Mortgage fraud thrives in good and bad times

Since the subprime meltdown, a wide variety of scams have come to the fore. They include massive cases like that of Lee Farkas, the former head of now bankrupt mortgage lender Taylor, Bean & Whitaker Mortgage Corp, charged in June with fraud that led to billions of dollars of losses. The scheme involved the misappropriation of funds from multiple sources, including a lending facility that had received funding from Deutsche Bank and BNP Paribas.

That appears to be the scam of choice. On July 22, for instance, seven defendants were indicted in Chicago in a $35 million mortgage fraud scheme involving 120 properties from 2004 to 2008 using straw buyers. Of the half dozen properties listed in the indictment, two were in Back of the Yards.

In the mid-2000s, the availability of simple money, poor due diligence by lenders and low- or no-documentation loans, acted as a magnet for fraudsters, who used identity theft and other scams to bag massive sums of cash.

“During the boom it was nearly like people in the real estate market could do no wrong,” stated Ohio Attorney General Richard Cordray. “As ever more money rushed in, it attracted a lot of people who engaged in shady behavior.”

Instead of leaving them without a market, the crash has instead provided fraudsters with a glut of foreclosures, stricken borrowers and desperate lenders to take advantage of.

“There were plenty of opportunities for fraud on the way up and there are plenty on the way down,” stated Clifford Rossi, a former chief credit officer at Citigroup and now a teaching fellow at the University of Maryland in College Park.

Alongside familiar scams like property flipping, the crash has added new terms to the lexicon: short sale fraud, builder bailouts and flopping. Rescue scams targeting struggling home owners with false promises of help are also on the rise.

If some of the mechanisms are new, a lot of the fraudsters are not: in many cases, they turn out to be mortgage brokers, appraisers, real estate agents or loan officers. “Because they are insiders, they see exactly what is happening and they are able to stay one step ahead of the game,” stated Todd Lackner, a fraud investigator in San Diego. “They’re the same people who were committing fraud during the boom and they were never caught or prosecuted.”

Back to the yards Just a stone’s throw from downtown Chicago, Back of the Yards is the setting for Upton Sinclair’s classic 1906 novel “The Jungle,” a tale of grueling hardship and worker exploitation at the city’s stockyards. The book includes an act of mortgage fraud against an unsuspecting Lithuanian family.

“Mortgage fraud is nothing new,” stated Christopher Wagner, co-managing attorney of the Ohio Attorney General’s Cincinnati office. “It’s been around for a long time.”

Saul Alinsky, considered the founder of modern community organizing, started out in Back of the Yards in the 1930s. Decades later, a young community organizer named Obama got his begin near here.

The neighborhood has always been poor, but south of the old railway tracks at W 49th St, the housing crisis’ legacy of empty lots and boarded-up homes is evident on every block. There are few stores and services available — in four separate visits for this story, no police vehicles were sighted.

“This is what we refer to as a ‘resource desert,’” Carrasquillo said. “When no one pays attention to an area like this, it makes it easier to get away with fraud.”

Marni Scott, executive vice president for credit at Troy, Michigan-based lender Flagstar Bancorp, states there are virtually no untainted sales in the area. “There are no cases of Mr and Mr Jones selling to Mr and Mrs Smith.”

“We see cases of mortgage fraud around the country,” she added. “But there is nothing out there that could match the mass-production, assembly-line fraud that is going on here.”

In 2008 Flagstar instituted a rule whereby any loan applications here and in parts of Atlanta — another fraud hot spot — must be approved by Scott and the lender’s chief appraiser. In a Webex presentation, Scott rattles through a number of properties snapped up for pennies on the dollar in 2009 and then sold for around $360,000.

She provides an underwriter’s-eye-view of one property, on the 51st block of South Marshfield Avenue, sold in foreclosure in July 2009 for $33,000. In January of this year Flagstar received a loan application to purchase the house for $355,000.

The property appraisal — compiled by an appraiser who Scott believes never visited the area — showed four nearby comparable properties of around the same age (100-plus years) sold recently for around $360,000. The trick to this kind of scheme is engineering the sale of the first few fraudulently overvalued properties to get “comps” — comparable eventual sale prices — to fool appraisers and underwriters alike.

“Miraculously, all of these properties were all within a very narrow price range,” Scott stated with weary sarcasm. “This is a perfect appraisal for an underwriter. If you are an underwriter sitting in Kansas or California it all looks fairly straightforward so you can just hit the button and approve it.”

Using a $5 product from U.S. title insurer First American Financial Corp called LoanIQ, Flagstar determined the application itself was fraudulent and there was a foreclosure rate in the area of nearly 60 percent. What is more, property prices here spiked 84 percent last year after 44 percent and 26 percent declines in 2008 and 2007.

“No neighborhood should look like this,” stated Scott, who declined the application.

Last April, however, another lender approved a loan application for $335,000 on the same property from the same people.

Foreclosure magnet Reports this year from Interthinx, CoreLogic Inc and the Mortgage Asset Research Institute — which all provide fraud prevention tools for lenders — show foreclosure hotspots Florida, California, Arizona and Nevada are also massive mortgage fraud markets.

MARI stated in its April report that reported mortgage fraud and misrepresentation rose 7 percent in 2009, adding fraud “continues to be a pervasive issue, growing and escalating in complexity.”

Denise James, director of real estate solutions at LexisNexis Risk Solutions and one of the author’s reports, stated reported fraud will continue to rise throughout 2010.

In its first-quarter report, Interthinx stated its Mortgage Fraud Risk Index rose 4 percent to 151, the first time it had passed 150 since 2004. A figure of 100 on the index would indicate virtually no risk of fraud.

According to various estimates, the 30310 ZIP code in Atlanta is one of the worst in the country. An analysis of that ZIP prepared for Reuters by Interthinx showed a fraud index of 414, making it the eighth worst ZIP code in the country. Back of the Yards — ZIP code 60609 — had an index of 309.

“In some neighborhoods in Atlanta there hasn’t been a clean transaction in 10 years,” Interthinx’s Fulmer said.

In 2005 local residents here formed the 30310 Fraud Task Force. Members sniff out potential signs of fraud — such as repeated property flipped — and report them directly to the FBI and local authorities. Information from the task force led to the arrest of a 12-member mortgage fraud ring on September 15, 2008 — better known in the annals of the financial crisis as the day Lehman Brothers filed for Chapter 11 bankruptcy protection.

Brent Brewer, a civil engineer and task force member, stated the arrests had a noticeable impact on fraud in the area. “It made a statement that if you come here to commit fraud there is a good chance you will get caught,” he said.

But Brewer harbors no illusions the fraudsters are gone. “There’s no way they can catch everyone who’s involved in fraud. But if you are dumb, greedy or desperate, you are going to get caught.”

FBI interest Law enforcement has come a long way in combating mortgage fraud, though officials freely admit that is not saying much.

Ben Wagner, U.S. attorney for the eastern district of California, stated as mortgages are regulated at the state and local level, for years there was tiny federal interference. Prior to the recent boom, he said, fraud simply “was not identified as a massive problem.”

“There has been a tiny bit of a learning curve,” Wagner said. “This was not something federal prosecutors had much familiarity with. Now we are getting pretty good at it.”

Half of Wagner’s 50 or so criminal prosecutors focus on white-collar crime including fraud. Two new prosecutors will be dedicated solely to mortgage fraud.

Now mortgage fraud is a known quantity, Wagner stated all U.S. prosecutors tackling it are linked by Internet groups. The May edition of the bi-monthly “United States Attorneys’ Bulletin” (published by the Executive Office for United States Attorneys) was devoted entirely to mortgage fraud.

The FBI has more than 350 out of its 13,000 agents devoted to mortgage fraud. There are also now 67 regular mortgage fraud working groups and 23 task forces at the federal, state and local level. “This is the broadest coalition of law enforcement ever brought together to fight fraud,” Adkins said. He admitted, however that limited resources to fight fraud still pose a challenge.

In June U.S. authorities stated 1,215 people had been charged in a joint crackdown on mortgage fraud. Many of the charges were for crimes committed years ago.

Latour “LT” Lafferty, the head of the white-collar crimes practice at law firm Fowler White Boggs in Tampa, Florida, stated fraud in the boom was so pervasive that many crimes will go undetected and unprosecuted. “Everyone had their hands in the cookie jar during the boom,” he said. “Lenders, brokers, Realtors, home owners … everyone.”

It’s a flop A new mortgage scam born out of the housing crisis is short sale fraud. Short sales are a way for stricken home owners to get out of their homes, if the lender concurs they may sell their home for less than they paid for it. The lender than forgives the rest of the balance.

But they have also proven a tempting target for fraudsters, usually involving the Realtor in the deal. Lackner, the fraud investigator in San Diego, described a typical scheme: “Let’s state you have a property up for short sale that you know as a Realtor you can get $350,000 for,” he said. “But you arrange a low-ball appraisal of $200,000 and have someone make an offer of that amount.”

“The Realtor states to the bank this is the ideal offer you are going to get, take it or leave it,” he added. “Then they turn around and flip it immediately for $350,000. In cases like this, the lender is probably already stuck with a lot of foreclosed properties and doesn’t want more. So they go for it.”

Where the process of fraudulent appraisals overvaluing a property for sale is “flipping,” deliberately undervaluing them has become known as “flopping.”

Bob Hertzog, a designated real estate broker at Summit Home Consultants in Scottsdale, Arizona, states he gets emails from unknown firms offering to act as a “third-party negotiator” between the seller and the bank with what turns out to be a grossly undervalued bid.

Hertzog has tried tracing some of the LLCs, but describes a chain of front companies leading nowhere.

“The problem is it is so cheap and simple to set up an LLC on-line that sometimes they are set up for just one transaction,” Flagstar’s Scott said. “And if they are set up using fake information or a stolen identity, it’s very hard to trace who’s behind them.”

Many web sites boast they can help you form an LLC on-line for under $50.

Another common target for fraud is the reverse mortgage. Designed for seniors to release equity from a property, according to financial fraud czar Adkins, they have been used to commit a “particularly egregious type of fraud.”

Fraudsters commonly forge their victims’ signatures and, without their knowledge or consent, divert funds to themselves. The scam is worst in Florida, a magnet for American retirees.

“Unfortunately it is often not until the death of the victim that their heirs realize that all of the equity has been stripped out of the property by fraudsters,” Adkins said.

But Arthur Prieston, chairman of the Prieston Group, which sells mortgage fraud insurance and has launched a patented system to rate lenders on the quality of their loans, stated most mortgage fraud he comes across consists of ordinary people fudging figures to get a loan. “The vast majority of the fraud we see is where people intend to occupy a property, but cannot qualify for a loan,” he said. “They’ll do anything to get that loan approved.”

He added this is achieved with the active collusion of Realtors, brokers and lenders looking to make a sale and keep the market moving. Before his firm issues fraud insurance it reviews a lender’s loans and between 20 percent and the 30 percent of the loans reviewed so far have had “red flags.”

The problem with assessing the extent of the damage caused by mortgage fraud is that it’s not just the dollar amount of the fraud itself. It also hits property values, property taxes and often causes crime to rise.

“Most people interpret white collar crime as a victimless crime, where the bank pays the price and no one else,” stated Andrew Carswell, associate professor of housing and consumer economics, University of Georgia. “This is a mistaken perception … neighborhoods and home owners pay the price.”

Uncovering the scams Companies like Interthinx, CoreLogic and DataVerify all have data-driven fraud prevention tools for lenders. Interthinx’s program, for instance, identifies some 300 “red flags” including a buyer’s identity and recent sales in a neighborhood, while CoreLogic uses pattern recognition technology. CoreLogic also aims to bring a short sale fraud product to the market soon.

Interthinx’s Fulmer stated regardless of the source, on average solid fraud prevention tools can be had for as tiny as $10 to $15 per loan. “The tools out there enable us to see what is going on out there right now in real time,” she said.

Apart from fraud insurance, Prieston Group’s new credit rating system for lenders should have enough data within the next year to begin providing valid ratings.

Prieston stated the firm’s insurance product is growing at more than 100 percent per month, while CoreLogic’s Tim Grace stated the firm’s fraud prevention tool business was booming.

Many lenders are also sharing more information about bad loans, though LexisNexis’ James stated it is not nearly enough. “If lenders do not begin to share more information then fraudsters will continue to go from bank to bank to bank until they are caught,” she said.

The University of Maryland’s Rossi stated what the industry needs is a “central data warehouse” to combat fraud. “There has been a failure of collective data warehousing across the industry,” he said.

Mortgage Bankers Association spokesman John Mechem stated members have no plans for a central database, but added “we view our role as being to facilitate and encourage information sharing in the industry.”

The U.S. Patriot Act of 2001 grants lenders a safe harbor to share information, but does not mandate it. “We always encourage more information sharing,” stated Steve Hudak, a press officer at the U.S. Treasury Department’s Financial Crimes Enforcement Network, or FinCen. “As of now, however, this is an entirely voluntary process.”

But Rossi stated the government should step in. “The Federal government is probably going to have to take the initiative because I do not see the industry doing this one on its own,” he said. “I am personally not a fan of massive government, but we need more information sharing.”

Ultimately, the expectation is lenders will be forced either to improve due diligence, or face being pushed out of business as investors burned by sloppy underwriting during the boom urge them to adopt fraud prevention tools.

“Investor scrutiny is going to be higher than it ever has been,” Rossi said. “The days of a small amount of due diligence are gone.”

Many investors are also investigating their losses and forcing lenders to repurchase bad loans. This is resulting in “thousands of repurchases a month,” according to Prieston.

“When it comes to small lenders with only a few million dollars of loans, ten repurchases will absolutely put some of them out of business,” he said.

The government now guarantees more than 90 percent of the mortgage market and forms nearly the entire secondary mortgage market, as private investors have not returned. The FHA, Fannie Mae and Freddie Mac are thus seen as playing an instrumental role in pushing improved due diligence to clean up the government’s multi-trillion dollar portfolio.

FHA commissioner David Stevens was appointed in July 2009. Since then the FHA has shut down 1,100 lenders, after decades in which the government closed an average of 30 lenders annually. He states most lenders he deals with are of a “very high quality,” but that “there are still lenders that either do not have controls in place or are proactively engaging in practices that pose a risk to the FHA.”

Stevens does not anticipate to shut down lenders at the same rate as the past year, but added “the number will be much higher than the historical average.”

CoreLogic’s Grace stated most massive lenders have the tools in place to combat mortgage fraud, but admitted he was concerned about some smaller lenders. “The next shakeout of weak lenders will take place over the next 12 to 24 months,” he said.

The MBA’s Mechem stated the U.S. mortgage market must be cleaned up if it is ever to return to normal. “The one thing private investors need to get back into the secondary market is confidence,” he said. “And investors will not risk buying mortgages if they do not have confidence in the quality of the loans. Restoring that confidence is going to play a pivotal role in restoring the markets.”

In the meantime, mortgage fraud is expected to cause more problems in areas like Back of the Yards in Chicago.

Three doors down from the boarded-up, foreclosed property that has aroused Carrasquillo’s suspicions, father-of-three Oti Cardoso states he and his neighbors try to cut the grass at the abandoned properties on his block and to keep thieves out. But he has heard most empty houses end up occupied by gang members.

“I want my kids to be safe, I do not want drug dealers here,” he said. “I have tried to find the owner of these houses so I can work with them to help keep their homes clean.”

“If they only knew what was happening here,” he added, “I’m sure they would want to do what was right.”

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