Before we use to rely on automated underwriting systems and credit scores we had humans who would carefully underwrite mortgage loan files. During the caveman human underwriter days, loan originators and loan processors knew that underwriters could make or break a file. An underwriter had god-like power to grant or deny the American dream. They had minds like a detective and long-term memory capabilities of an autistic child who can recount the entire screenplay of
The Incredible Journey along with all the background noises. Underwriters knew which loan originators had a history of submitting fake gift downpayment letters because they would all sit and chainsmoke together in an un-vented room for 9 hour straight comparing sob stories from loan originators whose files were denied. After work, they would saunter off to network with other underwriters from other banks at a local bar or Mortgage Banker’s Association meeting, same/same. Any fraud that a loan originator tried to pull off was easily sniffed out, with the LO retreating for a while and eventually leaving the company due to the ice cold group shun effect. There were no stated income loans. Two years of tax returns, a P&L and a balance sheet were brought in to underwriting and a few days later, an underwriter would hand the LO a sheet of paper telling the LO what number to use as income for qualifying purposes. If the newly self-employed could not qualify, that person found a co-signer, usually a parent.
Yes, I was an underwriter back in the mid 1980s, and I was the youngest underwriter on staff. I was recruited from processing because I use to submit my files already underwritten along with the conditions for loan approval. What was apparent to me even as a 23 year old was that if my boss had to report to the same person that was in charge of sales and production, every file would have been approved. But she reported to someone else. It was that person’s job to make sure we were making good credit decisions. The goals of production and risk are in harmony, if you take a long-term look at the possible consequences of making credit decisions that are too far out of balance either way. Each part of a mortgage company needs the other part to maximize good consequences for all.
Recent Mortgage Fraud Developments
The outlook for mortgage fraud across the United States is grim. I started this series at the end of October with background research conducted by the FBI that concluded that the most damaging mortgage fraud consisted of many people in the industry working together; fraud for profit.
As of today, I am no longer convinced that fraud for profit is the most damaging kind of mortgage fraud.
Today I believe if we put all the out-of-work underwriters back to work and opened up all the loan files in the defaulting tranches of subprime, Alt-A, and prime loans, we would find the same kind of problems that Fitch, the ratings agency, found when they re-undewrote a small sample of 45 early default loans from the 2006 vintage. Now granted, this is a small sample. However, after working within corporations most of my adult life, I also know that the public really never hears how bad things are. The name of the report is “The Impact of Poor Underwriting Practices and Fraud in Subprime Residential Mortgage Backed Securities” dated Nov 28, 2007. Anyone can read the report by going to fitchratings.com You have to provide them with an email address, but there is no charge. Here are the bullet points:
45 loans with early defaults, originated during 2006, subprime, with an average FICO score of 686. Each loan had one or more of the following characteristics:
66% Occupancy fraud (stated owner occupied but never occupied)
51% Property value was materially different from the original appraisal
48% First time homebuyer yet credit report showed other mortgage information
44% Payment shock greater than 100% and some instances of 200% payment shock
44% Questionable stated income or employment in conflict with info on the credit report
22% Hawk Alert (Fraud) noted on the credit report
18% Social security numbers on the credit report do not match the SS# on the application
17% Seller concessions outside the allowable parameters
16% Credit report indicated their score was artificially inflated via an authorized user
16% Straw buyer
16% Identity theft indicated
10% Signature fraud indicated
6% Not an arms-length transaction
Fitch explained that when a lender used a high FICO score or a high property value/lower LTV to offset other risk factors, when just one of the above areas of fraud were present, the risk of default overshadowed the high FICO and property value.
On December 31, 2007 Fitch downgraded 5.3 billion in RMBS, and this is just ONE ratings agency.
Future Outlook
Old-fashioned human underwriting is making its way back to banks and lenders. This is good news to everyone but the people who answered sales job ads that said “make six figures your first year with no experience” who got into the industry for no other reason than to make money, who don’t care about homeowners, and who really don’t care much about mortgage lending at all. Those that care, that will complain about the amount of time it will take to hand-underwrite your files, to that I say, let the invisible hand of the free market help re-build competent, competitive, service-oriented underwriting departments without the god-like attitude.
The future begins now. We should all expect massive re-assessment of risk management processes within those companies that originate loans such as bankers and lenders. Mortgage brokers should prepare for their banks and lenders to probe deeper into the mortgage broker’s business practices, including systems, education, and training on risk reduction, fraud “no tolerance” policies, and anonymous whistleblower fraud reporting systems.
This also holds true for investment bankers issuing Residential Mortgage Backed Securities. Fitch is putting everyone on notice that it was not able to and cannot, today properly rate RMBS if they’re left to rely on fraudulent loan files. Since risk assessment is only now beginning, I predict the vintage 2007 subprime loans will fare no better than 2006.
However, when we look back 20 years from now perhaps the biggest mortgage fraud case of them all will be the corporate CEOs that left taxpayers and shareholders holding the bag while they scooted out the door holding their golden parachute.
Report mortgage fraud tips to the FBI by following this link.
Part 1: Mortgage Fraud
Part 2: Case Studies