Feds Slap Bank of America with $850 Million Suit

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The Justice Department sued Bank of America (NYSE: BAC) this week, alleging that the big bank defrauded investors by understating the risks of the mortgages backing about $850 million in securities. The lawsuit is another legal woe for Bank of America related to mortgage securities losses and litigation since the financial crisis.

The DoJ’s Case Against Bank of America

While most of the prior cases against the big bank were connected to the acquisition of Countrywide and its subprime shenanigans, this case concerns prime loans originated by Bank of America – so called jumbo loans.

Jumbos are loans that exceed the limits established by Fannie Mae for residential properties. In 2007, the threshold for a single family dwelling was $417,000 – a limit that was repeatedly raised in the years leading up to the financial tsunami as home prices soared beyond reason.

The Justice Department’s lawsuit paints Bank of America’s mortgage operations “as emblematic of Wall Street’s reckless practices in the heady days before the financial crisis,” according to the New York Times Dealbook.

The DoJ contends that employees were coerced into short-cutting mortgage underwriting procedures, and that this edict came from the “upper echelons of the bank.” The bank is accused of misrepresenting the quality of the loans, causing five institutional investors to lose $100 million. Of course this begs the question of whether or not these aggrieved investors did their due diligence.

Lawrence Grayson, a spokesman for the big bank, said in a statement, “These were prime mortgages sold to sophisticated investors who had ample access to the underlying data and we will demonstrate that.”

In any event, Bank of America is not alone, as more federal suits stemming from the 2008 financial crisis are in the works.

JP Morgan Chase in the On Deck Circle

Just as the ink was drying in the DoJ case against Bank of America, JP Morgan Chase (NYSE: JPM) disclosed this week it is also in the Fed’s crosshairs. The bank is being probed to determine whether or not it sold tainted mortgage securities to investors.

The investigation surfaced in the big bank's recent quarterly regulatory filing. The statement said the bank is under investigation by the US attorney’s office for the Eastern District of California. Apparently a preliminary probe found evidence that JP Morgan “flouted federal laws” with its sale of subprime mortgage securities from 2005 to 2007.

While it is far too early to predict how the cases against Bank of America and JP Morgan will turn out, the legal costs for both big banks are piling up.

In fact, JP Morgan said in the regulatory filing that it has $678 million expensed for additional litigation reserves in the second quarter, up from $323 million in the same period a year ago. Furthermore, the bank also estimated it could incur up to $6.8 billion in losses beyond its reserves--nearly $1 billion more than the first quarter of the year.

That’s gonna leave a mark in addition to the other black and blues the big bank has suffered related to the London whale fiasco and the recently announced $410 million settlement with the Federal Energy Regulatory Commission (FERC).

UBS Settles More Claims

Finally, UBS (NYSE: UBS) just announced it will cough up $50 million to settle federal accusations for misleading investors concerning another mortgage security caper – the Fed’s recent legal victory against a former Goldman Sachs trader nailed for his hand in double dealing on a shoddy CDO offering.

The widely reported Securities Exchange Commission’s case against Fabrice P. Tourre concluded with the fallen high roller being convicted for six counts of civil securities fraud last week. UBS was busted for its role in marketing the deal where disclosure materials failed to make reference to the bank’s retention of $23 million in upfront cash payments for marketing the bad paper.

This settlement comes on the heels of last week’s $885 settlement with the Federal Housing Finance Agency for UBS’ sale of toxic mortgage securities to Fannie Mae and Freddie Mac.

In short, the legal hits keep coming for the big banks for their roles in selling tainted mortgage backed securities in the years leading into the financial crisis of 2008.

What Do These Legal Suits Mean for Investors?

The banks are on the road to recovery from the 2008 financial fiasco, and the Federal Reserve’s easy money policy has played a big part in the healing process. However, these ongoing legal settlements are taking small bites from the banks’ profits – and there are more cases to come.

Whether or not this will put downward pressure on share prices remain to be seen. But for investors who factor ethics into their investment calculations, there are alternative financial firms like community banks where they can invest and conduct consumer finance transactions without fretting over these legal troubles.

Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

Kyle Colona has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America and JPMorgan Chase & Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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