Mortgage Fraud: Where's the Fix?

Mortgage Fraud: Where's the Fix?
By Peter Goldmann

In 2004, the FBI warned that mortgage fraud was growing so rapidly it could become "the next S&L crisis."

In 2005, The Bureau reported that mortgage fraud suspicious activity reports (SARs) more than doubled from 6,936 in 2003 to 17,127 in 2004.

Fast-forward to mid-2009. The FBI reported that the number of mortgage fraud SARs filed in fiscal year 2008 was 63,173, with more than $1.5 billion in losses. Through April 30, 2009, the total was already 40,901. It is true that SARs reported by the FBI reflect suspicious financial activity that occurred two to three years earlier. But industry experts say that the upward trend in SARs is set to continue for years to come, suggesting that mortgage fraud is getting worse, not better. And other, more up-to-date statistics bear this out.

According to a March 2009 report by the Mortgage Asset Research Institute (MARI), a unit of Lexis-Nexis, "fraud incidence is at an all-time high and is comprised of continuing application misrepresentations and multiple verification-oriented issues. Fewer loan originations coupled with increased fraud incidence equals new times of desperation. Industry expertise and technological advancements, when mixed with desperate people and opportunities, are catalysts for the continuation and growth of fraud."

In other words, desperate people are filing more fraudulent mortgage applications and this, coupled with industry expertise on the part of presumably dishonest mortgage brokers, appraisers and others and new technologies has created a whole new set of forces fueling a new post-meltdown boom in mortgage fraud.

What's wrong with this picture?
What is incredibly difficult to understand is why legitimate, federally insured banks that processed bad loans by the boatload in the years of the real estate bubble apparently haven't learned the tricks of the fraudsters' trade and found ways to protect themselves against these scams.

Have they not heard the age-old idiom, "Fool me once, shame on you; fool me twice, shame on me?"

In 2004 you could almost understand why banks would be victims of mortgage scammers. Before 2002, there were plenty of cases of mortgage fraud that the FBI investigated, but it was a small fraction of the number in 2008. In 2003 and 2004, the number grew, but it was still small compared to 2007 and 2008. So, maybe banks weren't prepared for the onslaught of various types of fraud involving bogus applications (such as so-called "liar’s loans"), phony appraisals, use of straw buyers to generate illegal sales among others. But between then and now, there was a little thing called the subprime mortgage meltdown which played rather more than a bit part in the drama of the financial system collapse in 2007-2008.

During the subprime mortgage period of 2004-2008 the FBI reported that the number of mortgage fraud incidents being investigated was skyrocketing. This was no doubt a product of the housing boom which fueled a feeding frenzy by dishonest and unregulated mortgage brokers, appraisers and non-bank lenders, with some help from corrupt attorneys and unscrupulous borrowers. Once Wall Street got into the act by vacuuming up every subprime mortgage they could use as collateral for securities they could sell off to big investors, the upward spiral in housing prices shifted into overdrive.

Unfortunately, along the way, a number of these players lost site of their moral compasses and the FBI's 2004 prediction about mortgage fraud became a terrifying reality.

So today, having been burned by mortgage scammers to the tune of untold billions of dollars, the "excuse" that banks don't know what to look for in the way of red flags of mortgage fraud no longer flies -- not even close. Yet mortgage fraud is getting worse.

The reason for this mind-boggling continuation of bad business as usual is probably unknowable. One banking fraud prevention manager rather bluntly sums up the problem this way: "Banks have done little to improve the control environment. The entire industry is consumed with conservatism." An executive hired by Goldman Sachs during the subprime heyday to conduct due diligence on mortgages being collateralized says that mortgage fraud is still being perpetrated in the same way it has been for the past 10 years or more. Lenders too greedy to enforce responsible lending standards are looking the other way when brokers bring them fraudulent mortgage applicants. And their incentive to scrutinize the applications is further diminished by the fact that they plan on selling off the loans anyway to the secondary market.

Whatever is still enabling mortgage fraudsters to victimize borrowers and legitimate lenders needs to be fixed -- if not by the banks themselves, then by the government. Why should investors continue to suffer at the hands of incompetent (or corrupt) mortgage lenders who after the biggest mortgage meltdown in U.S. history continue to process fraudulent loans and to eat major losses when they go bad?

The Control Issue
If we wait for Washington to generate new regulations from among the myriad proposals now sitting in various committees, the losses will continue to mount and the fraudsters will continue to make off with honest peoples' money.

So, that leaves the banking industry to its own devices. Which is what it wanted in the first place. After years of pressuring Washington to loosen regulations, now they find themselves in a position where some form of regulation is unavoidable if they are to deter crooked mortgage brokers, appraisers and non-bank lenders from continuing to rip them off.

According to MARI, "to combat fraud, the (banking) industry must pay attention to details. Mortgage bankers must act with a sense of constant vigilance to protect their pipelines from becoming tainted with preventable fraud risk by leveraging smarter technologies and acquiring more relevant information about their customers, employees and vendors. Community bankers, steadily growing their own mortgage pipelines, are learning from the mistakes of others that they must do the same. The rules have changed and the stakes have been raised. The burden of responsibility rests with the industry if it is to sustain itself and prevent further losses due to reasons other than the rise of delinquencies and foreclosures and recession-related jobless claims."

Though somewhat of an understatement, there is no clearer way of saying that to get a grip on the scourge of mortgage fraud, the institutions that are suffering the losses need to get cracking on implementing controls to protect themselves. The bad guys are not going away. If anything, as long as they see opportunities to steal in the form of lax mortgage banking controls, they will keep coming back again and again.

If you're a skeptic (like me), you probably aren’t holding your breath that an industry that is "consumed by conservatism," as our bank fraud manager so aptly put it, will ever really put into place the internal controls necessary to reduce fraud.

That means government will be forced to step in. But how? Will we need a mortgage banking variety of Sarbanes-Oxley to force banks to strengthen their anti-fraud controls? Or will simply requiring mortgage brokers and appraisers to be registered with some type of federal oversight body be enough to at least stem the bleeding?

One thing is certain: There is no shortage of controls and regulations that could be implemented and enforced to make it tougher for fraudsters to do their thing. There are five federal banking regulatory bodies and 50 state counterparts. Between them there is a plethora of anti-fraud controls that could and should be implemented. If only a fraction of them were properly implemented, we'd probably see a significant drop in mortgage fraud.

Unfortunately, as has been the case for so long in the financial services arena, this is much easier said than done.

Source: www.acfe.com