Barclays' bluff called in mortgage case

Two people look out from the Canary Wharf headquarters of Barclays Bank. Photo / Getty

The management team at Barclays, facing a US demand that it pay up over mortgage misconduct from the financial crisis, dared prosecutors to sue. The Justice Department obliged.

After failing to agree with prosecutors on a price to put the US investigation behind it, the bank was slapped Thursday with a civil suit in Brooklyn. The US accused the firm of selling $31 billion (NZ$45b) of defective mortgage-linked securities into the market under false pretenses from December 2005 through 2007.

The complaint against Barclays - quoting consultants who privately called the underlying loans "craptacular" - broadly echoes allegations against other banks in mortgage-securities settlements that have netted the government US$46 and counting in penalties and reparations. The surprise this time is that a global bank is rejecting the Justice Department's demand for a staggering financial penalty and is forcing prosecutors to prevail in court. In a statement on Thursday, Barclays said the government's claims "are disconnected from the facts."

Barclays' position contrasts starkly with the one taken just hours later by its European colleague, Deutsche Bank. The German lender said it had reached a preliminary US$7.2b deal with the Justice Department - US$3.1b in penalties and the rest in consumer relief - to settle a probe into its own mortgage securities business. Credit Suisse soon announced its own deal as well.

Barclays has been preparing for its fight for months. Bloomberg reported in October that management had drawn a line at US$2b as the upper limit of what it was prepared to pay, given how the company's conduct compared with that of peers. The bank has hired an additional law firm, Williams & Connolly, which is home to star litigator Brendan V. Sullivan Jr.

The bank's defiance reflects frustration among U.K. and European financial firms with U.S. authorities - and not just the Justice Department. Since the financial crisis, global banks have faced costly probes by the Manhattan District Attorney's Office, New York's Department of Financial Services and a number of state attorneys general. The suspicion in Europe is that banks from outside the U.S. get hit harder than domestic lenders for the same misconduct.

Then came news this fall that the Justice Department had asked Deutsche Bank for US$14b to resolve its mortgage-backed securities probe. The disclosure of that "ask" sent the bank's shares tumbling on concern that the company would need a massive recapitalization.

Barclays may also be betting it can either get a better deal after Donald Trump assumes the US presidency in January, or that Barack Obama's administration will bend in its final days to complete years of work. Shortly after Trump's election victory last month, Barclays's own analysts predicted Deutsche Bank and Credit Suisse may be able to reach faster, cheaper deals to resolve their mortgage probes so that departing US officials can end tenures "with a sense of achievement."

Credit Suisse's settlement, announced hours after Deutsche Bank's on Friday morning, amounts to US$5.28b, comprised of a US$2.48b civil penalty plus consumer relief.

Barclays has a painful history with US authorities. The bank cooperated years ago with investigators in the US and UK who were examining alleged manipulation of the London Interbank Offered Rate, known as Libor.

As the investigation of Barclays wound down in 2012, its executives hoped authorities would include the company in a group settlement with several other banks. Instead, US regulators wanted to announce at least one big penalty quickly, according to people at the time. So that June, Barclays agreed to pay about US$450m to resolve accusations its employees had sought to manipulate Libor.

The bank's reward for being first to settle: Its chief executive officer, Bob Diamond, was pushed out amid a political furor, sending the firm sideways during a turbulent period. Although that was more than four years ago, the bank's leaders no doubt remember that time when they tried to make nice with US authorities.

-With assistance from Yalman Onaran