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Regulatory Sanctions

Wells Fargo to Pay $2Bn for Selling Toxic Residential Mortgages Leading up to the Financial Crisis

August 14, 2018

by Howard Haykin


On August 1, when Wells Fargo agreed to settle a long-standing DOJ investigation, the bank was hit with one of the smaller fines arising from big banks' roles in the financial crisis. (In 2014, Bank of America paid the largest fine, $16.7 billion.) That said, the reputational damage to Wells Fargo is nonetheless quite significant.


In what may be the last of the settlements with the U.S. Department of Justice ("DOJ") over the big banks’ role in precipitating the 2008 financial crisis, Wells Fargo Bank and several of its affiliates agreed to pay $2.1 billion in civil penalties to settle DOJ charges that it violated the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) by misrepresenting the quality of mortgage loans that it sold to other investors.


The residential mortgage loans in question – which did not meet the quality that Wells Fargo represented - ultimately made their way into residential mortgage-backed securities (RMBSs) that defaulted, leaving investors, including federally insured financial institutions, with billions of dollars in losses. 


According to the DOJ’s consent order, Wells Fargo “instituted a campaign in 2005 called ‘Courageous Underwriting,’ a philosophy that encouraged Wells Fargo’s underwriters to take more chances, and be more aggressive, in approving loans that were outside of Wells Fargo’s underwriting guidelines.” About 70% of the bank’s mortgages had an “unacceptable” divide between what the borrowers had to pay and what they could afford, according to the bank’s own research, the DOJ said. Almost half of those had no explanation for why, the DOJ said.


ACCORDING TO THE DOJ PRESS RELEASE, … its investigators alleged that, despite its knowledge that a substantial portion of its stated income loans contained misstated income, Wells Fargo failed to disclose this information, and instead reported to investors false debt-to-income ratios in connection with the loans it sold. Wells Fargo also allegedly heralded its fraud controls while failing to disclose the income discrepancies its controls had identified.


The United States further alleged that Wells Fargo took steps to insulate itself from the risks of its stated income loans, by screening out many of these loans from its own loan portfolio held for investment and by limiting its liability to 3rd parties for the accuracy of its stated income loans. Wells Fargo sold at least 73,539 stated income loans that were included in RMBS between 2005 to 2007, and nearly half of those loans have defaulted, resulting in billions of dollars in losses to investors.