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Article Exclusivity for the Journal of Financial Crime Vol 23 Issue 1: Holding Banks to Account after the Financial Crisis by Dr Oonagh McDonald CBE

Dr Oonagh McDonald CBE is presenting her work, "Holding Banks to Account after the Financial Crisis", that examines the ways in which the United States has sought to hold the leading banks to account for the financial crisis and to assess the validity of the methods used. Her research and findings will be published in the inaugural issue of the Journal of Financial Crime Vol 23 (subject to permissions).

The Department of Justice and the Banks.

1. Government Housing Policy and Fannie Mae and Freddie Mac.

These two articles examine the ways in which the Department of Justice and the Federal Housing Finance Agency together with other government agencies sought to hold the banks to account in the aftermath of the financial crisis. The narrative that the banks were to blame for abandoning traditional underwriting criteria and then for misrepresenting the quality of mortgages backing residential mortgage backed securities (RMBSs) had dominated the media and the popular view since then. The banks then misled Fannie Mae and Freddie Mac, the government sponsored agencies (GSEs), purchasing the loans and the RMBSs. The  function of the GSEs was to purchase mortgages from lenders, thus freeing up the credit market and enabling banks to lend at lower rates than would otherwise be the case.  The GSEs were one of the tools of government housing policy, designed to enable minorities and those on low to moderate and very low incomes to buy their own homes. When the housing bubble burst, the story went, the GSEs were left with RMBSs (called private label securities) based on subprime loans. They collapsed and had to be taken into conservatorship at a cost of $187.5bn. This account ignores the history of the GSEs since 1995, when President Clinton announced changes in the Community Reinvestment Act, which ultimately led to the banks being encouraged in every way possible to abandon accepted underwriting standards so that everyone who wished could own his own home. The GSEs were required to buy an ever-increasing proportion of these loans to meet the housing goals set for them by Government housing policy.

2. The Department of Justice.

 The Administration set up a Financial Fraud Enforcement Task Force in 2009, which was not all that successful. This was followed by the establishment of the Residential Mortgage-Backed Securities Working Group, composed of 15 Attorneys at the Department of Justice’s headquarters and 10 FBI agents, together with the Securities and Exchange Commission, the Department of Housing and Urban Development together with state and federal officials. They were directed by the Attorney General to investigate ‘potential false or misleading statements, deception or other misconduct by market participants’ in the creation or sale of mortgage-backed securities’.  This resulted in cases being brought against the leading banks (amongst others), which were settled out of court. JPMorgan settled for $13bn in November, 2013; Citigroup for $7bn and Bank of America was $16.65 bn.  The Department of Justice’s press release announcing the settlements provided a brief ‘statement of facts’. In the Bank of America’s case, the bank agreed to the settlement ‘without admitting or denying the allegations’.  

3. The Law and the Banks

The cases  against the banks were brought under two Acts: Financial Institutions Reform, Recovery and Enforcement Act, 1989, which allows fines to be imposed based on ‘the preponderance of the evidence’ and what some regard as an extension of the meaning of ‘affecting a federally insured institution’, where ‘affecting’ was  taken to mean ‘self-affecting’ whereby an institution can be ‘affected’ for the purposes of the Act by its own acts. The statute of limitations under this Act is ten years.
The second Act is the False Claims Act, as amended by the Fraud Enforcement and Recovery Act, 2009.  The result is legislation which appears to remove the notion of ‘intent’ as in section 3729 (a) of the False Claims Act, which now  reads ‘knowingly makes, uses or causes to be made or used, a false record or statement material to a false or fraudulent claim’.  The statute of limitations has been extended again because there may be a time lag between a whistleblower’s filing of a complaint and the Government’s decision on whether or not to take up the complaint. The Government could then argue that the complainant’s allegations were not time-barred because they ‘related back’ to the date on which the whistleblower had filed his complaint. The courts have at times challenged the delays. A case brought on this basis has other disadvantages for the defendant; for example, bringing a successful complaint can mean large financial rewards for the whistleblower.  The final problem with the  Fraud Enforcement and Recovery Act is the question of whether or not it applies retrospectively. That is a complicated question and the courts are divided on the issue. Some courts have taken the view that it is and others have not. The question is still undecided but it is an important one for the banks as they do not know whether potential cases against them are open or not.

4. The Federal Housing Finance Agency and the Banks.

The Federal Housing Finance Agency (FHFA) brought cases against 18 banks. These were all about the sale of mortgage-backed securities (private label securities) to Fannie Mae and Freddie Mac on the basis of their lack of compliance with underwriting guidelines; misleading statements regarding the occupancy status of the borrower, loan-to-value ratios and credit ratings of the securities. The FHFA brought its cases against the banks on the basis of strict liability, which simply meant that the evidence regarding material errors of fact had to be  proved. The strict liability applies to the Registration documents for the securities and the  Prospectus Supplements as well. Seventeen banks settled out of court, paying fines which ranged from $99.5 m in the case of RBS Securities (in Ally action) to $5.83 bn in the case of Bank of America.  Only one bank stuck out for a trial and that was Nomura and RBS.  What is really interesting about the trial is that the Judge was able to rule out much evidence on the grounds of strict liability, which might otherwise have been considered relevant.   That evidence includes statements by James Lockhart, then Director of the Office of Federal Housing Oversight (OFHEO), the regulator of  the GSEs, who pointed out that the precise purpose of their purchase of private label securities was because they contained subprime loans which the GSEs were required to purchase to meet the housing goals imposed on them by government housing policy. The Judge found against Nomura and RBS, but the judgement is likely to be appealed.

5 .What happened to the billions of dollars in fines?

For the FHFA, the funds were used to reimburse Fannie and Freddie for the ‘losses’ incurred by buying the securities,  with the remainder going to the Treasury.  For the Department of Justice, the huge fines were to be used to settle various federal and state civil claims relating to mortgage loans and securities; consumer relief such as reducing the principal reduction on mortgages for struggling homeowners, loans to credit worthy borrowers trying to get a loan and financing low cost rental housing. If the bank fails to meet all its obligations in the time set, then the monies would go to various nonprofit organisations concerned with affordable housing.

6. Who pays the fines?

The shareholders and the customers. The shareholders are mainly the pension funds and the mutual funds, so it’s the man savers who pay.

7.  Do the fines change the culture of the bank?

Probably not. But the trend for prosecutors even before the crisis has been to prosecute companies rather than high-level individuals.  This is presented as ‘transforming the corporate culture’ because the various deferred prosecution agreements and non prosecution agreements are ones in which the company agreed to take various measures to prevent such occurrences in the future. But perhaps in these cases the fines were about ‘recovering funds that are due to the American taxpayer’, as Freddie Mac’s CEO, Donald H Layton said in 2013. That leaves open the question of holding  senior executives accountable and accountability in the future. That is the issue to be addressed.

8.  A Change of Heart by the Department of Justice.
On September 9, the Department of Justice issued a Memorandum entitled ‘Individual Accountability for Corporate Wrongdoing’, no doubt in response to the widespread criticisms of the failure to hold any senior executives to account.  ‘Such accountability ...deters future illegal activity, it incentivizes changes in corporate behaviour, it ensures that the proper parties are held responsible for their actions, and it promotes the public’s confidence in our justice system’.  Holding individuals accountable is much more difficult than may first appear. For that to be effective for banks, that would require some fundamental changes in banking laws and regulations, such that banks could not hide who was responsible for what decisions. That has yet to come.

Dr Oonagh McDonald CBE

Dr. Oonagh McDonald, CBE, chaired a public inquiry into property valuation in the UK from July 2013 to February 2014. Before that, she was a director of the Board for Actuarial Standards.  McDonald served as a member of the Gibraltar Financial Services Commission until May 2007, and a director of the British Portfolio Trust, Dresdner RCM Global Investors (UK) Ltd until February 2009.  She is also Complaints Commissioner for IC E Futures, and ICE Clear and formerly fulfilled a similar role for the London Metal Exchange and Virtex SWX, the Swiss exchange in London. For more information, please visit

Fannie Mae and Freddie Mac: Turning the American Dream into a Nightmare, Bloomsbury, 2012. Paperback, 2013.
Lehman Brothers: A Crisis of Value, Manchester University Press,  forthcoming, November, 2015.