Remarkable Housing Fraud

It always interesting how much good reporting and disclosure occurs AFTER some scandalous meltdown of an economic sector.

Today's Washington Post has an amazing story detailing a type of mortgage fraud that evidently was pandemic during the recent housing boom, and which, of course, is now contributing to the inevitable housing bust.

[We can't help but notice that the online version of the story appears under a banner ad from "lowermybills.com," headlined "Mortgage Rates Fall Again" and promoting what appears to be an a teaser mortgage with an unrealistically low payment. Perhaps the Post will do a different story on its own role in the housing debacle.]

This past weekend we visited with an old friend who left the urban environs of Arlington a couple years ago to become CFO of a bank in suburban Michigan. His bank makes more traditional mortgage loans, and we got to discussing how deep the housing crisis really is, and how long it will last. We were in agreement that it's worse than many analysts think, and that it will probably take about five years--maybe more--to recover to anything like its recent boom levels. (Think 2001 stock market meltdown and how long it took to recover.)

The Post story reinforces our view, as it exposes widespread outright--and fairly obvious and open--fraud schemes that apparently operated across the country.

In the scheme elaborated upon by the Post, an Atlanta con artist obtained short term loans from wealthy individuals, such as sports stars, promising large returns. He used the money to purchase luxury homes in upscale neighborhoods. He then enlisted straw buyers--often students--to purchase the homes a couple months later. (He invited the straw buyers to lavish parties at his mansion and offered them $10,000 to get in on the deal.) The straw buyers would then pay double or more what the con artist initially paid, based on a fraudulent appraisal from a sleazy appraiser in on the scheme. The straw buyer would obtain a large mortgage--through a broker also in on the deal--and then ultimately default on the loan, the proceeds of which went to our con artist, who made a large profit on the quick flip of the property. (The con artist, who insists he didn't know this was all illegal, has been convicted of fraud an faces, we hope, a lifetime of jail.)

Evidently, these schemes existed throughout the country and involved hordes of greedy appraisers, brokers and real estate attorneys, all taking advantage of lax lending rules and practices that spread risks so diffusely that no one was minding the store.

Mortgage fraud scams like this caused injury to some innocent homebuyers by driving up prices in certain neighborhoods, followed by a collapse as the schemes unfolded, leaving new homeowners in those neighborhoods with properties unworthy of their inflated purchase prices.

(We use the term innocent loosely--a lot of folks were buying and selling properties on rampant speculation, hoping to make a quick buck (albeit not fraudulently). To the extent that such speculators lost money, we think they fall into the same category as folks who lost money in the '80's on junk bonds with outrageous interest rates--they were victims of their own greed.)

So what we're increasingly finding out is that the whole residential property market was a house of cards. The only reason it kept going the way it did is that so many people--mortgage brokers, real estate agents, closing attorneys, title companies, appraisers, packagers of mortgage loans as securities, new home builders--had such a huge stake in keeping it going that they all looked the other way even as they knew the lending practices fueling the boom were insane.

And, unfortunately, we think a lot of local government officials also looked the other way as income from all the housing deals flowed into their coffers as well.

Congress needs to look carefully at what happened and consider new regulations. We think the group that most needs scrutiny and oversight is the mortgage brokers, who have every incentive to push through as many loans as possible, without any regard whatsoever as to risk, and most of whom wittingly aided massive fraud by pushing "undocumented" loans that they knew, or certainly should have known, were going to unqualified purchasers. (The Post story notes that one survey of borrowers who obtained "stated income" loans--widely known in the industry as "liar loans"--found that 60% inflated their income by more than half.)

So, housing prices got you down? Check out hedge funds and private equity. You'll be reading about them in the Post in a couple of years.