The U.S. government is stepping up its scrutiny of the banking industry and its role in the financial crisis. In the latest move, the U.S. Department of Justice and the Securities and Exchange Commission are each suing Bank of America, accusing the bank of misleading investors about the risks of $850 million worth of mortgage-backed securities sold in 2008.
The lawsuits focus on a corner of the mortgage world that until now hasn't gotten much attention: “prime” mortgages.
In the wake of the financial crisis, most litigation has been over investments tied to those now notorious “sub-prime” mortgages -- home loans that went to risky borrowers with low-credit scores.
But this latest pair of federal lawsuits concerns investments tied to “prime” mortgages—home loans that went to folks with good credit and, at least theoretically, higher incomes. (Specifically, the loans at the heart of the lawsuits are “jumbo loans,” which are loans for lots of money. In most counties in the U.S., a home loan qualifies as “jumbo” if it exceeds $417,000.)
Though prime mortgages aren’t considered as risky as sub-prime ones, they can still involve risk and require vetting, according to the Justice Department. And that is where the suit alleges Bank of America failed.
“The charge is that Bank of America didn't do their proper homework in processing these loans,” says David Beim, a finance professor at Columbia Business School.
The lawsuits allege that Bank of America did not tell investors that 70% of the loans bundled in to the mortgage-backed securities they were buying were originated by outside mortgage companies, nor that 70% of the homeowners taking out the loans had not had their incomes verified by the bank.
The Department of Justice also charges that Bank of America concealed the risks of these prime loans to investors, even while employees debated the risks internally. In one colorful email exchange cited in the lawsuit, a banker writes of the loans, “Like a fat kid in dodge ball; these need to stay on the sidelines.”
Bank of America is fighting the lawsuit. A BofA spokesman told the Wall Street Journal, “These were prime mortgages sold to sophisticated investors who had ample access to the underlying data and we will demonstrate that.” He said the soured mortgage-backed securities came about not because the bank was negligent, but because of the collapse of the housing market.