U.S.-Backed Mortgages Put to Test in an Innovative Lawsuit

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Advocates for Basic Legal Equality, a legal aid group, is suing U.S. Bank using the False Claims Act.Credit Courtney Collins/The Waterloo Courier, via Associated Press

When Hayward Ferrell of Huber Heights, Ohio, fell behind on his mortgage payments several years ago, his bank did not meet with him to try to work out a plan to make the loan easier to pay, he says.

“They never sat me down and said, ‘It looks like you are going to lose this, so why don’t you do this?’ ” he said. “They never did that.” The lender, U.S. Bank, foreclosed on the house in 2009.

Not engaging with borrowers who have missed payments may not seem like the strongest grounds for litigation against a bank. Yet that is the basis for an innovative lawsuit against U.S. Bank, a division of U.S. Bancorp, one of the largest banks in the country. The legal action could mean fresh legal problems for other big mortgage banks, as well. It is the latest threat to emerge from a barrage of cases that have forced big banks to pay tens of billions of dollars in recent months.

The lawsuit focuses on a popular type of government-guaranteed mortgage that in fact requires that banks take distinct steps — like trying to arrange a meeting — when borrowers stop paying.

The lawsuit is being brought by Advocates for Basic Legal Equality, a legal aid group. In a twist, the group is suing U.S. Bank in federal court in Ohio on behalf of the United States government, using the False Claims Act. This legislation, which dates to the Civil War, allows private citizens and groups to pursue legal action against companies and other entities for receiving payments from the government on false grounds.

In this case, the legal aid group is focusing on mortgages that were guaranteed by the Federal Housing Administration, which is part of the United States Department of Housing and Urban Development. When a borrower defaults on such mortgages, the agency makes payments to the bank to make it whole. Specifically, the legal aid group asserts that U.S. Bank made false claims to the government by collecting payments from the F.H.A. without also fulfilling the agency’s requirements that banks take certain steps to try to work with the borrower in default. Such “loss mitigation” measures are also intended to reduce the amounts that the F.H.A. has to pay.

In 1995, Mr. Ferrell took out a mortgage guaranteed by the F.H.A. to buy a home in Huber Heights that cost $105, 000. A toolmaker, Mr. Ferrell, who is 48, started to fall behind on his payments in 2006. “I did a lot of overtime to keep things going, but it was fighting a losing battle,” he said.

The lawsuit recently suffered a setback when the Justice Department declined to join the legal action.

Lawyers bringing the case, however, contend that this does not doom their action. They note that the government, after declining to intervene, has later joined in cases that gained traction, including a false claims action against Westchester County over accusations of housing discrimination, which was settled in 2009.

Even so, U.S. Bank says the Justice Department’s decision is meaningful.

“My primary comment is to really highlight that the Department of Justice has officially and formally declined to intervene in this case,” Dana Ripley, a spokesman for the bank, said. “We firmly believe that the remaining civil action is without merit and we will defend ourselves vigorously.”

U.S. Bank has until early next month to file a motion to dismiss the suit.

The Justice Department declined to comment.

Banks are saying that the fear of facing government legal actions is causing them to pull back from making government-backed loans. In the last two years, large banks agreed to penalties of over $40 billion to settle government accusations that they packaged shoddy mortgages and sold them to investors. The F.H.A. backs about $1.2 trillion worth of loans, roughly 12 percent of total mortgages.

Some of the recent settlements have related to F.H.A. loans. In June, U.S. Bank paid out $200 million for making F.H.A. mortgages that did not comply with the agency’s standards when they were made. After JPMorgan Chase reached a similar settlement over F.H.A. loans this year, the bank’s chief executive, Jamie Dimon, asked, “The real question to me is, should we be in the F.H.A. business at all?”

The government is eager to bolster mortgage lending to people who may not easily qualify for taxpayer-backed loans. And the concern among some consumer advocates is that the government may respond to remarks like those of Mr. Dimon by softening or shelving any legal actions against the banks — or loosening rules that aim to hold lenders accountable. The Federal Housing Finance Agency, for instance, recently relaxed rules that require banks to take back loans that do not meet the requirements of Fannie Mae and Freddie Mac, other government entities that guarantee mortgages.

And some consumer lawyers say that they have seen problems at the F.H.A. for years.

“Holding servicers accountable has never really been a priority for the F.H.A.,” said Ira Rheingold, executive director of National Association of Consumer Advocates. In the mortgage industry, the term “servicers” refers to the banks that actually collect loan payments.

The F.H.A. declined to comment for this article.

The complaint against U.S. Bank has a feature that makes it stand out. Many actions brought under the False Claims Act originate with information provided by a whistle-blower, but the complaint against U.S. Bank does not have a whistle-blower. In certain courts this can be a disadvantage.

Instead, Advocates for Basic Legal Equality is the source of the evidence in the case. And lawyers working on the case contend that the material from the group can satisfy the need to bring new insights to light in False Claims Act cases.

“No one in the federal government would have access to that information unless they had spoken to the customers who had experienced foreclosure,” Stephen M. Dane, a partner at Relman, Dane & Colfax, who represents the legal aid group, and helped bring the Westchester case.

In its complaint, the legal aid group contends that U.S. Bank made 22,586 claims to the F.H.A. between 2001 and 2011 and received at least $2.37 billion in payments for the claims.

When asked whether Advocates for Basic Legal Equality could convincingly argue that a significant proportion of those claims did not meet F.H.A. requirements for dealing with borrowers, Andrew Neuhauser, a lawyer for the organization, said, “I’ve been representing homeowners in foreclosure for seven years and I’ve never seen a case when U.S. Bank complied with these regulations.”

But U.S. Bank can gain confidence that it will prevail if the Justice Department continues to decline to intervene in the case, according to specialists in False Claims Act cases. David Freeman Engstrom, a law professor at Stanford, has done research that shows that 90 percent of the cases that the government never joins end in dismissal. “So it doesn’t look good that the D.O.J. has declined,” he said in an email.

But Mr. Dane points to when the government initially declined to intervene in the Westchester action. “We went ahead and litigated,” he said.