This story was co-published with The New Yorker. It is not subject to our Creative Commons license.
Back in the late-housing-bubble period, in 2007, Countrywide Home Loans, which was then the largest mortgage provider in the country, rolled out a new lending program. The bank called it the “high-speed swim lane,” or HSSL, or, even more to the point, “hustle.”Countrywide, like most mortgage lenders, sold its loans to Wall Street banks or Fannie Mae and Freddie Mac, two mortgage giants, which bundled them and, in turn, sold them to investors. Unlike the Wall Street banks, Fannie and Freddie insured the loans, so they demanded only the ones of the highest quality. But by that time, borrowers with high credit scores were getting scarcer, and Countrywide faced the prospect of collapsing revenue and profits. Hence, the hustle program, which “streamlined” Countrywide’s loan origination, cutting out underwriters and putting loan processors, whom the company had previously deemed not qualified to answer borrowers’ questions, in charge of reviewing loan applications. In practice, Countrywide dropped most of the conditions meant to insure that loans would be repaid.
The company didn’t tell Fannie or Freddie any of this, however. Lower-level Countrywide executives repeatedly warned top executives that the mortgages did not fulfill the requirements. Employees changed data about the mortgages to make them look better, sometimes increasing the borrower’s income on the forms until the loan looked acceptable. Then, Countrywide sold them to the mortgage giants anyway.
At one point, the head of underwriting at Countrywide wrote an alarmed e-mail, with a list of questions from employees, such as, does “the request to move loans mean we no longer care about quality?”
The executive in charge of the decision, Rebecca Mairone, replied, “So – it sounds like it may work. Is that what I am hearing?”
To federal prosecutors—and to a jury in Manhattan—the hustle sounded like fraud. And in 2013, Bank of America, which had by then taken over Countrywide, was found liable for fraud and later ordered to pay a $1.27 billion judgment to the government.
But this week, the 2nd U.S. Circuit Court of Appeals looked at that judgment and asked this question: If a entity (in this case, a bank) enters into a contract pure of heart and only deceives its partners afterward, is that fraud?
The three-judge panel’s answer was no. Bank of America is no longer required to pay the judgment.
The Bank of America case was a rare outcome in the collapse of the financial system: a firm whose actions had contributed to the crisis was held to account by a court of law. The U.S. Attorney’s Office for the Southern District of New York, which brought the case in 2012, used an ingenious strategy, charging the bank under a law dating from the savings-and-loan crisis of the late 1980s, called Financial Institutions Reform, Recovery and Enforcement Act, or FIRREA. And the government actually identified a human being, Rebecca Mairone, claiming she defrauded Fannie and Freddie. Though it was a civil action, rather than a criminal one, the case actually went to trial—unusual in this day and age—and the jury found Bank of America and Mairone liable. (The 2nd Circuit panel’s ruling reversed a finding of fraud against Mairone and tossed out a million-dollar ruling against Mairone.)
The appellate-court panel accepted the main facts as described by the government. It acknowledged that Countrywide intentionally breached its contract but ruled that it had not engaged in fraud.
The ruling, written by Richard C. Wesley, a George W. Bush appointee, was unanimous, with another Bush appointee and an Obama appointee voting in favor. “What fraud … turns on, however, is when the representations were made and the intent of the promisorat that time,” Judge Wesley wrote. If the fraud is based on “promises made in a contract, a party claiming fraud must prove fraudulent intent at the time of contract execution; evidence of a subsequent, willful breach cannot sustain the claim.”