Republic Rules - The U.S.A. is a great representative republic.

The sub-prime mortgage melt-down has wreaked havoc in financial markets, local communities, and the economy in general.  Headlines have blared about the abuses in the industry and search for those who caused it.  I suspect there is plenty of blame to go around.  Most fingers in the media point toward the mortgage companies.

You don’t hear as much about one particular aspect of the crisis, though, and it’s worth exploring a bit deeper.  It is becoming apparent that a good portion of the bad mortgage loans… those that went into default when home prices stopped appreciating at a rate that would support the underlying valuations… are so-called “liar loans”.  These are loans that are approved based on “stated income”… meaning, the income written on the loan application is not verified.

While I certainly have compassion for people who lose their homes… but, realistically, if someone inflated their income (lied when stating it on their loan application), then they really didn’t qualify for the loan in the first place.  Had their income been validated and found to be incorrect, the loan would not have been approved and they would not have moved into the house to begin with.

The most common types of mortgage fraud are:

Source: Mortgage Bankers Association

It’s clear the that the methods used to commit fraud in originating mortgage loans are well known and haven’t really changed all that much over the past few years.  We should point out, though, that even small percentages (such as the difference between all loans and subprime loans), can add up to huge dollar figures given the volume of loans as well as the relatively high amount involved in home loans.

We can only guess at this point WHO committed the fraud, but it could only be someone directly involved in any given transaction… most likely:

• the borrower - most likely lying about their income
• the mortgage broker - manipulating the borrower by either encouraging them to lie on the application or insisting they leave some information blank and falsifying it themselves… or knowingly accepting a false application submitted by the borrower (in essence, colluding with them)
• someone within the mortgage company (or a contractor, such as an appraiser) who didn’t do their job:  on their own (willful negligence) or perhaps in collusion with another party or under instructions from their supervisor

Nevertheless, HOW mortgage fraud is perpetrated has not changed all that much… but the volume HAS.  In the same report cited above, we can see the volume of Suspicious Activity Reports (SARs) … data collected from all federally-insured financial institutions… has increased dramatically:

It must be noted that SAR submissions are currently only required of federally-insured financial institutions and their affiliates. Therefore, the fraud experiences of independent mortgage banking companies are not reflected above.  In other words, the numbers are probably HIGHER!

Given the dramatic rise in SARS submissions, you would think someone might have noticed and taken action.  I’m betting it was noticed.  Taking action is another matter.

It would seem that the recent problems might have been averted.  In trying to assemble “lessons learned”, this is something that truly needs to be discovered.  Apparently, the data was being collected… but for what purpose?  Does it make any sense to go to the time, trouble, and expense to gather information if nothing constructive will come of it?  You’d think that, in 2005, someone might have been shocked to discover the reports TRIPLED in the past two years and alerted everyone involved that something was going on.  Often, the mere fact that it becomes public information that people are looking into a problem will tend to reduce that activity (know what I mean?  wink- wink- nod- nod).

While earlier action might not have eliminated the problem, it very well could have prevented it from become a full-blown crisis.