That's the name of this post published by Daniel Colbert in the American Criminal Law Review. Colbert's piece examines United States v. Phillips, a recent en banc decision from the Seventh Circuit that deals with the intersection of criminal law and mortgage fraud. Here's the piece:
By Daniel Colbert, ACLR Featured Blogger
Lacey Phillips and Erin Hall were two of millions of
Americans who received subprime loans from unscrupulous lenders in the
years leading up to the financial crisis.[i] In 2006, the couple applied for a loan from a reputable bank and were turned down.[ii] A short time later, they found a mortgage broker – Brian Bowling – who directed them to Fremont Investment & Loan.[iii]
There is no indication the couple knew that Bowling had a history of
producing fraudulent loan documents or that Fremont was a disreputable
institution that would soon face prosecution for its predatory
practices.[iv]
Fremont specialized in “stated income” loans – known in the industry as
“liar’s loans” because they required no proof of the borrower’s income –
which it quickly repackaged into mortgage-backed securities and sold,
turning a profit despite the high risk of default.[v] Phillips and Hall applied for and received a loan, purchased the house, and soon lost it when they defaulted on the mortgage.[vi]
Phillips and Hall were convicted of violating 18 U.S.C.
§1014, which makes it a crime to “knowingly make[] any false statement .
. . for the purpose of influencing in any way the action of” a
federally insured bank like Fremont.[vii]
The couple had made several false statements on their loan application,
including inflating their income and misrepresenting Hall’s job title.[viii]
They appealed, arguing that the trial judge erred when she refused to
allow the defendants to testify that Bowling had told them they should
combine their incomes on the application.[ix]
A panel of the Seventh Circuit upheld the decision, with Judge
Easterbrook writing for the majority and Judge Posner dissenting.[x] The Seventh Circuit then granted a rehearing en banc, in which Posner carried the day and Easterbrook dissented.[xi]
Posner argued that the defendants’ testimony is pertinent to whether
they knowingly made a false statement, and if they did, whether they
intended to influence the bank’s behavior.[xii]
The couple may have believed, Posner argued, that the application’s
blank for “borrower’s income” was asking for the total income from which
the loan would be paid, and thus that their combined income was the
correct number.[xiii]
Further, the couple may have believed that the bank had essentially
already approved the loan and that the bank would grant the loan
regardless of what was reported on the form.[xiv] Given Fremont’s business model, this belief would have been close to the truth.[xv]
Easterbrook’s dissent notes that even if Phillips and
Hall believed the bank would be indifferent to the truth of the loan
application’s statements, they were undoubtedly aware – and possibly
were told – that a higher reported income was more likely to be
approved.[xvi]
The bank possibly did not care whether the borrowers could pay the
loans back, but it did care whether the debt would be rated high enough
to sell.[xvii]
Easterbrook thus argued that the defendants did intend to influence the
bank’s actions; they knew that without the false representations on the
application, the loan would not have been made.
Easterbrook seems to have much of the case law on his
side. Courts who had considered the question previously had found that
the bank’s awareness of the fraud is “not inconsistent with the intent
to influence which a violator of § 1014 must possess.”[xviii]
Because the statute does not require that the borrower intend to harm
the bank, but only that he intend to influence it, it does not “immunize
a party from criminal liability because an officer of the bank was
involved in the fraudulent scheme.”[xix]
Though one of the effects of the statute is that banks are protected
from false statements, its central goal was the vitality of the
government’s deposit insurance programs, which is only served if the
statute also bans statements that the bank knows are false.[xx]
Easterbrook is also correct to note that Bowling’s
testimony would have shown Phillips and Hall knew the bank cared about
the income they claimed, even if it didn’t care that it was true.[xxi] Perhaps unsurprisingly, Easterbrook is also concerned about the adverse economic effects of Posner’s decision:
The upshot of my colleagues' contrary conclusion is that crooked
brokers such as Bowling can confer on clients a legal entitlement to
obtain loans by deceit. That's bad economics as well as bad law. It
makes it harder to extirpate liars' loans programs, and it raises the
rate of interest that will be charged to honest applicants.[xxii]
Easterbrook seems worried that Posner’s approach will eviscerate the statute and allow borrowers to lie intentionally. Yet Easterbrook’s logic assumes that the borrowers are crooks, or at
least sophisticated financial actors. Posner’s justification, on the
other hand, stems from his sympathy for Phillips and Hall, whom he calls
“hapless victims” of Bowling and Fremont.[xxiii]
In his original dissent, Posner points out that Bowling and Fremont
were among the “unscrupulous” actors who helped cause the financial
crisis by lending money to “impecunious suckers.”[xxiv]
In fact, Bowling had become the subject of a federal investigation and
agreed to testify against several of his clients to reduce his prison
sentence.[xxv]
Phillips and Hall likely knew, as Easterbrook notes, that
the income they reported would matter. What the couple probably did not
know is that Fremont was willing to give them a loan they could not
afford to pay back. They likely did not know that two years after they
took out the loan, their interest rate would increase and they would
lose their house, even after working second jobs.[xxvi]
In recent years, prosecutions under § 1014 have “mushroomed” in the wake of the housing and credit collapse.[xxvii]
Unfortunately, many of those cases are of a different nature from the
frauds that the statute was designed to prevent. Many of the borrowers
who made false statements, perhaps like Phillips and Hall, were the
victims rather than the perpetrators of fraud. Posner’s approach –
allowing the jury to hear evidence that a mortgage broker misled the
borrowers – may not fit well with existing precedent, but it offers a
way to distinguish fraudsters from their victims.
There are undoubtedly cases in which borrowers have
conspired in a scheme to defraud, but there are also many cases in which
the borrowers were, in Posner’s words, “hapless victims.”[xxviii]
One would hope that prosecutors would consider the sophistication of
the borrowers before prosecuting. One former Assistant United States
Attorney called it “appalling and embarrassing that any self-respecting
U.S. Attorney's Office would prosecute a case” against Phillips and
Hall.[xxix]
But when an overzealous prosecutor brings a case against borrowers,
allowing the jury to consider the possibility that the borrowers were
unwitting victims can adapt § 1014 to fit the realities of the subprime
market.
