The False Claims Act was created to keep the Union Army from being ripped off by suppliers during the Civil War. But more than 150 years later, this law strikes fear in the hearts of mortgage lenders and servicers because of its potential for large financial penalties.
Industry observers expected the Trump administration to be less aggressive in using the False Claims Act to pursue fraud cases against lenders and servicers of government-insured loans. But so far, that hasn't happened. Instead, the Justice Department has shifted the focus of investigations and expanded their scope.
Case in point: the DOJ's latest False Claims Act action, a $75 million settlement with PHH Corp. that is unique in that it covers loans sold to Fannie Mae and Freddie Mac, in addition to loans insured by the Federal Housing Administration and Department of Veterans Affairs.
In disclosing the settlement, PHH cited its desire "to avoid the distraction and expense of potential litigation." While that's a common rationale to settle regulatory inquiries and private lawsuits, it's notable here given that PHH appears ready to take its legal wrangling with the Consumer Financial Protection Bureau all the way to the Supreme Court.
The industry criticism of the Justice Department lies in its use of the False Claims Act to pursue enforcement actions against FHA lenders and servicers. The DOJ is accused of being too heavy-handed and nitpicky in its investigations.
Consumer advocates obviously don't see it this way, largely because this industry earned a reputation for not being diligent about its processes and having shoddy documentation during the housing crisis. And at a time when low volume has lenders loosening credit standards and the FHA's role in the industry is evolving, perhaps stringent oversight is warranted.
Lenders are tapping into new low down payment programs with Fannie Mae and Freddie Mac as an alternative to the FHA program, in part because of the heightened risk of DOJ enforcement actions. And those programs appear to be having some success at attracting first-time home buyers.
This raises the question of what's the appropriate market share for FHA in the current environment and whether the Justice Department could end up regulating the FHA program into obscurity.
The FHA has been trying to reduce its size for some time. But the DOJ enforcement actions may be causing FHA market share to shrink too much. What's more, the share of FHA loans originated and serviced by nonbank mortgage companies is growing, prompting new risk management concerns because these institutions often lack the capital reserves of banks and credit unions.
Unfortunately, this issue may continue to go unresolved until a new FHA commissioner is appointed. And even then, lenders and servicers may not get the regulatory relief they're really looking for.