Fraud in Real Estate, Mortgages & Homebuilders
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
Sunday, August 17, 2008 | 07:30 PM | Permalink
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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.
Posted by: Jeff | Aug 17, 2008 7:49:16 PM
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.
Posted by: Jeff | Aug 17, 2008 7:53:40 PM
I consider it fraud that Greenspan kept interest rates so low.
Posted by: Mel | Aug 17, 2008 7:54:57 PM
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.
Posted by: Scott in Chicago | Aug 17, 2008 8:01:57 PM
Ha, if you want to read countless incidents of mortgage fraud, go here:
Posted by: Jojo | Aug 17, 2008 8:21:22 PM
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.
Posted by: Portland Refugee | Aug 17, 2008 8:27:36 PM
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...
Posted by: Roger Bigod | Aug 17, 2008 8:30:00 PM
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.
Posted by: Joe | Aug 17, 2008 8:41:47 PM
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.
Posted by: m3 | Aug 17, 2008 8:54:26 PM
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 ?
Posted by: Jeremy | Aug 17, 2008 8:59:15 PM
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
Posted by: m3 | Aug 17, 2008 9:05:14 PM
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
Posted by: Greg0658 | Aug 17, 2008 9:08:01 PM
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.
.
Posted by: VJ | Aug 17, 2008 9:17:47 PM
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
Posted by: DavidB | Aug 17, 2008 10:14:10 PM
"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.!
Posted by: Francois | Aug 17, 2008 11:46:41 PM
"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".
Posted by: Francois | Aug 17, 2008 11:52:24 PM
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.
Posted by: Jim D | Aug 17, 2008 11:57:10 PM
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.
Posted by: Jim D | Aug 18, 2008 12:04:38 AM
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
Posted by: Andrew Mackenzie | Aug 18, 2008 12:29:58 AM
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).
Posted by: Marcus Aurelius | Aug 18, 2008 12:36:18 AM
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.
Posted by: DaveinHackensack | Aug 18, 2008 1:26:14 AM
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.
Posted by: gene | Aug 18, 2008 1:34:03 AM
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.
.
Posted by: VJ | Aug 18, 2008 1:37:08 AM
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.
.
Posted by: VJ | Aug 18, 2008 1:40:59 AM
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.
Posted by: Zach | Aug 18, 2008 1:42:07 AM
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