Affordable Housing Institute : US

Unlike equity investing, where trust is paramount, the genius of modern lending is that it enables the provision of capital to people one does not trust — because we repose our trust not in the individual borrower, but rather in the network of professionals and documents.  The loan is valid by a holy trinity of the papers, the certifications, and the professionals who have certified them.  
 

Such a complex and far-flung network ought to be well-nigh invulnerable, right?

 

Not quite, as revealed in this remarkable tale from Atlanta, via The Wall Street Journal:

 

ATLANTA — Skyrocketing foreclosures are a testament to how easy it was to borrow from mortgage lenders in recent years.

 

It may also have been easy to steal from them, to judge from a multimillion-dollar fraud scheme that federal prosecutors unraveled here in Atlanta.

 

As beautifully expressed in David Mamet’s play and film, House of Games:

 

Mike: It’s called a confidence game. Why? Because you give me your confidence? No. Because I give you mine.

 

“It’s called a confidence game.”

 

The criminals obtained $6.8 million in mortgages from Bear Stearns Cos., including a $1.8 million mortgage to Calvin Wright, a New Yorker who told the investment bank that he and his wife earned more than $50,000 a month as the top officers of a marketing firm. Mr. Wright submitted statements showing assets of $3 million, a federal indictment alleged.

 

In fact, Mr. Wright was a phone technician earning only $105,000 a year, with assets of only $35,000, and his wife was a homemaker. The palm-tree-lined mansion they purchased with Bear Stearns’s $1.8 million recently sold out of foreclosure for just $1.1 million. Bear Stearns, meanwhile, posted the first quarterly loss in its 84-year history as it wrote down $1.9 billion of mortgage assets yesterday. (See related article.)

 

Fraud goes a long way toward explaining why mortgage defaults and foreclosures are rocking financial institutions, Wall Street and the economy.  

 

It starts, as so often, with a desire for financial gain, in this case by the lenders.

 

Mike: You can’t bluff someone who’s not paying attention.

 

“Human nature is a sucker bet.”

 

The Federal Bureau of Investigation says the share of its white-collar agents and analysts devoted to prosecuting mortgage fraud has risen to 28%, up from 7% in 2003. Suspicious Activity Reports, which many lenders are required to file with the Treasury Department’s Financial Crimes Enforcement Network when they suspect fraud, shot up nearly 700% between 2000 and 2006.

 

In 2006, losses from fraud could total a record $4.5 billion, a 100% increase from the previous year, says Arthur Prieston, chairman of the Prieston Group, which provides lenders with mortgage-fraud insurance and training.

 

As I’ve previously posted, reliance in standardized documents and professional certifications is the engine of loan aggregation and securitization, with the resulting compression of spreads — and hence lower interest rates — that powered so much of the last decade’s home equity growth.

 

Mike: Did I ever tell you my name? My name is Mike.
Dr. Margaret Ford: Glad to meet you.
Mike: Well, I’m glad to meet you, too.
Dr. Margaret Ford: I have a proposition for you.
Mike: And what’s YOUR name?

 

It’s a great system.  Like all systems, it can be hacked.

 

“You want to see how a true bad man plies his trade?”

 

Yet the system itself bears blame. The evolution of mortgages into a securities instrument turned loan origination into a competition. Caution gave way to a push for speed and volume. Embroiled in an all-out war for market share, issuers reduced barriers to credit, for example, by offering so-called “stated-income” loans, which require no proof of income. “The stated-income loan deserves the nickname used by many in the industry, the ‘liar’s loan,’ ” says the Mortgage Asset Research Institute, which works with lenders to prevent fraud. A recent review of a sampling of about 100 stated-income loans revealed that almost 60% of the stated amounts were exaggerated by more than 50%, MARI says.

 

This is both incredible and credible.  Credible that people asked to provide information with no documentation might fib in their own favor.  Incredible that a system could be set up with no verification whatsoever. 

 

Typing this, I realize that I’ve previously posted that I’d lend to the devil incarnate at 70% LTV, but that presumes I have a reliable estimate of the property’s value. 

 

So our little con needs more than just the borrower, it needs a crooked originator and a crooked appraiser:

 

It didn’t take a rocket scientist to steal a fortune from mortgage lenders in recent years. That much is clear from the Atlanta scheme. It was perpetrated in large part by a 23-year-old college dropout named Gregory Jerome Wings Jr., aka G-Money. His accomplices included a young nightclub owner, along with the director of an underground documentary called “Crackheads Gone Wild,” a cautionary tale about drug addiction.

 

“What is life without adventure?”

 

Their scam was garden variety:

 

1.       Recruit borrowers with good credit to apply for gigantic loans, often of the stated-income variety, using false income and asset statements.

2.       Find a mortgage broker willing to submit false information

3.       Find appraisers who will approve inflated values

 

All three links in the chain must be crooked, and collaborating — but that’s manageable.

 

Prison Ward Patient: Y’know, I know there are people who are normal.
Dr. Margaret Ford: Are there?
Patient: Yes, there are. But…
Dr. Margaret Ford: But what?
Patient: But I don’t know what those people do.

 

“When you have done something unforgivable, I’ll tell you what you do.  You forgive yourself.”

 

Once we have a fraudulent borrower, a fraudulent originator, and a fraudulent appraiser, they can all tell the same story.

 

The perpetrators line their pockets with the proceeds, using some as down payments or for future renovations. Some buyers diverted proceeds to themselves through shell companies.

 

The brazenness of the scheme is illustrated by the case of Mr. Wright, the New York telephone worker who posed as a highly paid executive to obtain a $1.8 million mortgage from Bear Stearns. Recruited into the scheme by an acquaintance in Atlanta, Mr. Wright, with the help of ring leaders, diverted hundreds of thousands of dollars from that Bear Stearns mortgage to himself, to Mr. Wings and to others in the scheme, according to a federal indictment.

 

In the very same week, Mr. Wright obtained a $1.9 million mortgage on a second value-inflated mansion near Atlanta, this time from BankFirst, a unit of Minneapolis-based Marshall BankFirst Corp. This deal also brought enormous spoils to Mr. Wright, Mr. Wings and other accomplices.

“It was so easy, it’s incredible,” says Akil Secret, attorney for Mr. Wright, who has pleaded guilty to bank fraud and is awaiting sentencing.

 

What did the lenders get?  More volume, more loans to securitize.  More chickens to cut up into little parts.

 

Mike: Everybody gets something out of every transaction.

 

Key to the scheme is that everything is reduced to documents and certifications.  People are cut out of the credit decision.  Yet it was people — the wetware credit bureau — who blew the whistle:

 

Residents of some fancy Atlanta suburbs spotted the scheme. They became suspicious when new homes in their neighborhoods sold for sky-high prices, then remained vacant. After the same individual bought several such homes in one ritzy development, neighbors alerted authorities. One homeowner who helped expose the fraud and other schemes in his neighborhood now carries a loaded handgun in his truck. “This is serious stuff,” he says. “We are putting people in prison for many, many years.”

 

Enforcement is important, as is publicizing the enforcement — but the best defense is not to be defrauded.

 

“You used me.”

“I used you.  I did.  I’m sorry.  And you learned things about yourself that you’d rather not know.”

 

Dr. Margaret Ford: Beg for your life, or I’m going to kill you.

 

Since federal authorities issued an indictment in April 2006, Mr. Wings, Mr. Smith, Mr. Wright and about 10 others have pleaded guilty to various counts, including bank fraud, and are awaiting sentencing. Another ringleader was convicted in federal court last month. Their sentences could be lengthy: In an unrelated case, an Atlanta attorney with no prior criminal record was sentenced in August 2005 to 30 years in federal prison on a mortgage-fraud conviction. Mr. Wings declined to comment for this story, as did Messrs. Wright and Smith.

 

Mike: I’m from the United States of kiss-my-ass.

 

How did it happen?

 

[Continued tomorrow in Part 2.]

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