On the Road Again

At the recent SourceMedia Mortgage Fraud Conference I chaired in Las Vegas, I also got to host a recorded roundtable with some of its participants, something I like to do whenever I can when I’m at meetings around the country. It’s a good way to stay in touch with industry execs and take the temperature of the business.This roundtable (and the whole conference!) was unusual in the unanimity and forcefulness of the people gathered to discuss fraud, which is continuing to grow in the industry despite being overshadowed by more general concerns like lack of liquidity, tons of foreclosures, and firings by the thousand.In fact, I only managed to get in one short question before I could sit back, relax and put my feet up, as my fellow panelists expostulated on fraud for about fifteen minutes without me getting another word in edgewise.What have you heard about mortgage fraud recently? Feel free to join the conversation by typing a comment into the box below and hitting reply!Participants were Ann Fulmer, vice president business relations, Interthinx; Gary Lacefield, executive vice president, director of compliance, WR Starkey Mortgage LLP; Merle Sharick, vice president-manager, CPS mortgage/real estate services business development, MARI; Bob Simpson, president, iMarc; and my colleague Brad Finkelstein, the editor of Broker.MARK: We'll start with the obvious question: Do you think mortgage fraud will get worse before it gets better?ANN: Yep!BOB: I think the losses are going to get a lot worse. I think we're closing a chapter on the rampant mortgage fraud that was out there. We're going at least require people to falsify a W-2 and a pay stub, we're not going to let them just slide it through. We're not going to do it as foolishly as we did in the last five years. If you're going to commit fraud now, you're going to have to get creative on your Photoshop.MERLE: There will continue to be a high percentage of reported frauds as the market continues to constrict because we haven't seen the losses come in from the 2005, 2006 and 2007 books and I think those are going to be fairly substantial. My only concern about the new market is, is that I don't think that tightening underwriting policies doesn't necessarily stop fraud. It stops a lot of the marginal deals, but there are fraudsters out there that have to do it for necessity, as opposed to opportunity.ANN: The fraud rates we are seeing on applications we are seeing for 2008 originations are increasing. They are going back up again and it is, as Merle said, because of desperation. You have borrowers who can't sell, you have spec investors who can't unload their inventory. There is still a healthy fraud for profit component, but instead of making money flipping houses, let's make millions on no money down and cash-back in foreclosures. You have these investment clubs that are buying foreclosed properties and then they are flipping them. And they get them a lot of times from foreclosure rescue schemes. In terms of underwriting, we're already seeing a huge increase in forged documentation, including fabricated banks, fictional banks. They are beautiful statements. I have a VOD from a bank, that unless you research the address — it look beautiful — but the address is the University of Georgia Bulldog Stadium.BOB: We had one where we did an investigation. The bank wrote back and said the name is wrong, the dates are wrong, everything is wrong. I bank at (that institution) and handed it to my bank officer and asked him to pull up the statement. He had three managers over looking at this by the time we were done talking about this file. The whole thing was Photoshop. It was an account, but it wasn't (the applicants). They even changed where it says "for questions call." They took what was basically real and Photoshoped it.GARY: I've looked at the 2003, 2005, 2007 numbers and two years ago I said we were looking at $1.5 billion in fraud out there. What I am seeing now is that companies that weren't doing FHA are now doing FHA and you have the same loan officers that were doing the convention non-conforming loans now pushing FHA. They don't understand the rule and they don't understand that there is more scrutiny on those loans. They don't understand the FHA model. They are operating it like they were doing a subprime loan. We have the same auditor look at the files from the same branch and this way they catch this stuff where people use the same kind of pay stubs and messed up documents. If it is going to a central place (to be audited) you don't have the opportunity to see those two screw-ups. I am also seeing, and I turned over two deals to the FBI, there is a group out of St. Louis that will for $2,500 send me a bank slip from (a bank) that shows I have $55,000 in the bank and show regulator deposits for the past six months.MERLE: What you just mentioned is the crux of what we are going to face over the next few months. We've got all this that is going to roll off the books that has already been originated and every indication that I have from our subscribers, from the private mortgage insurance companies and from everybody else is that those losses potentially are very large. So now what you have is complete shift over to FHA and I think just because of the struggles that are inherent with the kind of lending that involves, we're going to see a whole different set of issues as a result of that increase in volume.GARY: Let me just scare you. A couple of weeks ago I got a call from a magazine and they interviewed me. They wanted to know how — they had this very short list of companies — how they could get a full eagle FHA approval. I asked what are you talking about? She said let's start with (a subprime lender). (This company) did 100% subprime loans, carried them on portfolio. I went into the HUD system and, sure enough, they got their FHA approval three months ago. They've originated 55 loans, no defaults. Here's the deal, none of those loans have hit the system yet. So I got curious and I went into the HUD system — I went back two full years, a quarter at a time, and the increase in the number of FHA-approved correspondent lenders, in one jurisdiction — I picked one HUD jurisdiction in Dallas and in the last 18 months the number of approved correspondent lenders has gone from 300 to almost 900 in less than two years. Since I still have some ties at HUD, I called some folks that I knew and asked how could a company like (the subprime lender) which can't do business in Kentucky and some other states, (can do FHA)? First off all they are doing loans under (a) d/b/a. Second of all, when they completed their sanction report, did they disclose the ownership had been sanctioned, they have a gazillion lawsuits against them and half a gazillion fair housing claims against them?MERLE: Your asking questions you already know the answer to. You know they didn't report anything.GARY: Did they? Or did HUD just not have a chance to look at it? The answer is, HUD used to get 30 to 40 applications a week. They are getting 3,000 to 4,000 applications a week now, mostly brokers.ANN: The phenomenon you're talking about is subprime creep. When it comes to the losses, we're seeing almost 25% of the applications we screen up front have critical fraud-risk indicators. What's worse is on the back-end when we're doing reviews, we're seeing 40% of loans that foreclosed in the pools we're looking at, 40% are fraud.BOB: We're higher than that. We're almost double.ANN: You're at 80%?BOB: Yes. Our business is mortgage insurers sending us files for us to investigate for them to battle claims. That's what we do. So it is a polluted pool, it is not a statistically true pool of all the loans in the country. But of the files we get, in excess of 80% of them have a material misrepresentation.ANN: I think part of the reason that fraud had taken a back seat for so long and it was not a top priority and it is not a zero tolerance policy, you can't look at fraud as a cost of doing business anymore. We could get away with that because — what was the ballpark figure, 10% or less of the loans that were funded contained fraud? I think within the last couple of years and still now, it is way higher.BOB: You had to lie to get a loan in Southern California in the last five years. I'm sorry, you just did. You had to lie because the average price was $635,000 and the average income is $85,000. So people are misstating their income and when I asked my broker friend when we were working out in the gym, "Have you originated an honest loan in the last five years?" And his comment to me, just off-hand, two buddies working out, was "Bob, the lenders deserved everything I gave them." And this is one of the good guys. He is involved in associations, he's been originating for 20 years. In California, you have areas with $700,000 homes filled with firemen. I know what you're making as a fireman, a teacher, a county worker. What are you doing?ANN: And that was my point. The industry could push it under the rug because they thought it was only 10%, when we know it (was greater).MERLE: That's the fraud discussion, what a constricting market shows, it brings to the surface how flawed some entities business plans were. Freddie and Fannie are perfect examples. Flawed business plans because their idea was take loans from those who originated with warrantees and guarantees and we could put it back to those people if there was a problem. Except those people are no longer around. The principle most lenders use, at the end of every month we'll do a 10% audit of what we originated and see what we could have done better, well that doesn't work anymore. If don't catch the problem before the loan is funded, we're going to have all the problems that we're living with today. So it really requires a complete change on how does business.ANN: Part of what happened when you're talking about models that don't work, is that somewhere along the line the industry got sold a bill of goods and they became convinced all you needed was a FICO score and a collateral value. Fraud is such a multi-faceted problem that you can just take two data points and go "it's clean, it's good" because you can manipulate all of that and that only covers a couple of schemes any way. You have got to stop fraud prefunding. We cannot prosecute our way out of this mess.GARY: And the systems are in place now to do prefunding audits. We do that for half of our clients. We can go online, do a selection — however we want to do it, by credit score or by loan amount or by loan officer — and do a preclose audit. So we can catch a whole lot of it and we have caught a lot of it before it ever gets to the title company, before it gets to closing.ANN: The industry has had the tools for years, and there are great tools out there. When you get a forged document, you can't look at it and say 'gee this is forged.' You need a tool to look at the contents. The problem is we have had the way, we haven't had the will.BOB: Two points that I think everybody needs to understand moving forward as we work our way through this thing. No. 1, we've proven that the consuming public will take any amount of money that you give them. If you take all barriers out, people don't have the slightest idea how much they are qualified for. If you take a $60,000 wage earner and tell them they can borrow $1 million, they are going to take it. We've proven it. The other thing that was a folly was turning credit policy over to the commission guys on Wall St. and at the originators who said I can sell that (stuff). Just because you can sell it to the public and just because you can sell it to Wall St., which says "I can bundle that and make a ton." So what you had personal interests on the origination side and personal interests on the Wall St. side. They didn't have the larger policy concerns at heart; they had their beach house at heart. We as an industry know who is going to pay us back and who is not. We got to get credit policy that is written by people who don't have skin in this, commission in this. Not everybody should be given a loan, we've got to start saying you're not qualified (to borrowers).GARY: The issue is the mindset of this group is that it is not illegal unless you get caught and that is wrong. This 20-to-40-age group, that is their mindset. I have said, whether you get caught or not has no bearing on whether or not something is right or wrong. Getting caught has to do with what your punishment is going to be or what the consequences are. The second point is exactly what Bob is saying. The whole model has got to change. The word qualified — right now there are three legs to the mortgage process. One is someone's willingness to repay the loan, the second is the their ability to repay the loan and the third is the collateral value. There needs to be a fourth, and it needs to be can they afford the loan. Affordability, not suitability, affordability.ANN: My clients are telling me that they are running things through FHA and getting approvals where the back-end DTI is like 80% of gross income. That is not an affordable loan.GARY: There is a terrible problem with the automated underwriting systems. You can't qualify for a 30-year note, but you know what, I can get you qualified for a 10-year note or a 15-year note with the same numbers. This is because the logarithms built into the systems figure if you can make a larger payment for a shorter period of time, it is less risk. One way of the fastest ways we have been able to knock down early payment defaults is, is if anybody wants a loan with less than a 30-year note, they have to first qualify for the 30-year and they we will give them a 15-year or a 10-year or a 20-year.