Embattled BoA faces fresh challenges

In what has become yet another record-breaking settlement, the Bank of America has agreed to pay $17bn after claims it was dealing in toxic assets. But, despite the hefty price tag, the bank is still facing criminal charges

Bank of America flag
Commentators have suggested that big banks with a taste for toxic assets were to blame for the near collapse of the American financial system. Despite a $16.7bn payoff relating to a civil suit, Bank of America might still face criminal charges 

Over the past two years, US authorities have not been shy about dishing out sizeable fines to banks and institutions found guilty of financial bad practice in the months and years leading to the meltdown of 2007. But, until now, none of the settlements imposed by American authorities has been as large as the one Bank of America has just been slapped with. Perhaps most surprisingly, despite the $16.7bn payoff relating to a civil suit, BoA might still face criminal charges.

The settlement is in reference to claims that BoA and its subsidiaries may have misled investors and manipulated them into purchasing toxic mortgage backed securities. The bank commented that it “relates primarily to conduct that occurred at Countrywide and Merrill Lynch,” before either institution was taken over by BoA. According to the terms of the agreement, the bank will have to pay over $9.65bn in cash, to be divided between the US Justice Department, the authorities of six states and governmental agencies including the Securities and Exchange Commission (SEC).

The remaining $7bn will be allocated to consumers who have run into difficulties in repaying bad mortgages and costs of demolishing derelict and abandoned properties. This makes it the single largest payment in US history, surpassing the previous record payoff by close to $4bn. On that occasion, JP Morgan Chase agreed to pay $13bn for similar offenses to those BoA has allegedly committed. Citigroup also faced a $7bn penalty when it chose to settle its case for similar charges last year.

Since the onset of the crisis in the US in 2007, commentators have suggested that big banks with a taste of toxic and risky assets were to blame for the near collapse of the American financial system

Since the onset of the crisis in the US in 2007, commentators have suggested that big banks with a taste of toxic and risky assets – and the subsequent fallout from this particular indulgence – were to blame for the near collapse of the American financial system. It has emerged that in the years leading up to collapse in 2007, banks like Merrill Lynch, JP Morgan and Citigroup had been repackaging residential mortgage loans into bundles that then formed controversial derivatives known as residential mortgage backed securities (RMBS). These were then sold off to investors, reducing the risk for mortgage lenders for defaulted payments, and offering a viable investment opportunity.

“In the run-up to the financial crisis, Merrill Lynch bought more and more mortgage loans, packaged them together and sold them off in securities – even when the bank knew a substantial number of those loans were defective,” said US Attorney Paul Fishman, whose jurisdiction includes the state of New Jersey, one of the beneficiaries of the settlement.

Bad mortgages
On the surface, the system worked well and there was no cause for concern, though cracks appeared when it emerged that risky mortgages were being offered to borrowers regardless of their ability to repay those loans and with no appropriate checks or due diligence being carried out. As a result, the ensuing RMBS were backed essentially by toxic loans and were being sold off onto investors without meeting relevant underwriting guidelines and utterly inadequately collaterised.

“Bank of America has acknowledged that, in the years leading up to the financial crisis that devastated our economy in 2008, it, Merrill Lynch and Countrywide sold billions of dollars of RMBS backed by toxic loans whose quality and level of risk they knowingly misrepresented to investors and the US government,” Attorney General Eric Holder said. BoA has been eager to stress that the investigations and subsequent settlement relate to claims that “relate primarily to conduct that occurred at Countrywide and Merrill Lynch” before it acquired in 2008.

However, though BoA has been vigorously penalised the actions of Merrill Lynch the practice of selling on RMBS was extremely profitable to banks, and therefore, widespread. Which probably explains why, over the years, standard of due diligence carried out by these institutions dropped – the derivatives became much more profitable than the original product.

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Prior to the settlement, three separate investigations were being carried out by different US states: North Carolina; California and New Jersey, over the same claims that Merrill Lynch knew that the quality of the assets in the RMBS it was selling was extremely poor, “based on its own due diligence, that substantial numbers of the loans it was packaging into RMBS and selling to investors failed to meet underwriting guidelines, did not comply with the applicable law, or were inadequately collateralised – all contrary to representations Merrill was making to investors,” according to a statement by the Justice Department.

In California especially, investigators have uncovered instances of quite severe failings. On one occasion, detailed by the Department of Justice, Countrywide actively concealed their use of ‘shadow guidelines’ from investors – these far from official guidelines allowed the bank to provide loans and mortgages to risky borrowers that would not have been otherwise permitted under the lender’s official underwriting guidelines. In the 30-page document that accompanied the settlement, it was made clear that BoA was aware that many of the loans bundled into the securities were subprime or downright junk. The fact that BoA chose to continue selling the RMBS despite being aware of their defects, is nothing short of problematic.

“It’s kind of like going to your neighbourhood grocery store to buy milk advertised as fresh, only to discover that store employees knew the milk you were buying had been left out on the loading dock, unrefrigerated, the entire day before, yet they never told you,” West told the press. These are extremely damning accusations. It means that Merrill Lynch was in full knowledge of the questionable legality of its operations for years, and vitally, at the time BoA made the move for acquisition. The 2008 period will probably go down in BoA history as one of the toughest ever; first it acquired Countrywide – the largest subprime mortgage lender in the US before 2007 – in February for over $4bn, only a month before the FBI announced its investigation into the lender for alleged fraud relating home loans and mortgages. Despite this setback, BoA moved into acquire loss-making Merrill Lynch in September of that year, in a $50bn all-share deal, announced around the same time Lehman Brothers confirmed its collapse.

Bad outcome
Both acquisitions have proved themselves problematic for the embattled BoA. US prosecutors have now announced they are preparing a civil lawsuit to be brought against Angelo Mozilo, co-founder of Countrywide – three years after prosecutors were forced to abandon a criminal probe on the former CEO. According to Bloomberg, prosecutors are now turning to the Financial Institutions Reform, Recovery and Enforcement Act to charge Mozilo and as many as 10 other Countrywide employees over allegations of fraud in the handling of its mortgage business.

The 2008 period will probably go down in BoA history as one of the toughest ever

“This morning we demonstrate once again that no institution is either too big or too powerful to escape appropriate enforcement action by the department of justice. At nearly $17bn, this resolution with Bank of America is the largest the department has ever reached with a single entity in American history,” associate attorney general Tony West said at a press conference in the wake of the announcement in August. Though West’s words might sound pompous and brash, the string of costly settlements and Mozilo’s potential indictment suggest that the current US administration is not done investigating and potentially persecuting financial institutions and notable players for perceived crimes against the system.

“We believe this settlement, which resolves significant remaining mortgage-related exposures, is in the best interests of our shareholders, and allows us to continue to focus on the future,” said Brian Moynihan, CEO at BoA, in a statement when the settlement was agreed. Indeed, the settlement certainly closes the door on ‘certain and potential’ civil claims by the states and agencies involved in the original suit – US Department of Justice, SEC and State Attorneys General from California, Delaware, Illinois, Kentucky, Maryland and New York – as well as all pending claims against BoA entities brought by the Federal Deposit Insurance Corporation. It does not rule out further criminal suits being brought or the filing of new civil claims against individuals.

“We have many tools in our tool box,” said West. Civil charges could be very effective because of the “lower burden of proof. That does not preclude us being able to use other tools in our tool box,” said West in regards to future action against the bank. This certainly must make the $17bn settlement even more unpalatable for BoA bosses and shareholders.