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U.S. Probes Banks' Mortgage Practices

Partly as a result, the Justice Department has focused its attention on mortgage fraud and other types of misdeeds within the financial industry. Those investigations are being spearheaded by two career government attorneys, Tony West, who heads the Justice Department's civil division, and Renée Brooker, an assistant director. Before being nominated to lead the division, West had spent 15 years as a prosecutor in the Northern District of California. Brooker built her reputation in Washington, having helped orchestrate a $280 billion racketeering case against the tobacco industry -- the largest in U.S. history.

As it happens, the new DOJ lawyers have already used the False Claims Act successfully in the mortgage industry, albeit not against a bank. Just after West took the reins in 2009, the False Claims Act was expanded to include federal funds granted through stimulus and bailout programs. Less than two months after the president signed the Fraud Enforcement and Recovery Act of 2009 into law, the Justice Department announced a mortgage-related settlement with Beazer Homes (BZH) for $5 million, along with contingent payments of up to $48 million that would be shared with homeowners.

"Mortgage fraud is a top priority for this Administration, especially when public dollars are at stake," West said in a statement at the time. "We will aggressively pursue fraud on federal mortgage insurance programs, which are so vitally important to this economy."

The Justice Department accused Beazer's lending subsidiary of violating the False Claims Act in several ways: Pocketing upfront payments to reduce interest rates without ever providing the discounts; attempting to hide elevated default rates to qualify for federal programs; providing down payment assistance for federally backed loans, which is illegal under Federal Housing Administration guidelines; and fudging paperwork to make it appear as though borrowers qualified for federal assistance when they did not. (Beazer cooperated with the investigation and agreed to strengthen its "control and compliance culture" as a result.)

The case had a precedent in a $41 million settlement with ABN Amro in 2006, but generally speaking, housing-related cases under the False Claims Act were rare before the subprime-mortgage fallout. Now, with ample evidence of shoddy lending practices and inflated appraisal values, such cases appear much easier to prove.

"A lot of people had Budweiser incomes and champagne dreams," says Patrick Burns, of the advocacy group Taxpayers Against Fraud. "Banks wanted to sell them the most expensive thing they could buy, but banks have to be worried about all these whistleblower programs because they had a fiduciary responsibility that they didn't live up to. Not doing your job -- being oblivious to the obvious -- is not a defense in a False Claims Act case."

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