The US mortgage crisis has crept upon the judicial and political scene in bits and pieces. One lawsuit will concentrate on robo-signing by the big banks. Another will look at errors in the securitization process. A third will probe the way mortgages were originated. None of these lawsuits really puts the whole picture together – until now. Catherine Cortez Masto, the Attorney General for the state of Nevada, has filed a complaint against Bank of America that takes you from the origination of mortgages to their foreclosure, showing you exactly how Nevada thinks Bank of America defrauded consumers in that state. It is a well-written legal complaint, but it is not easy reading. It will be hard for you to believe that one bank could be so deceitful and so reckless with the law. It will be even harder for you to understand how Bank of America is still allowed to call itself a bank.

Countrywide Sets the Tone

The first third of the complaint concentrates on the fraudulent activity of Countrywide Financial under its CEO Angelo Mozilo, before it collapsed and was bought up by a covetous Bank of America. Bank of America at the time of the purchase assured its shareholders that management had done thorough due diligence on Countrywide and that BOA was satisfied it had uncovered all the sins of omission and commission possibly perpetrated by Countrywide. It is evident now, as BOA is being dragged underwater by the weight of these sins, that management’s idea of “due diligence” seemed to consist of nothing more that reading the frothy “all is well” press releases that Angelo Mozilo was issuing until the very end.

Too bad BOA never uncovered the email Mozilo sent around to his executives, alerting them to growing problems in the mortgage portfolio, including the rising number of defaults and the difficulties borrowers were having with “payment shock.” BOA should have been concerned that Countrywide in 2003 had abandoned traditional fixed rate mortgages to sell more lucrative but highly toxic mortgages to customers that couldn’t qualify for traditional mortgages in the first place.

The three favorite mortgages at Countrywide were:

1) Option Adjustable Rate Mortgages, which were often marketed with a 1% teaser rate for the first three months. The consumer had the option to defer principal payments and only pay interest, but the deferred amount accumulated and compounded so that the mortgage developed “negative amortization”, which meant the loan balance grew to a size greater than the amount initially borrowed.

2) Hybrid Adjustable Rate Mortgages. These mortgages carried low introductory interest rates for the first two or three years, and then significantly higher interest rates for the next 28 or 27 years.

3) Home Equity Lines of Credit (HELOCs). Countrywide marketed these loans as “piggyback mortgages”, encouraging homeowners to borrow up to 85% of the value of their home on their first mortgage, and take out a HELOC for the remaining 15% of the value. The customer walked out the door signing away all equity of the home as collateral to Countrywide.

Countrywide set up a very aggressive marketing program for all three of these loans. Advertisements never mentioned anything but the opening, low rates. Brochures conveniently left out information about the payment shock which would occur when rates reset. Loan officers were not allowed to talk about interest rates at all during the initial conversation with a borrower, and nor was there any discussion of how much equity was going to be shifted over to the bank as collateral. By 2006, over three-quarters of Countrywide loans were “liar loans”, in which the homeowner’s income and asset information could be submitted without any verification whatever, such as pay stubs or tax returns. Often the loan officers made up these numbers out of thin air in order to get a loan approved. Countrywide played hardball with appraisers who did not inflate the value of homes under review; those who refused to play along were blackballed completely from ever dealing with the nation’s largest home loan lender.

That was the home loan side of things. Countrywide was also the nation’s largest mortgage servicer, for its own loans and those of many other banks, handling over $1.5 trillion in mortgages. Once the housing crisis hit in 2006, Countrywide found new and imaginative ways to defraud consumers by collecting “impermissible and inflated fees” from any homeowner in default or foreclosure or bankruptcy. Interest due was routinely overstated and never explained in detail. In four states where Bankruptcy Trustees looked into the matter, it was shown that Countrywide collected unlawful servicing fees.

The Federal Trade Commission investigated Countrywide’s compliance under the Deceptive Trade Practices Act (DTPA), and fined the bank $108 million for its various criminal acts. When Bank of America bought Countrywide, it wanted to put all these problems behind it, especially since they were much bigger and more serious than they thought at first. BOA negotiated a multi-state settlement, conceding that “Countrywide engaged in widespread consumer fraud in origination, marketing, and servicing.” The state of Nevada came to its agreement with BOA on February 24, 2009, in which BOA consented to make major changes in its servicing practices.

The complaint filed this week by Nevada is the third since 2009 in which the state alleges BOA has routinely violated the terms of this agreement. This new suit is also the most comprehensive in describing these violations, which also include the way BOA sold mortgages into the secondary market.

Bank of America Promises to Clean Up its Mortgage Business

Under the consent agreement with the state of Nevada, Bank of America promised that under its participation in the National Homeownership Retention Program, the bank would:

• Make the modification process streamlined,
• Decide on modifications within 60 days, on average,
• Not initiate or advance any foreclosures on homeowners seeking modifications to their mortgage.

Based on numerous complaints filed with the Attorney General of Nevada, the state’s lawsuit against Bank of America claims none of these promises was met.

The modification process was anything but streamlined. Consumers were required to submit proof of income, copies of tax statements including all attached schedules, an IRS tax form 4506-T (authorizing a tax transcript), a signed affidavit applying for a modification, and a signed letter identifying the financial hardship behind the request. Under the terms of some of the government modification programs, financial hardship was not a condition required for a modification. This was a bank, by the way, that was happy to extend these loans without any proof of income required from the consumer.

Once consumers submitted the required documentation, for many of them a nightmare began in which documentation would be lost by the bank as many as half a dozen times. The bank never told consumers documentation was lost; it was only discovered if the consumer called the bank to find out why the modification was taking so long. The bank would repeatedly tell consumers documentation was complete and under review, when in fact it was lost. These and other problems made a mockery of the bank’s claims, plastered all over its website and in written material, that the streamlined modification process would take less than 60 days, and in many cases “within 45 days”. Bank of America has refused to release its statistics on the average wait time for a modification decision, but the Nevada Attorney General believes the average to be well beyond 60 days.

While modifications were under review, or even if the documentation was lost by the bank, Bank of America proceeded in many cases to file for foreclosure against the applicants, though this was strictly prohibited under the terms of the government programs involved. Consumers would receive letters of foreclosure at the same time they were told by the bank that modification was forthcoming. Employees working in the bank call center report numerous instances where they knew the home was in the process of foreclosure even though this was prohibited under the modification terms.

Consumers who were never late on a payment, and who sought a modification, were instantly labeled by the bank as a bad credit risk, and the credit agencies were notified of an adverse event that affected the consumer’s credit rating. It was also routine for the bank to hire collection agents to harass the applicants for payment if they were late on their mortgage obligation. One of the advantages to the bank of damaging a consumer’s credit rating or labeling them as delinquent and therefore subject to collection procedures, was that the bank could start accumulating missing payment fees and late payment interest charges. The Attorney General’s complaint cited a number of cases where the late fees and interest charges were so large, that the consumer lost the home to foreclosure anyway.

Consumers who were not late in making payments were routinely told that they could not proceed with an modification request until they deliberately failed to make a payment. This was definitely not a requirement under the government modification programs, but once a consumer stopped paying on their mortgage, the entire foreclosure process began in earnest, including compounding of late fees and other charges. In a number of such cases, these consumers ultimately lost their home to Bank of America under a foreclosure.

The bank said it made 20,000 modifications a month nationwide last year, but it won’t release data on how many applications were declined a modification. The Nevada Attorney General said that the decision process was opaque, and the reasons given for a refusal were often specious. If a request was denied, foreclosure was often the only option for the homeowner. The bank had any number of reasons to give when denying a modification. Consumers might be told that the investors owning the mortgage had refused to allow a modification, even though in most cases investors had authorized the bank to modify loans, and even though Bank of America had specific evidence in the consumer’s file that investors had waived their right to deny modifications for that specific mortgage. Another reason given was that the applicant had failed to file complete information; the complaint shows that in many such cases the applicant had filed the complete information required multiple times. On some occasions Bank of America denied modifications for incomplete information even though the only reason information was incomplete was because the bank had lost the file. One consumer was told his modification was denied because he had already received a modification, even though the applicant had rejected that modification because it was based on erroneous income information. In many cases the bank denied modifications because the applicant was “unable to be reached”, despite evidence in the file that the applicant had called the bank numerous times.

The denial of a modification usually allowed the bank to proceed with foreclosure. At the time of the Countrywide purchase, and when Bank of America entered into its consent agreement with the state of Nevada to clean up its mortgage servicing business, the bank knew that Countrywide had serious problems with its securitization process. Complaints had revealed that Countrywide hardly ever complied with the terms of the legal agreements governing securitizations, so that the trustee for the security rarely received the original note to the mortgages and never received any amendments or modifications to the note, as required.

Despite knowing this, since 2009 Bank of America, in the state of Nevada, has consistently foreclosed on properties for which it has no legal claim, according to the state Attorney General. The suit claims Bank of America “sought to enforce notes, engage in collection activity, pursue nonjudicial foreclosures, and defend foreclosures when it did not have the authority to act.”

Suppose a consumer was one of the few who received a modification. In many cases the modification involved an increase in the interest rate, which is yet another of the terms that are not permitted under the federal loan modification programs. Or, the consumer was allowed to go through mediation, which like arbitration, is one of those practices corporations are increasingly requiring to prevent consumers from suing in courts for redress. The Nevada suit claims, though, that Bank of America often did not show up at mediation hearings, or the people who came were unable to agree to mediation terms, or they didn’t have sufficient documentation in their file to discuss the terms. When the mediator got both sides to agree to a modification package, the mediator would discover months later that Bank of America never proceeded to grant the modifications. Some of these consumers therefore still went into foreclosure. A number of these mediators have reported to the state Attorney General that Bank of America “did not negotiate in good faith.”

What to Do About a Bad Faith Bank

The first defense Bank of America can make about its actions is that the Attorney General’s complaint consists of allegations. In other words, nothing has been proven yet. Except, the complaint cites several regulatory actions against Bank of America that have resulted in substantial fines being paid, even though the bank did not admit any guilt. It just didn’t want to go to court or to a jury trial. Second, this isn’t a complaint from a private party. The attorney general is in possession of thousands of complaints against the bank, complaints which have been investigated by the state, and for which the bank has no explanation or justification. The complaint is backed up by documentation from these thousands of consumers, by depositions, and other evidence. This isn’t some lawyer looking for an easy target and a quick settlement. This is, in fact, a state government that entered into an agreement with Bank of America on these same issues regarding mortgages and foreclosures, and has already concluded that the bank did not act in good faith.

Some of the observers who have had the stomach to read through all 48 pages of this suit – and it takes a good deal of fortitude to read about case after case of consumer fraud – think Bank of America is a criminal organization. Certainly you get the feeling that the bank operates in complete defiance of the law, of regulations set down in Washington, of the legal agreements it signed governing securitizations, of the promises it made to mediators, and of commitments it made previously to state attorneys general.

This week also saw two other complaints against Bank of America. The Federal Housing Finance Agency filed suit against BOA and 16 other banks, charging them with defrauding investors by lying about the condition of the mortgages included in mortgage-backed securities. The interesting thing about this complaint is that the allegations are about Bank of America’s behavior before it bought Countrywide, and when it was one of the large securitizers in the business. Separately it was revealed that HUD’s inspector general submitted to the Department of Justice evidence that many banks, including Bank of America, defrauded the government and consumers by forcing consumers to buy expensive home mortgage insurance, not revealing that the insurance provider was a subsidiary of the bank itself.

Adding all this up, you do get the image of a corporation which actively skirts, flouts, evades, and breaks the law. Does this mean that CEO Brian Moynihan meets regularly with his executives, or even his board of directors, to determine which laws to break next? No – nor is that necessary for one to conclude that the bank is a criminal enterprise. It is possible that the bank executives refused to hear the details of what their managers were doing, and winked and nodded at suggestions that the bank “stretch things” a little when it comes to the legalities.

But let us assume this is not the case. Assume that Moynihan and his fellow executives have every intention of following the law, and that they set a tone that should in normal circumstances encourage employees to follow the law and regulations to the letter and the spirit required. Even assuming this, something has gone severely wrong at Bank of America that still allows for egregious, fraudulent behavior. What could this be?

The large banks have admitted to serious errors in their mortgage servicing businesses. These businesses were sleepy underperformers before the housing collapse. They earned modest fees and modest returns for processing mortgage payments. Foreclosures were few and far between. They were grossly understaffed when the mortgage crisis hit, and they farmed out foreclosure and other duties to law firms that routinely broke the law with robo-signing and other techniques that jammed thousands of foreclosures through the system every week.

Having admitted all this, you would think an institution like Bank of America would devote top executive talent and the necessary hiring budget to fixing its problems. Whatever happens with the state of Nevada complaint, a bank lives and dies by its reputation, and cannot afford the reputational damage that is done when a high profile suit alleges consistent, deliberate criminal behavior. Bank of America has persisted in behavior that could utterly destroy its franchise.

This might be why shareholders have abandoned its stock, which has fallen over 45% in value this year. Given how the bank cannot afford continuing criminal behavior and the attendant law suits and reputational damage that results from this behavior, we have to conclude that the bank is incapable of correcting its fraudulent behavior. This may be because the bank cannot hire the right sort of people, or the cost of modifications is too high. This is certainly possible, because what is really needed are thousands of capable attorneys to handle all the modification claims and foreclosure legal requirements. It is also plausible that if the bank starts accepting modifications, it will need to write down billions in related first and second mortgages that would deserve similar treatment.

One a more macro scale, we have to consider that the big banks are quietly facing up to the fact that they have destroyed or at least seriously damaged the property records system in the US. They did so by doing an end-run around the county recorders of deeds, setting up their own records keeping system that they assumed would be accepted in the courts as a proper replacement. It wasn’t, and worse still – even if it was, the banks never bothered to follow their own rules under their legal contract governing securitizations. These rules required that the original note evidencing indebtedness by the homeowner was supposed to be sent, along with any amendments to the note, to the trustee managing the security. This rarely happened – it seemed to be just too much back office work in the frenzy of a housing bubble.

Trustees have been showing up in courts to process foreclosures, but they don’t have legal standing to do so because they don’t have the original note of indebtedness. The banks have been showing with the same requests, but with the same lack of legal standing to process a foreclosure. The courts ignored this for the longest time, which means millions of people lost their homes illegally, but now a lot of the courts are paying attention to these legal niceties, because they are more than niceties – they go to the core of the property system in the US. A homeowner has the basic right to know that the party suing them for foreclosure is actually the party owed the money on the debt.

The state of Nevada states very clearly that Bank of America has been acting fraudulently in foreclosures, and all the big banks must know they have been doing to same. But they barrel ahead anyway – even at this very moment banks are pushing foreclosures and hoping neither the homeowner nor the court will notice something as basic as their failure to establish proper legal standing for such an action. But what else can the banks do? If they admit they have compromised the record of indebtedness for at least half of all mortgages in the US (that is the current estimate of faulty notes and amendments), they have admitted that their largest asset class, the home mortgage, is legally compromised and no longer properly collateralized. That also means the record low rates being touted today for 30 year mortgages are meaningless. If the loan is uncollateralized, the real rate should be well above 30% p.a. for unsecured credit card debt. It should be more like 80% p.a. given the long maturity of the debt. This effectively kills the home mortgage product in the US.

Hence the banks push for foreclosure after foreclosure, insisting they still have the right to take such action against defaulting homeowners, and fighting any allegation that their right to do so doesn’t exist. They don’t dare admit what is increasingly obvious, which would also mean the lawsuits from millions of homeowners illegality booted out of their homes would drive these big banks into receivership. Notice also, that banks are not originating new mortgages. They will do so only if they can get a clear claim to the home as collateral, and if they are willing to keep the loan in the bank for 30 years. They are certainly not securitizing these loans to investors. Investors have caught on that these securities are deeply flawed and offer them little protection.

Finally, another possibility is that the executives running the business are incompetent. Bank of America gave notice this week that this is something to consider, when it fired the executive in charge of Consumer Banking. When you assess the lack of competent management, the destruction of the property records system, and the inherent ruination of their number one product, you have to come to the belief that Bank of America is Too Big to Manage.

Along with Too Big to Fail, we now have another reason to doubt whether Bank of America should be allowed to survive in its present form. And why wouldn’t the same conclusion be made for Wells Fargo, Citigroup, Chase Manhattan, Goldman Sachs and the other Too Big to Fail institutions? The same allegations have surfaced against these banks as well. Even the one bank supposedly above the fray of fraudulent behavior – JPM Chase, whose chairman insisted not one of its foreclosures was unjustified, was later forced to confess that by foreclosing on so many servicemen engaged in Iraq and Afghanistan, it violated the Service Members Civil Relief Act, which outlawed such foreclosures.

We would know a lot more about these other banks and their activities in the mortgage business if the attorneys general in other states were as conscientious as Catherine Cortez Masto. Lamentably, 46 state attorneys general have signed on to the effort of Attorney General Tom Miller of Iowa, who is attempting to come to some agreement with the banks regarding their role in the mortgage crisis. This agreement is said to involve a penalty of $20 billion or higher, and a commitment from the banks to cease their fraudulent behavior. Nevada has given up on this effort, as have officials in New York, Delaware, and Massachusetts. The banks have so far refused to accept any agreement until they get what they really want – a release “from all future liability for past mortgage practices and mortgage-backed securities they sold to investors”, according to some sources.

That the banks are pushing so hard for a blanket indemnity from all fraudulent behavior tells you that they must have a good deal of fraudulent behavior seeking absolution. They also feel in a strong enough position to demand it. Too bad these 46 attorneys general aren’t spending their time doing what Nevada has been doing – investigating the thousands of complaints many of them have received. Too bad there are so many of them that think the banks can be trusted to live up to their commitments once they get their blanket indemnity. Nevada has learned the hard way that Too Big to Fail also means Too Big to Manage, and Too Big to Obey the Law.

Bank of America, with its size and reach all across the United States, has proven itself to be a menace to the American economy. There are probably quite a few other banks its size which also pose a danger to the economic foundations of this country, which certainly rest in large part on respect for the law. Free market capitalism cannot survive if the major financial players disrespect, disregard and disobey the law.

President Obama should spend the hour it takes reading the state of Nevada’s complaint against Bank of America. It should be right up there with his national security briefing. If, after reading this, he still insists that Eric Holder remain in his job as US Attorney General, having done nothing for three years about these crimes, then Obama is owned by the bankers every bit as much as Congress. That would tell us that there are so far, at most, only four state attorneys general, plus a number of honest judges, bankruptcy trustees, and mediators, who are left standing up for the rule of law and the rights of the consumer.