FHA wants to allow banks to make more bad loans
The FHA is lobbying the Justice Department on behalf of lenders who want to make bad loans with impunity.
At the most basic level, lenders, realtors, and borrowers inflated a housing bubble because they got everything they asked for. From 2004 to 2006, there were no barriers whatsoever to complete real estate transactions as inventory was abundant, prices were financeable, and buyers were motivated. It was the best of all possible real estate markets.
Right now everyone who wants to see more transactions at higher prices is complaining about stringent lending standards. In their minds if qualifications were looser, more people would qualify for home loans, and they would make more money. They would be quite content to enjoy the high prices and transaction volumes associated with no lending standards at all. Unfortunately, we tried that once, and it didn’t work out very well.
Mortgage lending only works when the originating lender has fear of loss through borrower default, otherwise the lender’s only incentive is to maximize volume, a condition that inevitably leads to a rapid lowering of lending standards. In years past, lenders used to loan their own money, so they were very careful about who they loaned money to: they had direct risk of loss. Today, most originating lenders don’t keep loans on their books, but they fear the threat of a forced buy-back if the loan goes bad, so they are still careful to originate good loans — a circumstance necessary for a healthy housing market.
In the neverending push to lower lending standards and pass the risk of loss on to the US taxpayer, lenders lobby the FHA to consider letting originating lenders off the hook when loans to poor credit risks go bad. This is a really stupid idea.
Procedural Change Would Limit Justice Department’s Ability to Pursue Damages
By Joe Light, Updated Feb. 9, 2015 12:59 p.m. ET
A U.S. housing regulator is considering limiting one of the most powerful tools federal attorneys have to punish banks for making mistakes in mortgage lending, a move the Federal Housing Administration hopes will encourage banks to give more home loans to worthy but weaker borrowers, according to people familiar with the matter.
Weaker means lower FICO scores, lower down payments, and much higher likelihood of default and default losses. Worthy means not giving those people loans; the two concepts, worthy and weaker, don’t mix.
Since the mortgage crisis, the government has extracted billions of dollars in penalties from lenders that made mistakes on loans to borrowers who later defaulted. The errors ranged from small mistakes to ones that affected the riskiness of the mortgages.
Mistakes? Lenders rarely make “mistakes.” They knowingly let bend the rules to qualify an unqualified borrower to make money on origination. When the borrower defaults, the lender should absorb the loss. If they don’t, more “mistakes” are sure to follow.
We’re only two sentences into the report, and the reporter has already served up two nonsensical euphemisms designed to lessen the negative impact of this proposal.
Because banks must certify that FHA-backed mortgages they originate have no errors, when mistakes are found, the Justice Department has sometimes pursued damages under a Civil War-era law known as the False Claims Act that lets the government recover triple damages.
In one high-profile application of the act, the Justice Department a year ago reached a $614 million settlement with J.P. Morgan Chase & Co.
Sounds like a great law to me…
Some banks, believing the penalties are too harsh relative to the errors made, have pulled back from originating mortgages backed by the FHA and argued that the broad “certification” they must make when originating a mortgage should be limited to significant errors. …
The FHA’s attempt to change the provision shows the tightrope policy makers and regulators are trying to walk. While they want to hold lenders accountable for crisis-era mistakes and retain recourse should the loans go bad, they also want the banks to extend loans to some consumers who have been largely shut out of the mortgage market since the crisis.
Although the changes aren’t settled, people familiar with the matter say that one likely outcome is that banks continue to be liable for high damages on significant underwriting errors but not for smaller mistakes that wouldn’t have affected the decision to extend the loans.
That actually sounds like a good compromise. If a lender failed to get a document of low importance, like acopy of the borrowers 2012 W-2, and the document was immaterial to whether or not the loan would have been granted, then the lender shouldn’t necessarily be hurt for that. Losses on loans like that are the fault of the FHA for establishing guidelines that are too broad, which is why most lenders today have overlays that are tighter than the FHAs standards.
Discussions surrounding changing the FHA provision have been fraught and could fall apart. Officials within the Department of Housing and Urban Development, which oversees the FHA, are butting heads with those at the Justice Department, according to people familiar with the matter.
The enforcement attorneys argue that weakening the provision cedes too much ground to lenders’ lobbying efforts, while some HUD officials believe that not making changes could keep loans out of the hands of creditworthy borrowers. Lenders have largely been left out of the discussion, say people familiar with the situation. …
Quite honestly, this deal should fall apart. If I were at the Department of Justice, I too would feel the FHA is rolling over to banking lobbyists because that’s exactly what the FHA is doing.
A Justice Department spokeswoman said: “The False Claims Act restores scarce funds stolen from vital government programs and deters those who knowingly would misuse public funds. The Justice Department will continue to pursue all manners of financial fraud.”
Lenders typically have pulled back on FHA lending by having more stringent requirements than what the FHA would allow. For example, even though the FHA will guarantee loans to borrowers with credit scores of as little as 580, on a scale of 300 to 850, a bank might not give loans to borrowers with a score below 640. …
“The recognition of the fairly outrageous penalties that could be paid relative to the actual loss is extraordinary,” said David Stevens, president of the Mortgage Bankers Association, a trade group for lenders. “They can either do the loans and risk a False Claims Act violation…
or they can put credit overlays in place to make certain that they don’t expose themselves to loans that have a higher propensity for default.”
What’s wrong with that? FHA standards are far too loose, and if originating lenders don’t exercise judgment, then a plethora of bad loans will be originated and the US taxpayer will pay for the losses. Personally, I’m not in favor of that.