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Saturday, February 9, 2008

The F Word


(NJ is an expert in this field and this is a copy/notes from a speech she recently gave on the subprime mortgage crisis. - CP)

The subprime mortgage crisis has been the topic of headlines for many months now. Politicians and critics often cite “predatory Lending” as the culprit, but there are more factors to consider and a gigantic one not popularly discussed is the “F” word…. Fraud.

The Federal Bureau of Investigation (FBI) has reported that mortgage fraud cost the mortgage lending industry between $946 million and $4.2 billion in 2006 alone.

The Mortgage Bankers Association of America’s position on Fraud is: Current federal laws provide sufficient authority to prosecute mortgage fraud and that it would be a mistake to conflate mortgage fraud and predatory lending. From mbaa.org: “Rather than drafting new legislation, the focus should be on providing the structure and resources needed by law enforcement officials to combat mortgage fraud. While law enforcement has all the legal tools it needs at its disposal, it requires more resources and a more efficient framework to use those tools effectively.”


A Senate bill recently introduced by none other than Barak Obama does nothing to combat mortgage fraud, instead it hampers the lender’s ability to foreclose and focuses mainly on what the bill terms “deceptive practices” by lenders.

To illustrate one type of fraud that is plaguing the industry I’d like to share 2 stories:

Once upon a time there was a factory worker living in an apartment in New Jersey. The factory worker worked Saturdays and overtime and after several years plus a gift from Grandma for mowing her lawn he was able to save up 20% of the sales price of a new home for a down payment. The lender collected a big pile of documents from the factory worker to ensure he was able to pay back the 30 year loan they were making to him. When it was all done, he moved into his new house and ate off of TV trays for 2 years until he could afford furniture. He lived happily ever after on his 1/4 acre of American Dream.

Story #2: Once upon a time there was a factory worker living in apartment in NJ. The factory worker found out that his co-worker owned his very own house! Factory worker #2 wanted a house too. So Factory worker #2 went to a realtor who found him a nice home. Factory worker #2 had no savings. The realtor said that’s ok, we’ll find financing at 100% and we’ll raise the loan amount and sales price to cover all your costs. Uh oh – 100% means a higher loan amount and a higher payment, That’s OK says the loan officer, we’ll do it as “stated” income. Factory worker #2 is a smart guy, he says what he needs to say to get the loan and happily signs documents attesting to his “stated” income thinking everybody does it. No big deal --- oh and we need to “up” the sales price to cover your closing costs so we’ll get the appraiser to say the house is really worth the sales price. It’s ok everybody does it.

So Factory worker #2 moves into his new house just like factory worker #1, only guy #2 has $0 invested in his American Dream.

6 months later the Factory shuts down and both workers lose their jobs. Which loan goes into default?

Studies have shown that people with no investment (either monetary or in sweat equity) in their home are far more prone to walk away when they run into financial difficulties. Lenders knew this of course and in the past they would take the attitude that the risk was worth it because you could always fall back on your property value to recover in the event of default. However, Fraud connected to inflated values will have to be another topic for another day.

But the headlines are telling us that the lenders are all in big trouble. The lending industry took a huge gamble with high risk borrowers who were more llikely to default and they lost. Some blame the housing bubble and that may be a factor, others blame greedy lenders, but my opinion is that the industry did not pay enough attention to the huge gaping opportunity for Fraud. Nor did they estimate the high volume of fraudulent loans that would ultimately haunt them into ruin.

Now there are many other factors that contributed to the current crisis, including the “bubble”, the baby boomers wanting to downsize out of their McMansions, the big investors’ sudden unwillingness to finance the “stated loans” leaving small lenders holding big loans that ruined many of them literally overnight.

But Fraud --- much of it involving the so-called white lie such as the income and sales price fraud in the fairy tale, is a nightmare for the industry. Some Fraud took form in much more deliberate schemes than the “white lie” fraud, some involving just a few parties and others involving much larger rings. I worked on one where no less than 65 people all used the same apartment address in California who purchased 2 and 3 home each from various lenders. The borrowers never make even the 1st payment and never had any intention of moving into the house, and some were probably not even real people. These scams made a lot of people rich have hurt the mortgage industry.

There are many out there who want to provide a one-word answer to a complicated problem by blaming the “predatory lenders”…. Why everyone is ignoring the “predatory borrower” is beyond me….I guess it’s more acceptable to blame the big mean corporation and assume that the people who lied about their income and later cry that they were “hoodwinked” are just innocent victims.

Should the government provide a bailout? For government to bail out those who got in over their heads, or for the government to punish the investors by telling them they can’t foreclose or that the ARM loans are not allowed to adjust – is completely ludicrous. If you bought a 10% CD and the government came along and said you are only allowed to get 5% for it because the bank messed up you’d scream.

No, lenders who invested in bad loans whether it is hedge funds or someone’s pension, or whatever, I say you took the risk, you take the loss get over it. If big companies took big losses I don’t see how it is the taxpayers’ responsibility to remedy their woes. What I would like to see are convictions for those who committed Fraud since like the insurance business, it will end up costing all of us money. There are so many victims and analysts have so many reasons for the collapse but without the fraud factor this crisis would not be nearly as bad.

Yes people are losing their homes, this is sensationalized all over the media. Were some of them “hoodwinked” maybe – and those cases should be prosecuted; but if someone bought more house than he or she could afford, AND he or she “hoodwinked” the lender,

The foreclosure should proceed to fulfill the contract and be fair to the investor.

It might sound harsh but seriously, is Factory worker #2 really any worse off if you foreclose on him and he goes back to living in apartment? I know someone who had 2 kids who was foreclosed upon 4 years ago. They had exaggerated their income when they purchased the home. After foreclosure, they rented for a time, and even lived with the dreaded in-laws. Just a few months ago, after attending financial counseling, they were able to buy another very nice home that is within their means. So the foreclosure was difficult but they survived it and ended up better off.

The MBAA states that what is needed is:

  • A centrally coordinated federal mortgage fraud office at the justice dept

  • With adequate funding

  • And coordination with state prosecutors and law enforcement personell

  • MBAA has initiated steps to form a national database that will help lenders protect themselves from fraud.

The politicians are too afraid to speak the “F” word in public for fear of losing votes, but who else has the power to finance and support real solutions and not just a feel-good measure with no teeth?