Origination Fraud and Collective Embezzlement

A few weeks ago, I asked readers for suggestions as to what they would bring to the state Attorneys General offices. This led to a very interesting discussion with Michael White, formerly of CountryWide Subprime Unit, who now blogs at housingstory.net.

I worked one of the more fascinating observations he made into my presentation to the AGs last week:

“Eliminate the verification of income for a mortgage borrower, and you eliminate your ability to predict the likelihood of repayment or default.”

-Michael White, CountryWide Subprime Unit

Consider what that statement implies: The banking industry’s decision to voluntarily abstain from income verification amounts to what Mike called “Origination Fraud.” More than just an example of groupthink, it was the willful decision to make a substantial number of loans that the banks knew would go into default in much higher than usual numbers:

“You can’t issue 1 or 2 trillion dollars of mortgages and knowingly encourage fraudulent claims of income. The basic fact check which every lender should have used is the 4506t — the document which is presented to the IRS for direct verification of what the borrower reported as income. The fraud depended upon the lender knowingly failing to check W2s pay stubs and IRS records.”

Here is the key to understand credit and banking: It is the job of the banker is to decide who is creditworthy, and make loans accordingly. Throughout history, unqualified people have ALWAYS tried to get loans. But the bank had a fiduciary duty to their suppliers of capital, to the people that lent them money they lent out (depositors, gov’t, investors, etc.).

At the same time, the compensation for the employees, mortgage brokers, and senior management of these lenders was based on their total production. They managed to extract enormous bonuses based on making loans they knew (or should have known) were going to default.

This is where the term collective embezzlement comes from . .  .

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