An article in the weekend WSJ got me thinking about Real Estate related frauds of all kinds. Titled FBI Probes Unusual Incentives for Home Buyers, it looks at whether the homebuilder’s incentives, if not properly disclosed to a 3rd party mortgage underwriter, was a form of fraud:
"When home sales began to slow at the start of the downturn, home builders offered buyers incentives — instead of reducing prices — to stimulate demand. The incentives included cars, tuition and credit-card payments, and even cash.
A sign is posted in front of a bank-owned home that is for sale in Richmond, Calif.
Now, federal investigators are questioning whether some of those incentives misled lenders and caused them to write mortgages that were artificially inflated, contributing to today’s home-price crash"
Anyone who follows the real estate market long enough will eventually become familiar with various forms of fraud that at times lurks in the industry. Any industry where large sums of money are involved invites unsavory characters. With median home prices well over $200,000, housing was no different.
I do not believe Real Estate related fraud, under most circumstances, is all that widespread or common. One of the many things that made the 2002-2006 housing boom so unusual, however, was that fraud had become pandemic.
What might start out as a minor conflicts of interest slips over time into something more nefarious. When False statements get made to counter- or third parties who in good faith rely on those statements to their detriment, you have the makings of fraud. And what these types of undisclosed misleading statements become the norm, you have systemic fraud.
The most recent cycle saw many different types of fraud perpetrated by various industry players. All together, these various fraudulent actions contributed in a large way to the extent of the housing boom.
Here are what I see as the most common forms of fraud during the 2002 – 06 cycle:
1) Appraisal Fraud: Many appraisers found they could attract more referral business by inflating their appraisals to whatever the selling price was priced at. In a boom, it became easy to justify such fraud by using similarly priced homes in the neighborhood. Any basis of intrinsic value could be ignored, so long as “comparable” properties sold for similarly over-priced amounts.
The overuse of comparables helped justify prices that were increasingly unsupportable. As prices spiral upwards, the use of comparables becomes meaningless. High prices justify higher prices. It eventually reached the point where honest appraisers petitioned Washington D.C. to intervene in the widespread fraud. (The White House chose not to intervene).
2) Referral Fraud: Complicit in appraisal fraud were the real estate agencies that knowingly steered appraisal referrals to those agents they knew would give them the valuation they sought, rather than a true valuation. The agents and agencies were the enablers — they are the ones who incentivized the appraisers to commit the actual fraud. The agents were the unindicted co-conspirators to appraisal fraud, as they paid for, aided and abetted the actual fraud itself.
Many buyers do not realize that real estate agents legally represent not them but the seller. They are motivated to close the transaction in order to get their commissions. This can lead to "questionable" referrals (including engineers as well).
3) Application Fraud: It was an open industry secret that mortgage applications were usually completed by mortgage brokers, rather than by the borrowers themselves. “Just leave those lines blank, we will take care of them” was a common refrain. Savvy brokers knew how to meet the requirements of each bank in order to get loans approved. Indeed, the “No credit check, no income verification” loans practically invited this kind of fraud.
That the banks knew what was going on and looked the other way, however, does not make this form of financial deception any less a felony.
4) Underwriting Fraud: Just how aware were the banks that these borrowers were unqualified?
An internal memo from JPM Chase reveals exactly how much the banks understood who they were lending to. It involves Zippy, Chase’s in-house automated loan underwriting system. The memo’s title: "Zippy Cheats & Tricks." It explains to bank employees how to get an unqualified applicant approved for a mortgage. A Chase spokesperson denied that Zippy Cheats & Tricks was official policy; thus we are reassured that this was only "unofficial policy.”
5) Mortgage Fraud: Anyone who filled
out a mortgage app, and put false information on it committed fraud. I
do not believe, as some fraud apologists have claimed, that this rose
anywhere near the level of what has been so disingenuously termed “predatory borrowing.”We know it happened on more than a few
occasions. Where the intent was to obtain financing that the borrower
would not have otherwise qualified for, it is fraudulent. That banks
should have been more proactive in protecting against this form of
deception is no excuse.The bottom line remains that anyone who
overstated assets or income or understated debt or financial
obligations committed fraud.6) Predatory Lending/False Statements: As of this writing, the FBI has arrested nearly 1,000 in connection to this form of fraud. A significant number of borrowers (I don’t have a definitive number) may have been subject to predatory lending.
There have been numerous examples of lenders deceptively convincing borrowers to agree to loan terms that are abusive. One of the most common versions in recent years was representing an adjustable rate loan as a 30 year fixed mortgage. Anecdotally, I have seen many examples of this.
Note: This list is really just on the home purchase side, and doesn’t even get to the doesn’t include the fraud by Moody’s and S&P in rating the various RMBS, CDO and CLS and other RE related structured products.
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QUESTION: How many forms of fraud were associated with this last cycle in Real Estate, Mortgages, Securitization, Fund Management, Structured Products, etc. ? What other fraudulent activity took place?
What say ye?
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Previously:
How to Get an "Iffy" loan approved at JPM Chase (March 2008)
http://bigpicture.typepad.com/comments/2008/03/zippy-cheats-tr.html
Source:
FBI Probes Unusual Incentives for Home Buyers
Investigators Ask Whether Payments Misled Lenders
NICK TIMIRAOS
WSJ, August 16, 2008; Page A2
http://online.wsj.com/article/SB121884641242946145.html
Barry,
It seems like you focused on fraud on the part of all of the business types that were involved but forget about the individual buyers. In my opinion the largest fraud was the collective fraud perpetrated by the buyers on the low doc and no doc loans. While businesses were inviting this fraud with these types of loans this was fraud.
Barry,
It seems as though you focused on all of the different business that definitely perpetrated fraud in this area but forget about the individual buyers. In my opinion the largest fraud committed was the collective fraud committed by buyer with the low doc and no doc loans. While business did invite this fraud with these types of loans this still was fraud.
I consider it fraud that Greenspan kept interest rates so low.
Anecdotal only, of course, but my experience with realtors, mortgage lenders and the like has always had the slimy feel of the used car lot. I’m old fashioned I suppose, having never put less than 20% down on any of the six homes I have owned over the last nearly thirty years. The cocktail party come-ons by the refi-crowd were very annoying over the years. Refreshingly, they have been absent from the scene of late. Good things come to those who wait, I suppose. That said, one way or another, those of us who did things appropriately will be the ones paying the tab for the fraud, bad choices, etc.
Ha, if you want to read countless incidents of mortgage fraud, go here:
Mortgage Fraud Blog
Appraisal Methodology does state: Willing Buyer + Willing Seller constitutes market value. Therefore, it is arguable even those not “on the take” were providing baseless (or rather thin) opinions of value, however, in compliance with industry standards.
I hate to sound like a bedwetter liberal, but my impression is that the moral standards of downscale people didn’t suddenly implode 5 years ago. Supply of fraud will rise to meet the demand. If I leave a stack of money out in my front yard, anyone who takes it is certainly commiting a crime. Still…
For the no-doc loans, the lenders are as much to blame as the buyers. There was at least a *wink wink* are you sure that is all your income, if not more.
AAA ratings on the mortgage backs.
i read some prospectuses of these things, and easily 80% of these CDOs were stated income loans.
that means 80% of these so-called “investment grade” securities were fraudulently induced by either the borrower or the lender, and it was in plain view in the FRIGGIN PROSPECTUS.
yet fitch, moody’s, and s&p slapped AAA ratings on this garbage anyway for the fees.
and the sad thing is that no municipality or state in their right mind would go after these three, b/c the agencies would immediately downgrade all their publicly traded debt.
I wouldn’t necessarily label this fraud, but how widespread is the practice of homebuilders buying a potential buyer’s old house in order to sell them a new one ? Here in suburban Richmond, VA I know 2 friends who have been looking at new, spec houses (Centex and Main Street Homes are the most active builders here). The deal they have been offered is that the builder will buy their old house at the appraised value if they buy the builder’s new house thats for sale. Easy to see why…the more new units that move, the more occupied the spec neighborhood which makes the remaining homes more marketable. Also, I would suspect the new home sale hits the Income Statement whilst the old home purchase doesn’t. How widespread is this ?
oh, and let’s not forget fran and fred:
Study Finds ‘Extensive’ Fraud at Fannie Mae (WaPo)
http://tinyurl.com/62ajb2
Fannie Mae management may be ousted:
http://www.msnbc.msn.com/id/6070704
OFHEO REPORT: FANNIE MAE FAÇADE
Fannie Mae Criticized for Earnings Manipulation:
http://www.ofheo.gov/media/pdf/fnmserelease.pdf
Fannie Mae received a $400 million dollar fine and a scathing report on its “unethical corporate culture.”
http://www.pbs.org/newshour/bb/business/jan-june06/fanniemae_05-23.html
7> _MEW Fraud_ the work around of purchasing items on the mortgage to regain tax write-offs on purchases deemed unfavorable to the tax system of funding government – draining the banks equity insurance against default trouble
8> _Life Style Fraud_ the work around of funding the local economy with global money instead of balancing the local economy
maybe they are one in the same
Jeff,
“In my opinion the largest fraud was the collective fraud perpetrated by the buyers on the low doc and no doc loans.”
None of the data I’ve seen supports that.
The fraud by buyers (and there has always been a small level of criminal activity involving mortgages) is SWAMPED by the level of fraud by predatory mortgage lenders/brokers, realtors, appraisers, and fraudulent securities ratings/misrepresentation of securitized investments by ratings agencies.
.
I’m sure they will do their takedowns until they bump into someone ‘important’ who found a way to make an industry of it but didn’t have the sense to shred the witnesses. If that happens and they find a paper trail to someone with connections then the whole thing will fall apart. That’s pretty much a guarantee. Unless they can pin it on someone of lesser importance of course when they catch that person
Did they ever get the guys who bought the mass of put options on the airlines right before 9/11? No donkeys to pin that tail on I guess
“High prices justify higher prices. It eventually reached the point where honest appraisers petitioned Washington D.C. to intervene in the widespread fraud. (The White House chose not to intervene).”
The passage from “minor conflicts of interest” to pandemic fraud always find the top leadership as an enabler.
This was no different. And even after all the Fed’s actions to save the FIRE sector, foreign investors are forcing this administration to intervene much more directly into Fraudy and Phony whether they like it or not.
Heck of a job G.W.!
“In my opinion the largest fraud was the collective fraud perpetrated by the buyers on the low doc and no doc loans.”
(shaking my head in total disbelief)
I read financial blogs in 3 languages coming from at least 5 different countries and the USA might be the only one where there are always (as in “it never, ever fails”) people ready to excuse shoddy business practices in spite of the evidence, by shifting the blame to the individual/client.
No wonder it is such an awesome place “to do business”.
I try to state this every time it comes up, just to make the point: There is NO credible non-fraudulent reason for no-doc loans. The only stated reason, convenience, is patently not credible – who’d pay 2% on a half million dollar loan for convenience?
Every one of these loans is fraudulent, and in some markets, they make up 30% of the loans made.
And, to address Francois’ point, above, every single no-doc loan was either fraud or negligence of fraud on the part of the borrower. That doesn’t mean that the loan originator wasn’t also complicit – of course they were – there’s a simple form that they could have filed with the IRS to check on income.
But so what? Does that change the fact that the borrower committed fraud? Of course not.
Gotta agree with Jim D here. If the borrower is aware that the loan is fraudulent, and they are filling out the document, they share the blame.
“I read financial blogs in 3 languages coming from at least 5 different countries and the USA might be the only one where there are always (as in “it never, ever fails”) people ready to excuse shoddy business practices in spite of the evidence, by shifting the blame to the individual/client.”
Probably because some of us still believe in personal responsibility over here, and accepting the consequences of our actions.
“I consider it fraud that Greenspan kept interest rates so low”
^ Hit the nail on the head
It was fraudulent on every side of the deal. From the development loan to the rating and sale of bogus MBSs, the entire process was fraudulent. An unspoken conspiracy of those willing to go along (for a price).
Appraisal fraud didn’t just involve overuse of comparables, it involved using the wrong houses as comparables as well. For example: using as a comparable a nearby house that happens to be in the more-affluent town next door with the better schools.
Appraisers reflect the market; they don’t determine the values. there is no such thing as intrinsic value. Value is set by what people will pay. And sometimes people pay ridiculous (from a common sense point of view) amounts, for houses, for stocks. What appriasers are required to do, however, is to makr down the value/price of any comparables used by the amount of the incentives granted for that sale, which gives one the actual real price paid.
Jim,
“There is NO credible non-fraudulent reason for no-doc loans.”
Of course there WERE.
Anytime you had real cash flow not realistically reflected on a 1040, such as with a physician with a Personal Corporation, just as one example.
It was the lenders/brokers who subsequently perverted the use.
.
Andrew,
“If the borrower is aware that the loan is fraudulent, and they are filling out the document, they share the blame.”
That’s a mighty big “if”.
You’re forgetting that we’re dealing with lay people and what are supposed to be ‘professionals’. For decades, these lay people went to these professionals, and they told them how much they could borrow, how much they had to put down, what the term of the loan would be, what the interest rate would be, and what their monthly payment would be.
Then these lay people were put at the mercy of a bunch of intentionally UNREGULATED vultures, and you expect them to comprehend the intricacies of what even some sophisticates on Wall Street were bamboozled by ?
Gimme a break.
.
I have a problem with the definition of appraisal fraud. Comparables may be the best way to define the value of a house. The price is the market price, i.e. what the highest bidder is willing to pay. There is no “intrinsic” value for a home. The value is exactly what someone is willing to pay for it, thus if someone is willing to pay a similar amount for a similar home, then that should give a good idea of what the home is worth. Also, for a loan to be agreed, both the borrower and the lender have to sign, meaning that for the borrower to agree to an “unfair” interest rate, he has to be dumb enough not to properly examine the terms of the loan. No one is putting a gun to the head of a prospective borrower. The “predatory lending” term is used for borrowers who were dumb enough to agree to poor interest rate conditions on their loans.
“Anytime you had real cash flow not realistically reflected on a 1040, such as with a physician with a Personal Corporation, just as one example.”
Oh please – you have a 1040. Your corp has income and balance statements as well. If you can’t easily prove the income, then the odds are good the income isn’t secure enough to actually go into the loan in the first place. For instance, if the Physician’s corp burned through all the money with capital improvements, then THAT MONEY DOESN’T COUNT. YOU SPENT IT. IT’S NOT INCOME.
How hard is this to understand?
If, instead, you didn’t spend it, then guess what? You don’t need a no doc SINCE IT’S ACTUALLY INCOME, and it either shows up in the bottom line of your corp, or in your 1040.
Again, there is no non-fraudulent reason for a no doc loan.
zach-
i completely disagree.
first of all, you are confusing “value” with “price.” EVERYTHING has an intrinsic value, but the market price may be wildly disengaged from its value. obviously, current homes are not worth 600k; fair value of a house is about what would be paid on rent for a similar property.
secondly, the reason most people took out teaser rates was b/c part of the sales pitch was that they could refinance right when the rate reset.
and as for “borrowers who were dumb enough to agree to poor interest rate conditions on their loans,” the borrowers were the only ones thinking straight. the loans were non-recourse, so they had nothing to lose. it was the banks and all the currently unemployed mortgage brokers who had the most to lose, not the borrowers. so let’s watch who we’re calling “dumb” here.
>> Probably because some of us still believe in personal responsibility over here, and accepting the consequences of our actions.
Two thoughts:
– No one disagrees with this concept. Everyone here agrees people and organizations should bear responsibilty for their actions. What you’re debating instead is “who should we blame most?”
– I hope you’re not making that comment as a way to say executives and corporations (“people” in legal terms) should be given a free pass for shoddy — knowingly and intentionally shoddy — business practices. I hope you’re just saying many individual borrowers are also to blame.
Additional to the front end, is the institutional sale of the CDO. I watched the sales desk of a regional bank sell multi-traunch CDO paper to blue-haired old ladies as if they were as secure as AAA corporate paper. While this hasn’t backfired completely, yet, the practice is more than a little disingenuous and helped make a market for the newly minted mortgages.
7> _MEW Fraud_
8> _Life Style Fraud_
maybe they are one in the same … NOT
7> the individual is charged
8> the FED Regional Banks, SEC, White House
should have seen what was going on – and would be charged
Perhaps this is a minor point, but I was under the impression that there was a significant segment of buyer fraud related to declaring spec or second home properties as primary residences. Has anyone seen any statistics on this? I would think it would vary greatly by local market…
Well, as a former loan officer with Margaretten (retired in ’96), I can tell you that one hand washes the other. Made good coin buying Chemical et al in the bank recovery in the early ninties. Dumped bank stocks after Glass- Steagall was repealed. Have yet to feel comfy about buying them back.
Say, you guys wanna hear about the time I gave a dead guy a No Doc?? Perfectly good loan, I refied it 18 months later when rates dropped for the widow.
Speaking as a veteran of almost 40 years, the industry has seen allot of ups and downs, but this is the worst. What started out as a distinquished career is now considered filthy if you were in it. Many of us did not fall into the shoddy methods, and fought for integrity. Other businesses should understand that, but having that background is hard to crack jobs. Plus many of us were too specialized.
There was deception in all levels, inspired by greed. However, it starts with the application, and intention, period. Then it ends with the marketing of these knowingly bad products. I look forward to returning to the real world of property lending, with proper checks and balances.
WOW,
We are going to throw out the use of comparables – something the industry has used for 70 years? With all due respect for your usual excellent commentary, when that’s your #1 recommendation, I know that you’ve really wandered out in left field.
It is axiomatic in real estate valuation that the best method of valuation most closely aligns with the buyers method of valuation – and in houses, buyers look to see what competitive properties have listed and sold for.
“Intrinsic” value is meaningless in the context of market sales – properties are worth what they can be sold for, just like stocks (btw – I see estimates from respected Wall Street organizations for “intrinsic” values which are very, very far away from their current sale values, an analogous situation).
Comparable sales remains the #1 way to value anything, at any given time, around the world – not just real estate.
The problem isn’t the “overuse” of comparables – it’s the selection of the wrong comparable, or latching onto a singular comparable as the best indicator, wen in fact, it’s more or less a “rogue” sale.
An Honest Real Estate Appraiser.
“I hope you’re just saying many individual borrowers are also to blame.”
Sorry if I appeared to be heaping all the blame on the buyers. I don’t question the culpability of the brokers in this crisis. They share, at the very least, equal blame for this crisis.
Seeing as how the purpose of the “who is to blame?” argument is to determine who should be punished for it all: We dropped the ball when we bailed these guys out. People who were not at all to blame for the crisis, who didn’t buy or sell these risky loans, are now paying for it in inflation, while the criminals get away with relatively few consequences.
These days, we want to take big risks and suffer no consequences. Until the government makes clear that it will not protect people from the consequences of their actions, people will continue to make bad decisions, and the innocent will continue to pay for them.
Understood, Andrew.
I think almost everyone here is on the same page, just focusing on and emphasizing different parts of the problem.
What we should all be doing is marching on Washington.
Well, okay, I’m not one for a march. But, I do forward Barry’s articles to people in my address book and hope that somehow, somewhere, some way it makes a difference.
The biggest scam was leading the entire American public that everyone should be able to own a home. Wrong. Nobody is entitled to become a homeowner.
Jim,
“Again, there is no non-fraudulent reason for a no doc loan.”
A mere unsubstantiated belief.
.
“Again, there is no non-fraudulent reason for a no doc loan.”
A mere unsubstantiated belief.
I would be willing to surmise that probably 90%+ of no-doc loans involved some type of fraud.
If there is cash-flow that is not on an applicants 1040 an overwhelming majority of those are going to involve tax-fraud.
If there isn’t cash-flow or assets that match the applicants state no-doc loan, then there is mortgage fraud.
The sniff test is that why would someone pay 1.5 to 2.0 full points higher for a no-doc loan if they are not trying to hide something. If income/assets are legit, there is always paper trail.
How about the drive by appraisal for say 55 houses. The appraiser and the owner of the 55 houses drove by and the conversation went like this (or so I’ve heard).
Appraiser (and I use this term loosely):
How much do you want that house to be worth?
Owner (and I use this term loosely)
“How about $125,000.”
Appraiser:
“OK”
This sort of detailed appraisal went on for 55 houses. End result the “owner” took second mortgages on all 55 houses and lived high on the hog, pretty much just like much of this country.
What a country. But fraud in Iraq included
shoveling billions of US tax dollars out of the back of pick ups, pretty much no doc loans. So I guess all fraud is relative. But if there is one thing this country has a lot of it’s money, and since debts don’t matter, where’s the problem, just quit whinning and work harder and pay those taxes.
PS: I agree that Greenspan deserves much of the credit for the real estate bubble (as well as the tech bubble etc.) All bubbles are liquidity driven and Greenspan certainly provided the liquidity.
I think there are a few legit reasons to use no-doc. An example would be a celebrity or high net worth individual who doesn’t want to disclose sensitive information, and has plenty of money to cover the extra interest.
I don’t think that hiding income from the IRS could be considered a wholly legitimate use of no-doc! lol Maybe they’re not cheating the lender, but they are cheating someone else.
I agree with VJ, remember 25% of the population don’t know how to balance a checkbook. How were they supposed to understand a complicated loan.
I sympatize somewhat with those lower level professionals who were basically left with the choice of going along (participate), or lose so much business that they could no longer make a living. They were in part victims of the neo-con-men in our government who did not understand that the beast of free market forces must be controlled at all times, to make sure it’s powers are used to build society not to destroy it.
There has been fraud on every level from byers to investment banks with the motive of making a quick buck. However, the only ones that could credibly claim to not understand what was going on, is the J6P who purchased a house. For the regular J6P purchasing a house is done by professionals he hire, and he just signs on the dotted line after the loan officer has filled out the form. Why would he trust their word rather than get a 4-year college education so he can understand what he signs? Well besides the obvious, it makes absolutely no sense to him that the bank would get him into a house he could not afford, because he know that in a forclosure everybody lose money.
For those arrogant financial types who say that J6P should have known what he signed/got into, remember that we all end up having to relly on advice of professionals at some point in time. If you are stupid enough to take the advice of your doctor and start taking isoniazid even though you are already taking carbamezepine, is it then your own fault when your liver fails a week later?
The problem is with a society that has made it a crime when J6P robs the rich with a gun, but when the rich robs him with a pen, it’s just the free market laws of nature – if not J6P’s own fault. Thank god that every now and then the pigs that have set this up, get hit in the face with their own s**t. Otherwise we would end up with a “tar, feather and pitchfork” revolution and that would be bad for my stock portfolio.
DeDude
HIGH5
:-) :-| :-(
eds1830,
“I would be willing to surmise that probably 90%+ of no-doc loans involved some type of fraud.”
And I would be willing to “surmise” that you cannot substantiate that assertion.
.
Appraisal Fraud. Isn’t that the same method used to determine the pay packages of the CEO’s who helped get us in this mess?
Let’s see.
Many pay consultants found they could attract more referral business by inflating their appraisals to whatever the selling price was priced at. In a boom, it became easy to justify such fraud by using similarly priced packages. Any basis of intrinsic value could be ignored, so long as “comparable” pay packages sold for similarly over-priced amounts.
The overuse of comparables helped justify prices that were increasingly unsupportable. As prices spiral upwards, the use of comparables becomes meaningless. High prices justify higher prices.
Sounds right to me.
VJ –
“And I would be willing to “surmise” that you cannot substantiate that assertion.”
Simple logic –
If you have the income on your 1040, or as profit in your corp, you don’t need a no doc, you don’t need to pay an extra 2% on your loan.
Name one, ONE reason to pay an extra couple of points on your loan that doesn’t involve defrauding the originator (either by the borrower or the broker) or defrauding the US Gov’t.
Name ONE, and I’ll stop. I’ve yet to hear one valid reason.
That you don’t provide one is proof of my argument.
The example already given in this thread, the Physician’s Corp, I’ve already addressed. Most other examples I’ve heard are of a similar vein, in fact, *all* other examples I’ve heard were of a similar vein. Or do you disagree? If the corp doesn’t have a profit, it’s not income for the owner, and you are lying to the originator. If it does have profit, you don’t need a no doc.
If it’s so obvious that I’m wrong, then a single example should be easy to come up with, shouldn’t it?
Let’s not forget the borrowers, who signed their names on the contracts. I wonder how often borrowers signed a blank or partially filled in form being encouraged told by their loan originator that they’ll take care of the rest of it. There’s a lawyer Q & A found at http://www.UsHousingMeletdown.org addressing this loan document fraud issue. The onus is on the borrower, though, to prove their assertion.