In Rare Step, U.S. Sues Barclays Over 2008 Financial Crisis

(CN) – Bringing the first lawsuit of its kind, the United States says Barclays Capital repeatedly deceived investors about the risk of tens of billions of dollars of residential-mortgage-backed securities, causing “catastrophic” losses in the 2008 financial crisis.

Robert Capers, the U.S. attorney for the Eastern District of New York, brought the whopping 198-page complaint in Brooklyn Thursday over 36 residential mortgage-backed securities Barclays sold to investors between December 2005 and December 2007.

The lawsuit marks the first time the government has sued a major bank as a result of its investigation into the underwriting processes leading up to the financial crisis. Most banks subject to the investigation reached settlements with the government – Goldman Sachs settled for $5 billion, Morgan Stanley for $3.2 billion and Wells Fargo for $1.2 billion. Indeed, the government also announced Thursday that Deutsche Bank will pay $7.2 billion to settle claims against it, and Credit Suisse will pay $5.3 billion.

But settlement negotiations with Barclays recently broke down, possibly because the bank believes the incoming Trump administration will be less demanding.

When the 2008 financial crisis struck, Barclays experienced defaults on more than half of the $31 billion worth of mortgage loans it had securitized.

“In publicly filed offering documents, in other deal transaction documents, and in direct communications with investors and rating agencies, Barclays systematically and intentionally misrepresented key characteristics of the loans it included in the subject deals,” the complaint states. “The borrowers whose loans backed the subject deals were significantly less creditworthy than Barclays represented to investors.”

Promising to defend itself vigorously, Barclays denied the allegations.

“Barclays considers that the claims made in the complaint are disconnected from the facts,” the bank said in a statement. “We have an obligation to our shareholders, customers, clients and employees to defend ourselves against unreasonable allegations and demands.”

The government says the U.K.-based bank knew that underwriting standards at mortgage lenders was “severely deteriorating” over the two-year class period, to the point where lenders were routinely issuing loans based on knowingly false documentation.

“These companies then pushed to have Barclays buy as many of their shoddy loans as possible in order to shift the risk of default from the originators onto Barclays’ RMBS investors,” the complaint claims.

In Barclays, the lenders found a “willing and active participant” that relentlessly sought to increase its share of the residential mortgage-backed securities market. Capers says Barclays falsely assured investors that it excluded “unacceptable” loans from its securities, and promised reliable appraisals of mortgaged properties.

Due diligence at Barclays was a “sham,” however, that was often altogether skipped, according to the complaint.

Capers says Barclays vendors used language like “craptacular,” a “deluge of Fremont garbage,” and “about as bad as it can be” to describe underlying loans when they actually did fulfill due-diligence obligations.

“Barclays not only acquired and securitized billions of dollars of loans it knew had material defects, but it also extended billions of dollars in financing to lenders it knew were originating loans without regard to the ability of the borrowers to repay them,” the complaint states. “This pump-priming activity contributed to the housing bubble and to the ensuing crash, whose effects devastated the world economy.”

Despite these warnings signs, the bank securitized billions of dollars worth of these highly risky mortgages, largely because it perceived the mortgage lenders to be its true clients not investors, according to the complaint. The government says Barclays “bent over backwards” to please lenders and “on a number of occasions it even agreed to limit the percentage of loans that could be kicked out of a deal.”

Over and over again, Barclays allegedly decided to protect its own bottom line by securitizing loans already in default before the issue date, despite knowing that investors would have to pay the price. It even canceled a due-diligence job on loan pools from New Century, which was on the verge of bankruptcy, in order to save money, according to the complaint. Capers says it was more cost-effective to “tell the diligence guys to stand down” and lie to investors, without a solvent party to take back the defective loans.

The Justice Department seeks to impose the maximum civil penalty permitted by the Financial Institutions Reform, Recovery, and Enforcement Act, but the complaint does not name a figure.

Franklin Amanat, senior counsel for the Justice Department, signed the complaint.

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