Stated Income Fraud

Inman news is asking Is real estate fraud getting the greenlight?

The mortgage industry is getting used to all the Chicken Little warnings about fraud, but few have heard quite the proclamation of virtual surrender recently offered by two high-level individuals involved in the business.

Bruce Morris, executive vice president, quality control, Saxon Mortgage Services, Glen Allen, Va., said deception has advanced so far, so quickly that, "every portfolio in the country has fraudulent loans in it."

Speaking at a Texas Mortgage Bankers Association event in Dallas earlier this month, Morris complained that too many industry members tolerate fraud. "We are our own worst enemies, believe it or not," he said, demanding that "we can't have a tolerance for it, we just can't."

Special Agent Kellee Casebeer of the Dallas Division Field Office, reported that the world transformed for white-collar crime on Sept. 11, 2001. It was the number one priority of the FBI prior to the terrorist attacks in New York and Washington, D.C., on that day. "But afterward, combating white-collar crime became number seven," she said. "All the issues of terrorism moved into those first six slots."

What's worse, Casebeer said, "within white-collar crime, financial institution fraud is number four, and within that is mortgage fraud. So, unfortunately you're number four of number seven," she told mortgage professionals in the audience, drawing some nervous laughter.

The federal law enforcement agent said that "as a result of shifting priorities, at this time, we're not going to be able to expend resources on fighting fraud." Although she invites reports of fraud, the FBI must carefully prioritize cases to pursue and one consideration is whether there will be formal prosecution. Casebeer said: "If the United States Attorney's Office will not prosecute, we won't investigate [cases]."

Further on mortgage fraud, Saxon's Bruce Morris predicted problems "for all of us who made these wonderful [new] loans in California," where 19 percent of all the loans made in 2004 the borrowers would not have qualified for a traditional 30-year mortgage.

Fraud Invited

I have a friend in the industry, Dave Donhoff, a National Mortgage Banker/Broker, and he emailed me his response to that article. Following are his comments:

Fraud is actually INVITED (by default) with Stated Income loan guidelines, and the lender's Account Executives seeking to drive volume (who are being managed and coached, as the article discloses, by their company's principles.) There was a time... a 'hey day' when Stated Income loan programs filled a real need for the self-employed entrepreneur who had more bill-paying revenue at his disposal than his personal taxable revenue reflected. Way back then (what... 25 years ago maybe?) this was an evolution in income documentation methods, following what was then a "make sense" path of reasoning. We're now past that period of time.

TODAY "Stated Income" is completely unnecessary because either income can be verified by a variety of alternative means (bank statement deposits, for example,) OR... if someone truly lives 'cash & carry' there are now a multitude of fraud-resistant No-Income-Claimed document types (No Ratio, No Doc (both with or without asset verification.)) These programs are available at lower credit scores, and higher loan-to-value levels, than old fashioned "Stated Income" loans were "way back in the day" when Stated arrived... AND even though the interest rates on the non-fraudulent loan methods are priced to the relative risks, they are STILL lower than a Full Doc 30 FRM just 20 years ago, so there's really no excuse to commit fraud.

We are at a point in our industry where is is appropriate to ABOLISH all "Stated Income" programs entirely... make them regulatorily illegal entirely (or better yet, exempt lenders from any fraud recourse in law if they fund a Stated Income loan...) as an avoidance of such a fertile ground for larceny.

Today documentation fraud is *ALMOST PURELY* driven by desperate loan officers seeking a commission (hired en-masse by greed-blinded newby principles/owners allowed to drop to the lowest denomator of ethics.) The over-hiring of unqualified sales hacks (often young 1st-time-employees without basic math skills, let alone financial advisory skills) has been driven by a unique combination of unprecendented factors;

A) An environment of firesale interest rates driven down by market forces,
B) A technological breakthrough in automation allowing credit and risk analysis to micro-price loans to a borrower's personal specifics... making it possible to price loans for the riskiest of borrowers without forcing the cleaner borrowers to pay the same rates and fees as their riskier neighbors (thus EVERYONE had a gift dropped in their laps,)
C) Origination technology has superficially eliminated much of the manual/mental process of Origination, such that Loan Officers no longer have to sit face-to-face with a borrower and establish their financial credibility... so the normal consumer demand for that credibility has been relaxed dramatically... thereby opening the door for yesterday's gas-station clerk to become today's so-called "Loan Consultant."

Taken individually, each of these factors is WONDERFUL... however, combined together they've created an environment of degraded ethics in a field where the consumer is very easily lead astray.

Since it is extremely easy to see the direct relationship between documentation fraud and Stated Income loan programs (versus the alternative non-claimed programs,) the answer is to neuter the usage of Stated Income programs.

The FASTEST way (as in snap-of-a-finger) to bring "Stated Income' fraud to a screeching halt is to let all of the secondary market know that (for example,) "As of January 1, 2006, all federally regulated loans must either have all claimed income properly verified with documentation, or have no claim of undocumented income at all. Any loan funded with income claimed and undocumented will be exempt from any recourse to the lender from borrower, originator, and all 3rd party service providers."

No further finger-wagging bureaucracy is required... income fraud will virtually vanish instantly without a single additional dollar of tax-payer funded enforcement.

All the best,
Dave Donhoff
National Mortgage Banker/Broker

The Bottom Line

Here is my take on the matter. Fraud is always rampant at the peak of every market cycle. Stated income loans are fueled by greed and the ability for originators to take the loan, collateralize it, sell it to pension plans and mortgage "investors" willing to accept paltry returns over treasury yields for enormous extra risk.

Those investors or pension plans buying the lower tranches (highest risk slices) of CDO's and CMO's (collateralized debt and mortgage obligations) "backed" (using the word backed loosely) by poor credit risks who are buying houses on non-existent income at the peak of the market are going to have their heads handed to them by the market. The ripple affects will be felt in real estate prices and in pension plans across the country.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/