The Big Picture

« The Ticker Tape Parade Indicator | Main | Bull Market »

Real Estate, Speculation & "Occupancy Fraud"

Wednesday, February 06, 2008 | 01:58 PM

in Credit | Legal | Psychology/Sentiment | Real Estate

Today's WSJ had a run of Real Estate related articles that quite frankly, were rather surprising in their gentle naiveté.

The first is the somewhat surprised acknowledgment that speculators were involved in the run up and subsequent deflation of Housing prices.

Of course, every asset class attracts speculators when prices rapidly rise. Its why every big boom ends in a final blow off top -- that's the impact of late-to-the-party speculators -- followed by the inevitable spectacular collapse.

The latest after-the-fact revision (see our discussion on "predatory borrowing") has a new name: occupancy fraud.

This new nonsense word is a way to duck responsibility for failing to do appropriate due diligence prior to lending out money. Here are the details:

"As lenders pore over their defaulted mortgages, they are learning that the number of people who bought homes as investments is much greater than previously believed. Such borrowers turn up frequently in analyses of loans that defaulted within months after origination. In many cases, these speculators lied on loan applications, saying they intended to live in the homes in order to obtain more favorable loan terms or failed to provide the requested information.

Roughly 20% of mortgage fraud involved "occupancy fraud," or borrowers falsely claiming they intended to live in a property, according to an analysis by BasePoint Analytics, a provider of fraud-detection solutions in Carlsbad, Calif. Another study, by Fitch Ratings, looked at 45 subprime loans that defaulted within the first 12 months even though the borrowers had good credit scores. In two-thirds of the cases, borrowers said they intended to live in the property but never moved in."

Speaking of fraud -- I am curious about these lenders, now claiming they were defrauded by speculators. How many of them asked the following questions, and then did the due diligence to verify the data:

- Do you presently own your primary residence?
- Is your home currently listed for sale? Or, are you in contract ?
- What is the asking price? Who is your real estate agency?
- RE Agent name? What's their phone number?

Of course, none of these questions were asked, and no due diligence was performed, as these lenders were ~~whoring~~ clerking out loans as fast as they could process them. After the fact, this lack of due dilly has become "Occupancy Fraud."

If there was any genuine interest in not lending to speculators, its easy enough to verify . . .

>
Not surprisingly, all of this unchecked speculation ended badly. This has led to a big upswing in empty houses:

"Nationwide, the homeowner-vacancy rate, which measures the number of vacant homes for sale, rose to 2.8% in the fourth quarter, the Census Bureau recently reported. That matches a record set in the first quarter of 2007 and is the highest since the government began tracking vacant homes in the 1960s.

The current vacancy rate could be the highest since the Great Depression, when an exodus of Americans left the Dust Bowl states for the West Coast, says Mark Zandi, chief economist at Moody's Economy.com.. Data "strongly suggest that vacancies are at their highest level since the 1930s," he says, adding that the empty homes aren't only depressing property values, "they are weighing on the collective psyche of communities. ... It's kind of like playing for a losing team. It's debilitating."

High vacancies in Florida, Nevada and California partly reflect overbuilding during the housing boom along with rising foreclosures. Cities in the Midwest have some of the highest vacancies, due not only to foreclosures but also to weak economies and population declines. In Cleveland, for example, the number of vacant homes has reached as many as 12,000, about 10% of the city's total housing stock, according to the treasurer of Cuyahoga County, which includes Cleveland."

Astonishing. Zero adult situation across the entire process, and now, wild ass covering and blame shifting.

Previously:
Ongoing Impact of the Housing Sector
Assigning blame for all of the problems in the credit market
Tuesday, August 28, 2007 | 11:45 AM http://bigpicture.typepad.com/comments/2007/08/the-ongoing-imp.html

Sources:
Speculators May Have Accelerated Housing Downturn
Rising Number of Defaults Also Could Complicate Effort to Help Homeowners
By RUTH SIMON and MICHAEL CORKERY
WSJ, February 6, 2008; Page B8
http://online.wsj.com/article/SB120225852189145889.html

As Houses Empty, Cities Seek Ways To Fill the Void
MICHAEL CORKERY and RUTH SIMON
WSJ, February 6, 2008; Page B1
http://online.wsj.com/article/SB120226298614746353.html

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c52a953ef00e5502e24be8834

Listed below are links to weblogs that reference Real Estate, Speculation & "Occupancy Fraud":

Comments

Greenburg was a guest commentator on CNBC today. They had a piece with Olick and a rep from the Realtor's Association. It was disclosed that mortgage lenders are still offering teaser ARMs and interest only loans. Herb said something to the effect that he couldn't believe they were still doing that because that's what has caused the current housing market mess. The rep said something to the effect that mortgage lenders are doing whatever is necessary to drum up business. Because of FED rate cuts, REFIs are up 17%. Greed marches on.

Posted by: Pat G. | Feb 6, 2008 2:47:20 PM

Lenders not bothering to act upon or even do a primitive statistical test to determine the validity of their assumptions (regarding their borrower's ability to manage a loan) was plainly irresponsible. Banks writing down billions in losses is like watching your child crying after failing a test because they just didn't want to do their homework. There seems to be a systemic failure in our population to accurately gauge many forms of risk (economic, environmental, military,) but we're all going to pay for it...even those of us who were making very careful decisions along the way.

Posted by: Camille | Feb 6, 2008 2:53:10 PM

Reading an article cited by Atrios and others - http://www.washingtonpost.com/wp-dyn/content/article/2008/02/04/AR2008020403270_pf.html - I question the due diligence on lending $600,000 to a household earning $50,000.

Even with no revolving debt, the 36% ratio says they should have a max monthly mortgage payment around of $1500--or around a $250,000 traditional mortgage.

Whoever lent them the other 60% of their mortgage debt didn't cover their bases.

Posted by: lutton | Feb 6, 2008 2:53:57 PM

Reinflate the bubble? Who would have thunk.

It's amazing how many people are still trying to blame the credit crisis on "those people that lied on their applications". I think it fits into some ideology, that individual behaviour cannot be controlled by the "powers that be". However, this is a false belief since you can certainly take issue with the issuers (individuals) that did not do any due diligence and the regulators. The other false premise is that speculators and scammers took the investment banks and other investors for over $150 billion and counting. This woulod have put Nigeria out of business, if it were true.

Posted by: larry | Feb 6, 2008 2:55:55 PM

I saw this coming 2-3 years ago where I live (southwest). There are now whole neighborhoods sitting empty where close to 100% of the buyers were investors.

The positive migration occuring in the Sunbelt will absorb inventory in time, but the cold weather states could be another story.

Posted by: kk | Feb 6, 2008 3:04:02 PM

Occupancy fraud is joke. I had a friend in the finance group at on of the largest, and still one of the best capitalized builders in the country, explain to me how these sales worked (this was about 1 year ago and refers to Austin, TX). While executive management prohibited sales to investors, sales managers were incentivized to look the other way when their employees sold homes to speculators. How do you know if you are selling to a speculator? I think the better question is, how do you NOT? These "buyers" often had addresses outside of the state and often would buy several houses within the same day. Sales people were more than happy to make the sale, I mean why turn down an easy dollar. And sales managers were more than happy to approve the sale as their bonuses were directly tied to the number of homes sold within their region. Now I don't think there is anything wrong with selling homes to investors in and of itself, but blaming everyone possible and refusing to accept any responsibility for what was wholly their own fault is all together ridiculous. It reminds me of the trader over at Societe Generale whose actions were being ignored, if not loosely monitored, while they made money for the firm, but as soon as he lost, SG all of a sudden "realized" that he had been doing all these terrible, deceptive things.

Being robbed is one thing, but driving down to the ghetto, parking your car with the windows open, and leaving a box fulls of ipods and jewelry on the seat is another.

If you are running a public company, pleading ignorance is not a viable excuse, its a reason to get fired.

Posted by: AP | Feb 6, 2008 3:08:37 PM

"these speculators lied on loan applications, saying they intended to live in the homes in order to obtain more favorable loan terms or failed to provide the requested information."

I think they'll find that this was about more than just trying to accumulate an investment property portfolio at more favorable terms.

The tremendous number of early defaults suggest serious fraud for profit activity, where values are inflated, and cash stripped from the lender at closing through illegal disbursements of loan proceeds back to the borrowers and other actors in the scheme. Once all the key actors are playing along (originator, realtor, appraiser, title company) it becomes a simple paperwork drill to take $100,000 at a pop from a lender.

For the lender, this means they are not only getting back a property that has lost value due to normal market forces, but whose original value/loan amount may have been an utter fiction in the first place.

They were already upside down by 100k the moment the loan disbursed.

Posted by: Alex Stenback | Feb 6, 2008 3:09:19 PM

kk knows the score.....

Posted by: Paul Griffith | Feb 6, 2008 3:15:54 PM

"Today's WSJ had a run of Real Estate related articles that quite frankly, were rather surprising in their gentle naiveté."

"Naiveté?" Perhaps not. I think we are seeing the direction the WSJ is taking post-Murdoch.

As you point out, there was no due diligence done by these firms, yet somehow they are not to blame for the mess they put us in. Sounds to me like a lot of executives at other companies who blame everyone and everything but their own dumb ass policies for their failure.

RIP WSJ.

Posted by: Gary | Feb 6, 2008 3:37:04 PM

I live in FL and have been trying to purchase a home for about 25 months; the problem, I saw this coming and have made what I thought were reasonable offers only to be ridiculed by realtors/owners for submitting an insulting offer. Now, most of those homes are still on the market, about 33% cheaper. To the point of misrepresentation by speculators: when doing due diligence on prospective homes, I noticed how many "investors" owned what are claimed to be homesteaded domiciles. I have echoed this comment before. It is the individual who is most culpable, end of discussion. As a further incentive besides cheaper mortgages, what gets overlooked are the tax implications of selling (flipping) a homestead opposed to an investment property. These amatures full well knew what they were doing. I wish the IRS would start reviewing this aspect, talk about a goldmine of revenue. Oh, by the way, I have a friend who owns 5 homesteaded properties, 3 of which in the same county. How can this be happening?

Posted by: AJF | Feb 6, 2008 3:44:50 PM

Going back to your earlier piece on the stages of grief, Denial is the motivator here. Can't you just hear a grown up Bart Simpson saying "Not My Fault". This denial doesn't begin or end with the WSJ piece.

Has anyone noticed the visceral reactions I get for even suggesting that housing will begin to recover later this spring or summer. To me, this is just about as innocuous of a statement as "Have A Nice Day". Others must read something very different.

My guess is that the ones who react the most strongly lost something in the speculative real estate frenzy. To them, the loss couldn't have been their fault. It must have been the market or the economy or a regulator that went out of control and ruined them. Only something beyond the control of mere mortals could have done this to them. They're too smart for this. It's not their fault. It should have worked.

To suggest that a simple market up cycle in a couple of months will begin to save the day must make these people look inward and briefly see themselves honestly. They recognize their mistake in participating in the housing mania at some level at the worst possible time. These are the same people who would have paid thousands for a tulip a few hundred years ago.

Denial, followed by Anger at the terrible person who suggested their possible mistake is the reaction. Since so many screwed up so badly, they band together and share a mass support group. Thus the piling on when I describe the market and the economy as something less than mystical.

I can only imagine the Voodoo curses that will come my way after posting this.

Posted by: cinefoz | Feb 6, 2008 3:54:03 PM

Gary said:

"Naiveté?" Perhaps not. I think we are seeing the direction the WSJ is taking post-Murdoch."

You wanna see WSJ post-Murdoch...? Look no further than the front page feature on the TV show, "24" from last week's Weekend Edition. It might be fine on the weekend section, but where I live it ran on the front page of the main section.

Posted by: bonghiteric | Feb 6, 2008 3:54:27 PM

Due diligence in the past.

My wife and I tried to buy a house in 1962 and were told by a loan officer that her income could only be considered if we could prove she had had a hysterectomy. We finally did get a house, and now we have grandchildren, ha!

Posted by: side pocket | Feb 6, 2008 4:03:06 PM

I've been reading the blog for a long time and have really enjoyed the posts and commentary. Not one to really post on blogs, but since I'm in the mortgage industry I figured I'd give my 2 cents. Fraud is rampant in the industry, more then you will ever know. From lying about income, assets, occupancy, inflating credit scores....you name it, it happens.

A paper to Hard Money loans (below subprime) it happens more then anyone outside the industry cares to really discuss. Prior to my current job, I intervied at nearly 20 mortgage companies and I would say 80% of them openly discussed "how to get loans done" *(fraud).

There is a reason why that NO ONE wants mortgage paper on the secondary market....because it is not worth the ink used to print up the file or the hard drive disk space it takes up (not being funny).

We are still in the VERY early stages of this mess. Until the entire system is revamped or collapses completely it will still go on. Did you know you have to go through more training to become a barber then a loan officer? Think about it. This is the biggest transaction most Americans will ever make and most the time the Loan Officer is not Lic. by the state and he/she just quit hi 7-11 minimum wage job to score the "big paycheck" in the mortgage industry.

Before you go blame every Loan Officer/Mortgage company out there, the other side of the coin is consumers do not do enough to protect themselves and they tend to want to believe the "too good to be true loan terms". I've lost so many deals over the years because another loan officer quoted unrealistic numbers ( or fraud was committed to get a better terms) and the client does not even take the time to research the company online or verify if the Loan Officer is lic. by the state or question how the Loan Officer is structuring the loan.

Homeowners are very willing participants in lying to get a better deal. I've had potential clients call and say they make a certain amount but they know they'll need to state a higher amount on the loan application to lower their debt-to-income ratio to get a better loan. Again this is from the client and even when you tell them it's fraud, they don't care.

So the problems we face for the next few years were created by homeowners to willing to commit, Loan Officers to willing to help and mortgage companies to willing to allow it to happen. Until this cycle has completely stopped, the problems will continue.

My feeling is lenders were very slow in putting fraud protection in place because if they go too crazy with it, loan volume will drop dramaticaly. Until you see default rates on A-paper debt at 30-40% levels, more homeowners okay with walking away from a home thats worth half of what they owe then you really wont see much change from todays standards.

My guess is that we will see 30%-50% plus declines in home values in the next 2 years as the economy weakens, lenders become more restrictive and default rates sky rocket. As for default rates: In 2005 CA had somewhere in the neighborhood of 30k default notices, and a very small percentage of those went to foreclosure. 2007 that jumped to (est.) 300k-350k and a similar increase in the % of foreclosures.

Now what do you think will happen when all the resets take place (which really only started in Oct. 2007 and wont start appearing in default notices until spring time)for the next 2 years?

Disaster.

Posted by: mortgage guy | Feb 6, 2008 4:13:52 PM

cinefoz, we react so strongly to your comments because they are ridiculous. You keep saying housing is going to recover, but lend no support for your thesis...especially when it flies in the fact of all the facts available to anyone with a keyboard.

For instance, how can we have a "simple market up cycle" when we still have to work out the excesses of the past three-year "fraud-induced ridiculous off-the-charts up cycle"?

BTW, I know that the housing bulls like yourself are touting the skyrocketing mortgage app increases....problem is, from what I've been seeing, people are applying but can get funding from any of the lenders due to their tightening credit standards. Kinda ironic, isn't it, that mortgage rates are again at historic lows, but noone qualifies for them anymore....

Posted by: Mr. Obvious | Feb 6, 2008 4:15:22 PM

Cinefoz,
The only visceral reaction I have today is disapointment at your foray into pop psychology. Please stick with your batshit-crazy analogies. Good stuff otherwise.

Thanks, BHE

Posted by: bonghiteric | Feb 6, 2008 4:18:14 PM

Sooooo it's not the fault of the people who lied, but the lenders....?

You sound like a democrat.

Maybe we should reward them for lying and lock in their ARM rates for the next 5 years.

~~~

BR: Bruce,

If you followed the link to the article from August 2007 (under "Previously"), I specifically lay out blame for all parties involved -- at the top of the list are the borrowers.

You, on the other hand, sound exactly like a wingnut partisan. We don't tolerate that crap around here.

When you can behave civilly, come back and contribute. Until then, be gone.

Posted by: bruce | Feb 6, 2008 4:32:05 PM

Yeah, the banks and institutions certainly deserve a great big heaping share of the blame, but - in a free society - so do the borrowers, regardless of whether they were guilty of mild avarice or grand mal fraud. Call me a cold-hearted bastard, but I find it hard to generate even fleeting compassion for any of the persons involved in this mess, regardless of which side of the fraud - er, I mean the *trade* - they were on. Whatever happened to "caveat emptor" (which applies to everyone, really)??

The trouble with a situation like the one that we've been watching develop is that, viewed objectively and rationally, it's very hard to work up any sympathy whatsoever for even a single one of the participants. No one is innocent. All involved - the banks, the originators, the salesmen, the realtors, the builders, the institutions that repackaged and sold mortgages, the institutions that bought said mortgages, the rating agencies, the Fed, the esteemed reprobates in the Congress, the media (that means you - Kudlow!), the realtors, the speculators, and even your cousin Fred who thought this was his one chance to buy his dream "home" - either knew better than to do what they did, or *should have* known better. Nobody gets away scott-free (except for the curiously orange Mozillo).

Personally, I think it's part and parcel of the national "holiday from history" that we've been on for the last decade-and-a-half, which is itself the product of the national IQ die-off that began partway through the first Bush administration. Willem Buiter is only partly correct: we *are* in denial, but we've also become almost willfully stupid.

But that's just my opinion. And it's free, so you know what that's worth.

Posted by: A. Melmotte | Feb 6, 2008 4:32:37 PM

Too little too late, I guess. But I know some home builders were actually making people sign documents that said they would occupy the house and would not sell it for 6 months or something like that. I want to say it was Toll or Hovnanian. Whoever they were, they were the same guys that made you get a rate quote from their approved lender (for about $300, which you paid no matter what).

Posted by: Mike | Feb 6, 2008 4:41:46 PM

Don't expect to see much good news reporting from the WSJ anymore. Rupert Murdoch does not believe in good news reporting. It does not fit into his business plan. From now on it will be varying degrees and flavors of lies, sort of the Mad Cow Disease of financial reportage. Yum Yum.

Posted by: Doug Watts | Feb 6, 2008 4:46:15 PM

"Nobody ever went broke underestimating the intelligence of the American public."

H.L. Mencken

Posted by: bonghiteric | Feb 6, 2008 4:46:19 PM

I am shocked, shocked, to find g*mbling going on in this establishment!

Posted by: pmorrisonfl | Feb 6, 2008 4:52:56 PM

I used to work as a loan officer for one of the big mortgage originators in this country (I left for business school in '06 after foreseeing the housing meltdown) and I believe I can provide some inside info in regards to investment property buyers.
In short, the fault lies on both sides, sellers and lenders were both driving by greed and given the markets appetite for RMBS and CDO’s, it was very easy for both to cash in.
Now why would a borrower lie? Answer: Interest Rates, Down Payment requirements and asset reserves. Due to risk, the pricing on a mortgage is different for a primary property versus an investment property (.5% to 3% higher depending on credit and down payment) and down payment was required to be at least 10% but typically without 20% it was almost impossible to get an approval without 700+ credit and significant reserves. Borrowers were required to have six months of reserves for all outstanding mortgage payments.
So borrowers had a huge incentive to try and put through a property as a new primary versus an investment property. At the same time, lenders also had an incentive to get it through as a new primary as many borrowers could never actually qualify to buy an investment property, usually due to lack of down payment and not meeting reserve requirements.
And contrary to what some may believe, there were measures in place to spot borrowers attempting to take such actions. Whether these were followed by lenders is another question, but where I worked we wouldn’t put it through and my underwriters would never approve anything that was suspicious and here is how we looked for investment properties posing as primaries:
-Do you presently own your primary residence?
For any mortgage application, we have to pull credit and given that most people don’t completely own their current home, a mortgage or lien will show up on a borrower’s credit report. Any mortgage pulling up on credit must then be associated with a property. After matching the properties with the liens we would ask:
- Is your home currently listed for sale? Or, are you in contract?
If they said yes, the underwriter would require that we see a proof of sale for their existing home prior to closing on the new loan. If they wanted to close prior to the sale, they would then have to qualify for the new mortgage and their existing one. They would also have to provide proof that they were selling their current home, like a listing.
-What is the asking price? Who is your real estate agency?
Usually when people buy a new home they get something bigger. So if someone was buying a home at the same or lower price/value of their existing home, it would usually raise a flag. Of course, once it was caught that the property was an investment and we told the borrower the new rate, they usually said no thanks and would go to the next lender. And if they had half a brain, they would just lower the value of their current property to reduce suspicion; they could easily go to another lender and tell them their current property is worth less that what it is really worth.
There were countless other angles that borrowers and lenders would use to manipulate the system and I don’t have time to list them all. Like any bubble there was a lot of speculation going on and people were more concerned about profits then due diligence. My company was one of the better ones, but even still I doubt we caught all the bad mortgages and I suspect there were some bad apples somewhere within the ranks as well.

Posted by: Franks | Feb 6, 2008 4:53:17 PM

It takes two(or more) to turn the keys.

Since NO ONE WAS WATCHING everyone got away with murder.

The securitization model itself is flawed by the agency problem.

So who is to blame?

1) The borrowers for lying their asses off about their ability to pay and their intentions for the property....and profiting from it.

2) The Originators for enabling the borrowers and then profiting from it.

3) The ratings agencies for assigning the high ratings of the securitized MBS containing these shitty mortgages and profiting from it.

4) The IBs for pressuring the ratings agencies and also selling this shit to investors and profiting from it.

5) The investors who failed to do their own due dilly and lapping this stuff up as fast as the IB, and Originators could generate it.

These are people who should have to foot the bill for this madness, and should the government decide to stay out of it...they will. Everyone is collectively holding their breath with me on this one I am sure.

Posted by: KP | Feb 6, 2008 5:01:29 PM

Mortgage guy: On a side note, can you imagine if a CEO of a bank or homebuilder had a crystal ball 3 years ago that showed the mess that we are in now. He would have been fired by now because the investors in his stock would have run him out of town for not participating in the boom. Funny how stuff like that works. IMO this whole real estate debacle was a group effort. From the shareholders groping for short term momentum, down to the home speculators that watched a little too much "Flip this House".

Anybody have any thoughts on the next area that is currently getting thrown a little too much capital. My guess is Ag, emerging markets and commodities.

Posted by: kk | Feb 6, 2008 5:05:45 PM