If you were to read the news headlines and the fierce-sounding lawsuit filed by the Department of Justice against DeutscheBank on it “egregious” violations of FHA lending standards, you might be persuaded that Team Obama was getting serious about mortgage abuses.
FHA lending was only a small portion of mortgage lending prior to the crisis and did not play a meaningful role in the implosion. A bit over $1 billion in possible charges ($386 million in losses and triple damages), even with treble damages, is a mere cost of doing business relative to the profits earned on mortgages in the bubble era. Moreover, as Marshall Auerback noted via e-mail:
God forbid they should sue an American bank. Because, of course, Wells Fargo and JP Morgan would never dream of introducing the kinds of “reckless” lending practices of the kind practised here by Deutsche Bank.
And indeed, the mortgage industry experts I’ve consulted confirm that there is no reason to think Deutsche was worse than other lenders. When, as Bloomberg notes, even the head of the Mortgage Bankers Association says the DoJ is probably looking at other banks, you know the conduct was widespread. Indeed, all the major mortgage packagers were buying drecky subprime originators in late 2006. You might argue some of them were trying to catch a falling safe, but Goldman and Deutsche also had ongoing synthetic CDO programs, which meant effectively betting against the market. And Bill Black points out this is a civil, not criminal suit.
While it’s still better to have some enforcement rather than none, the FHA action is unlikely to be a sign of new-found seriousness at the DoJ, save possibly for other FHA-related litigation against other banks. As the suit recounts, the FHA program effectively outsourced loan underwriting to private firms and then guaranteed the loans due to the fact that the lenders had complied with a particularly strict and detailed set of program requirements. Direct Endorsement Lenders like Deutsche agreed to conduct due diligence on a loan by loan basis:
The Direct Endorsement Lender originates a proposed loan, or in some instances, acts as a spons~ing lender by underwriting and funding proposed mortgages originated by other FHA lenders known as loan correspondents. In either case, the Direct Endorsement Lender ultimatelr reviews the proposed mortgage. The borrower, along with the Direct Endorsement Lender’s representative, completes the loan application. A loan officer collects all supporting documentation from the borrower and submits the application and documentation to the Direct Endorsement Lender. The Direct Endorsement Lender obtains an appraisaL A professional underwriter employed by the Direct Endorsement Lender performs a mortgage credit analysis to determine the borrower’s ability and willingness to repay the mortgage debt in accordance with HUD rules. The Direct Endorsement Lender’s underwriter makes the underwrititing decision as to whether the mortgage may be approved for FHA insurance or not, according to HUD rules. If the underwriter has decided that the mortgage may be approved for FHA insurance in accordance with HUD rules, the Direct Endorsement Lender closes the loan with the borrower. Thereafter, the Direct Endorsement Lender certifies that the mortgage qualifies for FHA insurance. FHA endorses the loan on the basis of the Direct Endorsement Lender’s certification and provides the Direct Endorsement Lender with a mortgage insurance certificate.
There were considerably more procedures stipulated: what sort of borrower-level review had to be conducted, various quality control procedures (including monitoring initial defaults and taking corrective action if needed), certifications of individual loans and annual certifications of compliance with the overall program requirements.
Of the 39,000 Deutsche Bank originated loans guaranteed by the FHA, 12,500 defaulted. Historically, the strict documentation requirements of FHA loans kept default levels low. And some of the violations alleged, such as moving the lone audit staffer to origination and taking an outside audit report finding shortcomings and “literally” stuffing it in a closet unopened, would be awfully hard to minimize in court.
As Willem Buiter has noted in other contexts, self regulation is to regulation as self regard is to regard.
Eric Holder, in a briefing today, made remarks to the effect that if the mortgage settlement talks came to naught, he would bring prosecutions if there was a legal basis. Given that Eliot Spitzer’s criminal suit against AIG was depicted as a possible death knell for the company (funny, that, since AIG managed to do itself in with no official nudge), it appears pretty implausible that the bank-friendly Administration would take serious action against a major player.
Holder also said that there were “variety of positions that need to be harmonized.” Ahem. That means at the very best this lawsuit might be used to apply a bit of pressure to the
Office of Criminal Capitulation Office of the Comptroller of the Currency. I’m cynical enough to believe that this is merely window dressing, regulatory theater to make the effort to put the mortgage crisis abuses in mothballs look like a serious effort at law enforcement.