A perfect storm is brewing that threatens the entire mortgage lending industry. We believe that state and federal law enforcement and regulatory agencies will feel pressure to prosecute even inadvertent instances of regulatory noncompliance. Similarly, either through desperation or in an attempt to profit from public fear over what the media calls the "mortgage crisis," we believe that defaulting and troubled borrowers will increasingly take aggressive postures by challenging foreclosures through affirmative consumer claims. Three recent events merit your attention as they indicate ever increasing risks of criminal, administrative, and civil liability over and above the substantial risks from defaulting loans.
First, on November 6, 2007 University of Iowa College of Law Associate Professor Katherine Porter made national news with her paper claiming that the mortgage industry is guilty of institutional negligence and malice in its foreclosure practices and dealings with bankrupt debtors (Porter, Katherine M., "Misbehavior and Mistake in Bankruptcy Mortgage Claims (November 6, 2007). University of Iowa College of Law Legal Studies Research Paper Series). Based on a study of 1700 recent Chapter 13 bankruptcy cases, Professor Porter concluded that a majority of mortgage claims filed by creditors are missing required documentation and/or contain inflated and allegedly unreasonable charges. Her paper was widely reported in the mainstream media with the New York Times citing many of her conclusions as "fact" with limited rebuttal from the lending industry. (Morgenson, Gretchen "Dubious Fees Hit Borrowers in Foreclosures" (November 6, 2007) New York Times). The Times article further alleged that bankruptcy judges around the nation are considering imposing sanctions against mortgage creditors based on allegations of destroying checks from debtors in order to impose additional interest and late fees and/or assessing improper fees in connection with their claim.
Professor Porter's article was published only a week after the House Judiciary Committee heard testimony supporting the proposed Emergency Home Ownership and Mortgage Equity Protection Act of 2007 by Moody's Economy.com Chief Economist Mark Zandi. Mr. Zandi estimated that there will be approximately 3 million mortgage loan defaults of which 2 million will go through the entire foreclosure process. (Written Statement of Mark Zandi before the House Judiciary Committee, October 30, 2007).
Second, on November 1, 2007, the New York Attorney General's office brought suit against a major real estate appraisal firm alleging conspiracy to bolster home purchase prices, and thus loan amounts, through inflated estimates. (State of New York v. First American Corp. and First American eAppraiseIT; In the Supreme Court of the State of New York, New York County). The complaint alleges that the new landscape of mortgage lending discourages accurate collateral valuation and encourages inflated estimates to allow loans to close and then maximize profits upon sale in the secondary markets. Such charges, if proven, could constitute violations of both federal and state statutes and regulations. While the New York suit does not charge the nationally chartered bank that allegedly conspired with the real estate appraisal firm, this is likely because only federal agencies have the jurisdiction to bring such charges against nationally chartered financial institutions.
Third, last month a federal district court in Washington, D.C. again confirmed that claims by lending institutions for mortgage insurance or guarantee payments under federally funded programs are actionable under the Federal False Claims Act if the mortgage insurance or guarantee was obtained in violation of applicable law or regulation. United States ex rel. Fago v. M&T Mortgage Corp., 2007 U.S. Dist. LEXIS 73128. The D.C. court was presented with allegations that the lender forged debtor signatures on various loan binders after the debtor mistakenly failed to sign them at closing. While the D.C. court found that these forged signatures did cause the default, and thus did not create actual damages, it nevertheless held that the lender was potentially liable for the penalties imposed by the False Claims Act.
Future suits under the False Claims Act alleging that the federally guaranteed loans were inadequately collateralized due to inflated appraisals or faulty borrower qualification practices may create a danger for findings of actual damages in addition to the statutory penalties. Such situations would also create the risk of criminal liability.
Each of these recent events demonstrates the increasing risk that financial institutions, lenders, mortgage servicers, and others involved in the residential lending industry will face significant criminal, administrative, and civil liability.
Prudent parties will take this opportunity to ensure through attorney-led investigations and audits that their lending and servicing practices are compliant with applicable law and that past instances of noncompliance have been corrected. Bracewell & Giuliani LLP's teams of experienced white collar defense, restructuring, regulatory, financial services, and civil trial lawyers are prepared to assist in these efforts and to respond immediately and effectively if and when charges are brought.
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