The False Claims Act (FCA), also known as the "Lincoln Law," is a federal law passed in 1863 designed primarily to target contractors who have defrauded the federal government. Over the years, it has been used primarily to target defense contractors, but its use expanded in the 1990s to focus a great deal on health care (Medicare) fraud.
In 2011, the U.S. Department of Housing and Urban Development (HUD) teamed up with the Department of Justice (DOJ) to step up use of the False Claims Act in relation to mistakes made in the underwriting and packaging of an FHA mortgage.
In addressing the housing crisis and the Great Recession, the Obama Administration was searching for ways to increase enforcement actions against lenders that were originators or servicers of large volumes of loans that went into default. In February 2012, the DOJ and HUD announced a $25 billion settlement against the U.S.’s five largest mortgage servicers. But clearly the $25 billion was not enough and the Administration began to search for additional mechanisms for punishing FHA lenders.
To be clear, we need a well-regulated lending industry to protect taxpayers, homebuyers, and communities. This is a good thing. But the use of FCA is an inappropriate and harmful response that only reduces access to credit for qualified borrowers, harming the entry level buyer and those on the lower end of home price ranges in America.
The broad use of FCA has resulted in excessive penalties often for immaterial mistakes made during the loan process prior to settlement that made no difference to the quality of the loan or the decision to approve that loan.
Let’s face it, originating an FHA loan requires hundreds of pages of paper with multiple personnel contributing data elements to the loan file and for the ultimate loan decision. This information comes from a variety of sources, including the real estate brokers’ purchase contract, credit reporting agencies, title companies, real estate appraisers, bank statements, tax returns, employers’ information, letters to the file from the borrowers, and so much more. The likelihood of a clerical error along the way, something immaterial yet a mistake regardless, is almost unavoidable in many cases.
And lenders do everything possible to avoid any mistake, Quality control happens at time of application, prior to loan commitment, prior to funding the mortgage at settlement, and post-closing. Lenders use both in-house and external firms to try to avoid errors. But the fact is that a HUD loan file is big, and minor errors are unfortunately likely.
This is important because HUD has been using the FCA to review loans that go into default over a number of years from a lender. They do this usually by sampling a percentage of defaults and then taking the percentage of errors and applying that to the entire portfolio of loans originated. This can result in literally billions of dollars of risk to lenders who participate in the program.
Why? Because the FCA comes with penalties that are treble the actual damages. For example, a $200,000 loan with an immaterial clerical error that goes into default and generates a loss for FHA of $50,000 can cost the lender 3 times the actual damages, or $150,000 in the above case. This is for one loan.
That is why MBA has been pushing for a number of years now for HUD and DOJ to come up with a clear and reasonable interpretation of what a material loan defect is, so that all parties clearly understand what is a material mistake and what is an immaterial one.
As a model, HUD and DOJ should look at Fannie Mae and Freddie Mac (the GSEs). The GSEs have established the model for appropriate enforcement. They have identified the errors based on severity, established various remedies from lenders based on the severity of these errors, and assigned a dispute resolution process to address disagreements. The remedies typically include anything from fixing the mistake, to repurchasing or indemnifying Freddie or Fannie against any loss.
The difference between using the FCA, versus a responsible remedy process as used by the GSEs, has been significant. The unfortunate outcome is hurting homeownership and housing for potential FHA borrowers who are often first time buyers and minorities. Many large lenders have either exited the FHA program entirely or significantly scaled back the business with overlays to credit standards in an effort to make sure that they never get exposed to FCA risk.
We at the MBA have submitted formal letters to the HUD secretary and the attorney general in both the Obama and Trump administrations asking them end this unprecedented use of FCA. We have also brought this issue to the attention of others in the current administration and members of Congress.
This can be reversed quickly by Secretary Ben Carson and Attorney General Jeff Sessions. This needs to happen now. Until this misuse of the False Claims Act ends, we will continue to see lenders pulling away from the FHA program, stripping communities across the country from the benefits of owned housing and reducing the access to American Dream of sustainable homeownership.
We urge, I urge, support for responsible, balanced, and fair regulation – and the FCA use here is not that. It’s time to stop this.