Twenty One Flavors of Mortgage Fraud

Twenty One Flavors of Mortgage Fraud [¹]

By Howard Lax for iTulip.com | 29 October 2007

Mortgage fraud is now a part of our lexicon, but few people understand what this means and the harm it causes. Mortgage fraud is a catch all phrase that encompasses schemes allowing one or more parties to a real estate transaction to obtain money through illegal or unethical means. Mortgage fraud cost us, as a society, somewhere between $946 million and $4.2 billion in 2006, and the cost will increase. Residential mortgage transactions are particularly susceptible to fraud, since the mortgage lending industry relies on patterned transactions to simplify home sales and mortgage financing with as little cost and time as possible.

In a "normal" residential sale transaction, the buyer, seller, and real estate broker(s) negotiate a sale using a model purchase agreement. The buyer meets with a loan officer from a mortgage broker or lender, and chooses a standard loan product to finance the transaction. The lender obtains an appraisal of the property and a credit report for the borrower. An investor underwrites the loan with the assistance of an automated system, conditionally commits to purchase the loan after closing, and "locks" the loan terms. The mortgage broker or lender obtains a title insurance commitment and schedules the closing after the loan is approved. A closing agent (usually a title insurance agency) explains the closing documents, acknowledges the parties’ signatures, accounts for the parties’ funds, distributes the proceeds of the transaction, sends the deed and mortgage to the Register of Deeds for recording, and issues title insurance policies for the buyer and lender. The lender sells the loan to an investor, and the borrower makes monthly payments to the servicing agent selected by the investor. Because the documents are standard, and the roles of the parties are very uniform, nobody spends the time or money to perform much due diligence on the transaction. Hence, it is relatively easy for any of the players (except the investor) to use false documents or parties in the transaction.

Mortgage fraud schemes are extensive, ranging from simple to complex, and are far too common. It is possible to stop a mortgage fraud if one of the parties recognizes the fraudulent features of a transaction before the proceeds of the transaction are disbursed. Some of the more common schemes are:

Inflated income or assets: Some of the most misrepresented facts on an application for credit are borrower income and assets. Recent audits by one lender found actual income was significantly overstated in two thirds of the applications submitted for credit on a "stated income" basis (i.e. the borrower’s income is not verifiable and the loan is approved based on the borrower’s credit score and statement of income). Assets are often misrepresented to make the lender believe that the buyer has funds to make a down payment and to pay closing costs. Sometimes the buyer borrows the down payment without revealing the obligation to repay the funds. A debt may be characterized on the settlement statement as an unrecorded lien, or an invoice for unidentified management services, to hide the fact that the down payment was borrowed. Making false representations in a loan application, or providing false documents to verify income or assets, is a crime. It is also a crime for a mortgage broker or lender to knowingly process a false loan application. False Social Security Numbers: Borrowers sometimes use the social security number of another person, or fake identification documents of a person with "good credit" to obtain a loan. More sophisticated thieves use a good social security number and a fake name ("synthetic ID theft") to make it harder to detect and identify the thief. The first five digits of a social security number indicate the area of the country where the card was issued and the year of issue. These values can be checked against the area of the country where the borrower was raised and the age of the borrower. Altered documents: W-2 forms, bank statements, title commitments, leases, and all manner of documents used to verify income and asset information can be altered or forged. Fake employment verification forms can be purchased over the Internet. Some borrowers forge discharges from their prior lender, or erase the loan from the schedule of exceptions on a title commitment, to avoid paying the balance of their prior loan. Accepting these documents or verification forms from the borrower saves time, but invites fraud. Asking the source of these documents for a separate copy is safer. Multiple loans: Lenders rely on the credit report and title commitment to locate the borrower’s obligations. There is always a "gap period" between the date that documents are submitted to the Register of Deeds for recording, and the date that these documents are available for inspection. There is also a gap between the date of a loan payment (or a missed payment) and the date that information is listed in a credit report. Some borrowers will close two or three refinance loans on a property with different lenders during a "gap period," knowing that the credit report and title commitment will not reveal recent loan transactions and missed payments. Mandatory electronic recording and universal reporting of consumer loan payments to credit bureaus may some day eliminate gap periods. Inflated Deposits and Soft Second Mortgages: Consumers who have an equity interest in their home are less likely to default on their mortgage payments. Hence, most loan programs require a minimum down payment. A buyer may give a false purchase agreement to the lender, showing an earnest money deposit twice as large as the real deposit and an inflated purchase price. A buyer and seller sometimes inflate the purchase price of a home, and offer seller financing in lieu of a down payment, so that the buyer may obtain a larger loan than would be permitted by the lender’s underwriting standards. The seller’s note and mortgage are torn up after the closing. Insisting that all loans be documented and that mortgages must be recorded will reduce fraudulent seller financing. Identity theft: The closing agent relies on the borrower’s driver license or other forms of identification to verify that persons who physically sign the deed, note, mortgage, and other documents have the authority to sell the home and borrow money. Buyers, sellers and closing agents must remember that a forged mortgage is void. Use a "black light" to locate the reflective seal on a valid driver license card. If a person’s identity is stolen, it is important that one of the parties files a police report. The police report also entitles the victim to obtain a copy of any fraudulent financial documents that used the victim’s identity. Straw buyer: A real estate investor may ask a friend or relative, or a stranger, to be a straw buyer (usually for compensation). The real estate investor promises to make monthly loan payments, and to pay off the loan within a year or two. In some cases, a land speculator purchases a home at a low price, and conspires with a straw buyer to sell a home for an excessive price. The net proceeds are used to make monthly payments on the loan and/or the parties split the net sale proceeds and disappear. Besides the criminal liabilities mentioned above for making a false loan application, the straw buyer’s credit rating is ruined when the real estate investor stops making loan payments. Inflated appraisal: The homeowner, seller, or mortgage broker may have an illegal arrangement with an appraiser to inflate the true value of the property, or provide improper comparable sales information to the appraiser so that a loan will be approved for an amount that exceeds the home’s market value. Excessive valuations may be justified using fake pictures of the subject property or property values from other fraudulent transactions. Appraisers should thoroughly inspect the subject property and use comparable property data that they independently verify. Federally chartered lenders must review the appraisal if it is provided by another mortgage lender or by a mortgage broker. Money laundering: It is very easy to prepare and record a forged deed. To launder money, a straw buyer uses illegally obtained funds to buy the home. The title agency unknowingly takes the illegally obtained funds, and issues its own check to the fake seller with good funds. The object of exchanging tainted funds for good funds is to hide the trail of money from its illegal source. The property may be subject to a forfeiture action if the source of the purchase money is discovered. Foreclosure rescue: Avoid offers to "help" a homeowner in a difficult financial situation. The purpose of "saving" a borrower that nobody else considers a fair credit risk is often to "strip" the homeowner’s equity. A homeowner who is facing loss of a home through foreclosure may deed the home to a rescuer, who promises to sell it back at a higher price in a year or two through a land contract or lease with an option to purchase. The rescuer or a straw party (described above) obtains a conventional loan to buy the home. The rescuer may even convince the homeowner to sign over the proceeds of the sale of the home with a promise to pay off other debts owed by the homeowner. The rescuer knows that the homeowner has no means of obtaining a new loan to buy the home back at its inflated price. The investor does not provide any disclosures required by law for these transactions. Courts have held that a deed given as security, and not as a true sale, must be treated as an equitable mortgage. The difference between the amount paid by the rescuer to buy the loan and the price demanded to repurchase the home is interest, subject to state usury laws. Furthermore, these transactions are subject to federal Truth-in-Lending Act disclosure requirements. The homeowner may be able to rescind the transaction and seek the return of the home. Servicing transfers: Federal law requires a lender to send a Notice of Transfer of Servicing to the borrower when mortgage payments must be sent to a different entity or address. Since the content of this Notice is proscribed by federal regulations, a thief can send a convincing Notice of Transfer of Servicing to a borrower, instructing the borrower to send mortgage payments to the thief. Flipping: Frequent sales of a property are not illegal. Higher sale prices may be justified when the property is rehabilitated. However, frequent sales at increasing prices between parties with a hidden relationship can make the property appear more valuable than it is. Sometimes the parties attempt to justify the price increase with cosmetic improvements that hide more serious problems. Flipping is often accomplished with the help of an improper appraisal, a false title commitment, or intentional misrepresentation of the condition of the property. The FBI website highlights the case of a collapsed Detroit home sold one day for $25,000, and the next day for ten times that amount. Occupancy fraud: Mortgage lenders require higher down payments for second homes and investment properties than for a loan secured by a principal residence. To obtain better loan terms, borrowers will state that a second home or investment property is or will become their principal residence after the closing. Inflated Credit History: Borrowers with poor credit payment histories may purchase the right to become a "co-borrower" on good credit accounts ("tradelines"). Good tradelines dilute the impact of the borrower’s poor tradelines, and raise the borrower’s credit score. This scheme is not illegal (yet). Companies that produce credit scoring software are trying to identify these borrowers, to eliminate the impact of the purchased tradelines. Misleading Disclosures: Federal rules require disclosure of a good faith estimate of closing costs within three days after the mortgage broker or lender receives an application for a residential mortgage loan. Borrowers also receive an estimate of the annual percentage rate and monthly payments within three days after providing a purchase money loan application to a lender. However, there is no requirement that this information must be redisclosed if the actual closing costs are different. Some brokers will arrange a subprime loan for the borrower, even though the borrower would qualify for a conventional conforming loan. This does not violate federal law, and the borrower has nobody to blame but himself if he accepts a loan that is not advantageous. However, engaging in fraud, deceit or material misrepresentation is illegal. Providing an estimate of costs to originate a "prime" loan, knowing that the borrower will only qualify for a "subprime" loan with higher origination fees misrepresents closing costs and the cost of credit. A lender or broker violates state law if disclosures are provided for low cost credit, or low cost credit is promised, when such credit is not available to the applicants. Required Use of Affiliates: A seller and his/her real estate broker cannot require the borrower to use a particular title agency for the lender’s title policy if the buyer pays the insurance premium. Hence, it is illegal for a real estate broker or for the seller to require a documentation fee solely if the buyer does not use the seller’s preferred title agency. It is also illegal to require a borrower to use the services of an affiliated settlement service provider if the borrower will pay for the services. Illegal Kickbacks: It is illegal to directly or indirectly pay or receive something of value under an agreement or understanding that the payment is for the referral of settlement service business. It is also illegal to split a fee for settlement services without doing any work to earn a portion of the fee. Some mortgage brokers, lenders and title agencies find it more expedient to pay kickbacks "under the table" to assure business referrals than to generate business based on the merit of their services. These kickbacks, in theory, increase the cost of credit. Failing to Disburse: Some lenders wait until after the loan has closed to finish underwriting a loan. If the borrower fails to meet underwriting requirements, or the loan cannot be sold at a profit, the lender refuses to fund the loan. State law requires that a lender satisfy its lending commitments. Selling Fake Loans: Some unscrupulous lenders create documents for loans that do not exist, and sell the loans to raise capital or hide losses. A lender may also sell a loan more than once to hide losses at the company, or to satisfy credit obligations. The proceeds of the sale may be used to make monthly payments on behalf of a non-existent borrower. Perpetrators of these schemes typically receive stiff prison sentences. Closing Agent Defalcation: Licensed title insurance agencies are required to keep transaction funds in a trust account. There is no requirement that a notary closing service (a "signing service") maintain trust accounts. Employees may steal these funds, resulting in the failure of the closing agent to pay transaction proceeds. Mortgage Elimination: Some borrowers send an "International Commercial Claim in Admiralty Administrative Remedy" to their lender, and file a frivolous lawsuit to discharge their mortgage. This scheme evolved from the repudiated "Bonded Bill of Exchange" given to payoff mortgage loans.

What to do? Mortgage fraud succeeds because consumers do not understand residential transactions. Consumer education will help prevent consumers from falling into these schemes:

• We can strive to teach financial literacy to all consumers. Financial literacy training should be a mandatory part of the high school curriculum. Financial literacy course materials (the Money Smart program) and teacher reference guides are freely available from the FDIC.


• The FBI and the Mortgage Bankers Association recommend that lenders post a sign to warn borrowers that mortgage fraud is illegal.


• Lenders and homeowners should each assure themselves that they have identified a financially responsible party (e.g., the closing agent) who is willing to legally insure the reasonable accuracy of all documents and transactions, i.e, that no fraud has taken place anywhere in the chain.


• Interthinx produced a video, Fraud Scheme Investigation, to help consumers and industry employees recognize mortgage fraud.

We can implement safeguards to prevent mortgage fraud, and to guard against repeat offenders:

• The Mortgage Bankers Association is sponsoring a committee to draft uniform residential closing instructions. These instructions will require the closing agent to be a gatekeeper against mortgage fraud.


• Data mining techniques are used by many lenders to evaluate loan application characteristics against a pool of previously closed loans. These computer programs look for similar transactions that might reveal repeat fraud attempts.


• We should prosecute individuals who break the law. The Conference of State Bank Supervisors and the American Association of American Association of Residential Mortgage Regulators recently proposed a uniform mortgage company and mortgage company employee licensing program (pdf) to make licensing in multiple states easier and less costly, and to allow states to share information about bad actors within the mortgage industry. State oversight of the mortgaging process should be the law in all states, and the oversight process should be adequately funded (probably through a tax on the mortgaging process) and enforced.

Finally, we should draft consumer disclosures that are understandable and meaningful. The Federal Trade Commission released a Bureau of Economics report finding that mandatory mortgage disclosures fail to convey key mortgage costs and terms. Our legislatures must simplify disclosure laws. Disclosures should mandatorily highlight information that really matters to the average home buyer. Some legislatures are proposing to prohibit unsafe or unsound lending practices, and practices that mislead consumers. Better disclosures, and safer lending practices, may help consumers avoid inappropriate real estate and loan transactions.

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Stock Market— Update

Stock Market— Update [¹]
Click here for a link to complete article:

By Frank Barbera, CMT | 27 October 2007

At the present time, the S&P 500 is somewhat mildly oversold near term, and could be near another short term low. The 9 day RSI for the S&P reached down to a low value, below +30 earlier this week with the S&P holding support near the 50 day moving average and the 20 day lower Bollinger Band (1503). That said, it is important to remember that in emerging Bear Markets, Rule #1 is that surprises come to the downside. Now, we know that there are those who would disagree with our assessment that the S&P is in a bear market. A bull could still point out that the 200 day moving average is still rising, and therefore, that the primary trend of the market is still higher. They would be right, as at the moment, the evidence within the stock market really points to a grand transition phase and the presence of an emerging stealth bear market. In our experience, these types of conditions are usually the hallmark of a stock market that is moving into a full on bear, but the proof of that still waits to be seen in the weeks and months ahead.

For now, all we can do is point out some of the more glaring bearish indications, and let readers judge for themselves the health of the stock market. In the chart below, we show our own version of the DJIA along with its Daily Advance-Decline Line. The daily A/D Line is a cumulative summation of the daily NET of advances less declines within the DJIA. In the top chart, we re-compute the DJIA using our own Unweighted Formula so that instead of a Divisor and arithmetic computation, which favors high priced stocks over low priced stocks, using a logarithmic calculation, all stocks are are weighted equally. The value of our DJIA is arbitrary, and could be set to trade at 500, or 5,000 or 50,000.


Click Here, or on the image, to see a larger, undistorted image.

So the scaling on the chart is not important. What is important, is that the Unweighted DJIA is not at decisive new all time highs to anything like the degree seen in the widely reported DJIA. Re-computing the DJIA, we find the DJIA to be right back to the vicinity of its former January 2000 highs, and running into a lot of price resistance in that zone. Next, let's compare the A/D Line with its 2000 highs, nowhere close is the answer on that one despite a good performance in the last few months. On the positive side, we can also point out that the strong bias toward large cap stocks has been producing a robust undertone within the DJIA, which has been reflected in a strong A/D Line moving to new higher highs in recent weeks. Next, let's look at the Dow Jones Transports. Notice that unlike the DJIA, neither the traditional Transportation Average, nor the GST Unweighted Transportation Average were anywhere close to confirming the new “all time” highs in the DJIA. On a Dow Theory basis, this is the kind of bearish divergence that often signals a major market peak.


Click Here, or on the image, to see a larger, undistorted image.

In his fine efforts at "Cycles News and Views", market analyst Tim Wood notes that going back to 1896, there have been 27 four year cycle tops, with the current cycle potentially marking the 28th four year cycle top. During the prior 27 four year cycles, a bearish divergence between the Dow Transports and the Dow Jones Industrials marked 81% of those prior tops. Over the course of the last two to three months, that type of action is exactly what is taking place, with the Advance-Decline Line for the Dow Jones Transportation Average presently very close to a major breakdown below support.


Click Here, or on the image, to see a larger, undistorted image.

Above: the Unweighted DJ-65 Composite, could be finishing off the "right shoulder" of a major peak.


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Above: the Unweighted DJ-65 (upper), the Unweight DJIA, then the Transports and Utilities (lower). Only the DJIA made new highs in Sept, with the other averages failing to confirm.


Click Here, or on the image, to see a larger, undistorted image.

In addition to the obvious bearish divergences between the averages, we can also point out that with even the Dow Jones Industrial Average, overall participation in the advance has been thinning. For example, when the Dow went to new all time highs in July, nearly 86% of the DJIA 30 stocks were above their own 200 day moving averages. Flash forward to September and the latest round of new highs on the DJIA, and only 73% of the stocks were above the 200 day average. Looking at the other two averages, the Transports and the Utilities through this lens, we see that with DJIA hitting new all time highs in September, LESS than 50% of the DJTA average stocks were even above the 200 day average. Ditto the 15 DJ Utility stocks where more then half the list was below the 200 day average. We don’t know if that degree of failure has ever been seen before, but it certainly suggests that the market notwithstanding the CNBC Bobble-head cheerleading is not in good shape technically.


Click Here, or on the image, to see a larger, undistorted image.

Above: the Transports with Percent of Stocks above the 200 day average, less then 50% at the recent all time high in the DJIA, and Below: same thing for the Utility Index. These later two indices often lead, and that cannot be a good message for the market.


Click Here, or on the image, to see a larger, undistorted image.

As a result, we continue to suspect that the stock market is not far away from serious trouble, as looking at the four Dow Averages, the DJ-65 Composite, the Industrials, the Transports and the Utilities, ONLY the DJIA made new all time highs in September, and now, with prices reversing sharply lower, the odds are growing that the September high may have been a final exhaustion peak for the major indices.

Elsewhere, we also want to point out that over the last two years, the US Railroad Industry has thrived as a result of US-China Trade. Over this time, railroads were seen as the extension of the ports, which they are, and moved to P/E multiples not seen in years. In many ways, the rise in China as measured by the surging Shanghai exchange has been paralleled by the recovery in US Railroad fortunes. If demand is dropping off in the US as a result of a consumer led recession, then perhaps the recent downturn in the Transports, and especially the Rails, is an ominous sign for the fortunes of the Chinese Stock market, as the US Consumer has been a key source of aggregate demand. In addition, the Shanghai Stock Exchange, which has unquestionably held up longer than we ever imagined, appears to have completed its five wave advancing pattern, but to be sure, we need to see another three to four percent decline. The momentum profile on Shanghai looks very bearish in our view, and a break in the Asian stock markets where we have seen a speculative mania would be a very big negative for other global markets, including the US.

As another foot note, we also note that European stock markets like the DAX, CAC and FTSE, really lagged the US, perhaps a strong Euro biting into market share, with European ministers pointing the anti-free trade finger at China over the last few days. Protectionism and negative sentiment is rising against China, with the US and Europe now joining in against low priced Chinese goods and an undervalued Yuan. If there ever was a case of "be careful what you ask for" pushing the Chinese to revalue the Yuan has to be it. Attention Wal-Mart shoppers, everything in the store is about to get a lot more expensive once the Yuan revalues…


Click Here, or on the image, to see a larger, undistorted image.

Above: Shanghai with US Railroads.


Click Here, or on the image, to see a larger, undistorted image.

Above: the Shanghai Composite with a very clear five wave pattern, the final high looks to be in place and with a few more percentage points on the downside, we can start to make a bear case for China.


Click Here, or on the image, to see a larger, undistorted image.

Above: A double failure pattern on the medium term RSI for Shanghai, this can’t be good. Momentum peaked back in late 2006, and then made a first failing high in April - May 2007, and now a second failing high in Sept - October 2007.

To date, Asian stock markets have held up longer than we expected, but the roll over in RSI in recent days smacks of something more serious afoot. While some of the Hong Kong ‘H’ Shares still appear as though they could hold up and make token new highs over the next two to three weeks, overall, the vertical nature of the move appears to be very late in the cycle. In our view, a break in the Asian stock markets— perhaps in November or early December would be very serious and could accelerate the outcome to the downside for the US Equity and other International markets leaving us with a mindful approach to investment risk at this late date in the cycle. That’s all for now.

  M O R E. . .

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.