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Fraud Everywhere

Our mortgage finance system was and continues to be riddled with fraud but back before the crisis began no one cared because everyone was happy and Wall Street was making a ton of money.  Unfortunately, when this House of Cards collapsed it wasn’t Wall Street that paid the price.  It was the rest of us.  Today, as the financial sector tries to clean up the mess they created, they continue to employ fraudulent tactics to achieve an end. 

They did what a man with a gun in a dark alley couldn’t do. They stole my house.
- Victim of predatory home lender in Senate testimony, 3/98

Back in 2000 I was Deputy City Treasurer for Chicago.  Our office was leading a public education campaign addressing ‘predatory home lending’ an insidious practice that was destroying whole city blocks and stealing families’ most valuable asset - their homes.  We were working with local community groups to spread the word.  One morning I had an unexpected visitor - a retired widow.  I welcomed her into my office and when she sat down she began sobbing - quite an unusually situation for me.  After a few minutes she was able to collect herself and tell me that she was losing her home to foreclosure.  She told me that she couldn’t afford the payments on mortgage anymore.  She told me how felt incredibly guilty to have lost the family home.  I examined the document she had and she described for me a very common practice of predatory lenders - mortgage broker who she trusted convinced her to sign loan documents in blank and he later filled in the loan terms which, according to the retired widow, were quite different than she thought she was getting.  The loan terms included an low teaser interest rate that sprung to a much higher rate in a matter of months.  With a person on fixed income the payments became too much.  But that piece of shit mortgage broker knew this.  Back then these predators wanted the homes more than anything else because real estate values were starting to take-off. 

Unfortunately for the retired widow it was too late.  The foreclosure process had already run its course - she couldn’t find an attorney willing to represent her - and her house was scheduled for foreclosure sale but the retired widow didn’t understand how bad it was.  She came to me looking for answers and help but I couldn’t provide the answers she wanted to hear or help so was looking for.  I made a few phone calls to see if there was any way or anyone willing to seek an injunction of the foreclosure sale and try to re-open case - but no luck.  The best we can do for this retired widow was file a complaint with state attorney general’s office and hope that they decide to pursue the case (keep in mind in 2000 this was far from a priority for law enforcement). 

My personal experience with predatory home lending was far too common across Chicago and the rest of the country.  There were thousands of cases of predatory home lending but policy makers and regulators didn’t care because most people particularly Wall Street was happy. 

Obviously, the fraud didn’t stop.  After exploiting seniors and retirees, these predators moved on to home purchases.  With home prices increasing and more and more people wanting a piece of the “American Dream” - Wall Street had a huge market to exploit.  People barely making $95,000 per year were convinced and often duped by mortgage brokers/lenders to take out huge mortgages to buy $400,000 home with little to no down payment.  Sure, people/borrowers should have understood the risks and understood whether they could afford the mortgage payments but it was hard to resist a piece of that “American Dream” plus having a “mortgage expert” telling you “no problem when can get you that house” - resistance to financial devastation was extremely difficult.  Besides, who controlled the purse strings - who ultimately could have rejected such horrible loans?  Yep, Wall Street.

Wall Street had gained an insatiable appetite for mortgages. It wasn’t enough to simply package a pool of mortgages and issue mortgage-backed securities - the old fashion way.  Under the guise of “financial innovation” Wall Street created new ways of gaining fees. They created things such as Collateralized Debt Obligations that sliced and diced individual mortgages even further. But that wasn’t enough - they created Credit Default Swaps as “insurance” against mortgage defaults.  Wall Street created an multi-trillion dollar ponzi scheme out of residential home mortgages. 

But all good things much come to an end.  This ponzi scheme or House of Cards was based on the assumption that real estate prices always go up.  An assumption that has been completely destroyed by this financial crisis. 

Let’s take a look at a few cases of fraud or alleged fraud in the mortgage finance system.  Please keep in mind that we still do not know the full extent of fraud in the mortgage system and we may never know. 

1)  Goldman Sachs & John Paulson

In 2007, John Paulson, a hedge fund manager, who believed that the mortgage market was about to tank, was looking for deals to capitalize on.  Goldman Sachs obliged.  Paulson picked some of the worse mortgages with highest levels of default risk out there and Goldman Sachs pooled those mortgages and issued mortgage backed securities (MBS).  But Goldman Sachs needed a sucker to buy these rigged MBS and they found one.  Goldman Sachs, without disclosing that the mortgages behind MBS were hand picked by Paulson, sold the securities which allowed Paulson to short sell them (betting price on MBS would go down - although it was highly probable that they would).  Paulson made a cool $1 billion just three months after the sale to sucker investor and Goldman Sachs made tens of millions of dollars with quick and easy transaction.

2)  Angelo Mozilo

Angelo Mozilo was CEO of Countrywide Financial.  Countrywide Financial epitomized the problems with weak lending standards.  At the lender’s peak in 2006, it was taking in revenue of $11.4 billion, much of it built on subprime and liar loans that were the bundled and sold to investors on Wall Street for huge profits.  Then the bottom dropped out of the mortgage market and Countrywide’s fortunes tanked with it.  In 2009, SEC charged Mozilo with civil fraud and insider trading.  SEC alleged that Mozilo mislead investors to the extent of riskiness of Countrywide’s mortgage loan portfolio.  Mozilo and SEC settled the civl fraud claim last week.  But as an example of ‘crime does pay’ - the settlement calls for Mozilo to pay only $22.5 million fine because a the longer portion of the agreed fine will be paid Bank of America who bought Countrywide while Mozilo was CEO.  Mozilo walked away from BofA purchase with several hundred million dollars. 

3) AIG

AIG loved Credit Default Swaps.  CDS were a form of insurance, and heck, AIG being the world’s largest insurance company needed to get in on this mortgage action.  AIG, ignoring all insurance risk management standards, issues $440 BILLION in CDS - far exceeding what it could pay out if it had to.  Once the mortgage market began to tank it quickly became clear that AIG couldn’t make good on most of the CDS it issued and federal government had to bail them out.

4) Moody’s and Credit Rating Agencies

Someone had to give some level of credibility to this ponzi scheme created by Wall Street.  For a fee that someone were credit rating agencies.  Credit rating agencies, like Moody’s Investor Services, were for a handsome fee issuing high credit ratings on CDOs and other MBS with few questions asked or due diligence.  But hey it doesn’t matter that investors may have relied on these highly questionable credit ratings because Moody’s and other credit rating agencies are saying that freedom of speech allows them to issue what ever credit rating they want regardless of how much investigation they performed.  What a scam!

5) Foreclosure Fraud

The latest instance of fraud in the mortgage finance system was uncovered in foreclosure process.  Mortgage servicers (most ‘Too Big To Fail’ financial conglomerates) hired people to sign sworn affidavits that they were in possession of loan documents (promissory notes and mortgage), that they reviewed the loan documents and that they were the owner of promissory note.  Well, it turns out that hundreds of thousands of these sworn affidavits were wrong.  The signer, while under seal/oath of notary public, lied - they were not in possession of loan documents, they didn’t actually review the loan documents (just paid to sign) and there’s a huge question of who actually owns and is possession of the promissory note.  As a result, Bank of America, JP Morgan Chase and Ally Bank suspended foreclosures until this ‘technicality’ is resolved. 

One big issue is who actually owns these promissory notes and mortgages.  Remember, in their infinite wisdom, Wall Street sliced and diced mortgages every which way it could and issued securities.  A portion of a single mortgage could be one pool of securitized mortgages and the other portion in another pool.  However, it looks like with the flurry of mortgages being made Wall Street got sloppy with loan documentation.  After all who would question these Masters of the Universe?

Now, the fraudulent behavior (lying on sworn statements) of the mortgage servicers may have uncovered a much bigger problem and potentially more fraud in the mortgage finance system.  It’s not quite clear who owns or possesses the promissory notes to these mortgages (actual possession of promissory note is very important in some states).  This could have an impact on foreclosure process but an even bigger problem for MBS has come up.  Issuers had to make certain disclosures to MBS investors - one of them being that they were holders/owners of promissory notes and mortgages and another disclosure or representation was that borrowers in mortgage pools met certain loan criteria or underwriting standards.  But the truthfulness or accuracy of these disclosures has been called into question.  And if MBS investors decide to push the issue - after all they have lost a ton of money on these securities - they could force issuers to buy back mortgages in MBS pools.  That is a huge potential liability for many TBTF financial conglomerates. 

There is no question that there was fraud everywhere in the mortgage finance system.  The problem is that we don’t know and may never know the full extent of the fraud.  Based on my experience with predatory home lenders, I suspect that fraud was pretty common through out the entire system.  Once word got around of how one predatory lender was having success with a certain predatory practice other predatory lenders were quick to adopt it.  Same is probably true for Wall Street especially considering how much money was at stake. 

Policy makers, particularly the Obama Administration, have yet to not only address the fraud in mortgage finance system but provide solutions to another big problem - negative equity or underwater mortgages (where outstanding mortgage principal is more than home value).  We need far more drastic and effective proposals.  Basically, need to blow-up our current fraudulent mortgage finance system and build a new one. 

Good luck.

Further reference:
Who’s Who in the Foreclosure Scandal: A Primer on the Players
The Enormous Mortgage Bond Scandal