The Mortgage Meltdown Saga Continues - FBI Investigating Top Lenders for Fraud

In a commentary published on September 15, 2008, on Bloomberg.com, concerning the collapse of Lehman Brothers, the teetering of American International Group, and the federal takeover of Freddie Mac and Fannie Mae, writer Jonathan Weil opened with a simple question. "Now can we get some subpoenas flying?" he asked. Apparently, he is not the only one thinking along those lines. According to recent news reports, the FBI is investigating some of the nation’s top lenders for fraud. The top lenders aren’t the only ones being investigated, by far. Recent studies have shown a significant increase in mortgage fraud as the industries associated with home mortgages struggle to stay afloat.

According to a story published in the Wall Street Journal on September 24, 2008, there are at least 4 of the best known lenders currently under investigation for potential fraud, with this early stage of the investigation "focusing on whether fraud helped cause some of the troubles at Fannie Mae, Freddie Mac, Lehman Brothers Holdings Inc. and American International Group Inc., according to senior law-enforcement officials." While there are many variations, there are two basic types of fraud typically associated with the mortgage and lending industries.

Weil, in his commentary, made note of "stunned Lehman employees… leaving Lehman's offices carrying away boxes and duffel bags full of heaven knows what." What he is referring to, as does an article in The Public Record, written by Jason Leopold, and published on September 23, 2008, is creative accounting, also known as cooking the books. That is one of the two general types of fraud that is associated with the mortgage and lending industries.

The Public Record article gives an excellent example of this type of creative bookkeeping and how it can be used to manipulate stock prices and defraud investors, keeping the money flowing for the company. Leopold discusses Bear Stearns, the first of the major investment banks to fall. Bear Stearns was, according to the article, "one of Wall Street's top underwriters of mortgage backed securities."

Investment banks are usually organized into separate sections, handling separate types of financial procedures and business. Typically, there is what is called a sell side, in which they promote and sell investment packages to investors. Another aspect of investment banking researching various companies - i.e., for stability, long term growth potential, etc. - and advising investment clients. According to the Public Record article, Bear Stearns "issued biased stock recommendations during the housing boom in the hopes that they would win investment-banking business."

For example, in March, 2008, two Bear Sterns analysts "issued a report upgrading the stock of New Century Financial, a company that provides sub-prime mortgages to low-income homebuyers, from "underperform" to "peer-perform." However, in their research note about New Century Financial, they made no mention of the fact that "Bear Stearns was one of the Wall Street banks that financed New Century's mortgage operation." New Century’s Stocks went up - briefly. The newly upgraded company filed for bankruptcy in April, just one month later.

Whether the top lenders just recently added to the list of companies being investigated for fraud are guilty of creative bookkeeping and associated crimes remains to be seen - as does the degree to which their actions, whether they be illegal or incompetent, damage the nation’s economy, as well as that of the world.

The other general area of fraud associated with the mortgage and lending industries typically, but not always, is the arena of the loan originator. When lending shifted from lenders that held the loans for their duration to the practice of slicing and dicing them, then packaging them for sale as investment vehicles, the degree of risk to the lender was greatly reduced. There was a great deal of money to be made on fees and quantity of loans, rather than quality, became the important factor for many.

Fraudulent loan applications, with false income and employment information, were often pushed through with a wink and a nod for applicants that would not have been eligible under the old standards. Elaborate scams with "straw buyers" became common. Zero percent down and other low cash upfront deals flowed. Countless loans were made that are likely never to be paid back. However, many of those loans have changed hands, so the lender that made them initially will not bear the loss, though that lender enjoyed the profit of the initiating fees.

In an article published on August 30, 2008, in the Washington Post, writer Kenneth R. Harney points out that even though housing sales have slumped and the real estate markets have slowed to a crawl in many parts of the nation, rates of mortgage fraud have gone up. Harney cites data from "a benchmark quarterly study released this week by the mortgage industry's principal compiler of fraud reports, the Mortgage Asset Research Institute," which indicates that "the number of cases jumped 42 percent between the second quarter of 2007 and the same period this year."

Harney, as do many, concludes that this surge in fraud is directly related to the slump in the sense that it’s getting harder to make legitimate money in the industry, and, quoting Merle D. Sharick, vice president of the research institute, Harney wrote, ""Mortgage fraud used to be a crime of opportunity," he said. "Now it's a crime of necessity for people who are desperate to maintain lifestyles they became accustomed to" during the housing boom years."

With the degree of fraud in the mortgage and lending related industries, the whole pricing system was skewed, a major contributing factor to the inflation of housing prices. Furthermore, as these loans were chopped and wrapped for sale throughout the world, they became increasingly leveraged, with many of these loans being bad loans that will most likely be defaulted upon, something that makes the current $700 billion bailout request a very risky proposition, as the plan is to buy up those risks. Whether or not the FBI does find evidence of wrongdoing by the top lenders and whether or not they are brought to justice, as the saying goes, the damage to the economy has already been done, and continues to unfold day by day.

Making smart financial decisions requires good information and a clear understanding of financial options. Sharon Secor writes regularly for Direct Lending Solutions, Lenders Mark, and a variety of other publications and websites providing useful and practical personal finance information.