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UPDATE 2-Bank of America ordered to pay $1.27 bln for 'Hustle' fraud

(Adds comments On case, other litigation)

NEW YORK, July 30 (Reuters) - A federal judge on Wednesday ordered Bank of America Corp to pay a $1.27 billion penalty for fraud over shoddy mortgages sold by the former Countrywide Financial Corp.

U.S. District Judge Jed Rakoff in Manhattan ruled after a jury last October found the second-largest U.S. bank liable for the sale by Countrywide of defective loans to government-controlled mortgage companies Fannie Mae and Freddie Mac

Rakoff also ordered former mid-level Countrywide executive Rebecca Mairone, who was also found liable and was the only individual charged, to pay $1 million, citing her "leading role" in the fraud and calling some of her testimony "implausible."

While the bank's penalty was below the $2.1 billion sought by the U.S. Department of Justice, it marks another legal defeat for Bank of America over its disastrous July 2008 purchase of Countrywide, which has cost tens of billions of dollars in litigation, loan buybacks and writedowns.

Bank of America has also held talks on another, potentially multi-billion-dollar settlement to resolve separate government probes into mortgage securities, including from Countrywide and its Merrill Lynch unit.

"BRAZEN"

The case centered on a Countrywide lending program that ended around May 2008, and which was known as "High Speed Swim Lane," "HSSL" or "Hustle."

Investigators said the program emphasized quantity over quality, rewarding employees for producing more loans and eliminating checkpoints designed to ensure the loans' quality.

"While the HSSL process lasted only nine months, it was from start to finish the vehicle for a brazen fraud by the defendants, driven by a hunger for profits and oblivious to the harms thereby visited, not just on the immediate victims but also on the financial system as a whole," Rakoff wrote.

The Charlotte, North Carolina-based bank's liability was based on the $2.96 billion that Rakoff said Fannie Mae and Freddie Mac paid Countrywide for 17,611 suspect Hustle loans.

Rakoff said this was the appropriate standard under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), which was adopted after the 1980s savings and loan scandal and the basis for Bank of America's liability.

The $1.27 billion penalty reflected findings by a government expert that only some of the loans had material defects, while others were acceptable, Rakoff said.

"SCAPEGOATED"

Bank of America has said no penalty was justified, and spokesman Lawrence Grayson said the $1.27 billion award "simply bears no relation to a limited Countrywide program that lasted several months." An appeal is possible, he said.

According to her LinkedIn page, Mairone, who now uses her maiden name Rebecca Steele, recently started her own firm after working at Bank of America and then JPMorgan Chase & Co. The government had sought $1.2 million from her.

"Rebecca never intended to defraud anyone and never did defraud anyone," her lawyer Marc Mukasey said. "Unfortunately, more powerful people chose her as a scapegoat because they thought she was an easy target. We will fight on to clear her name."

U.S. Attorney Preet Bharara in New York said the verdict and penalties show that mortgage fraud "cannot be viewed as simply another cost of doing business in the financial world."

Bharara said it was the first case to impose civil penalties against a bank and executive under FIRREA to punish mortgage fraud leading up to the 2008 financial crisis.

"I don't see much downside to an appeal, if this is the first time a judge has imposed liability in this context," said Carl Tobias, a University of Richmond law professor.

The case was originally brought by former Countrywide vice president Edward O'Donnell, a whistleblower who later joined Fannie Mae. He declined to comment.

Rakoff began by noting that the Justice Department has not brought criminal charges over loan practices at Countrywide, widely seen as a key factor in the recent U.S. housing crisis.

He also noted that Countrywide's three top officials, including former Chief Executive Angelo Mozilo, settled U.S. Securities and Exchange Commission civil charges without addressing whether they did anything wrong.

The case is U.S. ex rel O'Donnell v. Bank of America Corp et al, U.S. District Court, Southern District of New York, No. 12-01422.

(Reporting by Jonathan Stempel in New York; Additional reporting by Karen Freifeld and Aruna Viswanatha; Editing by Bernard Orr)