For some time the lending industry has crackled with murmurs and musings about “over-regulation,” the idea that the government is suing lenders for minor infractions and forcing them to buy-back loans and pay huge fines, not because of wrongful behavior but because of inconsequential mistakes and technical errors.
Last September, Wells Fargo CEO John Stumpf told the National Press Club that his bank was facing buy-back claims for mortgages which had been in place for a decade, in other words loans where the origination process was no longer relevant.
Stumpf also said some buyback requests were based on minor clerical errors, such as the use of “John G. Stumpf” and “John Gerard Stumpf” in the same paperwork. According to Stumpf this could lead to claims of “technical default.”
Now the over-regulation debate is about to enter the courtroom. Quicken and the Justice Department have both filed suit, each claiming that the other has abused the system. (Full Disclosure: This writer provides content for various sites, some of which compete with Quicken.)
“After three years of struggling to understand the DOJ’s position and methodology that would warrant the country’s largest and highest quality FHA lender to make untrue admissions and pay an inexplicable penalty or face public legal action, it is time to ask the court to intervene,” said Bill Emerson, CEO of Quicken Loans in a news release. “No threat, including high-profile senseless lawsuits from powerful federal officials, will deter our company and its leadership from doing the right thing. We will stand in defense of our impeccable reputation established by thousands of hard-working ethical team members over our 30-year history.”
In turn, the government alleges that “from September 2007 through December 2011, Quicken knowingly submitted, or caused the submission of, claims for hundreds of improperly underwritten FHA-insured loans.”
Nobody knows what will happen as the dispute winds its way through the legal system. However, there is one aspect to this matter which will surely raise a few eyebrows: What — exactly — is an improperly-written loan?
Quicken is a huge player in the mortgage marketplace. The company says that it’s closed 250,000 FHA loans since 2007 and that the FHA has generated $5.7 billion in net profits from the insurance premiums generated from Quicken borrowers between 2007 and 2013.
The company also says that it’s “the nation’s largest FHA lender and has originated the government agency’s best performing loan portfolio. According to the FHA’s publicly available data, Quicken Loans maintains the lowest compare ratio — the default rate of a single lender compared to FHA’s total mortgage portfolio.”
In its suit, Quicken says it’s facing claims which have no material underwriting or performance impact:
“In one loan, Quicken Loans was accused of poor underwriting because it miscalculated an FHA applicant’s monthly income, when the error was only $2.10. Under FHA guidelines, and common sense, an immaterial difference like this is no bar to insurability.”
“Another supposed loan ‘defect’ occurred when Quicken Loans told an FHA borrower to bring $125 to closing even though it had approved the loan believing the borrower only needed to bring $48 to closing.”
“In another instance, a loan was pronounced ‘defective’ by the DOJ and HUD-OIG because Quicken Loans supposedly loaned an FHA customer $26 too much on a $99,500 loan.”
Borrowers complain that lenders are awfully picky about loan applications and they’re right. However, what’s not said is that lenders have every reason to be exacting because if a mortgage package has errors the lender may be forced to buy-back the debt — even if loan is performing and maybe years into the future. This is a huge problem, especially for small lenders with limited resources.
The search for paperwork perfection is both an obvious goal and a practical nightmare. The problem is that today’s loan packages typically include some 500 pages of documentation, enough verbiage to virtually assure imperfections somewhere in a complex and difficult process.
However, some element of common sense took hold last year. Both Fannie Mae and Freddie Mac, so-called government-sponsored enterprises (GSEs) which are the nation’s biggest mortgage buyers, said they would provide what’s called “representation and warranty relief” if certain standards were met. Instead of lender liabilities that continue for the life-of-the-loan, new rules were established which largely limited the lender’s liability to three years.
Here’s how the system works:
If there are no more than two 30-day and no 60-day or greater delinquencies during the first 36 monthly payments and the Mortgage is current as of the 36th monthly payment, then the mortgage will be eligible for representation and warranty relief.
Relief will be available if the loan is shown to be acceptable after a quality control review.
If the review is not acceptable but the lender fixes any deficiencies in a way that’s acceptable to Fannie Mae and Freddie Mac then, yup, warranty relief is available.
Relief can be provided if the mortgage is not acceptable and the lender agrees to an alternative to a buy-back which is okay with Fannie Mae and Freddie Mac.
Also, there’s now a “significance” test built into the buy-back process. As Mel Watt, director of the Federal Housing Finance Agency explained last year, “the ‘significance’ test requires the Enterprises to determine — based on their automated underwriting systems — that the loan would have been ineligible for purchase initially if the loan information had been accurately reported.”
The bottom-line result is that with the rule changes lenders now have a common-sense basis to contest buy-back demands from Fannie Mae and Freddie Mac. They can argue that yes, this loan has an error or errors but in the scheme of things the problem is so minor that no one should care, especially if the borrower is paying the loan.
All of which brings us back to Quicken. The standards adopted by Fannie Mae and Freddie Mac seem like a sensible middle-ground, a way to get loans that work, avoid costly litigation, and at the same time follow the legal standard established by Gilbert and Sullivan. As they wrote in the Mikado, “the punishment should fit the crime” and in this situation the courts will have to first determine if there has been any crime to punish.