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Housing Regulator Warms to Third-Party Risk

Matt Kelly | May 11, 2010

We often talk around here about the risks that corporations face from their third parties: resellers, distributors, venture partners and so forth. Typically that discussion is in the context of the Justice Department or Securities and Exchange Commission cracking down on the risk of bribery. Well, now the Federal Housing Administration is getting in on the act, cracking down on third-party risks in the mortgage industry.

Essentially, forthcoming rules from the FHA tell banks and other lenders that they are now responsible for confirming that no fraud exists in the loans they underwrite—loans often originated by a broker or some other third party, which are then passed along to the FHA to insure. If those FHA-backed loans do tank because of fraud, the FHA will no longer leave itself on the hook for losses; it will push them back onto the lender, with fines and penalties to boot. The rules go into effect May 20.

This is a wise move for the FHA. As the mortgage industry has unraveled in the recent years, banks, mortgage brokers and the like have flocked to it as an insurer-of-last-resort so they can keep business flowing. But the FHA isn’t an enforcement agency, and lacks the resources to police the surging number of brokers now permitted to arrange FHA-backed loans. So it’s pushing that risk of fraud back onto the lenders it regulates. They will be responsible for vetting the mortgage brokers they work with, and they will bear liability should that business partner turn out to be unreliable.

As taxpayers, we all should be pleased. As compliance officers, we all should take heed that yet another regulator is pushing the “know your partners” mantra. It’s hard to argue with the common-sense nature of that doctrine, and I suspect it will only gain more traction across the federal government as time passes.