In a recent blog, Jim Parrott, Nonresident Fellow, and Laurie Goodman, VP, Housing Finance Policy, Urban Institute [1] have given insights on why the Federal Housing Administration (FHA) clarified how it would enforce its underwriting standards and how they could be improved.
The blog [2] states that one of the key reasons for FHA's current announcement is to woo back lenders that had left is fold during the crisis and address some of the pitfalls of the False Claims Act that made them leave.
Parrott and Goodman write that a decade ago, "facing a rising tide of insurance claims following the crisis, FHA and the Department of Justice (DOJ) stepped up enforcement efforts against lenders that had made mistakes in their underwriting of FHA-insured loans, levying more and larger fines, requiring more indemnification, and, for the first time, bringing claims of fraud under the False Claims Act."
As a result, many large, well-capitalized longtime FHA lenders, pulled back on their FHA lending, "sometimes dramatically." Because of this shift, newer and less-well-capitalized lenders stepped in to fill the vacuum.
"The resulting reconfiguration has made the FHA market less durable, as some of the more thinly capitalized lenders that have stepped into the breach are likely to fail or pull out as defaults rise," the Goodman and Parrott said.
It also leaves the FHA more vulnerable compared to the last crisis and unable to play "the critical countercyclical role as effectively as it did during the previous downturn," not to forget creating a significant counterparty risk to Ginnie Mae which guarantees the securities backed by these loans.
The recent clarification issued by the FHA, Goodman and Parrott said, tackles two problems: clarifying what the rules are and clarifying how they will be enforced.
However, it does not address what the DOJ would do if the lender makes a mistake, "thus leaving unaddressed the biggest, most uncertain source of liability of all: the False Claims Act."
"In the face of that remaining uncertainty, it is hard to imagine that any lender that pulled back from FHA over enforcement uncertainty would return in response to these recent changes," Goodman and Parrott said.
As a solution, Goodman and Parrott said that the FHA would need to either narrow what a lender certifies to or narrow the kind of mistakes that can give rise to liability under the False Claims Act.
"If the administration wants to attract back into the FHA market those lenders scared off by uncertainty over how FHA’s rules are enforced, it will have to provide some certainty over when and how the False Claims Act will be used," Goodman and Parrott concluded.