Written by Rushi Jhaveri
Edited by Sarah Mejia
In recent years, U.S. banks have been re-packaging mortgages for investors in order to receive faster and greater benefits. Many of these mortgages, however, have turned into toxic assets since the investments decreased in value drastically. Consequently, many investors defaulted on their mortgages (Rothacker). These toxic assets are called subprime loans or mortgages. Banks knew that they were handing out subprime mortgages and misrepresenting their level of risk. The banks essentially did this so that they could claim very high profitability. This fueled the housing bubble that later burst and caused one of the biggest recessions in U.S. history since the Great Depression.
The Bank of America, currently the second largest U.S. bank, aided in the severity of the subprime-lending crisis (Raice). Due to their involvement in the crisis, the U.S. federal government has chosen to sue them for at least one billion dollars. According to court findings, Bank of America and its Countrywide Financial Corporation unit did not keep necessary checks on loan quality up to date (Breslow). By failing to place checks on loan quality, Countrywide Financial Corporation misrepresented the quality of loans sold to mortgage-finance firms Fannie Mae and Freddie Mac. Between 2007 and 2009, thousands of these misrepresented loans had been sold to Fannie Mae and Freddie Mac (Breslow). By letting Fannie and Freddie believe they were financing a certain level of quality mortgage, Bank of America and Countrywide were essentially lying to Fannie and Freddie.
Since Bank of America was misrepresenting the quality of its loans, it is being charged under the False Claims Act. The False Claims Act gives incentives to whistle blowers to uncover companies who try to defraud the government (Brooks). In this case, the False Claims Act lets the government file claims over corporations that that submit false records in order to benefit themselves.
The problem with Bank of America, and many other financial institutions just like it, relates all the way back to giving out mortgages to people who the banks know are going to default. If Bank of America placed tighter regulations on the distribution of mortgages, fewer mortgages would have to be insured and fewer claims would be held on them. Essentially, Countrywide should have been more responsible about whom they were giving loans out to.
Another problem committed by the Bank of America and Countrywide Financial was the misrepresentation of loan quality. By representing loans as a higher quality than it actually was, Fannie Mae and Freddie Mac were obviously ready to insure the loan. If management had set regulations on how to represent loans, there would be no way to misrepresent the quality of the loan. When the housing market collapsed, Countrywide eliminated checkpoints that gave proper representation of loan quality. With regulation, these checkpoints could not be eliminated under any circumstance and there could be no misrepresentation of the quality of Countrywide’s loans.
Although there are a few adjustments that can be made such as improvements in representing financial statements and tighter regulations on how loans are allocated, the Dodd-Frank Reform covered many of the problems wrong with financial institutions. However, increasing strength of Dodd-Frank would be beneficial. For example, one of the provisions of Dodd-Frank is that shareholders have a greater say in executive compensation (Brooks). If shareholders have a complete say in executive compensation, executives would be less likely to make risky decisions in order to manipulate financial records. It may seem a little extreme, however, in recent years greed has been a main deciding factor security.
Countrywide Financial and Bank of America were irresponsible with the loans they gave out. By foregoing the necessary checks, they put Fannie Mae and Freddie Mac in trouble. The two had to seek a combined total of $188 billion in federal aid due to financial institutions similar to Countrywide. Bank of America and Countrywide themselves have asked for $45 billion themselves so it just goes to show that institutions that are meant to benefit the general populous can also inflict harm.
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1) Raice, Shayndi, and Nick Timiraos. “U.S. Sues BofA Over Mortgage Sales.” Wall Street Journal (2012): C3. Print.
2) Brooks, Leonard J., and Paul Dunn. Business & Professional Ethics for Directors, Executives & Accountants. Mason, OH: South-Western, Cengage Learning, 2012. Print.
3) Rothacker, Rick. “U.S. Banks Haunted by Mortgage Demons That Won’t Go Away.”Reuters. Thomson Reuters, 19 July 2012. Web. 04 Nov. 2012. <http://www.reuters.com/article/2012/07/20/us-mortgages-repurchase-idUSBRE86J03220120720>.
4) Breslow, James M. “U.S. Sues Bank of America for $1 Billion Over Mortgage Sales.”PBS. PBS, 24 Oct. 2012. Web. 04 Nov. 2012. <http://www.pbs.org/wgbh/pages/frontline/business-economy-financial-crisis/money-power-wall-street/u-s-sues-bank-of-america-for-1-billion-over-mortgage-sales/>.