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Wednesday, April 9, 2008

Predatory Lending or Mortgage Fraud

There is an interesting article in today's Real Clear Markets that tries to add some context to the notion that borrowers were swindled and thus must be bailed out. Now, it has long been my contention that for the most part borrowers were active participants in the swindle, and this article lends credence to that notion...

So-called ‘occupancy fraud’—in which a speculator claims he will live in a house he is buying when it is actually a property he is purchasing for investment purposes-- accounted for about 20 percent of all mortgage swindles during the go-go years of subprime lending, according to a study by BasePoint Analytics, which specializes in detecting mortgage fraud. Buyers hid their intentions because lenders generally require bigger down payments on purchases of investment properties, and some builders will limit the number of investors they allow into a new development, because these buyers are more likely to walk away from a property when the market tanks. Home builders in hot markets were especially susceptible to this fraud because investors would purchase houses in new developments with the intent of flipping them as soon as they were ready to be occupied. Several builders told the Wall Street Journal earlier this year that while they thought that only 10 percent of their sales were to investors in recent years, in fact, it now appears that as many as a quarter of their homes were being snapped up by speculators, who often lied about their intent even when builders required them to sign documents affirming they would reside in
their homes.


One area of particular abuse was so-called ‘stated income’ loans which require little or no documentation of a borrower’s earnings. Originally designed to help self-employed borrowers who don’t have ready access to documents like W-2 forms, no-doc loans became widespread during the height of the real estate boom because lenders naively believed that borrowers wouldn’t lie about income to qualify for loans that they couldn’t afford to pay back. But as soaring housing values made it possible for homeowners to refinance out of unaffordable mortgages using their new homes’ rising equity, lying on no-doc loans became common. One lender which compared 100 stated income loans with IRS data found that in 60 percent of cases, the income that borrowers claimed exceeded their actual earnings by 50 percent or more. BasePoint found in its study that some applications exaggerated income by as much as 500 percent.

It should be noted that mortgage fraud is not new. I firmly believe that the reason that it exploded over the last couple years is because banks opened their programs up to be exploited. Stated loans, for instance, went through a revolution from perfectly reasonable mortgage instruments to instruments of corruption. They started out as loans geared for small business owners, investors, and others who's income was either complicated or choppy. In the last several years, the "revolutionized" into loans for anyone who couldn't qualify with their actual income.

Furthermore, along with brokers and borrowers banks must take their place in line of responsibility. Most banks allowed for stated loans in which the stated income was absurd. On regular bases, banks would accept income of janitors that was north of 50k per year, teachers at 100k per year, and secretaries at 50k per year. The rules were essentially made to be broken by banks who's only objective was to close as many loans as possible. The borrowers must share responsibility because they signed their names to applications in which their stated income was nowhere near their real income. Whatever the reason, the bottom line is that their signature was on the page of income that wasn't real. It is absurd to say they were swindled when they signed the documents. Brokers weren't themselves terribly concerned with whether or not a borrower could actually pay a loan back. The only thing that concerned the broker was closing the loan and making money. Thus, you have a confluence of players who each were in their own way responsible for the fraud.

The issue of "occupancy fraud" is even more complicated and there the borrower is even more directly responsible. Occupancy fraud is when it is stated the borrower plans on moving into a property when they really intend to use that property for investment purposes. Because investment properties have much stricter terms and higher rates, it is always more advantageous for a borrower to get a loan on a property stated as one they will live in. Many scams of mortgage fraud ran where one borrower worked with multiple brokers and banks at the same time to buy multiple properties all at once and list them all as owner occupied. Most times the banks and brokers didn't know about the other loans at all, certainly not the banks. Many other times, borrowers refused to accept the rates that investment property loans would bring and would shop around for mortgage brokers willing to do commit "occupancy fraud". Of course, there were likely other times when borrowers were surprised with low rates and simply didn't realize that there was occupancy fraud.

The key issue is how much of the mortgage crisis was created by the fraud and how much of it was perpetuated by the borrowers, at least in part. If borrowers were swindled, then politicians can make the reasonable arguement that they deserve relief. If they were in on the swindle, then you are rewarding fraud. Ultimately, the borrowers have to take responsibility because they signed their names to the fraud. Whether they realized it or not, their signature was on the document. That is the rub, as Shakespeare might say. Whether or not they were in on the scam, they signed their name to it making themselves responsible for it.

The proponents of bailouts claim that borrowers were innocent victims of predators...

On the one hand, remedies proposed separately by Senators Clinton and Obama, as well as the bailout package agreed to by both Republicans and Democrats in Congress last week, essentially treat many subprime borrowers as victims of seedy mortgage brokers, opportunistic lenders and aggressive Wall Street houses. Under this narrative many borrowers were ‘lured” (in a term used by both Sen. Obama and the New York Times) into mortgages they couldn’t afford, and the Bush administration’s rescue plan--which involves urging borrowers and lenders to work out new loan terms individually--amounts to too little help at too laborious a pace to make a difference.

My problem with this narrative has always been that this sort of behavior has always gone on and yet it never lead to a mortgage crisis before. To say that the mortgage crisis was caused by predators that preyed on unsuspecting borrowers is to frankly give my industry too much credit. That's because this narrative assumes that brokers only recently learned to take advantage of people. That simply isn't the case. In my opinion, what really happened was that banks opened up programs to be exploited, and they were by unscrupulous brokers with the active or at least passive participation of borrowers. None of the players deserve a bailout including the borrowers.


CyanSnowHawk said...

This is not too surprising. One of my lenders set up the stated income loan before I knew what they were doing. It was so prevalent, that every lender I dealt with assumed that I would be setting up my loans that way.

mike volpe said...

Here is the important point. While a borrower may or may not know how a loan is going to be approved, they had better know what the mortgage payment is because they are the ones responsible for making it. If they sign documents with a mortgage payment they can't afford, they must be held to account for their role.

Anonymous said...

I remember the car salesmen always inquire our income to determine our qualification to buy a new car or a used car. Or better still, they will suggest us to take the bus for a ride.
I remember we buy the house based on income verification, all expanses listed, & W2 Tax Form. Then we confirm all information with our "signature". The lenders would check our sources with the employer & other lenders. What is left after all the deductions made will determine if we have sufficient dollars & cents to pay the rental or the mortgage.

Both the lender & the borrower are responsible of what they sign on the papers. If they sign it, they know the agreement.- It is a loan between two parties. Both parties must be held to account for thier role.