WASHINGTON — Trump administration officials have made clear their intent to reexamine how Federal Housing Administration lenders are cited under the False Claims Act, but whether that means lenders can rest any easier is still an open question.
Housing and Urban Development Secretary Ben Carson multiple times has echoed lenders' concerns that the government has used the FCA too aggressively and White House officials are supporting the secretary's initiative.
But it is not yet clear that the Department of Justice, which joined HUD under the Obama administration to target FHA lenders for False Claims Act violations, is ready to pull back anytime soon, and industry observers say lenders should not ease up on compliance just yet.
"Until the DOJ and ... [HUD's Office of Inspector General] sign on, lenders will need to continue to be vigilant in their quality control and quality assurance practices to make sure their loans are in compliance with FHA standards," said Phillip Schulman, a partner at the Mayer Brown LLP law firm.
In the wake of the foreclosure crisis, the DOJ employed the False Claims Act — a Civil War-era law traditionally used to cite contractors for defrauding the government — to levy billions of dollars of fines against major banks and other FHA lenders.
But the industry has sharply criticized the extent to which the government brought claims, arguing that it seemed like any defect in an FHA loan could result in a fine. False Claims Act ligation prompted several large banks and other mortgage lenders to exit the FHA program. Lenders face elevated damages under the False Claims Act for loan losses.
Yet the DOJ has not filed a single FCA case since the start of the Trump administration in January.
"We hear concerns from the lending community about participating fully in [FHA] programs because they are wary of undue risk from lack of clarity for what we expect and out-sized liability," Carson said at a housing conference Nov. 2.
"We have recently announced, in consultation with the Justice Department, that HUD is committed to reviewing and addressing these concerns."
Among the steps HUD has taken is developing a new taxonomy to assess which loan defects necessitate action under the False Claims Act. The new system, which was implemented in May, is meant to better distinguish between clerical errors that do not impact the decision to make a loan and intentional fraud that would prompt DOJ to sue a lender under the False Claims Act. HUD has also taken steps to change the letter by which lenders certify a loan meets FHA requirements.
Industry representatives are optimistic that Carson will follow through with bringing more clarity to which errors are and are not enforceable.
"This is a HUD problem, not a DOJ problem, and they have to do their job and fix it," Mortgage Bankers Association President and CEO David Stevens, a former FHA commissioner in the Obama administration, said in an interview. "And Secretary Carson has shown his commitment to get this resolved."
Clarifying the FHA certification letter and formalizing the defect taxonomy is expected to narrow the scope of how the Department of Justice enforces the False Claims Act.
The Department of Justice has "told us they have no desire in pursuing cases and wasting time on issues that are not material or intentional fraudulent violations," Stevens said.
Yet a spokeswoman for the DOJ indicated that the department still has every intention of pursuing False Claims Act cases against lenders that are defrauding the government.
"There is no room for bad actors or fraudsters in the FHA program," the spokeswoman, Lauren Ehrsam, said in a written response. She added that DOJ "is proud to continue its partnership with the Department of Housing and Urban Development protecting this program and the consumers it serves.
"Lenders lacking proper internal controls, or those failing to take their obligations seriously, will be held appropriately accountable so that Americans can continue to enjoy broad access to this important homeownership loan program," Ehrsam said.
Lenders that exited the FHA program because of False Claims Act litigation include some of the nation's largest banks. A Federal Reserve staff report shows that Wells Fargo, Bank of America and JPMorgan Chase originated 43% of FHA loans in 2010. That dropped to 5% in 2016. FHA mainly serves moderate-to-low-income borrowers and all three banks were subject to False Claims Act litigation by the Justice Department.
Due to indemnification risk under the False Claims Act, FHA servicing costs and bank capital rules, large banks are unlikely to re-enter the FHA program, which mainly serves moderate-to-low-income borrowers, according to the Fed report.
However, Stevens said the False Claims Act litigation that prompted the big banks to leave the FHA program was just the "the straw that broke the camel's back." There were also other concerns with the FHA program, particularly with the default servicing process. Servicing costs in the FHA program are higher compared to servicing Fannie Mae and Freddie Mac loans.
Under the loan defect taxonomy implemented in May, when a defect is spotted, the FHA will give the lender a chance to fix it before taking a False Claims Act enforcement action.
FHA lenders must respond to any material findings in the defect taxonomy reviews, otherwise they can be fined for violations or required to indemnify FHA from any loan losses.
“FHA intends to further review its loan and loan-level requirements, and the framework of its Loan Quality Assessment Methodology (Defect Taxonomy) to identify potential areas where FHA can provide lenders greater clarity, resulting in increased confidence to make FHA mortgages available to borrowers," according to a HUD statement.
Meanwhile, assessing the impact of False Claims Act litigation on the mortgage industry appears to be an issue of concern in other domains of the government.
The Trump administration is "reevaluating the False Claims Act litigation that has driven so many lenders out" of the FHA single-family loan guarantee program, Mark Calabria, an adviser to Vice President Mike Pence, said at a recent housing conference.
And President Trump's nominee to be the new FHA commissioner, Brian Montgomery, said he hopes the DOJ will take a more reasonable approach toward False Claims Act enforcement and litigation.
"One reason for the tight credit environment is that lenders remain hyper-sensitive about defaults and claims out of fear of heavy-handed enforcement actions," Montgomery told the Senate Banking Committee during his Oct. 26 confirmation hearing.
"To be clear, fraud and misrepresentation has no place in any industry much less the one that represents the largest investment most families will ever make. But I wonder if we haven't gone too far," Montgomery said. "We need a serious discussion about whether or not the False Claims Act is the right tool going forward."