“Like Bernie, officials in the Obama Justice Department love to throw around the word “fraud” when a case involves a bank. In 2013 they even convinced a jury that fraud had occurred when Countrywide sold some mortgages to Fan and Fred that didn’t meet the quality standards required under its contracts with the two mortgage giants…

…But facts matter under the law even if they don’t in politics. The mortgages at issue were prime loans, and there’s a difference between failing to meet the terms of a contract and perpetrating a fraud. As the appeals court panel noted, “It is emphatically the case—and has been for more than a century—that a representation is fraudulent only if made with the contemporaneous intent to defraud—i.e., the statement was knowingly or recklessly false and made with the intent to induce harmful reliance.” The judges added that the government “did not prove—in fact, did not attempt to prove—that at the time the contracts were executed Countrywide never intended to perform its promise of investment quality. Nor did it prove that Countrywide made any later misrepresentations—i.e., ones not contained in the contracts—as to which fraudulent intent could be found.” Continuing to educate government attorneys, the appeals court noted Justice Oliver Wendell Holmes’s “articulation of the common law’s view of contracts as ‘simply a set of alternative promises either to perform or to pay damages for nonperformance.’” Justice officials must have known they didn’t have evidence of civil—never mind criminal—fraud. But they also knew that you can’t get the political left fired up by promising to punish banks merely for breach of contract. Occupy Wall Street until they fulfill previously agreed-upon covenants!

The case is thus another reminder that the financial crisis had more to do with bad policy incentives, loose monetary policy and the resulting mania for residential housing investment than with some spontaneous surge in greed and criminality.

Bank of America shareholders have every right to be outraged at the government’s conduct, which did more than simply tarnish their brand among financial consumers. The government’s initial win at trial gave the feds leverage, which they used to force the bank to pay more than $16 billion in a larger and even more dubious mortgage settlement. The bank’s victory makes us wish other banks had been willing to fight the federal extortion in court rather than roll over to appease the political demand for headlines. They might have won too. Oh, and where does Rebecca Mairone go to get her reputation back? An apology from U.S. Attorney Preet Bharara and other Justice officials would be a start.”, “The Bank Fraud That Wasn’t”,  The Wall Street Journal Editorial Board, May 25, 2016

Opinion

The Bank Fraud That Wasn’t

A federal appeals court overturns a politicized mortgage case.

Bernie Sanders claims that fraud is the business model of Wall Street, and most of the Democratic Party has complained for years that prosecutors went too easy on bankers after the financial panic. But this week three federal appellate judges unanimously ruled that the Justice Department didn’t go too easy on bankers; it went way too far.

A panel of the Second Circuit Court of Appeals overturned a $1.27 billion penalty against Bank of America and tossed out a $1 million penalty against Rebecca Mairone, a former executive at Countrywide Financial, which Bank of America bought during the panic. The government had claimed in its civil case that Countrywide ripped off Fannie Mae and Freddie Mac by selling shoddy mortgages to the two government-created firms.

Like Bernie, officials in the Obama Justice Department love to throw around the word “fraud” when a case involves a bank. In 2013 they even convinced a jury that fraud had occurred when Countrywide sold some mortgages to Fan and Fred that didn’t meet the quality standards required under its contracts with the two mortgage giants.

Regular readers of these columns know we were critics of all three parties in these transactions— Angelo Mozilo’s Countrywide subprime factory, as well as the two government-sponsored enterprises that were eager to buy his mortgage paper.

But facts matter under the law even if they don’t in politics. The mortgages at issue were prime loans, and there’s a difference between failing to meet the terms of a contract and perpetrating a fraud. As the appeals court panel noted, “It is emphatically the case—and has been for more than a century—that a representation is fraudulent only if made with the contemporaneous intent to defraud—i.e., the statement was knowingly or recklessly false and made with the intent to induce harmful reliance.”

The judges added that the government “did not prove—in fact, did not attempt to prove—that at the time the contracts were executed Countrywide never intended to perform its promise of investment quality. Nor did it prove that Countrywide made any later misrepresentations—i.e., ones not contained in the contracts—as to which fraudulent intent could be found.”

Continuing to educate government attorneys, the appeals court noted Justice Oliver Wendell Holmes’s “articulation of the common law’s view of contracts as ‘simply a set of alternative promises either to perform or to pay damages for nonperformance.’” Justice officials must have known they didn’t have evidence of civil—never mind criminal—fraud. But they also knew that you can’t get the political left fired up by promising to punish banks merely for breach of contract. Occupy Wall Street until they fulfill previously agreed-upon covenants!

Countrywide did rush loans through its mortgage pipeline that turned out to be bad credit risks. But it did so in part because Fannie and Freddie were in a rush to buy them. They were hardly innocent victims.

The case is thus another reminder that the financial crisis had more to do with bad policy incentives, loose monetary policy and the resulting mania for residential housing investment than with some spontaneous surge in greed and criminality.

The case also casts doubt on the use in these cases of the Financial Institutions Reform, Recovery, and Enforcement Act. Prosecutors like the law because in various ways it stacks the deck in their favor. The catch is that they have to claim the alleged fraud affected a federally insured financial institution.

In a novel interpretation developed after the financial crisis, prosecutors decided that if they couldn’t find a bank to serve as the victim, they could consider the banks to be victimizing themselves. The lawyers call it a “self-affecting” fraud. In this case since there wasn’t any fraud we won’t have the chance to learn whether it’s an actual offense or merely a case of prosecutors self-affecting themselves.

***

Bank of America shareholders have every right to be outraged at the government’s conduct, which did more than simply tarnish their brand among financial consumers. The government’s initial win at trial gave the feds leverage, which they used to force the bank to pay more than $16 billion in a larger and even more dubious mortgage settlement.

The bank’s victory makes us wish other banks had been willing to fight the federal extortion in court rather than roll over to appease the political demand for headlines. They might have won too.

Oh, and where does Rebecca Mairone go to get her reputation back? An apology from U.S. Attorney Preet Bharara and other Justice officials would be a start.

Posted on May 27, 2016, in Postings. Bookmark the permalink. Leave a comment.

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