Late last week, the Justice Department issued a filing that attempts to reinforce the release limitations set by the foreclosure fraud settlement, stopping Wells Fargo from reimagining the deal as a broader release of liability on various mortgage claims. However, a judge will have to make the final decision.

The US sued Wells Fargo in late October over issuing insurance claims on FHA loans while knowing that the loans did not meet underwriting requirements set by the agency. Wells charged in court that these specific charges were covered under the foreclosure fraud settlement. I actually thought Wells made a fairly compelling case on that front, but the DoJ disagrees:

The department, in a filing yesterday in federal court in Washington, said the bank’s allegation that the U.S. breached the terms of the $5 billion deal by suing in federal court in New York for hundreds of millions of dollars based on conduct that Wells Fargo is no longer liable for is “flatly inconsistent” with the terms of the settlement.

The New York case is premised on Wells Fargo, the biggest U.S. home lender, knowing that the origination of loans insured by the Federal Housing Administration didn’t meet agency requirements, resulting in “substantial losses” to the FHA insurance fund, according to the filing.

The settlement “only bars the government from asserting a very specific type of claim, i.e., where its ’sole basis’ is Wells Fargo’s submission of a false annual certification in connection with maintaining its status as an FHA-approved Direct Endorsement Lender,” John Warshawsky, a Justice Department lawyer, said in the filing.

US District Judge Rosemary Collyer, who approved the settlement, will have to make the determination here. And it’s an important one, as opening the terms of the release at any level will just encourage the big five banks to use this defense over and over again.

As I argued previously, ultimately the Justice Department stands responsible for having to argue this out in the first place.

And since the same companies in the settlement are the ones ruling the mortgage industry these days, in particular Wells Fargo, the idea that they can be held accountable for their past sins grows even more remote. Sooner or later, they’re going to complain that the consistent legal battles threaten their ability to lend, and by proxy the ability to lend for the entire financial system.

In other words, when the government failed to rein in the financial sector after the crisis, they created these problems for themselves.

And this point is critical to thinking about the Administration’s housing policies going forward. I expect that, considering their laissez-faire approach is now bearing fruit four years later, after at least 4 million homeowners had to suffer foreclosure, that they will argue their policies worked, the housing market has returned to solid footing, and everything is fine. That’s notwithstanding the still-high number of monthly foreclosures, and the factor that the banks finding “alternative disposition methods” means something like short sales, which still leads to the homeowner losing the home.

This case is important, but in many ways the exposure risk for the big banks, at least in terms of the federal government, has already dissipated.