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Mortgage loan fraud is a common and often overlooked crime; it is taking place with increased prevalence today, due to the predominance of third-party loan originators (both brokers and conduit lenders). This type of fraud takes many different forms and is committed by buyers, sellers, attorneys, title companies, and others; in most cases it is overlooked by individuals, corporations, and law enforcement because it is seen as a “victimless crime”. In recent years, the booming real-estate market has fueled this criminal activity; mortgage loan fraud has become a crime with both victims and harsh consequences.
In present day, banks and financial institutions have become inundated with “bad loans”, many of which are “bad” because they were fraudulently obtained. This plethora of defaulted loans has been a huge factor in the downfall of the lending industry. Mortgage loan fraud is a term used to describe a broad variety of criminal actions in which the intent is to materially misrepresent or omit information on a mortgage loan application in order to obtain a loan or larger loan than would have ordinarily been obtained.
Mortgage fraud is a low risk, high yield criminal activity that accounts for an estimated four to six billion dollars in annual losses. The FBI alone has 42 task forces dedicated to loan and real estate fraud. In the 2008 fiscal year, there were 62, 494 suspicious activity reports related to mortgage loan fraud, with billions of dollars in losses; that same year, the FBI had 523 indictments and 282 convictions related to these crimes. There are several common deceptions often employed in different types of mortgage loan fraud.
Deceptive purchase contracts may inflate the contract purchase price; this is done because many appraisers and lenders think of the purchase price as being evident of the true market value. These deceptive contracts are becoming increasingly common in the commercial arena as well. Property appraisers are under intense pressure to hit the sale prices of a home or property; they often “rubber stamp” it without truly appraising the property. This pressure often comes from mortgage companies themselves, who want the appraisers to provide the correct numbers so the deal goes through.
There may be hidden seller concessions, such as seller financing and repair allowances. Bogus offers to purchase are one of the oldest and most transparent scams; these are attempts to provide indicators of high market value. Other common deceptions include illegal improvements, extraordinary appraisal assumptions, misrepresented or undisclosed property conditions, false operating statements, straw tenants, phantom renovations, and misleading or erroneous statistics. Mortgage loan fraud is often confused with predatory lending.
Predatory lending typically affects senior citizens, lower incoming borrowers, and those with bad credit. Predatory lenders force borrowers to pay exorbitant loan origination and settlement fees, subprime or more interest rates and unreasonable service fees. These borrowers often end up defaulting on the mortgage payments and are forced to refinance or be foreclosed upon. Mortgage loan fraud can be divided into two general categories: fraud for financial profit (obvious fraud), and fraud for property/ housing; there are also several subcategories within these large designations.
Fraud for profit often involves multiple loans and schemes to gain illegal proceeds from property refinance and sales. This type of fraud receives the majority of law enforcement attention, and the participants are frequently paid for their participation in the scheme. Fraud for profit is associated with early payment defaults; the perpetrators disappear quickly and leave behind a property worth only a fraction of its appraised value. This type of fraud occurs most commonly in a property-flipping situation, where a buyer will purchase a dilapidated property and resell it at an inflated price to a “straw buyer” or a “duped buyer. The “straw buyer” will never occupy the property, and may be complicit in the fraud scheme. A “duped buyer” has no cash or good credit, and has been induced into buying a home at an inflated price with the incentive of no money down. Fraud for profit is often supported by inflated appraisals, false income statements or verifications of income, and/or false verification of deposits to deceive out-of-town lenders. There are four major subcategories of obvious fraud: • Appraisal fraud. This is frequently associated with the aforementioned property flipping. Lenders rely on accurate appraisals to nsure that loans are fully secured. In appraisal fraud, appraisers fail to accurately evaluate the property; this may be unintentional, or they may intentionally become a party to a fraud scheme begun by the lender or borrower. • Identity theft. This is very common in both the real estate and credit card markets, and involves a borrower who assumes the identity of another person in order to secure a loan. The thieves take the overage and run. Both victims (the bank and the person whose identity was stolen) typically incur financial losses. • Cash-back schemes.
Here, the price of a property is illegally inflated in order to provide a cash-back transaction to the participants. Many times, the borrower will receive a rebate which is hidden from the lender and not stated on the HUD-1. In this situation, the lender is bamboozled into lending more than the actual property value, and the buyer and/or participants benefit financially. Cash-back schemes go hand-in-hand with appraisal fraud; they are very common. • Shotgunning. Here, the same home is used to obtain several mortgage loans simultaneously, in excess of the actual value of the home.
The perpetrator applies for several loans on the same property with different lenders without their knowledge of the other loans. The closings are scheduled very close together (often on the same day); these scenarios leave lenders with large losses because the first mortgage secures the first position and the subsequent mortgages are junior. The property value is not sufficient to cover all mortgages in foreclosure. Another type of fraud is called “hidden fraud”, or fraud for loans.
In this scenario, there is the intention to repay the lender if the property’s value and performance as in income property increase; however, the buyer defaults if the property value plummets, leaving the lender with devalued land or property. This type of fraud usually involves misleading or corrupting a real estate appraiser; the appraiser effectively tricks the lender into lending more money than can be secured by the property. Payment defaults in hidden fraud occur at least a year after the origination of the loan; lenders usually don’t think to look backward in time for fraud during the loan origination.
This type of fraud is on the rise, now that more commercial properties are experiencing a decline in performance and revenue. Borrowers often know that they are in financial trouble long before the lenders do, and hidden fraud is commonly used to mitigate risk and maximize equity investment. Fraud for property/ housing includes misrepresentations by the applicant for the purpose of purchasing a property for a primary residence. The purchase usually involves only a single loan, but sometimes includes creative financing and multiple mortgages.
The applicant may conceal debt and overstate their income; however, their ultimate goal is to repay the loan. There are four sub-categories of property/ housing fraud : • False disclosure of liabilities. Borrowers intentionally conceal credit card, mortgage, and other debt. This intentional omission of debt will improve the income-to-debt ratio of the borrower and induce the lender to make a loan that has a larger chance of default. This is considered fraud because the lender is induced to grant a loan that would otherwise not have been granted, or to grant a larger loan than would ordinarily have been granted. Employment fraud: claims of higher positions and/or false companies. The borrower will claim that they hold a higher position within their company than they actually do; along with that often goes an inflated salary. Alternately, the borrower may create a fictional job at a non-existent company and forge necessary documents such as W-2’s, letterhead, and income tax returns. This form of fraud is quite common and is often assisted by mortgage brokers. Many times, the brokers are well-versed in forgery and know exactly which documents financial institutions will need to facilitate the loan. Occupancy fraud. This most commonly occurs when the borrower wants to obtain a mortgage to acquire an investment property, but states on the mortgage application that they will use the property as their primary residence. The borrower normally obtains a better interest rate this way, as lenders typically charge a higher interest rate for non-owner occupied properties. These types of properties have a higher percentage of foreclosure. • Income fraud. In this type of fraud, the borrower overstates their income in order to qualify for a mortgage or a larger loan amount.
Income fraud often involves the borrower and/or loan officer creating false income documentation, such as income tax returns, bank records, and W-2’s. Literature Review A great deal has been written about the problem of mortgage loan fraud, especially in recent years; much of it has been published by the FBI and the IRS, the two government agencies primarily responsible for the bulk of investigations into this type of fraud.. The FBI (2008) reported that the estimated annual losses due to mortgage loan fraud range from $4-6 billion dollars; in 2008 alone, the FBI received 62, 494 suspicious activity reports (SAR’s), with $1. billion in resulting losses. In August 2008, there were 1, 569 pending mortgage fraud investigations; 462 cases were opened in 2007, as compared to 295 in 2003. In a press release, United States Attorney David E. Nahmias (2008) stated that Atlanta and North Georgia were hotbeds of mortgage fraud and announced a sting operation called “Operation Malicious Mortgage”, a nationwide program designed to target mortgage fraud and related offenses. From March 1 to June 18th, 2008, Operation Malicious Mortgage resulted in 144 mortgage fraud cases in which 406 defendants were charged.
The FBI estimated that these cases alone generated over $1 billion dollars in losses. The Financial Crimes Enforcement Network (2006) published a document called “Mortgage Loan Fraud: An Industry Assessment based upon Suspicious Activity Report Analysis”. This lengthy document details vulnerabilities identified in SAR narratives, mortgage loan fraud suspicious activity report findings, reported suspicious activities in samples narratives, and emerging mortgage fraud schemes. The vulnerabilities identified in the study were: • Automated loan processing: increasingly, loans are being processed automatically.
These faceless transactions increase the opportunity for fraud (identity fraud in particular). Automated loan processing, when coupled with low-document and no-document loans, creates a condition particularly vulnerable to fraud. • Sub-prime loans associated with suspected fraud: This type of lending involves higher-interest loans extended to consumers with damaged credit histories or no credit histories. These lending packages were originally designed to allow more low-to-moderate income individuals to quality for home loans.
This study found a pattern of exaggerated or fabricated income associated with these sub-prime loans • Mortgage broker originated loans: the National Association of Mortgage Brokers reports that as many as two-thirds of mortgage loans are now originated by mortgage brokers. (Financial Crimes Enforcement Network, 2006) There are no national standards for licensing and oversight of mortgage brokers; 24 states have no specific educational requirements for mortgage brokers, and only a few states require criminal background checks on them.
This makes it easy for unethical individuals to move from one firm to another. • Identity theft: associated with both fraud for profit and fraud for property. Identity theft was characterized as a suspicious activity on 1,761 (2. 13%) of SARs involving mortgage loan fraud filed from January 1st, 2003 to March 31st, 2006. (Financial Crimes Enforcement Network, 2006) • Fixed income and elder exploitation: individuals who are elderly and/or on a fixed income are often a target for fraudulent schemes.
Retirees were identified as subjects in 769 (1%) of the SARs involving mortgage loan fraud filed between April 1, 1996 and March 31, 1996. (Financial Crimes Enforcement Network, 2006) The Financial Crimes Enforcement Network (2006) also identified a list of reported suspicious activities involving the reported fraudulent mortgages. 83. 65% of fraudulent loans were residential real estate purchase loans. 12. 17% were residential refinance loans, home equity/lines of credit loans, FHA Title One loans, or second Trust loans, and 1. 2% were new construction loans. Materials misrepresentation and false statements were reported on 65. 78% of the sampled loans; identity fraud was reported on 3. 9% of the loans. 36. 71% of the loans in question were originated by mortgage brokers or correspondent lenders. The following types of loan falsifications were reported in the sampled SARs: • Altered bank statements • Altered or fraudulent earnings documentation • Fraudulent letters of credit • Fabricated letters of gift Misrepresentation of employment • Altered credit scores • Invalid social security numbers • Silent second trust (occurs when a seller takes back a second trust from the buyer in lieu of a cash down payment. The lender is not aware of the second trust. ) • Failure to fully disclose debts or assets of the borrower • Mortgage brokers using the identities of prior customers to obtain loans for customers who would otherwise not have qualified for the loan
Other fraudulent activity reported in the sampled SARs included: • Loan closing services failed to properly disburse loan proceeds or pay off property leins, including prior mortgage trusts • Loan settlement officers failed to pay insurance premiums from funds collected at settlement • Borrowers signed multiple mortgages on the same property from multiple lenders • Loan closing services failed to record the mortgage in property land records • Prior lenders failed to release home equity loans in land record offices after receiving mortgage funds, causing the new lender’s loans to have a subordinate position.
Homeowners continued to use the prior lines of credit in addition to the new loan in order to obtain an extension of credit that exceeded the property value • Mortgage brokers or lenders failed to ensure proper signatures on all documents • Real Estate Settlement Procedures Act violations by lenders accepting kickbacks from mortgage brokers • Elder exploitation in which older individuals were persuaded to sign loan documents without understanding borrower rights and responsibilities • Theft of debit card or convenience checks associated with home equity lines of credit • Fraudulent bankruptcy filings to stall or prevent foreclosure • Suspected use of real estate purchases to launder criminal proceeds (Financial Crimes Enforcement Network, 2006) As far back as 2003, the IRS reported an increase in real estate fraud investigations. At that point, the IRS had over 4,000 returns under audit involving individuals and entities associated with the real estate business.
In their report, they list the three most common mortgage fraud schemes as involving property flipping, two sets of settlement statements (one accurate set is provided to the seller, and a second fraudulent set showing a highly inflated purported selling price is provided to the lender), and fraudulent qualifications. The FBI’s 2007 Mortgage Fraud Report published several more recent key findings. The FBI reported that mortgage loan fraud continues to be an escalating problem in the United States, and that subprime mortgage issues remain a key factor in influencing mortgage fraud directly and indirectly. Since the declining housing market directly affects many in the mortgage and real estate industry who are paid by commission, certain unethical individuals may take advantage of industry personnel attempting to generate loans to maintain current standards of living in a down market.
The FBI stated that mortgage loan fraud was most concentrated in the north-central United States. The top 10 states for this type of fraud in 2007 were Florida, Georgia, Michigan, California, Illinois, Ohio, Texas, New York, Colorado, and Minnesota. (Federal Bureau of Investigation, 2007) Legal Proceedings The upsurge of mortgage loan fraud in recent years has led to an increase in criminal prosecutions and convictions for this crime. 2008 alone saw a huge number of convictions and imprisonments resultant of fraudulent loan activity. On December 4th, 2008, three Palm Beach County residents were sentenced for their participation in a fraud scheme involving $6. 5 million dollars.
Lauren Jasky was sentenced to 36 months in prison and 5 years supervised release, Ralph Michel was sentenced to 30 months in prison followed by 4 years supervised release, and Barry Louidort was sentenced to 37 months in prison and 5 years supervised release. The defendants pled guilty to conspiracy to commit bank fraud and mail fraud; Michel and Louidort also plead guilty to a money laundering charge. This investigation began when the Florida Office of Financial Regulation conducted an audit investigation into 24 sub-prime mortgage loans initiated by Compass Mortgage Services, Inc. of Boca Raton, FL. The audit revealed that the loans included excessively large fees, ranging from $29,000 to $650,000 paid to Louidort and Michel.
The fees were described as “marketing or assignment fees”; in truth, however, the fees were kickbacks based on inflated property sales prices. The audit revealed that the majority of the loans in question were initiated by Jasky, who was also the senior vice president of Compass Mortgage. The defendants fraudulently bought and sold residential property in Palm Beach County, Florida; Louidort and Michel received the “marketing and assignment fees”, and Lasky received mortgage brokerage fees. The defendants also prepared fraudulent loan applications containing false information about the borrower’s employment history, income, funds on deposit, and rent history for the purchasers and submitted these applications to the lenders. On November 24th 2008, Michael Guy Cary, Sr. was sentenced to 60 months imprisonment and ordered to pay a $5 million dollar fine for money laundering, bank fraud, and conspiring to commit mail fraud. Cary’s fraud scheme involved the purchase and sale of 211 Texas homes; the purchases and sales involved a variety of fraudulent activity, including artificially inflated appraisals and deceptive dealings with buyers, many of whom believed they were buying the homes directly from the builder (Cary had purchased the homes from the builder himself and arranged transfer of the deeds names deceptively similar to those of the builders). Cary’s accomplice, Richard Kirkpatrick, provided the inflated appraisals on 89 of the 211 properties.
On November 4th, 2008, Toby Groves was sentenced to 24 months in prison and 3 years of supervised released in Cincinnati, Ohio; he was also ordered to pay $299,997 in restitution to the Internal Revenue Service for income tax evasion and bank fraud. Groves owned Groves Funding Corporation (Groves Funding); from June 2003 through 2005, Groves provided loans to the purchasers of residential real estate through his business. Groves obtained the funds to do so through a line of credit given to the business by another financial institution. Groves funding, in turn, sold these loans to other financial institutions in order to obtain loan proceeds from lenders at interest rates and in a greater total sum that we would have otherwise been able to obtain.
The loan applications and real estate closing packages that Groves submitted to the lenders contained false statements and omissions of pertinent information that induced the lenders to provide funding that they otherwise would likely not have provided. Groves even provided these lenders with fraudulent tax returns that were never filed with the IRS. On November 3rd, 2008, Carlos Bent of Tuscon, Arizona, was sentenced to 16 months in prison and ordered to pay $867,916 in restitution for wire fraud and engagement in illegal monetary transactions. His mortgage fraud scheme defrauded a total of $13 million from various lenders. Bent and co-defendant Frank Padilla convinced owners of real estate that had not sold despite considerable time on the market to use them as sales agents.
Bent and Padilla told these owners that their properties were worth significantly more than the listing price; the owners were promised that a buyer would be found if they would agree to a “net listing” wherein Padilla and Bent would retain any sales proceeds above the asking price. The defendants found “straw buyers” who, for a substantial fee, served as the purported purchasers of these properties. The defendants and other accomplices created fraudulent documents that included false employment verifications, bank statements, mortgage loan applications and contractor’s licenses in order to qualify their straw buyers for 23 mortgages from various banks that totaled over $13 million. The straw buyers “purchased” 21 properties (two properties were “sold” twice). Minimal or no payments were made on each of the properties and the loans went into default and foreclosure. The defendants also negotiated 33 checks, totaling $1. million, from title companies for currency. Each check was for more than $10,000 and represented proceeds from the fraud scheme. Frank Padilla was imprisoned for 24 months and ordered to pay $1. 1 million in restitution to the financial institutions involved. On October 30th, 2008, Gregory Claude Brown was sentenced to 20 years in prison, followed by 3 years supervised release, and was also ordered to pay $2 million in restitution to the victims of his fraud scheme. Brown was convicted by a jury of conspiracy, wire fraud and mail fraud committed as a part of a scheme to obtain over $9 million in fraudulent home mortgages by submitting false information to banks.
Additionally, Brown was found guilty of failing to file his federal income tax returns for 2001 through 2005 and of income tax evasion with regard to his 1998, 1999, and 2001-2005 income taxes; the total amount involved was $214, 299. Brown was found to have engaged in willful acts of evasion, including concealing income and assets, filing false documents with the IRS, and placing funds and property in the names of nominees. Brown and his accomplices created false income tax returns to prove their statements of income on the mortgage applications; Brown filed these false returns with the IRS significantly after they were due, and failed to pay taxes due. However, during this time period he bought more houses, a 40-foot power boat, traveled to foreign countries, leased luxury vehicles, and bought other luxury items.
His co-defendant, Monica Martinez (Brown’s girlfriend) was sentenced to 3 years of probation. Second co-defendant Wilfredo Martinez was sentenced to 12 months probation for wire fraud. On September 11th, 2008, Eric Kendall Taylor of Lee’s Summit, Missouri was given a 63-month prison sentence for participating in a $5 million mortgage fraud conspiracy. Taylor pled guilty to conspiracy and money laundering; he was also ordered to pay $1. 4 million in restitution. In August 2006, Taylor invested in residential real estate using the business name C and K Co. to create false second mortgages on properties and to obtain loan proceeds. He created other fictitious businesses in order to falsify employment and income information.
Taylor bought residential properties after foreclosure, then recruited straw buyers to purchase the properties and obtained mortgages for them. Taylor submitted false and fraudulent loan applications with falsified supporting documentation to lenders in the name of his straw buyers; he also purchased a false Social Security number and false payroll stubs to back up the fraudulent information on the applications. He even had a business telephone line installed in the home of one of his relatives to list on the loan applications as his employer’s telephone number. In August 2008, Molly Heise was convicted of participating in a money-laundering scheme involving the defrauding of $2. 5 million from the clients of her real estate closing company, Profile Title and Escrow Corporation.
Heise was sentenced to 70 months in prison and 3 years of supervised release; she was also ordered to pay $134,000 in restitution. Heise’s corporation closed real estate transactions between 2002 and 2003; the corporation accepted hundreds of millions of dollars in wire transfers and check deposits from both buyers and lenders; the funds were intended to be held in escrow for the purpose of closing residential real estate deals. During this time, Heise moved $370 million of these funds to a secret escrow account that she used to pay her personal expenses. Georgia resident Riley Graham (aka Riley Williams) continued his fraudulent dealings even while in prison awaiting sentencing for mail fraud, wire fraud, and money laundering.
Graham was sentenced to 120 months in prison, followed by 3 years supervised release and $670,000 in restitution payments. Graham and his partner, Marcus Alcindor, obtained a $1. 3 million loan in the name of “Alcindor-Williams Group LLC”, using fraudulent means to obtain the loan. The houses purchased with this loan were then resold at greatly inflated prices to “straw buyers” who applied for mortgages based upon the inflated price. The straw buyers were complicit in the scheme and were paid for their participation out of the loan proceeds. While Graham was in jail awaiting sentencing his for his crimes, he used the jail telephone to contact his associates on the outside and attempted to continue obtaining fraudulent loans.
Fraud indicators such as inflated appraisals, exclusive use of the same appraiser, commissions and bonuses paid to appraisers and brokers, fake supporting loan documentation and short-term investments with guaranteed re-purchase rates are used by law enforcement, along with sophisticated databases to combat fraud. Since 1999, the FBI has been actively investigating mortgage fraud throughout the United States. (Federal Bureau of Investigation, 2007) The Bureau also focuses on working with the mortgage industry to foster awareness of fraudulent practices. There are seemingly countless mortgage loan schemes; however, law enforcement focuses its resources on those perpetrated by industry insiders. Federal Bureau of Investigation, 2007) The FBI and IRS are engaged with the mortgage industry primarily in identifying fraud trends and educating the public. There are nine federal statutes by which the government charges criminals for mortgage fraud: 18 U. S. C. 1001- Statements or entries generally 18 U. S. C. 1010- HUD and Federal Housing Administration Transactions 18 U. S. C. 1014- Loan and credit applications generally 18 U. S. C. 1028- Fraud and related activity in connection with identification documents 18 U. S. C. 1341- Frauds and swindles by mail 18 U. S. C. 1342- Fictitious name or address 18 U. S. C. 1343- Fraud by wire 18 U. S. C. 1344- Bank fraud 18 U. S. C. 08 (a)- False social security number Mortgage loan fraud is currently punishable by up to 30 years in federal prison, a $1,000,000 fine, or both. The FBI states, “It is illegal for a person to make any false statement regarding income, assets, debt, or matters of identification, or to willfully overvalue any land or property, in a loan and credit application for the purpose of influencing in any way the action of a financial institution. ” (Federal Bureau of Investigation, 2009) Economic Consequences The dramatic rise in mortgage loan fraud and consequent delinquencies and foreclosures has resulted in the subprime mortgage crisis in the United States.
Although the crisis actually began in the late 1990’s, it first truly became apparent in 2007; it has been through the subprime mortgage crisis that the country first realized the true scope and extent of fraudulent and predatory lending practices and the extensive lack in industry regulation. The “trigger” of the subprime crisis occurred when the “housing bubble” in the United States burst (Lahart 2007). Quickly after the bubble burst, there was a dramatic increase in the default rate on subprime and adjustable rate mortgages. In the years leading up to 2007, borrowers had assumed difficult mortgages in the belief that they would quickly be able to sell their property when the need arose, or refinance with more favorable terms. Interest rates began to climb in 2006, and housing prices simultaneously began to decline.
Refinancing became more difficult, and there followed high default rates on subprime and adjustable-rate mortgages; these defaults increased as the easy initial terms of the mortgages expired and ARM interest rates shot up. Home prices failed to rise, which resulted in homes whose mortgages were worth more than the actual property, thus providing owners with the incentive to enter foreclosure. This flurry of foreclosure activity began in late 2006. In 2002-2004, easy credit conditions existed; interest rates were low, and vast amounts of foreign money were entering the United States economy. These easy credit conditions contributed to housing and credit bubbles; consumers obtained loans easily and took on huge amounts of debt. Bernanke, 2009) These years saw a significant increase in financial agreements called mortgage-backed securities (MBS); these securities derive their value from mortgage payments and housing prices. As housing prices subsequently declined, major financial losses were reported by global firms that had invested in subprime MBS. During the housing boom of the 1990’s, lending behavior changed dramatically as lenders offered money to higher-risk borrowers. In 1994, subprime mortgages amounted to $35 billion (5% of loan originations); in 2006, subprime loans accounted for $600 billion (20% of total originations). (Bernanke 2009) At the same time, lenders were also offering riskier loan options, such as mortgages with no down payment. Another high-risk option, called the “Ninja loan”, required no income, job, or assets.
Other risky options include the interest-only adjustable-rate mortgage (in which the homeowner pays only the interest during the first period of the loan) and the “payment option” loan (in which the owner can pay a variable amount, but any unpaid interest is added to the principal). Historically, subprime borrowers have had weaker average credit scores and a weaker repayment history than prime borrowers; consequently, subprime loans have a higher risk of default. (FDIC, 2009) In March 2007, the value of subprime mortgages in the United States was estimated at $1. 3 trillion (Associated Press, 2007); over 7. 5 million first-lien subprime mortgages were outstanding (Bernanke, 2007).
Between 2001-2003, the share of subprime mortgages relative to total mortgage originations was less than 10% (Perry, 2008); by 2004-2006, that number had risen to between 18%-21% (Joint Center for Housing Studies of Harvard University, 2008). By October 2007, 16% of subprime ARMs were 90 days delinquent, or the lender had initiated foreclosure proceedings (Mortgage Bankers Association, 2007); this represented a threefold increase from 2005. In January 2008, the subprime delinquency rate was 21%, and by May of the same year it had risen to 25% (Bernanke 2009). The housing boom also saw a great decline in the standards of mortgage underwriting. Banks made increasing use of automated loan approvals; in 2007, 40% of subprime loans were approved automatically (Board of Governors of the Federal Reserve System, 2009), without review by a human being.
At this same time, there was a significant increase in mortgage loan fraud; even in 2004, the FBI warned of a mortgage fraud epidemic that, they warned, “could lead to a problem that could have as much impact as the savings and loan crisis. ” (Frieden 2004) The subprime mortgage crisis has had a devastating financial impact in the United States. Between June 2007 and November 2008, Americans lost over 25% of their net worth. (Bernanke 2009) By November 2008, the S 500 stock index was down 45 percent from the high it had seen in 2007. Housing prices were down 20% from their 2006 high, and total home equity had dropped over $4 trillion dollars and was still falling. (Bernanke 2009) Americans’ total retirement assets had dropped by 22%; other savings and investments dropped $1. trillion dollars and pension assets lost $1. 3 trillion. (Joint Center for Housing Studies of Harvard University, 2008) The economic burden of the subprime crisis has been felt disproportionately by various minority groups throughout the United States, since it was they who received the bulk of the subprime mortgages during the housing boom. (Fernandez, 2007) The financial sector was first affected by the subprime crisis in February 2007. During this year, over 100 mortgage companies either closed, suspended their operations, or were bought out by other companies. In late 2007, the CEOs of both Merrill Lynch and Citigroup resigned within one week of each other.
In subsequent weeks, more financial firms underwent mergers or advertised that they were seeking firms with which to merge. (BBC News, 2008) The subprime crisis caused a panic in worldwide financial markets; many investors removed their money from mortgage bonds and put it into commodities. This resulted in speculation in commodity futures that, in turn, contributed to the crisis of food prices throughout the world, and also an oil-price increase. The worldwide financial impact of this crisis continued the following year. By August 2008, financial firms had written down their holdings of subprime-related securities by $501 billion US dollars. Bernanke, 2009) The International Monetary Fund has estimated that, by the end of the crisis, worldwide financial firms will have written off $1. 5 trillion of their holdings of subprime MBSs. As of November 2008, the IMF had recognized $750 billion dollars (US) of these losses. The major instability in various financial markets brought on by the United States subprime crisis resulted in several steps by the Federal Reserve and other world banks. In 2008, Ben Bernanke, chairman of the Federal reserve, remarked, “Broadly, the Federal Reserve’s response has followed two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy. (Bernanke 2009) The Federal Reserve, in collaboration with other banks, undertook open market operations to ensure that member banks remained liquid- these market operations were short-term loans that were collaterized by government securities. Various central banks lowered the interest rates charged to member banks for short-term loans. The Federal Reserve created several lending facilities, including the Term Auction Facility and Term Asset-Backed Securities Loan Facility, to facilitate direct lending to banks and other financial institutions. Ben Bernanke stated that at this time the Federal Reserve is effectively creating money electronically, which he deems necessary because “…our economy is very weak and inflation is very low.
When the economy begins to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation. ” (Bernanke 2009) In an effort to assist struggling homeowners in avoiding loan default and property foreclosure, certain lenders have offered their borrowers more favorable loan terms (such as refinancing, loan modification, or loss mitigation). The Economist stated, “No part of the financial crisis has received so much attention, with so little to show for it, as the tidal wave of home foreclosures sweeping over America. Government programs have been ineffectual, and private efforts not much better. (Economist. com, 2008) In a typical year (pre-crisis), 1 million homes enter foreclosure. It is estimated, however, that between 2009 and 2011, that number may jump to 9 million. The Chicago Federal Reserve bank has determined that the average foreclosure costs lending institutions $50,000; at this rate, 9 million foreclosures would yield $450 billion in losses. (New York Times, 2009) The impact of the subprime mortgage crisis is currently still climbing. In April 2008, the International Monetary Fund estimated that global losses for financial institutions alone (discounting private individuals) would approach $1 trillion United States dollars. Finfacts Ireland, 2008) In 2009, the IMF adjusted this figure to $4 trillion dollars. (IMF, 2009) This year, economist Paul Krugman wrote, “The prosperity of a few years ago, such as it was- profits were terrific, wages not so much- depended on a huge bubble in housing, which replaced an earlier huge bubble in stocks. And since the housing bubble isn’t coming back, the spending that sustained the economy in the pre-crisis years isn’t coming back, either. ” (Krugman, 2009) Conclusion It is clear that mortgage fraud, combined with predatory and irresponsible lending practices, has contributed to the major economic crisis in which the United States currently finds itself.
The combination of sub-prime lending practices and mortgage fraud dealt a serious blow to the mortgage industry; consequently, many banks failed, insurance companies defaulted on bonds, the stock market in the United States was crippled, millions of Americans found themselves unemployed and facing foreclosure, and investors all over the world lost trillions of dollars. It is likely that as the subprime mortgage crisis rages on, additional fraudulent activity will be exposed. At the close of 2009, the United States is still in a state of recession. The federal government has initiated many bailout programs to try and turn the economy around; however, the recovery process will be long and arduous.
The mortgage crisis is being scrutinized by the government in an attempt to prevent a crisis of this magnitude from ever happening again; the FBI continues to investigate and prosecute cases of mortgage fraud. Banks and other lenders have also revised and tightened their lending guidelines. Now more than ever, lenders must increase their efforts and improve methods for detecting fraudulent loan scams. They must consider the possibility of bias or inaccuracy in any information submitted by interested parties, and steps must be taken to verify all facts presented. Lenders must also redouble their efforts to ensure that controls supporting extensions of credit related to real estate are reviewed and updated on a regular basis.
Increased watchfulness, both on the part of lenders and honest individuals (who are often unwittingly swept up in mortgage loan scams), is the necessary first step in curtailing this prevalent- and definitely not victimless- crime. References Associated Press. (2007). “Will subprime mess ripple through economy? ” MSNBC. com, accessed online at http://www. msnbc. msn. com/id/17584725 on June 30th, 2009 BBC News. “Timeline: Sub-prime losses. ” BBCNews. com. Accessed online at http://news. bbc. co. uk/2/hi/business/7096845. stm. Accessed July 15th, 2008. Bernanke, Ben. (2009) “Four questions about the financial crisis. ” Board of Governors of the Federal Reserve System. Accessed online at http://www. federalreserve. gov/newsevents/speech/bernanke20090414a. htm.
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