Bank Of America Won’t Have To Pay $1.2 Billion For Countrywide’s “Hustle” Mortgage Scam

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Nearly eight years after Bank of America bailed out Countrywide Financial, a federal appeals court has ruled that BofA should not have been held liable for Countrywide’s “Hustle” scam in which the company sold Fannie Mae and Freddie Mac a ton of poorly underwritten mortgages knowing that they were worthless.

Before Countrywide’s disastrous collapse, it sought to approve and resell as many mortgages as possible, so the lender launched a program it dubbed the High Speed Swim Lane (or HSSL, or Hustle) that effectively removed all the regular underwriting roadblocks in the mortgage approval process.

“Move forward, never backward,” was the directive, meaning trained underwriters sometimes never even saw mortgage applications. Instead, according to the Justice Department, loan review was handed off to mere processors who “were previously considered unqualified even to answer questions.”

Billions of dollars in Hustle loans were sold off to Fannie Mae and Freddie Mac before anyone realized that about half of these mortgages were about to be worthless. Because the government had bailed these two mortgage-backers out, it meant taxpayers were on the hook when these loans failed.

Meanwhile, the executive in charge of the Hustle went on to run JPMorgan Chase’s foreclosure review program.

In Oct. 2012, the Justice Dept. sued BofA over Hustle, alleging that BofA — through Countrywide — had violated the False Claims Act by making fraudulent claims for payment to government officials.

The DOJ also accused the bank under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), a law that grew out of the savings and loan scandal in the late ’80s and involves the making of false statements to a federally insured financial institution.

In Aug. 2013, the court dismissed the False Claims part of the case, noting that the Hustle had ended before the bailouts of Fannie and Freddie. However, the FIRREA case was allowed to proceed, and in Oct. 2013 a federal jury found BofA liable.

It wasn’t until July 2014 that the court finally settled on the financial penalty, hitting BofA for $1.27 billion.

The bank immediately appealed this judgment, arguing that the DOJ had failed to prove their was any actual fraud involved.

This morning, the Second Circuit Court of Appeals agreed [PDF], finding that the “proof at trial is insufficient under the mail and wire fraud statutes as a matter of law.”

BofA successfully argued that Countrywide did not commit fraud, even if the lender intentionally breached its contracts with Fannie and Freddie by selling them a bunch of worthless loans.

At issue is when did Countrywide intend to breach those contracts. If the lender entered into those contracts honestly and did not immediately start reselling toxic mortgages, BofA contends that no fraud exists. In BofA’s view, Countrywide would have needed to enter into those contracts knowing it would never honor them for fraud to have occurred.

The Second Circuit found this line of thinking convincing.

“[W]here allegedly fraudulent misrepresentations are promises made in a contract, a party claiming fraud must prove fraudulent intent at the time of contract execution,” reads the opinion, “evidence of a subsequent, willful breach cannot sustain the claim.”

The panel points to a Second Circuit ruling in a 1994 case, in which the court explicitly stated that “A breach of contract does not amount to mail fraud. Failure to comply with a contractual obligation is only fraudulent when the promisor never intended to honor the contract.”

Thus, writes the court in this opinion, “a subsequent breach of that promise — even where willful and intentional — cannot in itself transform the promise into a fraud.”

Since the DOJ failed to provide sufficient evidence that Countrywide entered into its contracts with Fannie and Freddie with the intent to defraud, “the jury had no legally sufficient basis on which to conclude that the misrepresentations alleged were made with contemporaneous fraudulent intent.”

Today’s ruling reverses the jury’s decision and the District Court’s penalty, and remands the case to the lower court with the instruction to enter judgment in favor of BofA and the executive.

We’ve reached out to the DOJ for comment on this story but have not yet heard back.