Big Housing Fraud Settlements, But No Convictions

When the government decided a few years back to target insider trading on Wall Street, it set its sights high, and Raj Rajaratnam is now sitting in a prison cell.

With that high-profile conviction, federal prosecutors turned Rajaratnam, the billionaire founder of the Galleon Group hedge fund, into the face of insider trading, a cautionary tale of unchecked Wall Street greed and mendacity.

So where are the Raj Rajaratnams of the subprime mortgage crisis?

“In order to have a true deterrent impact, individuals must be indicted.”

- Andrew Stoltmann, securities lawyer and advocate

Wells Fargo (NYSE:WFC) is the latest giant lender to face broad allegations of misconduct stemming from years of “reckless” lending practices during the boom years of the U.S. housing bubble.

Earlier this week, the U.S. prosecutor’s office in New York filed suit against Wells Fargo, now the largest mortgage lender in the U.S., seeking hundreds of millions in damages and claiming the San Francisco-based bank approved tens of thousands of risky mortgages knowing the loans would ultimately be guaranteed by the government rather than Wells Fargo.

According to the complaint, Wells Fargo used a bonus system as an incentive for its loan officers to rubber stamp risky mortgage applications in order to generate profits for the bank.

“As the complaint alleges, yet another major bank has engaged in a longstanding and reckless trifecta of deficient training, deficient underwriting and deficient disclosure, all while relying on the convenient backstop of government insurance,” U.S. Attorney Preet Bharara said in a statement.

Bharara’s office has also gone after Bank of America (NYSE:BAC), Deutsche Bank (NYSE:DB), and Citigroup’s (NYSE:C) CitiMortgage unit, as well as a handful of smaller banks, alleging similar widespread and systemic fraud.

In each case, the banks were accused of knowingly approving risky home loans on a huge scale because it was profitable to do so at the time and because the banks making the loans wouldn’t have to guarantee them should the borrowers eventually default.

In hindsight, we now know the consequences of all those banks making all those risky loans secure in the belief someone else would be on the hook (in this case, the government and taxpayers) if the loans went sour.

Big Fines But No Convictions

To sure, a lot of money has exchanged hands as a result of the government’s mortgage fraud lawsuits. In February, Bank of America agreed to pay $1 billion to settle charges the bank’s Countrywide lending unit, which it acquired in 2008, approved loans to unqualified borrowers then collected government insurance when the borrowers defaulted. A few weeks later, Citigroup agreed to pony up $158 million to settle similar charges, and Deutsche Bank in May reached a $200 million settlement deal.

Nearly $1.4 billion in fines, but not a single criminal indictment.

The banks, apparently acting as vast autonomous organisms, perpetuated these frauds without instructions or directions from a single human being. No senior executives devised and then set into motion the strategies by which millions of bad loans were made to millions of unqualified borrowers, setting off a chain reaction the ramifications of which the U.S. is still reeling from today.

What message is sent if prosecutors and bankers settle these disturbing allegations with multi-million dollar deals that have no significant impact on the bottom lines of the banks and do little (or nothing) to help the millions of Americans still threatened with foreclosure or who’ve seen the values of their homes plummet since the collapse of the housing market in 2008?

Critics of these settlements argue that if these truly were widespread frauds that need to be punished and hopefully averted in the future, a handful of criminal indictments of well-placed executives would be far more effective than these bland civil suits that the banks sweep under the rug by paying a one-time fine.

“In order to have a true deterrent impact, individuals must be indicted,” said Andrew Stoltmann, a Chicago-based securities lawyer and investor advocate.

“White-collar executives and others are highly rational, intelligent folks. The risk of a 12-foot by 10-foot cell really deters them,” Stoltmann added. “Prosecutors have been incredibly passive going after mortgage and banking executives for their roles in almost melting down the worldwide economy. It's unfortunate and it almost ensures we will have another substantial massive fraud in the coming years.”

The closest prosecutors have come to targeting high-level executives for their roles in the mortgage meltdown was the indictment earlier this year of three former Credit Suisse (NYSE:CS) traders.

The trio, two of whom have already pleaded guilty (the third was recently arrested in London), were accused of inflating the value of bonds – mortgage-backed securities – they traded in order to hide losses and boost their bonuses.

Devious and selfish, yes. But hardly the kind of systemic misconduct that set the mortgage crisis in motion in the late 1990s and early 2000s.

The explanation offered most often by prosecutors for the lack of mortgage-related criminal indictments against individuals is that it’s hard (and costly) to prove intent to defraud beyond a reasonable doubt.

Maybe, but a handful of costly indictments and convictions might go a long way toward averting another vast lending scandal down the road.