for $4 billion in a deal that is scheduled to be completed in the third quarter of this year. While Bank of America has said that it based its bid for Countrywide taking into account potential lawsuits and additional losses the company might incur, charges of mortgage fraud and/or securities fraud in federal court would not only raise the ante on legal costs, it would call into doubt the stated financials used by Bank of America in conducting its due diligence.

Countrywide told the Journal it was not aware of any investigation being conducted by the FBI.

The Illinois and FBI investigations are not the only legal problems faced by Countrywide. Florida is looking into whether the company placed borrowers into loans with rates that were different than those advertised. A class action lawsuit filed by a consortium of government pension funds accuses Countrywide with inflating the value of its portfolio and the Securities and Exchange Commission is looking at Countrywides accounting practices.

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