How Big a Problem is Mortgage Fraud?
December 27, 2009
Whether you find a recent post on the blog Seeking Alpha completely persuasive or not, it’s a useful reminder that at least part of the reason for the mortgage crisis was fraud, pure and simple. (Thanks to former colleague John Fulford for linking me to this post.) Whether through predatory use of unsuitable products to churn mortgage debt through unsophisticated/greedy/ignorant homebuyers/refinancers, through total misrepresentation of a borrower’s qualfications in order to write a loan and earn a fee, or through blatant disregard of investors’ terms and conditions for qualified loans in securitizations, there can’t be any doubt that the mortgage system at the height of the housing bubble was riddled with fraud.
Hopefully, aggrieved investors will prosecute those who defrauded them. Hopefully, as Seeking Alpha suggests, we’ll see some perp walks and folks learning how to accessorize orange jump suits.
But what to learn from all this, and what to do about it in the future?
- When investors require reps and warrants, they must put in place reliable quality control systems to actually check whether their counterparties are playing fair. Folks inside every securitizer/investor/lender will push back on tough QC procedures—they alienate the client, they push business to others with fewer qualms, “my comp is based on what I sell, and your dumb procedures are costing me money.” The example cited in the Seeking Alpha post make it clear that the fraud was there to be found from the start. Why should it take a forensic review of the securities to ferret it out? Unless the mortgage industry gets way more serious about how they review and manage counterparties, the sheer volume of the US housing market is an open invitation to commit fraud. Chances of being caught are small, the cost of paying up can be negligible, and if the risks are sliced into dozens or scores of pieces held by hundreds of investors, who’s gonna know or even care?
- Every player in the mortgage conveyor belt should get paid not for production but for long-term performance. Brokers can be paid a portion of their fee on delivery, the rest over the first three years, when early payment defaults are most likely to show up. If they underwrite solid borrowers, they will get paid. If they cheat or cut corners, it’s their compensation that’s at risk. The same right on up the chain. During the height of the boom a secondary market colleague who should know told me one of his customers replied to voiced concerns about credit quality in the loans he was delivering, “Hey, we are simply a conveyor belt. We move the loan from the originator to you. The rest is not our problem.”
- Housing and mortgage counseling by unrelated parties should be mandatory for any low downpayment or equity stripping refinancings. First time homebuyers are especially vulnerable, but owners suckered by refinancing offers also ended up with toxic mortgages that are putting them out of their homes.
- Disclosures at loan settlement should be clearer than they are today, and delivered to borrowers with plenty of time to review them. The Federal Reserve Board recently closed a months-long comment period on changes to its Regulation Z, covering Truth-In-Lending disclosures. They recommended a heap of really good changes. They’ve received strong support from Consumer Federation of America, National Consumer Law Center, Center for Responsible Lending and others. (Check out the Fed’s regulatory pages to see copies of these and other comments on the proposed rule.)