One of the biggest banks frauds in recent history was that perpetrated by Allied Home Mortgage. As I type this post, a federal jury trial is underway in Houston to determine whether Allied and its owner Jim Hodge engaged in a greedy scheme to rip off taxpayers for $2.4 billion. Allied claims it was an innocent victim of the 2008 housing bubble.
Shadow Branch Schemes
Before HUD pulled the plug on the company, Allied allegedly operated what is called a “shadow branch” scheme. Shadow branches – sometimes called “net branches” – are satellite offices of a bank or lender. They are called “shadows” because they usually lack necessary licenses and the financial backing of the lender.
HUD doesn’t mind branch operations. Most banks rely on an extensive network of branches in order to reach the broadest segment of the market. To operate a branch, however, HUD wants to know about it so it can inspect and make sure that all rules are being followed. The agency also wants to insure that the lender has skin in the game and is financially responsible for the branch.
Some mortgage companies have sought to expand rapidly and have allowed anyone with a few dollars in cash to open their own branch. Instead of the bank or mortgage company being on the hook for expenses, however, the lender requires the branch manager to take responsibility for the branch’s rent, utilities, salary expenses, phones, etc. Unfortunately, when an individual manager is on the hook for expenses, there is an increased chance that the manager will cut corners when finances get tight.
Banks love these arrangements because it allows them to quickly expand with less risk and capital outlay. Mortgage professionals like these arrangements because they can quickly set up shop while relying on the lender’s licensing and name. HUD, of course, believes that many net branches are an illegal method for independent brokers to originate FHA mortgages without meeting HUD’s rigid application and asset requirements.
Regulators believe that when lenders push all the operational costs onto the branch, the lenders are inviting the branch to cut corners in an effort to write enough mortgages to meet its expenses. In other words, quality usually suffers.
HUD cracked down after the meltdown and most lenders cleaned up their act. Almost a decade later, however, history looks like it may soon repeat itself. Brokers tell us that instead of ending net branches, lenders are now growing more sophisticated in hiding these arrangements.
The Rise of Shadow Banks
When I was growing up, if your parents wanted a mortgage, they went to the local bank. There were no Internet lenders and few big national banks. When a mortgage was written, the bank that originated the loan often kept it and usually serviced it too. All of that has changed.
Today shadow banks, which aren’t really banks at all, write a large percentage of home loans. Frequently their business model is built on turn over and volume. Write the loan, earn your commission and then quickly sell the loan to an investor or a mortgage pool.
Companies like Quicken Loans or loanDepot now write billions of dollars of loans each year.
Once again, there is nothing illegal with these arrangements. We call them “shadow banks” because their only purpose is to write and sell mortgage loans. You can’t walk into a branch of one of these companies and obtain a credit card, open a checking account or get cash from a drive through window.
While banks have more government oversight, there certainly is still a tremendous amount of regulatory oversight of home lending including loans written by shadow banks.
A recent article in realtor.com suggests that “the people involved in today’s shadow branches are some of the same people that some of the same characters that played leading roles [in the last housing crisis].”
Should we be worried about shadow branches and shadow banks? Yes.
Lenders seem to have a very short memory. Already we are seeing an increase in risky lending behavior. While we aren’t back to 2007 where even a dog could obtain a mortgage (some did), we hear of banks once again manipulating appraisals, cutting back on quality control and loosening underwriting standards. This year, Regions Bank and BB&T both paid large settlements for their recent underwriting behavior, a very disturbing sign.
False Claims Act and Whistleblower Awards
Some of our best laws were written long, long ago. Our founding fathers laid out the Constitution in the 1700’s, a document that is still relevant and makes us such a great nation today. In 1863, President Abraham Lincoln and Congress gave us a law called the False Claims Act (“FCA”) designed to empower citizen whistleblowers to bring actions against fraud and mismanagement of federal tax dollars. Passed long before the advent of “shadow branches” or “shadow banks,” the FCA is still relevant today and remains the government’s number one weapon against fraud.
Under the Act, individuals and companies that defraud the government can be pay penalties of over $20,000 per violation and be liable for triple damages. For example, if a lender violates HUD’s net branch prohibitions and the government, Fannie Mae or Freddie Mac has to pay $100,000 on a loan guaranty, that lender could face penalties and damages of $320,000.
Whistleblowers love the Act because it allows them to receive an award of between 15% and 30% of whatever the government collects from the wrongdoer. The law also protects the person reporting the wrongdoing from retaliation.
To qualify for an award, one must have inside information about the fraud and be the first to file a sealed complaint in federal court. The awards are certainly real, in the last few years our whistleblower clients have received over $100,000,000.00.
Need more information? The whistleblower lawyers at MahanyLaw have deep ties within the lending industry and certainly have experience with the False Claims Act. We know how to help clients achieve the highest possible awards.
MahanyLaw – America’s Whistleblower Lawyers
*Looking for specific information on net branch violations? Use the search feature on our blog or check out Net Branch Fraud 101 – Allied Home Mortgage Opinion Provides New Insights.