Adventures in Mortgage Fraud
The newspapers were full of news today about the US Attorney’s probe of mortgage fraud which led to the arrest of 400 people nationwide. A headline in the Chicago Tribune screamed “67 from Chicago area charged in U.S. Crackdown on mortgage fraud”. We played a small role in helping to bring down one of these rings. Here’s our story.
One of the nation’s largest cities retained us to help sort out suspected mortgage fraud and we found ourselves performing some forensic accounting. Here’s the short version: suspicion of a fraud ring led to a search warrant and, in a classic case of “be careful what you ask for”, our client found themselves swamped with boxes of files. One thing about mortgages — there’s no shortage of paperwork. We were asked to help make sense of it all.
All the elements you’ve heard about in the worst cases of fraud were there: straw buyers, collusion by appraisers, false documents from compliant CPAs, etc. But, as bankers, what really struck us was how easy the scheme was to detect — and yet the lending banks, including some of the largest and best respected in the country, were so obviously negligent in performing even the simplest due diligence that it seemed at times they were virtual co-conspirators.
Just one example: a dummied up paystub from an out of town corporation would have been easily detected by a telephone search (no listing), web search (not there) or check of business licenses (never heard of them). Yet a leading bank welcomed this newcomer, gave them a multi-million dollar mortgage based on an artificially inflated appraisal, and then a home equity loan for almost all the remaining (non-existent) value. And with the bona fides established by one bank, these fraudsters went to another financial institution, showed their first month’s bank statement from the competition (entirely composed of proceeds from the no-equity home equity loan), and had these new bankers virtually fall over themselves offering even more loan services in order to win the relationship from the competition. Then they went to another bank….well, you get the picture. And this is just one of the inventive schemes we uncovered.
Can’t happen to you? Didn’t happen to you? Maybe, or perhaps similar problems are just lost in the morass of bad loans and it’s hard to see the pattern.
We’ve always been a believer that growing the top line — growing revenue as opposed to obsessive cost cutting – is the only way for banks to succeed. And, yes, we’ve encouraged our clients to be innovative and aggressive. But we’ve also always had a very healthy respect for the controls that need to be in place to provide balance. The current mortgage crisis is not the first time banks have let their guard down and become reliant on the addiction of easy growth as a way to make the numbers and, unfortunately, once there’s been enough time for memories to fade, it won’t be the last.
Mortgage lending is notoriously cyclical. These are bad times now, but this listing ship will right itself. We believe this is a good time for financial institutions that were not overly aggressive during the mortgage run-up to take judicious advantage of the fact that some of the most prominent lenders have over-corrected while sorting out credit problems. But we also believe that many of the lenders expanding today do not have sufficient controls in place to manage their growing real estate loan portfolio.
In the 1st Quarter, credit unions posted $60.9 billion in loan originations with first mortgage originations up 53% compared to the prior year. Many community banks are also reporting double and triple digit gains. This growth needs to be balanced with more dynamic risk management controls. As we see it, when controls fail it is often because they were developed as part of a point-in-time analysis but never evolved into a dynamic, and detailed, system of continuously assessing overall portfolio risk. It’s not just the average credit score, but the weighted average score based on dollars outstanding. It’s not just the score at the time the loan was granted, but the current score today based on regular re-scoring of the portfolio. It’s not just the policies we have in place, but careful audits of exception rates and the impact on risk.
The perp walks staged by the US Attorney’s Office highlight the most egregious cases of fraud, but fraud didn’t create this crisis, it only contributed to it. And while the crisis seems to be abating, it is definitely not over. Many of those lucky enough to avoid the past crisis were just that — lucky– and would be well served to beef up their credit risk management processes now.