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Generational Dynamics Web Log for 30-Jan-08
FBI joins SEC into wide-ranging investigation into mortgage-lending industry

Web Log - January, 2008

FBI joins SEC into wide-ranging investigation into mortgage-lending industry

The widespread fraud against investors and the public is getting more scrutiny.

As we've been discussing a great deal recently, it's increasingly important that crimes like fraud have been THE RULE in the real estate industry in the last few years of the real estate bubble, rather than the exception.

We might break down the actors into these groups:

Consumers who lied on their mortgage loan applications.

Retail service providers: Housing contractors, housing inspectors, real estate appraisers, real estate brokers, mortgage brokers, mortgage lenders, savings banks.

Securities firms and investment banks that create and trade in high-priced securities created by "financial engineers." These securities are now burning out to be near worthless.

Watchdog and oversight service providers: Ratings agencies, "monoline" bond insurers, and due diligence firms.

The following notes apply to the above list:

The people in these groups might argue that they acted innocently in 2002-2005, but they cannot argue that in 2006 and 2007, when the abuses actually accelerated and got worse.

At the bottom of the pyramid, there were two kinds of fraud. The first kind were consumers who lied in order to get title to a home they otherwise couldn't afford. But more important were people who lied in order to get title to a home that they could "flip" within a few months to obtain a net gain. Very often, these people lied about income and assets, when in fact they had virtually no income or assets. Very often, these people did not even make the FIRST mortgage payment, since their intention was only to "flip." Sometimes the consumer told the truth, but the mortgage broker changed the income figures on the loan application to higher figures without even telling the consumer.

The second type of fraud at the bottom of the pyramid was lying about the value of a property. In the extreme case, the building contractor, appraiser, mortgage lender, and even the home purchaser would add tens of thousands of dollars to the appraised value of a home, in order to get a higher mortgage loan. Afterwards, they would split the extra money among themselves, and just leave the property to go into foreclosure.

At all service levels above the bottom, the general technique was the same: Perform a service fraudulently in order to obtain fat fees and commissions. Whether it's fraudulent approval of "liar loan" mortgage applications, fraudulent creation of high-priced but near-worthless securities, or fraudulent approvals by ratings and due diligence agencies, you're dealing with with a world where A loans money to or invests in B, and the deal is consumated by C, who has no relationship to A or B, and no "skin" in the game, but gets a fat fee or commission no matter what he does.

What's really remarkable about this world is that the same debauched standards are practiced by lenders and borrowers alike -- in fact by everyone in the game -- because no one cares if loans can be paid off, as long as they get their fees and commissions.

Up until now, any investigations by the FBI or SEC have focused on the lower levels, mainly retail service provides.

Now the FBI has indicated that it opened criminal investigations into fourteen companies, including some of the world's largest banks.

The possible charges include accounting fraud, improperly securing loans and insider trading during the sub-prime mortgage scandal.

The FBI did not name the companies, but Bear Stearns, Goldman Sachs and Morgan Stanley have all announced that they are targets of the inquiries.

The FBI has been warning for years that mortgage fraud is a significant and growing problem. In the 2006 fiscal year, it documented 35,600 suspicious-activity reports related to mortgage fraud, up from 22,000 the year before and as few as 7,000 in 2003.

As the financial crisis deepens, we can expect these first few criminal investigations to turn into a torrent. (30-Jan-08) Permanent Link
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Generational Dynamics Web Log for 30-Jan-08 FBI joins SEC into wide-ranging investigation into mortgage-lending industry

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Generational Dynamics Web Log for 30-Jan-08
FBI joins SEC into wide-ranging investigation into mortgage-lending industry