Catch of the Week — General Electric to Pay $1.5 Billion under FIRREA in Subprime Loan Scheme

The Department of Justice today announced that General Electric will pay a civil penalty of $1.5 billion under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) to resolve claims of fraud involving the marketing of subprime residential mortgage loans.  The loans at issue originated by a GE subsidiary, WMC Mortgage.  The government alleged that WMC, GE, and their affiliates allegedly misrepresented the quality of WMC’s loans and the extent of WMC’s internal quality and fraud controls in connection with the marketing and sale of residential mortgage-backed securities.

The government said that between 2005-2007, in a scheme to increase its profits, WMC sought to increase originations and set high loan targets.  To meet these targets, WMC loan analysts were encouraged to approve loans, even where the loan applications did not meet the criteria outlined in its own underwriting guidelines.  Loan analysts also received additional compensation based on the number of mortgages they approved.  At the same time, there were significant deficiencies with respect to WMC’s quality control, which was viewed by some as an impediment to volume.  In 2005, a WMC quality control manager described his department as a “toothless tiger” with inadequate resources and no authority to prevent the approval or sale of loans his department had determined were fraudulent or otherwise defective.

From 2005 through 2007, WMC originated more than $65 billion dollars in mortgage loans and sold the majority of its loans to investment banks, which, in turn, issued and sold residential mortgage backed securities to investors.  The government alleged that most of the mortgage loans WMC originated and sold for inclusion in residential mortgage backed securities did not comply with WMC’s representations about the loans – and that investors suffered billions of dollars in losses as a result.

The United States alleged that by late 2005 and early 2006, investors in RMBS backed by WMC loans raised concerns about the quality of loans originated by WMC because WMC borrowers were failing to repay their loans at unexpectedly high rates. WMC also began receiving increased numbers of requests from investment banks to buy back, or repurchase, loans.  Even in the face of increasing repurchase demands, kick-outs, and concerns about WMC’s underwriting quality, WMC continued selling its loans and making false representations about their qualities and attributes.

In response to the $1.5 billion fine, Assistant Attorney General Jody Hunt said, “[t]he financial system counts on originators, which are in the best position to know the true condition of their mortgage loans, to make accurate and complete representations about their products.  The failure to disclose material deficiencies in those loans contributed to the financial crisis.”  She also stated that “as today’s resolution demonstrates, the Department of Justice will continue to employ FIRREA as a powerful tool for protecting our financial markets against fraud.”

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