Government Agency Wants to Curb Penalizing Banks to Increase Lower Quality Mortgages

A government agency wants to roll back penalties on banks that make errors when providing mortgages backed by government.

If a loan is backed by the Federal Housing Administration (FHA), that means if the borrower defaults, the government will cover some of the original loan the bank made to the borrower. So it makes sense that banks which make errors face penalties: the government isn’t agreeing to back any would-be borrower, but only those who meet certain standards.

Currently, if the banks give FHA-backed loans to people who shouldn’t qualify for them, the banks face penalties. “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,” reported the Wall Street Journal. “The errors ranged from small mistakes to ones that affected the riskiness of the mortgages.”

One of the highest-profile cases was J.P. Morgan Chase & Co., who agreed to settle its suit for a $614 million fine to the U.S. government.

Not surprisingly, some banks have been hesitant to make FHA loans since the Justice Department started pursuing these cases. But banks haven’t simply stopped making the loans. Instead, they’ve decided to use more stringent standards than those set by the FHA. The Journal reports:

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.

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This is the scenario that has Justice Department and Housing and Urban Development (HUD) officials disagreeing. The Justice Department wants to extract penalties, but HUD wants the big banks to lend more money to people with lower credit scores. “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,” the Journal reports, “but not for smaller mistakes that wouldn’t have affected the decision to extend the loans.”

You can’t make this stuff up.

On an earnings call last July, J.P. Morgan’s CEO, Jamie Dimon, proclaimed “The real question to me is, should we be in the FHA business at all?”

That’s an excellent question and one only the company’s board can decide. The same question applies more broadly, though, to the rest of us.

After all, the FHA has already cost taxpayers dearly. In 2013, the FHA received nearly $2 billion to cover losses on mortgage loans it insures.

Should U.S. taxpayers be in the business of insuring home mortgages? History suggests they shouldn’t.