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US sues Barclays for fraud over crisis-era mortgage-backed loans

US sues Barclays for fraud over crisis-era mortgage-backed loans

By:  in Washington and  in London

DoJ says bank’s practices during housing bubble were ‘irresponsible and dishonest’

Federal prosecutors have sued Barclays and two of its executives over allegedly fraudulent mortgage-backed securities the bank issued as the US housing bubble was at its peak.

The suit claims the bank “securitised billions of dollars of loans it knew had material defects” and financed lenders that it knew were issuing mortgages to customers who would be unable to repay them, prosecutors charged. The loans in question defaulted “at exceptionally high rates early in the life of the deals”.

It comes after the breakdown of talks aimed at reaching a negotiated settlement with the US Department of Justice and seeks unspecified civil penalties from the bank and the two men. 

People close to the Barclays board said it had been prepared only to agree a settlement that was in proportion with those already reached by its US rivals, and was willing to go to court to fight more costly US demands. 

Barclays felt it should pay a fine of only about $1bn if its settlement was to be proportional with those of its US rivals. It was prepared to settle for a total of about $2bn, including customer redress, according to two people briefed on the matter. But the DoJ pushed for something closer to the settlements agreed by Deutsche Bank and Credit Suisse; Deutsche said early on Friday that it had agreed to pay $7.2bn to resolve the DoJ probe, while Credit Suisse has agreed to pay $5.28bn.

Barclays has calculated that investors in the residential mortgage-backed securities it issued suffered half the losses of investors in similar products issued by Goldman Sachsand less than a third of those of Citigroup.

While some US banks bet against the RMBS products they sold and kept little if any exposure to them, Barclays told the DoJ that it held the equity tranches of most mortgage securities it issued and so lost money alongside other investors when they went bad.

The DoJ has been pushing the three European banks to agree an omnibus settlementbefore Donald Trump’s inauguration as US president in the third week of January. Mr Trump is expected to appoint a new leadership team at the DoJ, which is likely to oversee the case against Barclays.

From 2005 to 2007, Barclays fraudulently sold more than $31bn of mortgage-backed securities in 36 separate deals, prosecutors in New York said on Thursday. 

“Barclays jeopardised billions of dollars of wealth through practices that were plainly irresponsible and dishonest,” said Loretta Lynch, the US attorney-general. “We are sending a clear message that the Department of Justice will not tolerate the defrauding of investors and the American people.” 

The US government is charging the defendants with violations of the Financial Institutions Reform, Recovery and Enforcement Act, via mail fraud, wire fraud, bank fraud and other misconduct. 

The two Barclays executives named in the suit are Paul Menefee, its head banker on subprime residential mortgage-backed securities, and John Carroll, the bank’s head trader for subprime loan acquisitions.

In a statement, the bank rejected the government claims. “Barclays considers that the claims made in the complaint are disconnected from the facts. We have an obligation to our shareholders, customers, clients and employees to defend ourselves against unreasonable allegations and demands. Barclays will vigorously defend the complaint and seek its dismissal at the earliest opportunity.”

The DoJ said the bank had falsely assured investors it had conducted adequate due diligence on the loans underlying its subprime securities and had excluded “unacceptable” loans. “In reality, Barclays’ due diligence on the subject deals was a sham,” prosecutors wrote. 

Even investors in triple A-rated securities, which carry the same rating as US Treasuries, suffered steep losses. 

The DoJ said the bank had falsely assured investors it had conducted adequate due diligence on the loans underlying its subprime securities and had excluded “unacceptable” loans. “In reality, Barclays’ due diligence on the subject deals was a sham,” prosecutors wrote.

Even investors in triple A-rated securities, which carry the same rating as US Treasuries, suffered steep losses. 

At issue are loans originated by mortgage companies such as Fremont, New Century, WMC, Countrywide and IndyMac.

According to the complaint filed in federal court on Thursday, the bank misled investors and rating agencies about its loan selection criteria. In some cases, the lawsuit says, the bank found that more than half of the loans it reviewed contained defects, yet officials assured investors they were sound. 

Companies that reviewed the loans for Barclays informed the bank that many did not meet underwriting guidelines or legal standards. “These vendors described some of these securitised loans as ‘craptacular’, others as ‘scariest collateral’, and others as having the ‘distinct aroma of default’,” the lawsuit says. 

Mr Menefee, the Barclays executive in charge of due diligence on the subprime deals, is quoted as calling one loan pool “about as bad as it can be” and saying of a Wells Fargo pool that “we have to eat their sh*t loans”.

Mr Carroll, Barclays’ head subprime trader, allegedly told Mr Menefee to leave one group of 40 delinquent loans in a securitisation pool to save the bank $1m, even though it would make investor losses more likely. 

Barclays ordered its vendors to change the grades they assigned on thousands of loans “for no legitimate reason”, the lawsuit says. “Even when loans were already delinquent or in default by the time a deal closed, it did not seem to matter to Barclays.”

Barclays prioritised its relationships with loan originators over protecting the investors who bought its mortgage-backed securities, the lawsuit alleges. As the housing bubble popped, the bank in some cases abandoned due diligence entirely. 

In 2007, the DoJ alleges, Barclays executives decided that checking the quality of loans originated by New Century was a waste of time since any defective ones could not be forced back on to the cash-strapped issuer. The bank took that decision even as Mr Menefee and Mr Carroll agreed that the loans “look(ed) like sh*t”, the suit says.

“Defendants repeatedly misled investors and kept to themselves critical information about the loans in the deals, knowingly putting those investors at risk of harm,” the lawsuit says. 

It is not the first time that Barclays has stood its ground against US regulators. In 2014 it pulled out, at the last minute, of an omnibus settlement by six other banks with US and UK regulators over alleged manipulation of foreign exchange rates. In that case, the British bank had wanted to wait until all regulators were ready to settle but it ended up paying a record $2.38bn in fines. 

Now, Barclays appears to believe that it can stand up to the US authorities because there are no other pending legal cases that would give prosecutors leverage, unlike rival Deutsche Bank, which is also being investigated for its ###a href="https://www.ft.com/content/9b1bad44-8bcf-11e6-8aa5-f79f5696c731" data-trackable="link">trades in Russia. 

Shares in Barclays fell slightly after the news on Friday morning, to 226.3p.

Copyright The Financial Times Limited 2016. All rights reserved. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.

https://www.ft.com/content/739bd0c2-c889-11e6-8f29-9445cac8966f

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