Lender liability is a tricky legal question. Above my grade. The case law is pretty clear that when a lender uses unscrupulous or illegal methods to get a borrower to sign a piece of paper the lender loses his rights. There is a grey area in this where the lender may also lose their rights to repayment if a fiduciary relationship can be established between borrower and lender. In this later example the lender has a responsibility or an Obligation to not do things that conflict with the best interests of the borrower.

The conditions for establishing this fiduciary status are as follows:

In Waddell v. Dewey County Bank, the court attempted to define the elements of a fiduciary relationship between lender and borrower as follows: 1) the borrower must have faith, trust and confidence in the bank; 2) the borrower must be in a position of inequality, dependence, weakness or lack of knowledge; and 3) the bank must exercise dominion, control or influence over the borrower's affairs.

HUD announced a new program today to assist struggling homeowners. They are going to lend up to $50,000 to families in trouble. These are bridge loans so that the owners can continue to service the existing debt and pay property taxes. The individual loans will be made at a zero interest rate. $1 billion of these loans will be made.

My question is, does the FHA have a fiduciary responsibility to the borrowers, and if so is this billion-dollar loan program just a way to print more money and kick the can down the road?

On #1. The lender is the US Government. One would assume the borrower has faith and trust that they are not being led down a debt hole for political purposes.

On #2. Each borrower will have a different profile. However two condition to get the $50K:

Be at least three months delinquent in their payments.

Be at risk of foreclosure and have experienced a substantial reduction in income due to involuntary unemployment, underemployment, or a medical condition.

Do these two mandatory conditions meet the lenders description as “weakness”? Yes is my answer. You have to be up against it to qualify. By definition one is in a weak position. Same for “dependence”. Without these loans many of the people would be foreclosed on.

On #3. There are many strings attached to these loans. The restrictions include that the proceeds must be used to pay existing installment debt. No second homes. Limitations on indebtedness. Reporting requirements. There is no question but that FHA has dominion and control of the borrowers affairs.

Case closed.

The new FHA loans are not collectable. They would not stand up in court. The FHA is well aware of that fact. They have no intention of collecting on these “loans”. Some additional terms of the bridge loans to nowhere:

zero percent interest, non-recourse, subordinate loan.

So they get no return on the money, but they also make it non-recourse and they subordinate it to any existing first or second liens on an obviously underwater property? If it is non-recourse you can just walk away. They won’t even call you. They can take the house but the first liens come first so the FHA gets the big goose egg. This is not a loan. It is a gift.

60% of all mortgages are owed back to Uncle Sam. On paper this means that at least $6b of mortgages on the government’s books will be artificially kept alive for another 24 months as a result of this. After two years all of them will just go poof overnight and the taxpayers will have a bigger pill to swallow. In this case FHA will be taking back bad paper and in exchange it will keep a portion of its loan book current. The conflict of interest is obvious to me

By definition a loan should have a source of repayment that is predictable and adequate collateral. These new loans by FHA do not meet those standards. This program will cover only 20,000 borrowers. A billion dollars is meaningless when the problem is measured in trillions. It is a “nothing” policy. It is another show pony. While there may be 20k folks in the country who will end up voting for the Dems as a result of this, I am certain that another few hundred thousand will line up to vote against them just because the bailout mentality will not stop.

In the worst days of mortgage lending back in 2006 some terrible loans were made. But not one of them was made that was non-recourse and subordinated. The FHA just announced it will be making the very worst loans in history. Something to celebrate for the boys over at HUD.