Arnold Kling  

Mortgage Fraud

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Moody's plotted the rate at which recent mortgages are going into default within the first 9 months of issuance, and it is quite high. Look at the graph at Calculated Risk, reproduced by James Hamilton.

When I was at Freddie Mac, we presumed that any loan that defaulted within 12 months was fraud. Typical cases included inflated appraisals, loans that were sold to us as owner-occupied when they were actually investor loans, loans on vacant lots, totally fictitious loans...These were not just minor misrepresentations. They were pure mini-conspiracies to enrich mortgage brokers. In some cases, the broker did more than just take fees for originating junk loans. If you traced the recipient of the loan, you might find a close relative of the broker--a relative who never had any intention of repaying the loan.

We had several full-time investigators employed in a fraud unit. We also had a number of other layers of controls that were used to limit our exposure to fly-by-night brokers.

Hamilton notes that in recent years the share of mortgages going to nontraditional investors (meaning not Freddie Mac or Fannie Mae) went up. Put this together with the high rate of early-payment defaults, and my guess would be that a lot of fraud has taken place. The new players on Wall Street thought they were buying genuine mortgage loans. I would not be surprised to find that they were just helping a lot of small-time operators steal a quick few million dollars each.

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COMMENTS (5 to date)

I suppose Arnold is right that fraud is part of the cause of current mortgage crisis.

But traders have always faced the possibility of fraud, throughout the history of trade. Every threat of substantial loss to a trader creates an opportunity for an entrepreneur to invent a service which moderates the threat. Entrepreneurs constantly innovate with institutions of surety and trust, with the result that most of us can trade most of the time without encountering more risk than we can tolerate.

The scale of the current disturbance in mortgages suggests that something has happened outside this picture of market moderation. I suppose there must have been some act (or set of acts) by the state which encouraged or tolerated abnormal levels of fraud. But I have not yet seen a description of that act (or set of acts) by the state which convincingly identifies the cause of the current disturbance, to my thinking that is.

Matt writes:

"Wall Street thought they were buying genuine mortgage loans"

Bull. The proof is simple, they could have paid you a few thousand and you would have explained it to them.

MT57 writes:

On the subject of subprime mortgage fraud, this link will take you to a colorful hedge fund letter on the subject that circulated "on wall street" a couple of months ago.

Wallstreet was aware of the risks in buying mortgage backed securities. They should man up to their risks and stop blaming other ppl. Many brokers, processors, underwriters, etc have lost their jobs due to the mess.

North Carolina Mortgage

JKB writes:

Yes, there was a blind eye turned to the risks of investing in mortgages by investors. However, the system was set up that the particulars needed to spot fraud were aggregated into oblivion by the time an investor saw anything.

Fraud detection was required early and low in the aggregation. Brokers and wholesalers chose not to do ask questions and thus put their business at risk. Now that the losses are accruing, investors aren't willing to risk their money on something with a history of going bad. Brokers and others in the industry are losing their jobs because the "industry" failed to protect their interests but rather went for the quick cash. Now anything coming out of a broker/wholesaler is viewed with suspicion and being mistrusted isn't a good trait for an investment.

Claiming you added sawdust to the candy only because the buyer had an insatiable sweet tooth and sugar was hard to come by, won't cause the buyer to purchase more candy once he realizes he has wood pulp in his teeth. Same goes for bad loans.

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