Mortgage Fraud - Creating a Crisis in the Housing Industry

This was one of my famous Corsetti housing doom-and-gloom articles. But the stuff on mortgage fraud was priceless at the time. I should have been paid for this stuff :)

So much has happened over the past few months, global equity markets have rallied, the housing bubble seems to be in jeopardy of collapsing, oil prices have come down, gold and silver have regained their footing, the US Treasury yield-curve has inverted again, and the US Dollar index has seesawed back and forth between 84-87 (this is a measure of dollar strength against a basket of currencies).

I will get into my views on the equity, bond, currency and commodity markets over the next few weeks, but I would like to note that there is a serious disconnect between each of these markets – with the bond and commodity markets forecasting a recession in 2007 and the equity market forecasting a “soft-landing” (meaning moderate growth and low inflation) followed by a pick-up in growth. The currency markets are confused and swing back and forth on each piece of economic data.

Cash-Back Loans

Over the past weekend, I have put together some research (see below) on a problem which I think could develop into a serious scandal in the mortgage industry: “Cash-back Mortgage Loans”. They seem to have become mainstream over the past 5 years, the idea being that a homebuyer borrows more than the value of the house so that they can finance “renovations” which theoretically increase the value of the house. Until recently, this type of lax lending standards would never have been allowed by risk managers, shareholders, or regulators – but like so many other things, it’s now a free for all, especially if it helps banks meet their quarterly earnings targets.

Over the past couple of years, a new scam has grown out of these lax lending standards: it seems real estate agents, appraisers, buyers, sellers and maybe even the bankers themselves have teamed up to perpetrate fraud. You can read how they do it and why in the articles below (note these articles are from local papers in at least 5 different parts of the country). If this turns out to be even a fraction as widespread as I believe it might be, this could deal a crippling blow to our banking system (making the S&L scandal of the late 80s look like a misdemeanor).

By the way, this is just one of many potential scandals that may come out of the whole ridiculous housing bubble that gripped the U.S. over the past few years. Also coming soon: Liar’s Loans (loans where you state your income with no verification), Interest-Only Loans (where you pay no principal for the first few years – these are usually adjustable rate), Negative Amortization loans (loans where for the first few years you pay NO principal and only a portion of the interest – the remainder is added back to the principal), and the big kahuna: Adjustable-Rate Loans (where the interest rate is variable – most of these were taken out in 2003-2004 when rates were 1-3%, not closer to 6%).

Unless the housing market can make a comeback over the next two years (I place a low probability on this – but you never know), all of the people taking out the loans above are going to be wiped out. The idea was that they bought places they could not afford using traditional loans (30 year – fixed rate) but figured they could “flip” the houses in a couple of years and make a huge profit. That does not even count the millions of people who became real estate “investors”, agents, mortgage brokers, title insurance, etc…… who were all riding the Easy Al Greenspan Housing Bubble Gravy Train.

It all worked for a while – but like I found out with my AskJeeves.com stock, the music eventually stops and someone gets left holding the bag.

One last comment on the housing market – I pulled this from a Wall Street Journal Article from 1932: “During a panic your home suddenly becomes worthless because nobody wants it.”
As promised – enjoy (or at least do not get too scared):

1. From the Denver Post: “In the Denver metro area alone, more than 1,000 homes sold for at least 110 percent of the original asking price in the 18 months ending in June, according to research.”

“‘It clearly is a problem,’ said Colorado Attorney General John Suthers. ‘We have been looking at house purchases over cost and money going back to the buyers.’ Suthers’ consumer protection chief, Jan Zavislan, said the office is investigating various participants in inflated sales, including buyers, sellers, appraisers, mortgage brokers, real estate agents and title companies.”‘

“We’re looking at potentially every participant in these transactions,’ Zavislan said. ‘We’re just seeing way too many of these things. 'The problem is bigger than all the law enforcement agencies in the state put together.’”

"Sonya Leonard, who owns a real-estate firm, said her own industry is guilty of various practices that can put a false value on a house, from counting basement space in the listed square feet to undercounting how long it has been for sale."

"She told Zavislan she had complained to several state agencies and the FBI when the prospective buyers of one house wanted her to raise the price from $499,000 to $625,000 and kick back the difference to a third party."

“Critics say mortgage companies have little incentive to ferret out inflated sales because they bundle and resell their home loans to Wall Street investors, taking their profits and diluting fraud losses in large pools of mortgage-backed bonds.”

“These securities get ’sold in little pieces all over the world,’ said Lou Barnes, a Colorado mortgage bank owner. ‘It makes it very difficult to figure out who, if anyone, bears any responsibility for the flow of Colorado’s foreclosures.’”

“Marc Loewenthal, a senior VP of New Century Financial Corp., says his company’s mortgage subsidiary financed and resold loans on four of the allegedly fraudulent villa purchases. But ‘the investor has the right to demand we repurchase the loan if there is fraud involved,’ he said. ‘We’re at risk. We do have an interest in keeping fraud down.’”

“New Century grew concerned enough about fraud to install a new screening technology early this year, he said. As a result, ‘we have stopped close to $1 billion in loans.’”

2. The Columbus Dispatch from Ohio. "The peculiar but tempting offers sometimes came a year or more after homeowners planted for-sale signs in their front yards. Interested buyers suddenly appeared, proposing to pay hundreds of thousands of dollars more than the asking price for houses in some of central Ohio's elite neighborhoods."

"The catch: the sellers must agree to immediately refund the difference between the asking price and the sale price. At least 14 such deals worth more than $11 million have closed since spring, and the offers continue."

"'We turned down five of them,' said Bryan Wing, executive VP of CV Perry Builders. 'Believe me, in this day and age, we could have used it.' Others couldn't resist."

"A lawyer for the central Ohio chapter of the Building Industry Association warned group members in October to steer clear of such deals. Even sellers could be held liable if deals turn out to be fraudulent, he said, reminding builders of the danger of lawsuits or criminal racketeering charges."

"'This has been a really recent phenomenon,' said David Martin, chief executive of Stewart Title, which refused some of the deals. 'It's like a whole new industry has formed overnight.'"

3. The Review Journal from Las Vegas : “Glenn Goodman has had his Las Vegas home on the market since March and eventually lowered the price to $379,000 from $430,000. Interesting, he said, that he now has in his possession an offer for the home at $460,000. ‘The buyer wants us to give her $57,000 cash at the close of escrow. Obviously this buyer will then just walk away from the house, leaving it to be foreclosed upon,’ Goodman said. ‘It smells like fraud all over it. The Realtor’s got to be in on it.’”

4. The Tampa Tribune. "A New York lender fears it is on the hook for millions of dollars in loans that now total more than the New Port Richey properties are worth. Lehman Bros. filed suit in Tampa on Tuesday against a group of investors, title companies, a mortgage company and an appraisal company involved in potential mortgage fraud at a Pasco County condominium complex."

"Fifteen defendants used overvalued appraisals in a 'scheme to defraud'
the bank, according to the lawsuit. The 13 properties each were appraised for $733,000. The lawsuit says the triplexes are worth 'barely one-third' of that value."

"Lenders across the country are investigating mortgages that may be worth more than the market value of the properties. Part of the problem, they say, is that lenders usually don't spot problem mortgages until buyers start missing payments."

"Lenders are discovering overvalued loans now for two reasons, said Doug Pollock, a mortgage investigator in Sanford. For one thing, fraudulent loans were easily overlooked during the past five years' real estate boom. Second, industry professionals may be tempted to participate in fraudulent deals to attract business, Pollock said."

5. Again from the Tampa Tribune. "State agencies are investigating potential mortgage and title fraud involving 36 unorthodox real estate deals in the Bay area. The deals aren't an anomaly. 'The reports we're getting are incredible,' said Doug Pollock, (who) investigates problem mortgages.

'This scheme is hitting every county in Florida. It's like people are going to classes to learn how to do this.'"

"How widespread are the inflated deals? The answer, industry experts fear, is that they're everywhere, but there's no way to determine the extent. 'This is prevalent in some areas,' said Brad Monroe, president of the Greater Tampa Association of Realtors. 'It just makes you wonder how many of these deals are going on that we don't know about yet.'"

6. And More from Tampa. “A year ago, Dawn L. Molen quit her job as a commercial loan officer and set out to become a real estate agent. With three months’ experience, the agent who had never listed a home closed her first sale Jan. 27 in a working-class neighborhood.”

“Her buyer paid $45,000 more than the asking price. It stunned her peers. From then on, Molen brought in contracts by the stack.”

“Molen found buyers willing to consistently pay $50,000 to $70,000 more than the original price, according to documents obtained by The Tampa Tribune. Collectively, the homes sold for at least $2 million more than originally listed.”

“But there was something her boss said he didn’t know: Some of the money wasn’t going to the sellers. It was going to a third party with ties to Molen, sometimes without the knowledge of the lenders or the sellers.”

“Molen’s deals have several similarities to cases that have surfaced recently across the nation, some of which have resulted in investigations or prosecution for illegal activity. As the torrid real estate market has cooled nationwide, more industry professionals may take chances to make a deal, experts say. Lenders say they are bracing for a fallout in which buyers ultimately default on their mortgages.”

“Local real estate agents fear future buyers in the neighborhoods involved in the transactions may not be able to afford homes or higher taxes as a result of inflated prices.”

“More than a dozen sellers and listing agents interviewed by the Tribune said they felt uneasy about the transactions but went along after employees at the title company assured them they were legal and not unusual. ‘As long as I got my $180,000, I didn’t care what they were doing,’ said John Dieumegarde.”

“Now, other appraisers are stumbling across Molen’s deals as they search for comparable home sales to help determine the value of nearby properties. On paper, the sales appreciation is astonishing, said appraiser Doug Nail.”

“‘This is not a $250,000 neighborhood,’ Nail said, referring to one in St. Petersburg.”
“Nail evaluated one of Molen’s sales for the Tribune, without relying on recent sales represented by Molen. He estimated the house’s value at about $145,000. One of Molen’s buyers paid $250,000 for the house in September.”

“Appraiser Caryn Blauser was astonished by what she found. Molen’s sales are not isolated. She has found many local homes selling for substantially more than the original price. ‘There’s some weird stuff going on,’ Blauser said. ‘The buyers may chalk it up to creative financing, but we may soon see a lot of mortgage foreclosures because everyone wanted to make a quick buck.’”

7. Northern California - Although he beautifully renovated it and priced it below market, the Oakland bungalow just wouldn't sell. Deals fell through repeatedly for bizarre and unrelated reasons: Buyers got cold feet or moved -- one was even arrested.

By the time the fourth deal collapsed, the developer was in a state of financial panic. So, when one of the mortgage brokers who had helped a previous prospective buyer called with a new one who would close the deal for -- get this -- $100,00 over the asking price, he naturally jumped at the offer.

"The catch was that I had to give the $100K back to them after the close of escrow," the guy told me, still looking shell-shocked. "I couldn't understand why they would want to do that. The place was completely remodeled."

(Most buyers who get cash back after escrow pour that money into repairs. Typically, though, lenders like to keep this amount to no more than 3 percent of the purchase price.)

The developer went through with the sale, wondering what his buyers (whom he never met) were up to. Because he wasn't lying about anything -- everything was disclosed on the purchase contract -- he didn't feel he was doing anything wrong.

A couple weeks later, another friend who is a real estate agent called me. "I think I have a scoop for you," he told me, his voice vibrating with gumshoe grit. He'd heard that a prominent East Bay company was training its agents to inflate properties by $50,000 to $150,000, then have sellers return the cash after the close of the deal.

Unlike the arrangement with the developer, these deals were concealed from lenders by adding the cash-back arrangement onto an addendum apart from the purchase contract.

How did my friend hear about this practice? A local manager of a prominent real estate company had tipped off my friend's broker over lunch. The manager, who had been shocked at the behavior, had then gone back and looked at his own agents' files to see whether the practice ever happened in his own office. "The guy said he found so many in his own files in the past couple weeks, he didn't want to look anymore," my agent friend said.

What exactly was happening here? The developer didn't think he was doing anything illegal, and the broker had no idea the inflation was happening on his watch. But in both cases, everyone involved probably would have been considered at least partially culpable if the lenders could mount a case that they were being deceived.

8. More From Denver - Denver attorney John Head, along with several Realtors and brokers in the audience, said the state isn't doing enough to crack down on mortgage fraud. James Spray of America's Mortgage LLC said bringing cases of mortgage fraud to the attorney general's office 'is like complaining to a black hole.'"

"(Realtor) Sonja Leonard said that in one case, a Denver home was purchased for $1.3 million in December, listed for $2.25 million in April, and the price was lowered to $2.15 million in June. Then in August, it was placed under contract for $3.1 million."


9. Liars Loans and Cash-Back juxtaposition - The last example I am including is perhaps the most striking. A 24-years-old real estate “investor” from California (here is his website: http://iamfacingforeclosure.com/). He discusses how he was able to secure financing of 6 homes for over $2.2 million dollars (all cash back at close) on which he has been able to sell only one house – at a loss.

At least one loan is from Countrywide Financial (although he is no longer publishing the names of the lenders) and he use “liar loans”, or stated income loans in which he admits that he lied (with lender knowledge) about his income and intent to live in the homes – both in order to qualify for the loan.