The U.S. Justice Department has sued Barclays PLC after failing to settle a long-running probe into the U.K. bank's role in selling U.S. mortgage-backed securities before the financial crisis, according to documents filed in New York federal court.
The settlement talks were aimed at resolving allegations over the bank's role in the sale of toxic securities that have been blamed for helping spark the 2008 financial crisis. It is highly unusual for the Justice Department to sue a bank, rather than reaching a settlement.
"Barclays rejects the claims made in the complaint," the bank said in a statement, adding that it considers the allegations "disconnected from the facts." The statement also said "we have an obligation to our shareholders, customers, clients, and employees to defend ourselves against unreasonable allegations and demands."
As of this summer, the U.K. bank had set aside £2.5 billion ($ 3.1 billion) to cover fines and litigation more generally.
Investors have feared that a sizable fine will eat into Barclays's capital position. The litigation will prolong the uncertainty around the settlement and likely weigh on the bank's share price.
The British bank is currently selling down assets in Europe and Africa to try to bolster its capital position. It still faces a number of civil suits on mortgage-backed securities.
The 198-page lawsuit by the U.S. government charges that between December 2005 and December 2007, Barclays "engaged in a fraudulent scheme to sell tens of billions of dollars of residential mortgage-backed securities (RMBS), in which it repeatedly deceived investors about the characteristics of the loans backing those trusts.'' The suit also said that the bank "systematically and intentionally misrepresented key characteristics of the loans"
The lawsuit focuses on 36 of those securitizations, holding $ 31 billion worth of mortgage loans. Those securities "proved to be catastrophic failures," according to the lawsuit. "More than half of the underlying loans defaulted, causing investors in those deals to lose many billions of dollars, with hundreds of millions more in losses projected during the remaining life of the deals.''
The Justice Department's decision to sue in the waning days of the Obama administration means that the high-stakes litigation will be overseen by members of the incoming Trump administration. The filing also signals the extent to which the Justice Department is trying to resolve its outstanding investigations into activity on Wall Street leading up to the financial crisis before Obama appointees leave their jobs next month.
Justice Department lawyers have also been negotiating with Deutsche Bank AG and Credit Suisse over similar charges, and while those talks are progressing, they haven't reached a point yet where a settlement is certain, according to people familiar with the discussions.
The anticipated legal bills have concerned shareholders of the banks, spurring worries that settlements could force them to raise capital, something the banks have sought to avoid.
The stakes are high also for other European banks— Royal Bank of Scotland Group PLC and UBS Group AG—that aren't as far along in talks with the government. Those banks also face potential penalties tied to mortgage-securities cases, according to bank disclosures and people familiar with the matter.
The breakdown in the talks with Barclays is in sharp contrast with how previous mortgage cases have unfolded over Justice Department accusations that banks had misled investors about the quality of home loans packaged into securities. To resolve similar claims, Bank of America Corp., J.P. Morgan Chase & Co. and others have together reached settlements agreeing to pay more than $ 40 billion in cash and help to consumers.
The cases have been brought under the 1989 Financial Institutions Reform, Recovery and Enforcement Act, which was little used before the crisis but which the Obama administration has revived and used to levy large penalties on banks for conduct that contributed to the mid-2000s housing bubble and subsequent collapse.
The Justice Department and lawyers for the banks have been racing to reach agreements before the end of the Obama administration. Several senior officials working on the cases will leave the government by Jan. 20, and hope to finish cases that were developed on their watch. It would likely take several months for new leadership to be in place at the Justice Department, prolonging uncertainty for banks.
In the lawsuit, the government charged that Barclays employees knew they were pushing shoddy, likely-to-default loans, and kept doing so to keep making money off the deals.
"Barclays was a willing and active participant in this business, eagerly seeking to do more and more deals, and to securitize more and more loans, in order to increase its profits and its share of the RMBS market,'' the lawsuit charges. "This pump-priming activity contributed to the housing bubble and to the ensuing crash, whose effects devastated the world economy in the financial crisis of 2008.''
The government charges that while Barclays claimed to have robust due-diligence measures in place to monitor the quality of the underlying mortgages, the bank's scrutiny of the deals "was a sham.''
The bank "routinely ignored or kept to itself the results of that due diligence,'' the lawsuit charges.
The companies hired to conduct due-diligence checks on the mortgages warned the bank, and those warnings were essentially ignored, the complaint states.
"These vendors described some of these securitized loans as 'craptacular,' others as 'scariest collateral,' and others as having the 'distinct aroma of default,' the suit says. The complaint says that a Barclays executive in charge of due diligence on the subprime deals allegedly said that one loan pool "scares the sh*t out of me.'' At another point, that same executive said about a Wells Fargo pool, according to the complaint: "We have to eat their sh*t loans."
Write to Max Colchester at max.colchester@wsj.com, Devlin Barrett at devlin.barrett@wsj.com and Jenny Strasburg at jenny.strasburg@wsj.com
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