The recent jury verdict against Bank of America (NYSE:BAC), in which the bank was found to be liable for defrauding government-sponsored entities Fannie Mae and Freddie Mac by selling the organizations mortgage bonds stuffed with toxic home loans, is significant for two reasons. One is that this is the first time a bank has been found guilty of deliberate wrongdoing in generating faulty investment products that eventually led to the financial crisis.
The other is that the government has finally found the weapon that it needs to prove such misconduct, in the form of a little-known law called the Financial Institutions Reform, Recovery, and Enforcement Act. There's little doubt that regulators will be wielding that club more often in the future.
Roots in the savings and loan crisis
As The Wall Street Journal notes, the law was created during the savings and loan crisis in the 1980s to punish financial institutions whose actions adversely affected insured financial institutions. The meaning of the law has recently been expanded to include not only GSEs like Fannie and Freddie, but the banks themselves.
Therefore, Bank of America was being sued for costing itself money when the GSEs demanded the bank repurchase the faulty loans that Fannie and Freddie bought from 2007 and 2008. This is a novel interpretation of the law that has been recently upheld by no fewer than three federal judges.
The act has been used against BofA peer JPMorgan Chase (NYSE:JPM), too. That bank's tentative $13 billion settlement with regulators is based, in part, upon FIRREA charges. A sweet aspect of the law, at least for regulators, is that it allows for a 10-year statute of limitations, twice as long as the usual five-year limit – which is winding down, perhaps due to the government's need to wait until banks were solvent enough, post-crisis, to handle the levying of large fines.
No relief for Bank of America or its peers
It seems certain that future lawsuits against big banks for hawking crummy mortgage-backed securities back in the day will feature this dusted-off legal weapon. The Department of Justice has announced that several institutions, including Bank of America, are under investigation for sales of toxic securities right before the financial crisis.
For its part, Bank of America is also being probed by U.S. Attorney's offices in three states. That's in addition to a new lawsuit it faces from the Federal Housing Finance Agency, which is looking to squeeze $6 billion out of BofA for its part in selling Fannie and Freddie lousy mortgage bonds all those years ago. Considering that FHFA wrung $4 billion out of JPMorgan Chase for similar misdeeds, chances are good that Bank of America won't get away cheaply.
Charging banks enormous fines for bringing down financial liabilities upon themselves through misconduct may seem counterintuitive. Nonetheless, it appers safe to say these kinds of lawsuits aren't going to disappear anytime soon and, in fact, will likely escalate. For Bank of America, saddled as it is with its acquisition of crappy mortgage megaproducer Countrywide, the recent fraud decision is probably only the beginning of a whole new era of legal strife.
Fool contributor Amanda Alix 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. 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.