Revisionist History on FBI and Mortgage Fraud

Reader Doug pointed to a Seattle Post-Intelligencer article, “FBI saw mortgage fraud early,” which was sufficiently misleading to get my juices going. Some key sections:

The FBI was aware for years of “pervasive and growing” fraud in the mortgage industry that eventually contributed to America’s financial meltdown, but did not take definitive action to stop it.

“It is clear that we had good intelligence on the mortgage-fraud schemes, the corrupt attorneys, the corrupt appraisers, the insider schemes,” said a recently retired, high FBI official. Another retired top FBI official confirmed that such intelligence went back to 2002….

Both retired FBI officials asserted that the Bush administration was thoroughly briefed on the mortgage fraud crisis and its potential to cascade out of control with devastating financial consequences, but made the decision not to give back to the FBI the agents it needed to address the problem. After the terrorist attacks of 2001, about 2,400 agents were reassigned to counterterrorism duties….

Further complicating efforts to detect and prosecute mortgage fraud, banks and other mortgage lenders were making so much money from the constant churn of transactions and the continually escalating price of homes that the fraud that did arise simply didn’t cost the industry enough money to raise their concerns.

“You had victim banks that would not acknowledge that they were victims,” said the first retired FBI official. ” ‘We’re not out any money,’ they would say. Nothing has been foreclosed. The banks weren’t reporting, the regulators weren’t regulating and the FBI was concentrating on external mortgage fraud as opposed to the underlying internal problem.”

Now what is wrong with this picture? Here is the story line: “We did see the fraud, but no one listened, and we didn’t have the staffing to go after it either.’

Well, in a word, no. Consider what “fraud” is. The FBI subscribes to traditional notions of mortgage fraud: either “fraud for profit” which occurs when groups of people collude to defraud mortgage lenders (there are so many moving parts that fraud for profit is seldom a solo activity). “Fraud for housing” occurs when someone buys a house via misrepresenting themselves on mortgage applications. (indeed, if you read the story closely, it is remarkably unclear as to what type of criminal behavior they thought they might have been able to catch, and who the victim was).

Now here is the clincher: there is ample evidence that the FBI did not understand the new paradigm. As described ad nauseum elsewhere, those who signed low doc and no doc loans were often encouraged by the bank or mortgage broker to exaggerate income , or told to sign forms and let the firm fill in the details.

Technically, that makes the person who misrepresented their income the fraudster. As this FHA mortgage guide suggests, fraud for housing was not seem as that big a deal. The fraudster would intend to make good on the loan, and if the loan was made prudently the bank would still have enough of a buffer (via the down payment) to recover in enough cases for this to be manageable.

Of course, we now know that plenty of loans were imprudent. More important, the real breakdown occurred in two places: the use of third party mortgage brokers as originators. Some of them might indeed have been identified by the FBI, but likely only the worst offenders.

But the big subprime and Alt-A lenders were often as aggressive in pushing borrowers into loans they couldn’t afford (consider WaMu, CountryWide, and IndyMac, for starters). The FBI and regulators were predisposed to see individuals and small firms as criminals, the big players as victims, not big firms victimizing other big firms and investors.

Consider this excerpt from a 2007 post, “Disturbing Conversation with Fed Official on Subprimes” (which is worth reading in its entirety):

I happened to meet an official in the Fed’s Banking Supervision and Regulation division at a cocktail party this evening and chatted him up. He helped brief Roger Cole before met with the Senate Banking Committee last month to defend the Fed’s conduct regarding subprimes, so he is up to speed on this topic…

I was taken aback at what this individual said, and while he was not speaking in an official capacity, I have no reason to think his views were unrepresentative.

His view was that the Fed was not at all at fault in the subprime matter. He said that he disagreed with Roger Cole’s statement that in hindsight, the Fed could have done better. He said the Fed had enforced the laws that were in effect at the time (query why then did the OCC read and enforce HOEPA differently?).

He also asserted that there was a tremendous amount of consumer fraud, that the FBI was pursuing a lot of cases (if so, I wonder why this hasn’t been reported, since people like the Fed and the subprime originators would have every reason to present the institutions, rather than the consumers, as victims). In the narrow sense, there clearly was a lot of fraud, since in the “no doc” loans, a very high proportion of borrowers overstated their income by large amounts. But the implication of the Fed official’s statement was that the fraud was “fraud for profit” meaning the intent was to make off with money, as opposed to “fraud for housing” in which one gets to live in a house one shouldn’t on paper have. In “fraud for housing” a sensible lender will come out whole (even in a no-doc scenario, if the buyer makes a high enough down payment and the lender gets a realistic appraisal, it will come out fine even in a foreclosure, unless the local housing market falls out of bed). So despite the Fed guy’s aggrieved tone, it’s hard to see the lenders as victims.

Equally disturbing was his confidence that the markets were working fine…..

This tidbit also suggests that the FBI was more aware of mortgage fraud than the revisionist history suggests:

An article in eFinance Directory, citing the FBI 2006 Mortgage Fraud Report, reports that mortgage fraud played a role in as many as 70% of early payment defaults. The type of fraud wasn’t specified, but one assumes it was mainly overstatement of income. As the story notes:

A study of more than 3 million mortgage loans found that between 30 and 70 percent of early payment defaults are directly linked to misrepresentations in mortgage loan applications

Defaults are largely concentrated in ARM loans, but are present in nearly every lending sector.

Of the 10 states with the highest concentration of mortgage fraud, 7 of them rank in the top 10 states with the highest default rates.

But this quote from Tanta illustrates why the FBI would not have been very effective, for it would not have been predisposed to see how the big institutions had in some sense become perps too. From a 2007 post:

Tanta made another astute observation about how the shift in liability from lender to borrower enabled borrower recklessness. She 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. Of course, higher-risk loans do fail from time to time, and no one has to engage in excessive brow-beating over it, if you believed that what you did when you originally made the loan was legit. If you’re thinking better of it now, at least with Number 2 you have an opportunity to see where your underwriting practice or assumptions about small business analysis went wrong….

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.

We use the term “bagholder” all the time, and it seems to me we’ve forgotten where that metaphor comes from. It didn’t used to be considered acceptable to find some naive rube you could manipulate into holding the bag when the cops showed up, while the seasoned robbers scampered…. You aren’t getting those stated income loans because lenders like to do business with entrepreneurs, “the backbone of America.” You’re not getting an “exception” from a lender who puts it in writing and takes the responsibility for its own decision. You’re getting stated income loans because you’re willing to be the bagholder.

And that’s why the “gee if the FBI had more staffing, we could have made a difference” is bunk. Yes, there were some egregious scams they could have caught. But the most common type of fraud was the one Tanta described, and the FBI wouldn’t have gone after it, because, per the FHA, it had been assumed historically to be the sort of problem that didn’t lead to losses all that often.

We’ve learned otherwise.

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  1. Anonymous

    No doubt borrowers and mtge brokers and realtors and lenders were involved in a plot to inflate income on apps for no doc loans. But that is just the small story. What enabled or encouraged this sort of frenzy needs to be determined and rooted out.

    The biggest of the big frauds was committed by the members of congress and local housing authorities and non-profit housing organizations and the rest of the housing axis. many of these groups are well intentioned but fraud is fraud. Their fraud was (and still is) to convince Americans that everyone deserves a home and we will do everything including changing the laws and the lending guidelines and whatever else we have to do to put you in a nice house you can call your own. Because homeownership is the american dream, you know you arrived when you buy a home, ownership is the pinnacle and objective and even the ultimate purpose for existence. Ownership will give youy a stake in society, you will develop equity, its your main asset, retirement, blah bla bla.

    Except that this nonsense led to a bubble with the fed getting in on the housing binge by keeping rates low to enable the american dream isn’t that laudable?

    Anyone think the FBI will tackle all that fraud?

    Unfortunately the same folks who pushed the agenda of homeownership for all have not backed off even one iota despite the crisis and the horrific consequences of their agenda. While the democrats are heavily involved in pushing the home ownership agenda for low income buyers, the republicans are just as guilty because all parties pushed the tax deduction for mortgage interest and no capital gains for sale of your residence etc.

    So not only do the groups who drive the agenda need to be stopped but the notion of the primacy of home ownership needs to be rooted out of our culture. Otherwise all this destruction will re-occur (if the markets ever recover to allow it).

    –Shase Ribelyon

  2. Tom Stone

    Thank you Yves,I am reminded of how much I miss Tanta.I worked for a while as a loan broker starting in 2005 and the first week I was there the rep for World introduced himself and told me about their great product,3 points back on stated POA loans and if the underwriters had a problem with the income he would call me and we could fix it…BUT they were tight on appraisals.I told him I really wasn’t into committing felonies for less than $100MM minimum and he told me not to worry,everybody did it.He is still with Wachovia…but think about someone casually broaching the commission of at least two felonies (conspiracy,mortgage fraud) to a complete stranger.

  3. Anonymous

    To Anonymous @ 1:33 am (Shase Ribelyon?)

    This may be an exceptionally naive question, but who was holding the gun to the head of the mortgage originator? I guess I’ve never had someone fill in the blanks as to how the home ownership encouraged rhetorically and through regulations/laws forced the hand of banks. Unless you can show me how their hands were literally forced to sign the papers via this government actions, I’d still have to say the buck stops at the bankers’ desk – if they take profit, they also take loss.

    Anyway, like I said, naive… someone point me in the right direction.

  4. Random Title Dog

    Any of those groups outside the title industry claiming they cared about mortgage fraud at the time is simply lying. With the exception of liar loans, it was always the title insurance underwriter responsible for the claims. And there was always very little risk for the rest of the parties, other than being the bagholder, of course. They only came up with new schemes for us to chase.

    When you consider that that tiny industry had a combined market cap of approximately $17 billion back then and only 4 major players, you realize that it’s not a situation the audit group could possibly be equipped to handle (though they all tried very hard). A helping hand was needed, but the FBI was nowhere in the picture in ’05 or ’06.

    One thing is true, the lender was the victim if it went undetected, but they simply didn’t care. The illegal flips using straw buyers and inflated appraisals, the seller funded down payments (sometimes concealed from the lender, the title company, or both), the gift fund down payment companies that the lender didn’t know was providing it (that’s a newer one), or the occasional seller with a fake ID selling a home he didn’t own. In all situations, it’s the title insurance company that must verify the homeowner, ensure the lender would be first in line for the lien, and then disburse the funds exactly as directed. The risk was only with one party that was too small to be able to do much about it.

    The FBI dropped the ball. But to hell with it, it’s over. Time to sit back and watch the fireworks

  5. russell1200

    A number of state Attorney Generals were interested in the predatory lending issue early. North Carolina passed the first law in 1999,

    What is key about predatory lending (versus sub-prime or fraud) is that you could not look at the particulars of the issue and not realize that there were really really big problems with the system.

    The predatory lending never really went away. But eventually the brokers became more interested in bringing the borrower into the scam so that they could pump up the volume: essentially making the bondholder the bagholder. Except that so long as prices went up, everyone would be fine.

    The earliest versions I recall hearing about were in mobile home lending. But the mobile home market collapsed so that issue went away.

    There were a number of big fraud cases going on early (prior to Alt-A showing up) on that involved organized groups of varying sizes. To varying degrees the banks were not that interested in publicizing them. The FBI occasionally got involved in them, but they were fairly exotic operations at that time and required a lot of work. It has always been hard to get law enforcement: FBI, local DA, local police, etc. to take on white collar crime because of the amount of work involved per case.

  6. Anonymous

    Some of this ‘fraud for housing’ is/was not as benign as one might believe. There are companies that offer to ‘enhance’ one’s credit score for a fee for the purpose of qualifying for a home loan. Often this is accomplished by adding the loan applicants name to a credit card account and thus ‘borrowing’ that persons superior credit history.

    While technically illegal some of these companies still operate via the internet and I wonder why no US Attorney has subpoeaned the client lists of these companies and brought wholesale criminal charges against those who used such schemes to obtain bank loans.

    I note that James Wells the CEO of SunTrust has complained that his bank has been adversely affected by such fraudulent loan applications and SunTrust would not be alone. Why these banks are not pressuring the Department of Justice to make at least a few high profile prosecutions of such cases ( The US Code allows for fines of $1 million and up to 30 years imprisonment) in much the same way the IRS makes a few high profile prosecutions each tax season.

    By announcing a few aggressive prosecutions of such fraudulent loan applications the effect might be to stop some percentage of Alt-A borrowers from defaulting on their loans knowing they too could be prosecuted for having made a fraudulent loan application.

  7. Blurtman

    It is fraud to sell junk bonds as Triple A securities. Ratings analysts at Moody's and Standard & Poor's are on record admitting this fraud. The selling of this toxic junk is bringing on the depression.

    Why is no one going to jail?

  8. Anonymous

    Best of luck to anyone wanting to bring a fraud case against the debtor OR the lender at this point.
    The problem with bringing a fraud criminal case against a debtor is that the prosecutor’s prime witness is the bank, and defense counsel can ask ALL kinds of stuff about the bank to impeach it.

    As for the civil case? Well, then, the bank’s attorney has the Herculean task of trying to argue before a judge (who has already received 90 new filings from that bank for foreclosures this week), “Your honor, my client was wronged and knew nothing about it.” With a straight face.

    Good luck.

    And as for bringing a fraud case against the bank – what are you going to get back if the judge imposes sanctions? TARP money?

  9. Doug

    Good points, and it is essential to make the distinction between “fraud for profit” and “fraud for housing”.

    I would agree to some extent that the FBI didn’t do much with regard to the larger “fraud for housing” problem, but in some ways I consider “fraud for profit” to be more in the FBI’s purview, while the systemic lending standard problems with “fraud for housing” should really have been tackled by the SEC or the Federal Reserve.

    So I tend to go a bit easier on the FBI in this whole mess… at least they put in a half-hearted effort, whereas the SEC and the Fed are clearly guilty of complete nonfeasance.

  10. Anonymous

    Response to:

    “I note that James Wells the CEO of SunTrust has complained that his bank has been adversely affected by such fraudulent loan applications and SunTrust would not be alone. Why these banks are not pressuring the Department of Justice to make at least a few high profile prosecutions of such cases ( The US Code allows for fines of $1 million and up to 30 years imprisonment) in much the same way the IRS makes a few high profile prosecutions each tax season.

    By announcing a few aggressive prosecutions of such fraudulent loan applications the effect might be to stop some percentage of Alt-A borrowers….”

    Of course Suntrust Bank was affected! And I will tell you why. Because Suntrust Mortgage was one of the biggest perpetrators in the Alt-A scam. The crap that they did to approve these loans was just plain scary! And not only did Suntrust Mortgage screw the debtor, they screwed the investor when they packaged these Alt-A loans and sold them to investors without proper disclosure. Suntrust is being sued for it now. And the LAST thing Suntrust wants is to have the justice department sniffing around!

    Also, there’s a big difference between civil and criminal fraud. FBI and justice dept doesn’t get involved with civil, just as the FRB doesn’t get involved in criminal. If you claim the wrong one with the wrong group, don’t expect to get very far.

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