The Wall Street Journal has a page one story, “Fraud Seen as a Driver In Wave of Foreclosures,” which probes the role of mortgage scams.
I’m sure Tanta will wax eloquent on this article, but let me hazard a couple of observations. First, the article seeks to describe the fraud problem, citing the widely-touted Mortgage Asset Research Institute factoid that stated income loan mortgages overreported their income more than 50% in 60% of the cases 50 (this based on a sample of 100 loans). A 2006 FBI report, based on a much larger sample (3 million loans) concluded that fraud played a role in early payment defaults 30% to 70% of the time.
The role of fraud isn’t exactly news (stated income loans are called liar loans for good reason) and the Journals’ story generates more heat than light. It discusses, in long form, an Atlanta fraud ring with a college dropout nicknamed G-Money as the mastermind.
The problem is this story equates mortgage fraud with one particular flavor of fraud, namely, “fraud for profit.” It’s misleading not to mention the other type of mortgage fraud, “fraud for housing” in which the borrower winds up with a more expensive asseet than his financial standing entitles him to.
Mind you, the concepts above are well-established; the Journal was remiss to omit them. And the Brave New World has created new, more ambiguous sorts of mortgage misbehavior. One is the circumstance that is probably reported out of proportion to its occcurance, but nevertheless appears to be a genuine phenomenon, that of the mortgage broker exaggerating the borrowers’ income to sell a bigger mortgage and win himself a larger commission.
And Tanta has discussed the fact that while the borrower who overstates his income is indeed the liable party, in fact the dynamic is a co-conspiracy even in the more-obviously-criminal “fraud for profit” scenario:
…..we seem to have an epidemic of predator meeting predator and forming an alliance: a borrower willing to commit fraud for housing meets up with a seller or lender willing to commit fraud for profit, and the thing gets jacked up to a whole new level of nastiness. Consider the “cash-back purchase” scam we keep hearing about: that’s a perfect example of a borrower who wants a house, a seller who wants an illegitimate profit, and a broker or appraiser or settlement agent who wants a kickback all conspiring to defraud the lender…
Telling the difference between the victims and the victimizers, the predators and the prey, and the fraudulent and the defrauded, is getting a lot harder when you have borrowers not required to make down payments able to lie about their incomes in order to buy a home the seller is overpricing in order to take an illegal kickback. The lender is getting defrauded, but the lender is the one who offered the zero-down stated-income program, delegated the drawing up of the legal documents and the final disbursement of funds to a fee-for-service settlement agent, and didn’t do enough due diligence on the appraisal to see the inflation of the value. Legally, of course, there’s a difference between lender as co-conspirator and lender as mark, utterly failing to exercise reasonable caution, but it’s small comfort when the losses rack up.
And consider how the the shift in liability from lender to borrower enabled borrower recklessness. Tanta contrasts the process for lending to a self-employed person who has trouble verifying income. Number 1 is via a stated income loan; Number 2 is the traditional “full doc” approach, in which the bank notes that the debt-to-income (DTI) is considerably above the bank’s guidelines but is warranted for various good reasons:
…..what happens if it actually goes bad?
Well, with Number 1, it’s “clearly” the borrower’s fault. He or she lied, and we can pursue a deficiency judgment or other measures with a clear conscience, because we were defrauded here. We can show the examiners and auditors how it’s just not our fault….
With Number 2? There is no way the lender can say it did not know the loan carried higher risk….
What the stated income lenders are doing is getting themselves off the hook by encouraging borrowers to make misrepresentations. That is, they’re taking risky loans, but instead of doing so with eyes open and docs on the table, they’re putting their customers at risk of prosecution while producing aggregate data that appears to show that there is minimal risk in what they’re doing. This practice is not only unsafe and unsound, it’s contemptible.
But even in this lightweight article, one element of the mortgage mess jumps out: the virtual absence of borrower and transaction due diligence. Indeed, some mortgage builders who appeared to be passive beneficiaries of the scam mounted a successful defense by indicting the lender’s lax procedures:
Prosecutors had attacked the home builders for failing to raise red flags when they witnessed mortgages being issued far in excess of what the builders were being paid.
But some defense attorneys went on the offensive and attacked lenders for failing to guard against fraud. Particularly illuminating was the testimony of Lucy Lynch, a former vice president of mortgage operations at BankFirst.
“Fraud was not really a consideration in our world,” Ms. Lynch testified, according to a trial transcript.
Ms. Lynch said the bank relied on an outside “loan officer” at a reputable mortgage broker to serve as its “eyes and ears” in the real-estate transactions. As it turned out, that person was indicted as part of the fraud ring. Ms. Lynch stressed that the bank took measures such as running all loan applications through a software program designed to detect fraud. “And things that didn’t seem quite right, an underwriter could quickly pick those things out,” Ms. Lynch said, according to a trial transcript. “So as far as having an actual policy or procedure around fraud, we didn’t think it was necessary, quite frankly.”
A total of $4.9 million in loans from BankFirst were used by the Atlanta fraud ring. In some cases, the bank gave its blessing to closing documents that showed unexplained payments of hundreds of thousands of dollars to obscure companies that turned out to be owned by the fraudsters. On three different Atlanta-area homes over a three-month period starting in late 2005, closing documents approved by BankFirst showed large payouts to the same companies.
Ms. Lynch said the bank assumed that the cash was going to subcontractors for construction work. But the bank never asked for invoices. In an interview, Ms. Lynch says the bank was primarily checking to make sure the borrower wasn’t being charged any additional fees or debt. “We didn’t do anything different from the rest of the industry,” she said, adding that she believes her testimony helped convict three perpetrators of the fraud — two borrowers and a real-estate agent who helped lead the ring.
Asked in court why the pattern of payouts didn’t raise any red flags, Ms. Lynch responded: “Do you have any idea how many loans came into BankFirst during that time period?” She said BankFirst typically allowed a “15-minute window” from the time it received closing documents by fax to the time it released the loan proceeds to the borrower.
Ever heard the remark, “We’re losing money on every sale, but we’ll make it up in volume?” That is what the mortgage industry’s mindless drive for efficiency has produced.