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John Lounsbury, Managing Editor and Co-founder of Global Economic Intersection, provides comprehensive financial planning and investment advisory services to a small number of families on a fee only basis. He has a background which includes 34 years with a major international corporation, 25... More
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  • One Man’s 20-Year War Against The Mortgage Fraud Industry 21 comments
    Feb 7, 2012 2:01 AM | about stocks: JPM, BAC, WFC, XLF
    Note to readers: This post was rejected by Seeking Alpha editors as an article because it did not contain "actionable information." I am posting it as an Instablog in hopes of determining if there is any interest among readers here for this type of article. This was written expressly for Seeking Alpha and I had not planned to post it anywhere else. If you want me to continue to post material like this at Seeking Alpha, even only as an Instablog, please advise by commenting. If there is no interest I will post material like this elsewhere without cluttering this space.

    Gretchen Morgenson has a great New York Times column recounting the more than 20 year investigation of the mortgage industry by one Nye Lavalle. This one man crusade to learn how the mortgage industry was prospering from outright fraud for more than two decades is astounding. In 1996 Lavalle took evidence of what appeared to be forgery and fraud in mortgage servicing and foreclosures to a number of banks including Banc One, Bear Stearns, Countrywide Financial, Freddie Mac, JPMorgan and Washington Mutual. According to the Morgenson article most did not even respond at the time and banks later said his claims were not valid.

    In 2003 Lavalle presented to Fannie Mae a detailed accounting of questionable activities (Morgenson characterizes this as a "dossier of improprieties") by loan servicing companies that worked for the mortgage giant. The prestigious law firm of Baker & Hostetler LLC did a review of the documented cases presented by Lavalle in 2003, 2004, 2005 and early 2006. Although substantiating some of the problems, the attorneys who wrote the firm's 147 page investigative report missed a key to the entire mortgage-foreclosure fraud situation. The attorneys' report dismissed the problem pointed out by Lavalle that promissory notes and mortgage documents were not properly accounted on Fannie Mae and processor firms' books. They said, "It appears that Mr. Lavalle has incorrectly analyzed the issue." (Baker & Hostetler report OCJ Case No. 5595, May 19, 2006, page 16).

    The analysis of the law firm attorneys seems extremely superficial. From GEI News:

    The problem was not with Fannie Mae's books. The problem was that the promissory note connection with the mortgage was often severed by improper title transfers (actually forgone transfers) in local county records offices. Fannie Mae may have had the promissory notes properly recorded on the corporate books but the connection to the security had been broken in many cases through the machinations of the electronic records system MERS.

    It appears that the attorneys who wrote this report did not understand the mortgage system operational details.

    Barry Ritholtz has taken a different point of emphasis on this matter. He characterizes the Morgenson story as fascinating. But he also says the story is absurd in its "complete lack of recognition of how large companies operate." Ritholtz then goes on to say what he thinks the real lesson from the Lavalle story is:
    The thing to blame companies for is not that they ignored some outsider's warnings; Rather, it is that they themselves failed to recognize the many warning signs of the coming housing collapse. This is the true failure of the Mortgage Lenders, Wall Street Secritizers, GSEs, Real Estate Agents, Appraisers, and of course, Central Bankers. Their expertise should have alerted them to the obvious coming tornado. Or worse - and IMO criminally - they saw it all coming and went about running up risky exposure regardless. The massive smash and grab, break the bank, snatch huge IBGYBG bonuses, and split before anyone noticed was the order of the day.

    It is not that they ignored the public warnings. If the economy is dependent upon large companies recognizing broad warnings of economic danger coming from the public, we are all doomed.Rather, it is that they should have known better on their own.That was their massive failure.

    So Ritholtz really comes back to the same bottom line that I have: Fannie Mae (and banks in general) had no idea of what their business risks were, indeed how their businesses operated. And the millions spent on outside consultants and counsel didn't seem to help as well. If the superficial evaluation of the mortgage - promissory note documentation process by the attorneys' report quoted is representative, it is obvious why consultants didn't help.

    Of course, there may have been some who did know what was happening and then their actions would clearly be criminal. Those cases would be ones of control fraud of historic proportions. But, of course, years later there has been no investigation (yet) of this.

    Note: The GEI News article (link above) contains further quotes from the Baker & Hostetler 2006 report as well as links to two definitive articles on the mortgage fraud problem (Yves Smith in 2010 and William K. Black in 2011).

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Comments (21)
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  • Thanks for taking the time to post this, John.


    I believe the risks were known but ignored. For instance, the very existence and use of MERS was to stream-line the process and go outside existing contract and real estate transfer documentation laws on the local and state levels; specifically because they were time consuming and detailed ( with different laws in different communities). They ran rough shod and knew it.
    I have never heard of a bank or financial institution that doesn't have its own auditors. What the hell were they doing for two decades?
    Lastly, I think it is incorrect to blame realtors and appraisers for the mess. These are the people that are supposed to safe-guard underwriting standards in banks? That's ridiculous.
    Lastly, the public companies all had oversight by government regulators.
    Outside whistle blowers are most often ignored. That has certainly been the case with Bernie Madoff and other frauds.
    7 Feb 2012, 03:41 AM Reply Like
  • Good for you, John. I'm with OptionsGirl above, thank you for remembering us on this site.
    7 Feb 2012, 04:31 AM Reply Like
  • The issue is as likely to be one of lack of personal consequences or skin in the game as one of ignorance. It was and is one big smash and grab, and our financial system continues to operate on that premis today. The CEO's have bonus/parachutes in place before they take the desk. The heads of Government sponsored entities (hey, that seems to be the banks too) get paid regardless. Nobody at the helm gives back any assets to cover losses caused by their business failures...not even in the case of massive theft, like MFGlobal.


    So give it up. There is no reward for doing it right. Smash, grab and loot is the business plan of our Fed supported financial institutions smoke-screened by their paid-for puppet government. They've got that down pat.


    Thanks for posting.
    7 Feb 2012, 06:56 AM Reply Like
  • The best observation I've seen, offered from Jesse's Cafe:


    "If I have ever seen the opportunity for those in the government to take a heroic stand in defense of the people against the predations of powerful financial interests this was it. And so whatever they say from this point is at best a shallow mockery, with the ring of untruth, and the hollowness of hypocrisy. And this is why the American people turn away from their corporate-branded presidential candidates with righteous disgust and revulsion. They must have no sense of justice, or of proportion, or history, and apparently they have no shame."
    7 Feb 2012, 07:04 AM Reply Like
  • Wonderful quote. Election reform is the number 1 issue in America. We have to make elections less costly -- and, to do this, probably shorter. Otherwise, the candidates will always have to be rich; or, at least, the rich will ALWAYS own all the candidates.


    Current American political scene: the worst that money can buy.
    7 Feb 2012, 07:14 AM Reply Like
  • Thank you for the article John. I appreciate the fine research and thought that you put into your writing. Actionable? When isn't information, provocative or not, actionable. Thought provoking writing is action.
    7 Feb 2012, 07:21 AM Reply Like
  • Everyone in the business had to know it was a vast pig-out of epic proportions. I definitely choose this interpretation of events: "Or worse - and IMO criminally - they saw it all coming and went about running up risky exposure regardless. The massive smash and grab, break the bank, snatch huge IBGYBG bonuses, and split before anyone noticed was the order of the day."


    I refinanced in 2005 and I freely expressed my opinion then about the insanity of the process where dozens of companies at the time would practically break your door down to get your mortgage business, no documentation required. Who couldn't see that?


    And it was notable then that the pages of boilerplate had risen to 183 from 13 at my first closing. It was also evident that this was likely a smokescreen for fraud rather than it's antidote. Like Obamacare and everything else government pushes upon the hapless, dumbed-down US citizenry, thousands of pages provide the employment for legions of superfluous bureaucrats, lawyers and accountants and ample dark places for criminals to hide in.
    7 Feb 2012, 10:56 AM Reply Like
  • Any article that deals with the history of the great housing bubble is valuable to those interested in real estate investment.
    7 Feb 2012, 11:57 AM Reply Like
  • Thank you for posting this John Lounsbury.
    7 Feb 2012, 12:39 PM Reply Like
  • Author’s reply » Readers - - -


    Thanks for commenting. Without feedback I don't know what is being read on the Instablog and what is not. With articles I can see reader counts and have a pretty good idea when what I have written is wasting time and space on SA.


    Since this is summarizing what I have already written on GEI and brings in the additional views that Ritholtz had on the subject I will not be posting it on our own site. I may send it to Credit Writedowns. I have to check what Edward has on this over there - don't want to be redundant.


    Thanks again for the feedback.
    8 Feb 2012, 01:36 PM Reply Like
  • John,
    Thanks for the article. I would hope that legal action would be taken in these types of matters, but when the regulators come from the ranks of the perpetrators it seems to be a false hope. What was the name of the ancient Greek guy looking for an honest man?
    8 Feb 2012, 01:45 PM Reply Like
  • The Hermit. An account attributed to the cynic Diogenes.

    8 Feb 2012, 05:04 PM Reply Like
  • Thanks for the link, it was more of a rhetorical question but nice to know I am not the only person that remembers the classics.
    8 Feb 2012, 05:49 PM Reply Like
  • I only "mostly remember". For everything else, there's Wikipedia.
    8 Feb 2012, 07:52 PM Reply Like
  • John,


    The only case I can make for your NOT posting this kind of thing is that it is extremely depressing!


    Good read, and thanks for posting it.
    8 Feb 2012, 05:01 PM Reply Like
  • Thanks for another interesting article.
    It's a little hard for me to understand exactly what this issue is that Mr Lavelle tried so hard to shed light on (with apparently no particular upside to himself?)
    That said, the errors, however egregious don't seem to rise to the level of a central/core cause of the meltdown. (Maybe im missing something). It's no doubt a symptom of the bigger disaster, but unless these booking errors legally impact the true sale and transfer of property and related rights, or impacted risk of repayment in full (credit), seems, sadly, maybe more ancillary.


    Big.takeaway for me is how we need the Nye Lavelle's out there, and the Lavelle's need transparency to see and identify where things are broken. Cant expect do the.right thing, that seems to be a consistent lesson over past.4 year post-mortem. Wish we had more.transparency today.
    8 Feb 2012, 06:24 PM Reply Like
  • Author’s reply » thegoodoledays - - -


    The problem is that the processes instituted over the past 20-25 years have created millions of potentially broken title records through the implementation of short cuts in maintaining the legal connection between promissory notes and the mortgages they relate to. This was done to enable the functioning of the MBS (mortgage backed securities) market.


    The MBS market only works if the securities can be readily traded, sometimes even on an hourly and/or daily basis. If the legal process of recording every mortgage transaction were enforced the MBS market would be clogged with paperwork and delays while county records offices recorded every mortgage change. And I haven't even talked about the expense.


    So the banks had a new entity created in the mid 1990s called MERS (Mortgage Electronic Registry Service) that used modern technology to presumably handle all the transactions data and keep the records that would otherwise have been handled through county recording offices. This led to at least two problems:


    1. By law the mortgage transactions are required to be filed at the time they occur in the local records offices; and
    2. The MERS system did not in fact accurately track the sequence of transactions so the records could not be reconstructed at a later date in many cases.


    That led to a process known as robo-signing to produce the required documentation to establish a phony transaction record for the presumed mortgage holder to use when pursuing foreclosure on a delinquent property.


    This has led to many cases of multiple foreclosures being filed on the same property because more than one bank produced forged documents to establish standing to foreclose.


    Mr. Lavalle, because of his own experience in seeing his family defrauded in the 1980s (on a mortgage for which all payments were made on time), started an investigation of mortgage industry practices in the 1990s and found this documentation problem had roots going back 20 years or more from today.


    His standing for seeking action with the banks? He was a stockholder and wanted to protect his investments. We can only hope that he gave up on that objective and sold his bank stocks by the time he was basically thrown out by Fannie Mae in 2006.


    By the way, there is criminal action being started in a few cases, the most recently in Missouri this week:
    There was also some action in Massachusetts in December (sorry I don't have a link).


    A lot of people are upset that a group of about 25 states Attorney Generals are negotiating a civil settlement with the banks for a few tens of billions of dollars to resolve all legal issues associated with the banks and the mortgage documentation mess. People are upset because they feel that widespread criminal prosecution is warranted.


    What is happening is another one of those settlements where the banks will make payments totaling $XX billions and sign statements saying "we did nothing wrong and we promise not to do it again."


    I understand why you said "It's a little hard for me to understand exactly what this issue is..." The reason it is hard to understand is because this is such a colossal fraud which permeates to the very heart of our property ownership system that without many hours of study the details of what has actually happened sound unbelievable. For most people the amount of time (and actually the mental tenacity) necessary to start to understand what has happened just isn't available.


    When I write updates on happenings in this area I don't go back to the basics, but simply provide reference links (which I did here if you click back through the GEI News link in the article. Many people just don't have time to track back through the references. And I don't have time to keep retelling the whole story from the beginning. That puts me in the position of having to write long comment replies like this, so I just can't win!
    9 Feb 2012, 03:49 AM Reply Like
  • Author’s reply » We have posted a detailed summary of the mortgage settlement announced today:
    and will have at least one more news summary this evening.
    I will post an Instablog that summarizes both and gives both (or all if more than two) links later.


    9 Feb 2012, 05:38 PM Reply Like
  • <<...For most people the amount of time (and actually the mental tenacity) necessary to start to understand what has happened just isn't available...>>


    for me please insert [let alone rudimentary thinking skills] immed after "tenacity" above... 


    youre a gentleman for taking the time to respond, and that's enormously helpful.   


    my one lingering comment will be that if indeed the MERS system was flawed from the get-go, and (presumably) all of the multi-trillion dollars in MBS was utilizing MERS In some way, my attention would go directly to the legal opinions at time it was launched and all along the way thereafter, to know how exactly thgis could have ever occurred.  The transfer of rights to collateral, and rights to pursue remedies, aren't just minor nice-to-have before signing the scores of documents memorializing each deal.  It's singularly "the deal" itself, and has everything to do with any investors' risk/reward write-up and approval.  this huge, un-modelled risk factor feels like it would have fallen to a bank's counsel for sign-off, or at least a highly confident opinion.  Wonder why lawfims arent showing up in this news?  maybe not yet.
    thanks again.
    9 Feb 2012, 06:48 PM Reply Like
  • John,
    Great summary. And that's one of the major problems, lack of criminal prosecution. Until criminal prosecution starts to happen, it's just no big deal for big money to defraud and literally steal billions and trillions and break multiple laws. Why not when the financial rewards are so great?
    10 Feb 2012, 12:51 AM Reply Like
  • Thanks for that post as well.


    A little bit more governance and less "horsefeathers" would be nice. Alas... apparently, we vote for producers of horsefeathers from both parties with no end in sight.
    12 Feb 2012, 07:25 AM Reply Like
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