Turning a Costly Blind Eye to Mortgage Speculators

One angle of the mortgage crisis that has been incredibly under-covered by the financial and mainstream press is the adverse role that fraud and speculation played in the crisis. The Prince first began to seriously consider the scale and reach of fraud in obtaining mortgages by single home homeowners, originators, originating mortgage brokers, wholesale originators, and speculators, after a call done by Deutsche Bank (DB) on CDOs during the heat of the mortgage crisis. In this call, some anecdotal information was provided by some of the analysts about what kind of color they were hearing from mortgage originators about the actions of the owners of foreclosed properties. Now it is already acknowledged in the industry that many people with negative equity in their homes, who are unable to pay high monthly servicing payments because of resets on their ARMs, are walking away from their houses. They are not stripping the homes or living in them until they are foreclosed; they are simply moving out and beginning to rent or live with family. Sure their credit is taking a hit, but that can always be mended the next time they get a cheap credit for a house purchase, when the cycle swings back the other way. Also, consider that if they are already a borrower of subprime or questionable credit worthiness, even a hit like a foreclosure is not going to knock their FICO score much lower.

What was unique about the Deutsche Bank call was not their description of the empty houses that were about to be foreclosed, but the presentation of anecdotal evidence that many of the homes that were being foreclosed in new subdivisions were owned by speculators who had accumulated 3, 5, or even a dozen homes in one or multiple subdivisions, using stated income loans (aka "liar loans’ as described by many in the industry) or Alt-A loans. Some had used Option ARMs or even subprime fixed rate mortgages. It was suggested by the DB analysts and some questioners on the lines at clients of the firm, that many of these speculators grossly exaggerated their stated incomes to qualify to purchase so many homes. Many of these speculators were clearly reasoning that price appreciation over many houses, even if small, would provide enough income to allow them to resell the house before their case for servicing payments ran out. When prices stopped rising, many of these speculators had to walk away from the homes they had accumulated. In new subdivisions where speculators were active, the downward price pressure exerted on homes is enormous and particularly damaging to homeowners who bought in the subdivision with a mortgage that was responsibly matched to their proven income. Lenders poring over their defaulted mortgages are already learning that the number of people who bought homes as investments (i.e. speculators) is much greater than previously believed. Well, Duh! If you participate in a market where the incentives are so ripe for fraud and speculation, because you, as a lender, don’t say no and allow fraudulent misstating of income, you are going to see more defaults from speculators.

Furthermore, we must take note that many of these speculators used stated income loans or Alt-A loans. The speculators may have had high FICO scores so they qualified for Alt-A loans, but their actual income was usually far lower than the income they stated on their applications. There are even claims among mortgage broker whistle blowers that mortgage brokers colluded with speculators to state high incomes when the originators knew that actual income was much lower. This collusion is to be expected when the brokers and originators incentives give them no reason to say no, since the risk of giving loans dolled out with dubious information was going to be passed onto investors. When we consider that speculators used Alt-A stated income loans, it is no wonder that the derivatives tracking the value of Alt-A CDOs have experienced sharp declines similar to subprime CDOs. Many investors who were short subprime CDOs were, and are, short CDOs predominately composed of Alt-A loans. Some of the pain in Alt-A loans experienced by long investors in the paper and originators that hold the paper in their portfolios (i.e. Countrywide (CFC), IndyMac (IMB), etc.) may be offset by refinancing and workouts, that may allow speculators to keep some or all of their houses from being foreclosed. This is especially the case, since the new stimulus plan raised the limit on GSE guarantees, which will allow many home mortgages that could not be guaranteed originally by GSEs easier to guarantee, which will make refinancing much more attractive. That is attractive in the sense of lower, more affordable payments, as a result of lower interest rates caused by the added credit protection of a GSE guarantee. However, it is doubtful that this relief will be large enough to substantially support the value of Alt-A CDOs in the secondary market, or increase the actual cash flows from the underlying assets.

The speculation numbers reported by the Wall Street Journal are almost beyond belief. About 20% of mortgage fraud involved "occupancy fraud," or borrowers falsely claiming they intended to live in a property, according to an analysis by BasePoint Analytics, a provider of fraud-detection solutions in Carlsbad, Calif. Another study, by Fitch Ratings, looked at 45 subprime loans that defaulted within the first 12 months even though the borrowers had good credit scores. In two-thirds of the cases, borrowers said they intended to live in the property but never moved in. The lenders knew this was happening and did nothing to proactively prevent it. Home builders have reached similar conclusions. Many believe believe that as many as one in four home buyers in some markets were investors during the boom, up from their earlier estimates of one in 10 buyers. Obviously the home builders knew "occupancy fraud" was occurring, because there was no way they could possibly sell all the new houses they were building in subdivisions in hot markets like Southern California without this form of fraud. They too turned a blind eye, to get homes sold at the expense of protecting subsequent investors in the repackaged loans from increased credit risk. Although this isn’t surprising, since no short-term incentives existed for homebuilders to stop the speculators from committing fraud. If you want more numbers to wrap your head around describing how widespread this was, check out this excerpt from the WSJ.

Much of the occupancy fraud was concentrated in markets such as Florida, Nevada and Arizona, where prices were appreciating by double-digit percentages annually, said Kevin Kanouff, president of Denver-based Clayton Fixed-Income Services, a unit of Clayton Holdings Inc. (CLAY) that reviews about seven million loans a month on behalf of investors.

In Las Vegas, as many as 60% of the foreclosures last year involved non-owner-occupied homes, according to Applied Analysis, a real-estate-research firm. The Las Vegas firm compared the addresses of the borrowers with the locations of their homes. Where the addresses didn’t match, [this] likely indicated a speculator.

The temptation to lie can be substantial and may have been encouraged, or at least tolerated, by mortgage brokers and real-estate agents eager to close a home sale. Standards tend to be tougher for borrowers purchasing investment properties, since these loans are considered riskier.

Lenders typically allowed investors to finance no more than 90% of a home’s value, but if borrowers said they planned to live in the property, they could buy a home with no money down, even if they had scuffed credit and didn’t document their income, said Pete Ogilvie, a mortgage broker in Santa Cruz, Calif., and president of the California Association of Mortgage Brokers.

The bottom line is that the incentives in the mortgage industry for the originators and speculators were so skewed, that creative innovations like Alt-A stated income loans were ripe for fraud. The story about this fraud that is not being prominently covered by the financial media with the benefit of time, will be seen as a lesson and warning sign for mortgage market participants once the mortgage credit market rebound. Speculators lied to get more favorable loan terms or just qualify for loans period, and the lenders turned a blind eye. The lenders did this to pursue short-term profit and now the lenders and investors are paying the price. In some cases, speculators failed to provide required proof of income on non-stated income loans, and mortgages were still issued by lenders, which were later resold to investors as loans that had proven income as part of their terms.

Comments

[John Wake]

Now don't be blaming it all on mortgage brokers. I was shocked to hear from a mortgage broker that reps of the subprime lenders encouraged his brokers to lie about borrowers' income. He would have to walk around the office after the rep's visit to re-educate his staff. www.arizonarealestaten...

I believe the fraud was an open secret in the trade, all the way to Wall Street.

[jack kreg]

Can a lender get the IRS to varify income claims from the loan applicant, otherwise, how does the Lender really varify income?
How does the lender know that the applicant already owns, several homes? If he can't, is that not a big risk for the mortgage investor?
The borrower needs to have a lot more skin in the game.
If I were the mortgage investor, I would want the borrowers money in the game infront of mine. We have made this tooo easy for the borrower to game the system.
If a borrower wants a loan for his 2nd house, then the equity in his 1st house, should also be on the line. Then, he would not risk losing his actual home, on a spec home.

[Richard Weed]

I'm glad to see some press on one of the biggest instigators in this mess. I've had people say, "Why are you so heartless about people who are losing their homes?", but the truth is, I have no sympathy for the speculators who were greedy and lost on their gamble. The idea that any of these folks could be "bailed out" by the government assistant programs makes me sick. While I still don't really gush over the people who have an "Owner Occupied" property and are struggling to keep up with their rate adjustment, at least they were just trying to own a home, not speculate and perpetuate greed. Thanks for the insightful article.

[300mph]

This is old news.

[fl_landscam.victims]

Accused Con-Artists Face Trial in Hampton Subdivision Scam!

Bradford County N. Florida – An old scam with a new twist is back, when you can purchase almost 2 acres of land to build your dream home in a brand new subdivision, but you can’t build anything! Developers Stephen F. Smith, Edith Ellen Smith, and Realtor/Developer Wayne E. Douglas Sr. from Douglas Realty in Starke are facing fraud charges, and numerous state & federal disclosure violations from the sale of a lot in their Edith Ellen Estates subdivision on Hampton Lake. The lot they sold is almost 99% restricted property and is in violation of Interstate Land Sales laws and other state statutes! Unlike the olden days of selling swampland that could be developed in some cases, selling restricted government land that is not disclosed to the buyer is illegal. What is it? It’s called a Government Restricted State Jurisdictional Wetland, and it is “land that is protected by the government for the bugs, bushes, and animals”, you cannot step foot on it! Buyers have no more rights to their property any other person driving down the street looking out their car window would have.

The buyers from California researched the land with the local courthouse, property appraiser, building officials, zoning directors, and everyone said it was “good property”, a “good deal”’ and “they would buy it themselves”, etc. which obviously is not true. After moving cross-country and wasting over one hundred thousand dollars, victims are told “That’s Life” and “You Shouldn’t Listen To What People Tell You or What You Hear Them Say”? These are from people who drive around town with signs on their vehicle telling everyone to read the Bible?

Attorneys for the plaintiffs say the lot in question is not large enough to sustain a required septic system, or any known-recorded architect's design for a house that has ever been published or built in the area. The restrictions were not disclosed as required by State & Federal law, and the maximum dimensions squared along the street that can be developed are 40'ft. x 40'ft. as per survey, which is less than 2% of the total lot size (2.2 football fields end to end along the street). The buyers were emphatically told the entire lot could be cleared without restrictions. The lot is a permitted subdivision Drainage Easement/Jurisdictiona... Wetland, but NOT a home-site, and was specifically required NOT to be conveyed/deeded outside of the homeowners association according to the subdivision permit and homeowner’s association contract. The state agency issuing the permit has not been enforcing permits previously issued, which has caused numerous similar situations throughout North Florida. However, recent talks have already begun and enforcement of previously issued permits should begin later this year according to the SRWMD who issued this subdivision’s permit.

Any conceivable defense the defendants could attempt would involve much twisting and contortion of the law, which has never been successfully done before since most people who promote these underhanded frauds eventually end up in jail say legal experts. This is probably one of the most blatant schemes out there right now to rip somebody off of their hard-earned money. Enforcement of the law is an extremely slow process, which explains why most people just quietly put up a “For Sale” sign on their land instead of complaining. The buyers have said that there is absolutely no way they will leave town without their money and are ready to fight. They are even prepared to take this matter to the Supreme Court if necessary. “This is just not right how people can steal from one another and the law expects the victims to spend thousands of dollars on attorney fees and handle everything on their own just because of budget shortfalls, etc.” “Then the perpetrators hide behind their church, that’s sacrilegious!” “ The law must be enforced and the government regulatory agencies better get their act together soon”. “They stole our home,” says Florence Gata, who is one of the buyers in the lot scam, and is legal guardian of her 82 yr.-old paralyzed mother who lives with her and her husband and now have no home in Florida. “What kind of greedy people do this to one another”? “Now my mother will never realize her dreams, those people should be ashamed of themselves and in jail!”

The honorable judge appears to be connected with a church, the defendants are fellow members, and are wealthy well-known individuals. This may explain previous rulings that have allowed a counter suit against the plaintiffs for slander, defamation of character, and libel against the plaintiffs who are exposing the wrongdoing? This defense was allowed without reference to the written law? Under the guise of a home-site, a restricted jurisdictional wetland that cannot be developed was sold, and you cannot even make a campsite! However this point has not been addressed thus far, or zero need for a trial should the current law on the books be referred to. The plaintiffs did try to amicably work things out with the sellers who were promised another lot or their money back. But the defendants never intended to remedy the situation at all, and the promises were just another lie. This fiasco has been ongoing for over 2 years now, and the trial is set for Sept. 2, 2008.

This material may be published, broadcast, rewritten or redistributed.

[Mr. SpecYou Later]

I love how the economy goes South and the word speculator becomes a four letter word.

So when the speculator makes money on a property and you gain equity from the rising comps he is a hero, but as soon as the market tanks the same speculator is the bad guy.

I am not asking for any government bail out, I don't want that.
What I want is the banks who purchased my loans second hand for pennies on the dollar to come to the table and negotiate the principle balance so that it makes financial sense to stay in the property.
We are all losing money on the deal, but if we keep playing "every man for himself" we will all lose even more.
Cooperation is the answer, not stubbornness and finger pointing.