We're in the midst of an already huge bubble in the debt markets that's going to get bigger before it finally deflates. That bubble is characterized by huge bets on risk in the markets for government notes, corporate bonds, home mortgages and the various synthetic derivatives based on those instruments. And it's likely to take years to deflate -- either gently or in one big pop.
Ultimately this trend can't be sustained. The more money there is in search of higher yields, the higher those buyers will drive prices for high-yielding debt securities, and the lower those yields will fall. The only way to make up for falling yields, of course, is to take on more risk. But taking on the next level of risk isn't enough, as more and more institutional investors will soon drive up the price of those debt instruments, reducing their yield, too. Then the only solution is to move up yet another level in risk.
Charlie, I certainly agree that there is a widespread lack of confidence in lenders' books. I've run into more than a few cases where I thought, honestly, that it was more paranoia than prudence. But the point is, what difference does it ultimately make? Confidence crises are confidence crises, and if people are paranoid they have their reasons. I do think honest lenders get punished for taking early losses in an attempt to unwind wisely. That's just a way of saying that the confidence problem does not distinguish between the innocent and the guilty.
Correction? In the second paragraph the article reads:
" If it is borrower-initiated fraud, its not a borrower who wants a house; its a borrower who wants to flip a piece of real estate or launder money or in some other way grab the cash "
Shouldn't that be
If it is fraud-for-profit, its not a borrower who wants a house; its a borrower who wants to flip a piece of real estate or launder money or in some other way grab the cash
The difference between airline pilots and doctors is airline pilots get killed when the plane crashes and doctors say, "Next patient," when the first one dies...and gets paid no matter what.
So the quality of the system (which, in the case of the airlines, is absolutely extraordinary) is dependent upon the sense of risk felt by the participants, the principals in the system.
Tanta, you seem to be identifying two processes that reduce the perception of risk in the housing market:
1) The shared delusion that prices always go up, and
2) The ability of lenders to sell risk: "Is everyone still convinced that hey, we sell the risk to someone else still means squat when it comes to fraud and misrepresentation?"
Personally, I think 2) is far, far, more important than 1). It turns airline pilots into doctors, "Hey, if the plane crashes, I've got my parachute. So long, suckers."
The reason the yield curve is inverted is definitionally that risk appears to be perceived more in the short term than the long term, but, of course, that is a illusion, because the only reason the short term is pricier than the long term is that the short term is under the control of the Fed, whereas the long term is not.
It's as if NFL referees were only permitted to work the part of the field between the 40 yard lines.
So you'd have bloodshed near the goal lines (low long term rates) and fair play in mid-field (higher short term rates).
No risk and free money (well, you do have to pay 0.5% to borrow the yen). I'm not sure you have to believe that prices will go up.
Actually, Mozo Maz, I think I should have said "borrower-initiated fraud for profit." In contrast to other-party initiated fraud-for-profit. I'm just trying to fight off the assumption that borrower-initiated fraud is always for housing, and that fraud for profit is always initiated by someone else.
Plus, it's too early in the morning for me to proofread anything capably.
Maybe the fraud begins when a bank produces more money than it should so that savers money is worth less.
Maybe the fraud is in the system where white collar crime (unless it involves billions) gets a few years time compared to blue collar crime where threatening behaviour gets you 14 years?
Call me robin hood or something but given the widespread thievery at the very heart of the money making system where those who know take advantage of those that dont who exactly are the villians in this piece?
Worried, that's my point. Is a white-collar manager who earns W-2 income of 150% of the area median, with a 780 FICO, who gets a stated income loan to buy a McMansion that she can't afford, a victim of the lender? Well, sure. But is this Robin Hood's usual target market?
And what about the person who sold the McMansion to my white-collar fraudster? Are those "ill-gotten gains"? Is a borrower who sells at a still-inflated price to a sucker, in order to get out of the loan, truly more "honorable" than the borrower who lets the lender foreclose and lose money?
In a dramatic reversal, Morgan Stanley is in the process of holding an auction for $2.48 billion in mortgages from subprime lender New Century.
The loans represent the collateral given to Morgan for a $2.5 billion credit line the firm extended to New Century. As the Irvine, Calif. -based company sank deeper into dire straits earlier this month, Morgan assured the market that the loans and repurchase agreements it had made to the company were in order.
I can't tell from the NYP whether Morgan is selling the loans outright or is selling its security interest in the loans. In other words, if Morgan owns the loans outright and is selling them outright, then it "foreclosed" on the loan to NEW that was secured by the loans. If the loans are still "collateral" for a loan to NEW that has not yet been called, then Morgan is looking for someone to buy a collateralized loan to NEW, not loans to borrowers. That second scenario would certainly be interesting.
become too complicated for the participants. Whenever you have highly complex systems (think Federal Tax Code), it becomes hard to tell the difference between people deliberately gaming the system from those who simply don't understand it. For the gullible borrower, it's easier to latch on to some fantasy about the "American Dream" or prices going up forever, than it is to figure out the complexities of the mortgage underwriting process (and why I'm being charged a $500 "documentation fee"). Add in the complexities associated with the MBS and CDO markets, and you've got a recipe for market disaster.
For law enforcement, it might help to look at these fraud cases from a RICO perspective. The right hand doesn't need to know what the left hand did. So long as the right hand benefited from the left hands actions, he's guilty.
Labor costs are directly expensed immediately. Benefits of those costs are likely to exist either in hard to measure things like customer satisfaction or are future streams of income.
Too often management is rewarded in the short term so the devil takes the long term view.
Yal, I don't actually agree with that. Certainly the sales people have been pocketing some big change. Commissions to loan officers that are based solely on loan amounts and loan closings, not on the profitability to the lender of the loan, encourage a lot of the LO-collusion frauds. And all that churning, which is just fee extraction from borrowers.
But buyers and sellers benefit from low RE transaction costs, and low-cost loans (at least low-upfront-cash-outlay loans) are part of low RE transaction costs. In other words, flippers and specu-vestors make out when getting a residential mortgage loan--instead of a short-term commercial loan, which is what they ought to be getting--is cheap.
If I could have my way as Czarina Tanta, the first thing I'd do is change the GSEs' charters to prevent them from purchasing investment and second home loans. The second thing I'd do is change regulatory rules so that depositories cannot count such loans as 1-4 family residential mortgages. I don't object at all to people investing in real estate, or buying second homes (if they can afford it). But I see no reason for the GSEs or the federally insured depositories to subsidize that.
New home sales are out and the numbers are not pretty, Feb was 848K vs 985K expectations, Jan was revised to 882K from 937. Months of supply hit 8.1 vs 7.3 in Jan. Importantly, median price was up 2.8% m/m and average price was up 6.7% m/m suggesting that we are seeing the impact of the subprime crunch on FTHB.
I was not surprised by the numbers for Feb, but I was surprised with revise down of numbers for Jan. What was wrong with Jan? It was such a happy month!
Tanta,
I think all the lenders are going to take a big hit. I'm not saying that honest lenders will be OK and dishonest ones won't. I don't even know what the definition of an honest vs. dishonest lender is. All lenders take a certain amount of risk whenever they originate a loan. Some take more risks than others. I don't think honesty has anything to do with it.
The botton line is everyone has a lot of red ink on their balance sheets. Some have yet to disclose or realize the loss, but they all have it. Lenders with bad loans have to maintain cash flow in order to hide the bad loans. It looks like cash flow is going to slow down with fewer orginations going forward. Lenders who are more diversified like Countrywide or Wells Fargo will be able to mask problems longer than lenders who are strictly in the mortgage business, but eventually the problems will show up.
I laugh when I read analysis like bad loans will only be $200bb in 2007. A small percentage of the overall mortgage market. It's true if you're looking at the RMBS market, but if these loans are returned to the originators, even if it's a smll percent, it's lights out for them. Most lenders and even most banks can't take a multi billion dollar charge against their books.
There are neighborhoods in cities in the midwest that are going to see billions in losses. 50% of houses will be forclosed and will be worth 10% of the loan amounts (maybe even less than that. The property taxes due will be more than the rental value, so essentially the houses can't even be given away). Who wants to buy a house in a neighborhood that has half the houses in need of demolition and no long term growth outlook.
My mother used to buy old houses and renovate them. This was during the 1970's. Once a neighborhood goes down the tubes, housing prices really crash. I remember being a young lad in Washington DC and going into some of the homes that were destroyed during the Martin Luther King riots. She bought 5000 ft^2 houses for $15,000. The houses were worth 10x that amount prior to the riots and this was in DC, a good investment area.
I am a lawyer who does both inurance and re-insurance (which is insurance for insurance companies).
Insurance is probably one of the most heavily regulated markets next to banking. (some would say even more regulated but I am not here to quibble about that). Reinsurance has been around for centuries and involves the "laying off of risk" to others. The business of reinsurance has developed its own terms and its own duties that are meant to reflect an appropriate balance between the risk "layer off" (the cedant) and the risk "taker" (the reinsurer). Basically it can be summed up as "utmost good faith" where it is understood that the cedant will be in a better position to understand the risk.
I have personally seen many scandals involving reinsurance. Schemes set up and run over many years where the brokers were the main beneficiaries.
One thing I can definitely say is that the main problem which ocurs is that when people perceive that they have "layed off" their risk, absent some countervailing duty, they really start acting as if they no longer need to be concerned about the risk. This is a fallacy as the law clearly intends that they should act no differently. But they do. That is a classic moral hazard.
The mortgage brokers are no different. None of this is "new" it is just simply being played out in a largely unregulated niche of the market. Whenever anyone talks about the wonder of the MBS markets it just makes me chuckle. Its all about liquidity without any regard for responsibility. The "fraud" is not really surprising at all. Its practicaly guaranteed when you de-couple the risk takers from those who actually end up paying for it.
We can thank all those way too bright investment bankers who love number crunching and absolutely lack any semblance of common sense. Of course, they are mere brokers, so they have no real responsibility. They are just there to generate com ission s off this garbage.
Unfortunately the FED will never let them go bust so it will all just move to some other area.
The moral hazard component on the part of the brokers/lenders really increases this problem as well.
My grandmother, in the 50s-80s made a lot of the family money with "improve and sell" real estate and writing 2nd mortgages (often to the buyers of the renovated properties, but to others as well) to what would today be subprime borrowers.
Being the second mortgage, she was obviously in the much riskier position, as a default would affect her share first.
She had 0 defaults over the years. Because it was HER money at stake, she was a shrewd judge of finances, and would carefully EXPLAIN to the borrowers what the costs were, so she only wrote loans the borrower could afford.
(And she viewed it as a competitive service. She underpriced what the bank would charge if a bank would underwrite the 2nd at all, but she'd still get more income than what the bank would give her.)
But if you aren't the one holding the bag, as a broker or lender, fraud is a benefit, not a risk. So you "nudge nudge, wink wink" and ignore the M. Mouse signature.
It still shocks me that Casey Serin has become a celebrity while I believe he belongs to jail. Along with his mortgage brokers and appraisers.
It will take just one good trial and conviction to stop 90% of this fraud from continuing. How come no one at FBI sees that?
a million years ago when I worked for a large regional bank, there were stories of check fraud that would curl your toes. including a check signed M Mouse, (makes me wonder if this could be an urban legend) but check fraud comes to light pretty quickly, mortgage fraud takes so much longer, it will be "interesting" to watch and see how pervasive the fraud is.
Leaving aside the objection that closings would end up getting delayed because everyone would have to do that "wait, wait, let me redo my hair" shit? As a person who has lovingly spent days preparing lavish holiday meals that have ended up served cold and tough and dry because some birdbrain got out the camera so pictures can be taken of the beautiful table, I say pox on all of them.
Seriously? It's like making your trades on a recorded line. Worthless for routine quality control, to some extent--who's got time to go through that much tape? Useful if and when someone finds probable cause to issue a subpoena. Generally some sort of inhibition on the participants. I say this as someone whose line one was a recorded line for many years. Even when I was on line two, I generally refrained from saying words like "shit." But then I wasn't a dishonest trader. I recall that trade line tapes put some Enronistas in hoosegow.
So it's not as much fun as the idea of making all RE closings happen in the mall food court, under the glare of public opinion, but it's not a bad idea.
Fort Lauderdale, I've never seen "M. Mouse." I have, however, seen a "borrower signature" that misspelled the surname. Documents in file show borrower is Joseph Rodgers. Goddamned note is signed "Joseph Rogers." It was my lifetime record for spotting a mortgage fraud: thirty seconds. I had just picked up the note and flipped to the signature page to endorse it, because I wanted to sell it to somebody. As I had just executed the Assignment of Mortgage, I had just seen that name spelled with a "d." A quick glance at the loan file, and there you go.
I don't know why fraudsters are so stupid, either. But what I really don't understand is why we aren't taking advantage of their stupidity.
Thanks for the hat tip Tanta, makes me feel like I actually contribute around here..
The IMF and World Bank have a corruption standard. I believe they try to enforce this standard on countries that they are giving aid to with the idea that corruption is seen as a financial "drag" on the system. Corruption at any level damages people's faith in the system, encourages more shady dealings (i.e., The Jones' are doing it, why shouldn't I get mine!), and lessen the impact of the aid. As the IMF/World Bank are in the game ostensibly to act in part as financial medics, stabilizing economies that have gotten side-swiped and/or to try to fix some the worse case offenders. Thus effectiveness of the aid, corruption, and engendering business and legal expectations that are compatible with the world's open markets is a big deal for them (besides soothing the morays of their major contributors and allowing them to sound a bit holier than thou to these economic miscreants, always a good thing domestically).
The point I'm trying to make in all this is that the distrust in the mortgage system and expectation of corruption may be one of the unexpected collateral fallouts of this entire debacle. (I'll see if I can dig up that economics paper I vaguely remember reading lately on the effects of corruption in an economic system.) While I don't think this will bring down the system, it is something I don't think we want to have happen and dang sure don't want to continue to encourage regardless of the short term profits of the parties involved.
Hmm, one of the other points I was trying to make is that shady dealing is a SYSTEMIC disease; a slippery slope to a system riddled with abuses. There generally are no overt villains as everyone assumes that most people are doing it, so what's the harm in getting their's when the getting is good.
Does corruption create economic incentives that improve efficiency? Sometimes it can. For example, bribing your professor to grade exams and homeworks quickly rather than waiting two or three weeks might improve efficiency, but bribing them to give you a higher grade you don't deserve would not. In this article examining corruption in the equivalent of the DMV in India, the negative effect - bribing for a higher score on the driving test - outweighs the positive effect of reducing processing time:
Driving in New Delhi: Don't complain about standing in line at the DMV., by Joel Waldfogel, Slate: At least in principle, some kinds of government corruption are not so bad because they promote efficiency in how regulations are administered. ... But a new study of driver's license examinations in New Delhi, India, confirms what most international policy wonks have long said: The benefits of corruption are not worth the costs.
....
This study confirms the view of the World Bank, which "has identified corruption as among the greatest obstacles to economic and social development." Payoffs at the Indian DMV may save some qualified drivers some time. But it has the bad direct effect of allowing unsafe drivers on the road. ... The lesson applies beyond the DMV. If bribing a procurement officer works better than building a solid airplane or bridge, why bother with safety checks? Dealing with by-the-book Pattys and Selmas is pretty unpleasant. But a world without them is much worse.
...
[E]ven if corruption can be a useful means of bypassing inefficiencies in the short term, in the long term it tends to create inefficiencies of its own. Bribing, it turns out, doesnt always speed things up ... a vast study of twenty-four hundred companies in fifty-eight countries ... found that the more a company had to bribe, the more time it spent tied up in negotiations with bureaucrats. Graft also encourages government officials to keep complicated procedures in place... So corruption isnt just a product of bad institutions and policies; it also helps cause them. Almost every study done in the past ten years has found that, on the whole, corrupt countries grow more slowly and have a much harder time attracting foreign investment.
Can you regulate after the fact? I hope the lawsuits that are winding through the courts (soon to be clogging up the courts) will produce some rulings about civil liabilites for lenders who dupe naive buyers, or buyers who defraud lenders, but I wonder if anyone will ever be made to pay...
But here's a first sloppy swing preventive medicine:
Way back when the snakeoil salesmen roamed the earth, routinely killing consumers with "health" potions, the government initiated the Pure Food and Drug Act, which required clear labeling of ingredients in products, as well as a means to test products for safety. This is what we need for the lending industry -- purity, transparency and clarity of information about loans -- from the homebuying consumer on up to the investors. All parties must be clearly informed of every fee, payment and potential or actual rate reset through the life of the loan, as well as the true risk level of the homebuyer (meaning something better than FICO). That means the consumer must provide truthful, clear information about his/her ability to repay the loan.
The second thing is to impose some nasty penalties to discourage snake oil peddling -- whether consumer or lender. Make each and ever fee-collecter along the line responsible for some minimum standard of data verification --or else their fee becomes forfeitable. Make the consumer responsible for a minimum level of data verification-or their house becomes forfeitable.
And make the direct lender the ultimate bagholder--if any loans they sell as securites are found to be fraudulent, it's all on them--and make lenders have enough insurance/reserves on hand before they can even be permitted to sell mortgages as securites.
--
I came to the conclusion in 2003 that America is being controlled by Bankrupters and Fraudsters of New York City (BFNYC) whether we Americans like it or not. And there isn't a damn thing we can do about it because:
Democracy = Domination of Money Oswald Spengler
BTW, that was the case in Greece in 3rd and 4th Century BC (capitalists did well and migrated with their ships when the rest were left suffering).
We as a nation have matured to the final stage of democracy that precedes COLLAPSE. It is unavoidable because all the necessary work for the collapse has been completed including the construction and overcrowding of the Debt Concentration Camps. It was quite amazing to see the efficiency with which BFNYC completed the task with the help of Fed, of course, their sworn agents. There is a whole different vista of America once you start at the very top.
Tanta wrote: I don't know why fraudsters are so stupid, either. But what I really don't understand is why we aren't taking advantage of their stupidity.
Stop thinking like an honest person and start thinking like a bastard (err, an economist specializing in psychological issues. Its the same thing. )
Because the answer to your question is simple, its the whole moral hazard caused by securitization. So many brokers are actually taking ADVANTAGE of the stupidity. They just put it in slightly more subtle ways.
If you are going to securitize the loans, or are just a broker and not the lender, you get your money from WRITING loans, and its a percentage of the value written, not the interest from SERVICING loans.
So as long as the loan lasts long enough that you don't have to buy it back, let the fraud commence. It is in the broker/lender's interest to aquiesce any fraud up to the point where the loan defaults before you can sell it to someone else/have to buy it back.
So you want to catch the truely blatent stuff (eg, M. Mouse) as that would result in an immediate loss, but not the slightly more subtle stuff (interfamily straw byers, down payment "assistance" etc, inflated income from a buyer trying to streach it), its just nudge nudge, wink wink, say no more say no more and sign the papers.
So you smackdown the dumb ones, but you SHOULD turn a blind eye to those smart enough to improve the W2 generator.
Arguably, fraud for housing serves as a guard agains excessive credit tightening. IF (and that's a big if) the people engaged in it DO manage to make their payments successfully, everyone goes away in presumably better shape than if they couldn't get a loan. Of course the "so long as it's still performing we're not worried about it," logic engendered probably helped pump up this bubble.
It's really the stupid teaser rates that will be the biggest part of the problem IMHO. Why would anyone buy a MBS backed by loans that the borrower had no hope of paying off? Even the upper tranches should represent such a small percentage of the principal involved that one would think that they would have little affect on the profitability of these loans. Tanta? Is there some approximate idea of how small a percentage of loan values are well rated when you tranch subprime poo? Surely when you tranche it only a tiny percentage of the debt is investment grade.
Nicholas, I would disagree with you only to the extent that I really believe there are other mechanisms in play besides selling off the loans. Like selling off your employees and replacing them with contractors, temps, brokers, and other people who can't quite be expected to be particularly loyal to you--and therefore, say, as attentive to signature details. Insofar as things were different in the old days, it had something to do with the fact that I expected to retire from my bank and wanted it to be around for the long haul. But you know all that.
Jim, loans don't get allocated to tranches. Tranches are basically just positions in the cash-flow (and loss) cascade: the A tranches get paid first, the Cs get paid last; the Cs take the first losses, the As take whatever the subordinate tranches don't absorb. But the cash-flow and the losses are based on the entire underlying pool. Or poo, as the case may be. So subprime loans are never "investment grade." But a senior tranche of a security backed by subrime loans can be investment grade, just because it is "credit enhanced" by being first in line for payments and last in line for losses.
Arguably, fraud for housing serves as a guard agains excessive credit tightening. IF (and that's a big if) the people engaged in it DO manage to make their payments successfully, everyone goes away in presumably better shape than if they couldn't get a loan.
Jim, I don't think you can make a case for fraud-for-housing as a guard against a credit crunch, and I'm sure you don't want to.
I will only say that FHA, VA, state and county bond programs, the GSEs' affordable housing programs, all of those have functioned, during past credit crunches, as a wedge for the first-time and moderate income borrowers (and refinancing owners) to get through the crunch. I will happily make the argument that this is a necessary part of our--society's--arsenal.
Which is why I don't want them shooting off all their ammo in the battle to keep the party going. We will need them after the party stops. And it's a hell of a lot better than relying on fraud.
Fraud may be part of the problem, but what is the cause of it becoming more rampant. Two things come to mind.
1)A general environment at the top of government that regulation gets in the way of good business.
2) Someone needs to buy risky investment vehicles. The article Vader linked above explains who this is-everyone who is going to retire and the governments and businesses who will pay the retirement benefits. The squeeze on workers has begun, it is not just taking away of benefits, it is forcing many to quit, through various means, either reducing or eliminating their retirement benefits. Link again. Why the debt bubble hasn't burst -- yet
As you discussed earlier, some of these mortgage innovations were created out of disrespect of risks. Anyone who has a health respect for risks will realize the risk premium for these innovations will kill them. However if you believe, or want to believe RE never goes down, then here come all our exotic new friends.
Why couldn't we have a tracking system for mortgage brokers, appraisors, or mortgage approvers. Link their track records to their SSN. Won't it be better if we can have some facts to back their reputation. It will probably make it easier for future securitization.
My mom had a good friend and handyman neighbor come in and do some minor remodeling. She paid him with a personal check, which he dutifully took to his favorite bar. "Hey, I can't cash this check" the bartender said. "Why not?" he replied increduluously. "Becaused it's signed 'Mickey Mouse'".
You were much to kind and easy on these individuals and institutions.
The paper trails on real estate make it very easy to go after the perpetrators. Their acts are willful, intentional and malicious! (And in writing)
Separating the fraud for legitimate home borrowers is a very slippery slope. Is it okay to fudge your income 10%; 24% or 50%. What about whiting out a W-2 or bank statement?
I concur that the institutions have been complicit and an unindicted co-conspirator who have encouraged this behavior.
The amazing part of the whole story is where have the Regulators been. Fremont Cease & Desist Order is to little too late.
Even more amazing is that Wall Street continues to buy MBS and that spreads have not increased.
It almost seem as though everyone was doing 95 mph on the highway, saw a cop, a few got pulled over and the rest of the pack speeds on.
That Wall Street still wants the product and the originators leads me to believe that not much will change over the long term in regards to the paperwork.
I spoke to an appraiser the other day at a fraud seminar,he was from the modesto area,and mentioned a large subdivision that had had a gang of realtors,loan brokers,and crooked appraisers work it over so thoroughly that he refused to even try to appraise a property there.he didn't bother to report it to OREA,because they are so understaffed and toothless,with only 8 investigators statewide.I referred him to MortgageFraudWatchlist.com.the Dollar amount of this fraud exceeds 2 billion Dollars.in one large subdivision.in modesto.Houston,we have a problem.
I'm all in favor of tracking the performance of market participants. Let me just say that this business of using SSNs for public purposes is what has enabled a huge amount of this fraud. You must be willing to pay the additional costs of assigning another identifier--HUD uses a "mortgagee number"--that can be tracked, but is not used in other transactions. If I were a HUD DE Underwriter--which I'm not--my underwriter number would be used to track my activities. But I would never use my DE number to get a loan or open a checking account, so I wouldn't care if you had my DE number for that reason. Of course I'd care if you were a fraudster who "borrowed" my DE number to approve fraudulent loans. So you must also put up with the additional costs to the system of controlling for that kind of thing. It can be done with good systems--think of the VISA people who call you when their system notices that unusual things are happening with your account. I'm never bothered by that; back when I was on the road a lot it would happen to me a lot.
The sad fact--which I'm sure tom stone could verify--is that I could steal an appraiser's license number and facsimile signature to paste into a fake electronic appraisal in a few minutes, and I'm not even much of a hacker. If you accept electronic appraisals without e-verification technology, backed up with routine QC like calling the licensed appraiser to verify the source, you are at huge exposure. I have been involved--as the "business expert," not the programmer--with building appraisal tracking databases for lenders. They can be very effective. They cost money. This quarter's bottom line always beats next year's bottom line for some people.
Tom, I'm old enough to remember the days of staff appraisers. That setup had its problems, but there is nothing like being able to walk over to the appraiser's office, wiggle your finger a little, and stalk off into that nasty little conference room with a terrified appraiser trailing you for solving certain problems in a direct and timely fashion. As someone whose signature has appeared on some loan approvals--not to mention some big-assed loan sales--I can assure everyone that there's really no place to hide in the "back office," unless the back office itself is corrupt. Which is becoming the problem here.
Thanks for all of the good work (along with CR, of course!). You state the following:
"My theory of the Fraud for Bubbles is, in a nutshell, that it isnt that lenders forgot that there are risks. It is that the miserable dynamic . . . simply masked fraud problems sufficiently, and delayed the eventual feedback mechanisms . . ."
I think you have hit the nail almost on the head. (My perspective is corporate strategy and industry dynamics.) Over the last ten years, with the development of new (better?) investment tools (e.g. derivatives, credit swaps, hybrid ARMs, securization of everything imaginable, even future works of art . . .) we have come to believe that we are now effectively "managing risk." However the mortgage industry is making three big mistakes 1.) Not seeing how the kinds and degrees of risk in the game have changed substantially, 2.) Thinking that "managing risk" means "removing risk," and 3.) equating risk and uncertainty. Risk is a hot potatoe. Every level of risk taker, at each stage of the mortgage chain, wants to dump off the bottom tranche. How all of these bottom risk slices richochet is yet to be seen. I don't think the industry has begun to understand how new financial tools, along with the changing mortgage industry, have actually dispersed and hidden risk AND uncertainty . . . while blithely assuming they are really "managing" it. Risk is not just economic. But economic risk is the type of risk most easily rendered mathematical, and hence thought to be precise and manageable. Growth in an industry hides incompetence and ignorance. How all of this interacts, in a time of lowering asset prices, tightening credit, and hot potatoes being stuffed down organizational pants, is yet to be seen. It will be interesting . . .
We should have a pool where we guess at the number of houses that will be destroyed (demolished because they are vacant and worth less than the taxes, can't be given away, etc.) before this is all over.
Fremont? The same owners as back when they were a Workers Comp insurance company:
In this case, auditors were investigating allegations that Fremont Compensation Insurance Group had illegally falsified dates on benefit notices to injured workers, backdated checks to avoid paying penalties, and altered medical bills and invoices at several of its adjusting locations, including San Francisco, Glendale, and Fresno.
In June, 1998, the company abruptly denied DWC further access to claims files and filed a lawsuit in San Francisco Superior Court, requesting the court to require the agency to obtain a subpoena before releasing records to auditors.
In his opinion denying the preliminary injunction, Judge Raymond D. Williamson, Jr. found that: "The procedures used by DWC to audit and investigate Fremont are clearly constitutional on their face and as applied." At a later point he added that if a preliminary injunction were to be issued, "it is clear that the Audit Unit would be prevented from carrying out its legislative mandate...to ensure payment of compensation to injured workers."
"This action will allow the audit program to continue to do its job," said Sugarman. "The audit program is a critical element in the state's efforts to ensure that all parties in the workers' compensation system are carrying out their responsibilities as mandated by law and plays a major role in the state's anti-fraud efforts."
The court order denying the preliminary injuction is Fremont Compensation Insurance Group v. Department of Industrial Relations, et al, San Francisco Superior Court Case No. 996193, filed Aug. 20, 1998.
I suspect there's a lot of fraud going on at the mortgage companies now trying to hide the truth of what's in their books.
The public will find out the day they are effectively bankrupt. I think there are a lot of Enrons in the mortgage industry.
reposting link that went bad.
Gonna get much worst before it pops.
Why the debt bubble hasn't burst -- yet
We're in the midst of an already huge bubble in the debt markets that's going to get bigger before it finally deflates. That bubble is characterized by huge bets on risk in the markets for government notes, corporate bonds, home mortgages and the various synthetic derivatives based on those instruments. And it's likely to take years to deflate -- either gently or in one big pop.
Ultimately this trend can't be sustained. The more money there is in search of higher yields, the higher those buyers will drive prices for high-yielding debt securities, and the lower those yields will fall. The only way to make up for falling yields, of course, is to take on more risk. But taking on the next level of risk isn't enough, as more and more institutional investors will soon drive up the price of those debt instruments, reducing their yield, too. Then the only solution is to move up yet another level in risk.
Charlie, I certainly agree that there is a widespread lack of confidence in lenders' books. I've run into more than a few cases where I thought, honestly, that it was more paranoia than prudence. But the point is, what difference does it ultimately make? Confidence crises are confidence crises, and if people are paranoid they have their reasons. I do think honest lenders get punished for taking early losses in an attempt to unwind wisely. That's just a way of saying that the confidence problem does not distinguish between the innocent and the guilty.
Correction? In the second paragraph the article reads:
" If it is borrower-initiated fraud, its not a borrower who wants a house; its a borrower who wants to flip a piece of real estate or launder money or in some other way grab the cash "
Shouldn't that be
If it is fraud-for-profit, its not a borrower who wants a house; its a borrower who wants to flip a piece of real estate or launder money or in some other way grab the cash
The difference between airline pilots and doctors is airline pilots get killed when the plane crashes and doctors say, "Next patient," when the first one dies...and gets paid no matter what.
So the quality of the system (which, in the case of the airlines, is absolutely extraordinary) is dependent upon the sense of risk felt by the participants, the principals in the system.
Tanta, you seem to be identifying two processes that reduce the perception of risk in the housing market:
1) The shared delusion that prices always go up, and
2) The ability of lenders to sell risk: "Is everyone still convinced that hey, we sell the risk to someone else still means squat when it comes to fraud and misrepresentation?"
Personally, I think 2) is far, far, more important than 1). It turns airline pilots into doctors, "Hey, if the plane crashes, I've got my parachute. So long, suckers."
The reason the yield curve is inverted is definitionally that risk appears to be perceived more in the short term than the long term, but, of course, that is a illusion, because the only reason the short term is pricier than the long term is that the short term is under the control of the Fed, whereas the long term is not.
It's as if NFL referees were only permitted to work the part of the field between the 40 yard lines.
So you'd have bloodshed near the goal lines (low long term rates) and fair play in mid-field (higher short term rates).
No risk and free money (well, you do have to pay 0.5% to borrow the yen). I'm not sure you have to believe that prices will go up.
Housing prices are an epiphenomenon.
Actually, Mozo Maz, I think I should have said "borrower-initiated fraud for profit." In contrast to other-party initiated fraud-for-profit. I'm just trying to fight off the assumption that borrower-initiated fraud is always for housing, and that fraud for profit is always initiated by someone else.
Plus, it's too early in the morning for me to proofread anything capably.
this is a little bit ot but
PIMCO has a new housing outlook for 2007 including comments on alt-a, agency bonds etc.
immobilienblasen: The Housing Project Update / PIMCO
Maybe the fraud begins when a bank produces more money than it should so that savers money is worth less.
Maybe the fraud is in the system where white collar crime (unless it involves billions) gets a few years time compared to blue collar crime where threatening behaviour gets you 14 years?
Call me robin hood or something but given the widespread thievery at the very heart of the money making system where those who know take advantage of those that dont who exactly are the villians in this piece?
I have no idea how to provide the link but go to:
Business, financial, personal finance news - CNNMoney.com
on the left look up moron lenders
News: PageNotFound
Is this a major event as it seesm to me ?
who exactly are the villians in this piece?
Worried, that's my point. Is a white-collar manager who earns W-2 income of 150% of the area median, with a 780 FICO, who gets a stated income loan to buy a McMansion that she can't afford, a victim of the lender? Well, sure. But is this Robin Hood's usual target market?
And what about the person who sold the McMansion to my white-collar fraudster? Are those "ill-gotten gains"? Is a borrower who sells at a still-inflated price to a sucker, in order to get out of the loan, truly more "honorable" than the borrower who lets the lender foreclose and lose money?
Yes, it isn't simple.
In a dramatic reversal, Morgan Stanley is in the process of holding an auction for $2.48 billion in mortgages from subprime lender New Century.
The loans represent the collateral given to Morgan for a $2.5 billion credit line the firm extended to New Century. As the Irvine, Calif. -based company sank deeper into dire straits earlier this month, Morgan assured the market that the loans and repurchase agreements it had made to the company were in order.
I can't tell from the NYP whether Morgan is selling the loans outright or is selling its security interest in the loans. In other words, if Morgan owns the loans outright and is selling them outright, then it "foreclosed" on the loan to NEW that was secured by the loans. If the loans are still "collateral" for a loan to NEW that has not yet been called, then Morgan is looking for someone to buy a collateralized loan to NEW, not loans to borrowers. That second scenario would certainly be interesting.
become too complicated for the participants. Whenever you have highly complex systems (think Federal Tax Code), it becomes hard to tell the difference between people deliberately gaming the system from those who simply don't understand it. For the gullible borrower, it's easier to latch on to some fantasy about the "American Dream" or prices going up forever, than it is to figure out the complexities of the mortgage underwriting process (and why I'm being charged a $500 "documentation fee"). Add in the complexities associated with the MBS and CDO markets, and you've got a recipe for market disaster.
For law enforcement, it might help to look at these fraud cases from a RICO
perspective. The right hand doesn't need to know what the left hand did. So long as the right hand benefited from the left hands actions, he's guilty.
Add this to the above:
"Speaking from the standpoint of a security person; this is what happens when systems"
Tanta, You hit the nail on the head:
Transaction costs.
It seems that just like everything else today all that people care about was to get to high "production" volume and to do it with a minimum cost.
The only ones who make the big bucks are the sales people.
Blame it on accounting.
Labor costs are directly expensed immediately. Benefits of those costs are likely to exist either in hard to measure things like customer satisfaction or are future streams of income.
Too often management is rewarded in the short term so the devil takes the long term view.
Yal, I don't actually agree with that. Certainly the sales people have been pocketing some big change. Commissions to loan officers that are based solely on loan amounts and loan closings, not on the profitability to the lender of the loan, encourage a lot of the LO-collusion frauds. And all that churning, which is just fee extraction from borrowers.
But buyers and sellers benefit from low RE transaction costs, and low-cost loans (at least low-upfront-cash-outlay loans) are part of low RE transaction costs. In other words, flippers and specu-vestors make out when getting a residential mortgage loan--instead of a short-term commercial loan, which is what they ought to be getting--is cheap.
If I could have my way as Czarina Tanta, the first thing I'd do is change the GSEs' charters to prevent them from purchasing investment and second home loans. The second thing I'd do is change regulatory rules so that depositories cannot count such loans as 1-4 family residential mortgages. I don't object at all to people investing in real estate, or buying second homes (if they can afford it). But I see no reason for the GSEs or the federally insured depositories to subsidize that.
Tanta:
Excellent post, I guess those software lending programs need more adjustments, click-click
For example:
trade-your-good-name-for-50k
New home sales are out and the numbers are not pretty, Feb was 848K vs 985K expectations, Jan was revised to 882K from 937. Months of supply hit 8.1 vs 7.3 in Jan. Importantly, median price was up 2.8% m/m and average price was up 6.7% m/m suggesting that we are seeing the impact of the subprime crunch on FTHB.
I was not surprised by the numbers for Feb, but I was surprised with revise down of numbers for Jan. What was wrong with Jan? It was such a happy month!
Tanta,
I think all the lenders are going to take a big hit. I'm not saying that honest lenders will be OK and dishonest ones won't. I don't even know what the definition of an honest vs. dishonest lender is. All lenders take a certain amount of risk whenever they originate a loan. Some take more risks than others. I don't think honesty has anything to do with it.
The botton line is everyone has a lot of red ink on their balance sheets. Some have yet to disclose or realize the loss, but they all have it. Lenders with bad loans have to maintain cash flow in order to hide the bad loans. It looks like cash flow is going to slow down with fewer orginations going forward. Lenders who are more diversified like Countrywide or Wells Fargo will be able to mask problems longer than lenders who are strictly in the mortgage business, but eventually the problems will show up.
I laugh when I read analysis like bad loans will only be $200bb in 2007. A small percentage of the overall mortgage market. It's true if you're looking at the RMBS market, but if these loans are returned to the originators, even if it's a smll percent, it's lights out for them. Most lenders and even most banks can't take a multi billion dollar charge against their books.
There are neighborhoods in cities in the midwest that are going to see billions in losses. 50% of houses will be forclosed and will be worth 10% of the loan amounts (maybe even less than that. The property taxes due will be more than the rental value, so essentially the houses can't even be given away). Who wants to buy a house in a neighborhood that has half the houses in need of demolition and no long term growth outlook.
My mother used to buy old houses and renovate them. This was during the 1970's. Once a neighborhood goes down the tubes, housing prices really crash. I remember being a young lad in Washington DC and going into some of the homes that were destroyed during the Martin Luther King riots. She bought 5000 ft^2 houses for $15,000. The houses were worth 10x that amount prior to the riots and this was in DC, a good investment area.
Before you judge, please attend to the heartrending stories of some of thedowntrodden victims
Sen. Dodd is trying to help.
I am a lawyer who does both inurance and re-insurance (which is insurance for insurance companies).
Insurance is probably one of the most heavily regulated markets next to banking. (some would say even more regulated but I am not here to quibble about that). Reinsurance has been around for centuries and involves the "laying off of risk" to others. The business of reinsurance has developed its own terms and its own duties that are meant to reflect an appropriate balance between the risk "layer off" (the cedant) and the risk "taker" (the reinsurer). Basically it can be summed up as "utmost good faith" where it is understood that the cedant will be in a better position to understand the risk.
I have personally seen many scandals involving reinsurance. Schemes set up and run over many years where the brokers were the main beneficiaries.
One thing I can definitely say is that the main problem which ocurs is that when people perceive that they have "layed off" their risk, absent some countervailing duty, they really start acting as if they no longer need to be concerned about the risk. This is a fallacy as the law clearly intends that they should act no differently. But they do. That is a classic moral hazard.
The mortgage brokers are no different. None of this is "new" it is just simply being played out in a largely unregulated niche of the market. Whenever anyone talks about the wonder of the MBS markets it just makes me chuckle. Its all about liquidity without any regard for responsibility. The "fraud" is not really surprising at all. Its practicaly guaranteed when you de-couple the risk takers from those who actually end up paying for it.
We can thank all those way too bright investment bankers who love number crunching and absolutely lack any semblance of common sense. Of course, they are mere brokers, so they have no real responsibility. They are just there to generate com ission s off this garbage.
Unfortunately the FED will never let them go bust so it will all just move to some other area.
great post Tanta. Thanks.
What do you think about video-taping the closing?
The moral hazard component on the part of the brokers/lenders really increases this problem as well.
My grandmother, in the 50s-80s made a lot of the family money with "improve and sell" real estate and writing 2nd mortgages (often to the buyers of the renovated properties, but to others as well) to what would today be subprime borrowers.
Being the second mortgage, she was obviously in the much riskier position, as a default would affect her share first.
She had 0 defaults over the years. Because it was HER money at stake, she was a shrewd judge of finances, and would carefully EXPLAIN to the borrowers what the costs were, so she only wrote loans the borrower could afford.
(And she viewed it as a competitive service. She underpriced what the bank would charge if a bank would underwrite the 2nd at all, but she'd still get more income than what the bank would give her.)
But if you aren't the one holding the bag, as a broker or lender, fraud is a benefit, not a risk. So you "nudge nudge, wink wink" and ignore the M. Mouse signature.
It still shocks me that Casey Serin has become a celebrity while I believe he belongs to jail. Along with his mortgage brokers and appraisers.
It will take just one good trial and conviction to stop 90% of this fraud from continuing. How come no one at FBI sees that?
Wow! The Ubernerd posts leave me in this dust. This one just blows me away.
a million years ago when I worked for a large regional bank, there were stories of check fraud that would curl your toes. including a check signed M Mouse, (makes me wonder if this could be an urban legend) but check fraud comes to light pretty quickly, mortgage fraud takes so much longer, it will be "interesting" to watch and see how pervasive the fraud is.
What do you think about video-taping the closing?
Leaving aside the objection that closings would end up getting delayed because everyone would have to do that "wait, wait, let me redo my hair" shit? As a person who has lovingly spent days preparing lavish holiday meals that have ended up served cold and tough and dry because some birdbrain got out the camera so pictures can be taken of the beautiful table, I say pox on all of them.
Seriously? It's like making your trades on a recorded line. Worthless for routine quality control, to some extent--who's got time to go through that much tape? Useful if and when someone finds probable cause to issue a subpoena. Generally some sort of inhibition on the participants. I say this as someone whose line one was a recorded line for many years. Even when I was on line two, I generally refrained from saying words like "shit." But then I wasn't a dishonest trader. I recall that trade line tapes put some Enronistas in hoosegow.
So it's not as much fun as the idea of making all RE closings happen in the mall food court, under the glare of public opinion, but it's not a bad idea.
Fort Lauderdale, I've never seen "M. Mouse." I have, however, seen a "borrower signature" that misspelled the surname. Documents in file show borrower is Joseph Rodgers. Goddamned note is signed "Joseph Rogers." It was my lifetime record for spotting a mortgage fraud: thirty seconds. I had just picked up the note and flipped to the signature page to endorse it, because I wanted to sell it to somebody. As I had just executed the Assignment of Mortgage, I had just seen that name spelled with a "d." A quick glance at the loan file, and there you go.
I don't know why fraudsters are so stupid, either. But what I really don't understand is why we aren't taking advantage of their stupidity.
Thanks for the hat tip Tanta, makes me feel like I actually contribute around here..
The IMF and World Bank have a corruption standard. I believe they try to enforce this standard on countries that they are giving aid to with the idea that corruption is seen as a financial "drag" on the system. Corruption at any level damages people's faith in the system, encourages more shady dealings (i.e., The Jones' are doing it, why shouldn't I get mine!), and lessen the impact of the aid. As the IMF/World Bank are in the game ostensibly to act in part as financial medics, stabilizing economies that have gotten side-swiped and/or to try to fix some the worse case offenders. Thus effectiveness of the aid, corruption, and engendering business and legal expectations that are compatible with the world's open markets is a big deal for them (besides soothing the morays of their major contributors and allowing them to sound a bit holier than thou to these economic miscreants, always a good thing domestically).
The point I'm trying to make in all this is that the distrust in the mortgage system and expectation of corruption may be one of the unexpected collateral fallouts of this entire debacle. (I'll see if I can dig up that economics paper I vaguely remember reading lately on the effects of corruption in an economic system.) While I don't think this will bring down the system, it is something I don't think we want to have happen and dang sure don't want to continue to encourage regardless of the short term profits of the parties involved.
Hmm, one of the other points I was trying to make is that shady dealing is a SYSTEMIC disease; a slippery slope to a system riddled with abuses. There generally are no overt villains as everyone assumes that most people are doing it, so what's the harm in getting their's when the getting is good.
Ahh.. Here we go, the promised articles
When is corruption good? - PSD Blog - The World Bank Group
Economist's View: Does Corruption Improve Economic Efficiency?
Does Corruption Improve Economic Efficiency?
Does corruption create economic incentives that improve efficiency? Sometimes it can. For example, bribing your professor to grade exams and homeworks quickly rather than waiting two or three weeks might improve efficiency, but bribing them to give you a higher grade you don't deserve would not. In this article examining corruption in the equivalent of the DMV in India, the negative effect - bribing for a higher score on the driving test - outweighs the positive effect of reducing processing time:
Driving in New Delhi: Don't complain about standing in line at the DMV., by Joel Waldfogel, Slate: At least in principle, some kinds of government corruption are not so bad because they promote efficiency in how regulations are administered. ... But a new study of driver's license examinations in New Delhi, India, confirms what most international policy wonks have long said: The benefits of corruption are not worth the costs.
....
This study confirms the view of the World Bank, which "has identified corruption as among the greatest obstacles to economic and social development." Payoffs at the Indian DMV may save some qualified drivers some time. But it has the bad direct effect of allowing unsafe drivers on the road. ... The lesson applies beyond the DMV. If bribing a procurement officer works better than building a solid airplane or bridge, why bother with safety checks? Dealing with by-the-book Pattys and Selmas is pretty unpleasant. But a world without them is much worse.
...
[E]ven if corruption can be a useful means of bypassing inefficiencies in the short term, in the long term it tends to create inefficiencies of its own. Bribing, it turns out, doesnt always speed things up ... a vast study of twenty-four hundred companies in fifty-eight countries ... found that the more a company had to bribe, the more time it spent tied up in negotiations with bureaucrats. Graft also encourages government officials to keep complicated procedures in place... So corruption isnt just a product of bad institutions and policies; it also helps cause them. Almost every study done in the past ten years has found that, on the whole, corrupt countries grow more slowly and have a much harder time attracting foreign investment.
Whoops. Dang Haloscan, the above Anon was me.
Can you regulate after the fact? I hope the lawsuits that are winding through the courts (soon to be clogging up the courts) will produce some rulings about civil liabilites for lenders who dupe naive buyers, or buyers who defraud lenders, but I wonder if anyone will ever be made to pay...
But here's a first sloppy swing preventive medicine:
Way back when the snakeoil salesmen roamed the earth, routinely killing consumers with "health" potions, the government initiated the Pure Food and Drug Act, which required clear labeling of ingredients in products, as well as a means to test products for safety. This is what we need for the lending industry -- purity, transparency and clarity of information about loans -- from the homebuying consumer on up to the investors. All parties must be clearly informed of every fee, payment and potential or actual rate reset through the life of the loan, as well as the true risk level of the homebuyer (meaning something better than FICO). That means the consumer must provide truthful, clear information about his/her ability to repay the loan.
The second thing is to impose some nasty penalties to discourage snake oil peddling -- whether consumer or lender. Make each and ever fee-collecter along the line responsible for some minimum standard of data verification --or else their fee becomes forfeitable. Make the consumer responsible for a minimum level of data verification-or their house becomes forfeitable.
And make the direct lender the ultimate bagholder--if any loans they sell as securites are found to be fraudulent, it's all on them--and make lenders have enough insurance/reserves on hand before they can even be permitted to sell mortgages as securites.
--
I came to the conclusion in 2003 that America is being controlled by Bankrupters and Fraudsters of New York City (BFNYC) whether we Americans like it or not. And there isn't a damn thing we can do about it because:
Democracy = Domination of Money Oswald Spengler
BTW, that was the case in Greece in 3rd and 4th Century BC (capitalists did well and migrated with their ships when the rest were left suffering).
We as a nation have matured to the final stage of democracy that precedes COLLAPSE. It is unavoidable because all the necessary work for the collapse has been completed including the construction and overcrowding of the Debt Concentration Camps. It was quite amazing to see the efficiency with which BFNYC completed the task with the help of Fed, of course, their sworn agents. There is a whole different vista of America once you start at the very top.
Jas
Tanta wrote: I don't know why fraudsters are so stupid, either. But what I really don't understand is why we aren't taking advantage of their stupidity.
Stop thinking like an honest person and start thinking like a bastard (err, an economist specializing in psychological issues. Its the same thing.
)
Because the answer to your question is simple, its the whole moral hazard caused by securitization. So many brokers are actually taking ADVANTAGE of the stupidity. They just put it in slightly more subtle ways.
If you are going to securitize the loans, or are just a broker and not the lender, you get your money from WRITING loans, and its a percentage of the value written, not the interest from SERVICING loans.
So as long as the loan lasts long enough that you don't have to buy it back, let the fraud commence. It is in the broker/lender's interest to aquiesce any fraud up to the point where the loan defaults before you can sell it to someone else/have to buy it back.
So you want to catch the truely blatent stuff (eg, M. Mouse) as that would result in an immediate loss, but not the slightly more subtle stuff (interfamily straw byers, down payment "assistance" etc, inflated income from a buyer trying to streach it), its just nudge nudge, wink wink, say no more say no more and sign the papers.
So you smackdown the dumb ones, but you SHOULD turn a blind eye to those smart enough to improve the W2 generator.
Arguably, fraud for housing serves as a guard agains excessive credit tightening. IF (and that's a big if) the people engaged in it DO manage to make their payments successfully, everyone goes away in presumably better shape than if they couldn't get a loan. Of course the "so long as it's still performing we're not worried about it," logic engendered probably helped pump up this bubble.
It's really the stupid teaser rates that will be the biggest part of the problem IMHO. Why would anyone buy a MBS backed by loans that the borrower had no hope of paying off? Even the upper tranches should represent such a small percentage of the principal involved that one would think that they would have little affect on the profitability of these loans. Tanta? Is there some approximate idea of how small a percentage of loan values are well rated when you tranch subprime poo? Surely when you tranche it only a tiny percentage of the debt is investment grade.
Nicholas, I would disagree with you only to the extent that I really believe there are other mechanisms in play besides selling off the loans. Like selling off your employees and replacing them with contractors, temps, brokers, and other people who can't quite be expected to be particularly loyal to you--and therefore, say, as attentive to signature details. Insofar as things were different in the old days, it had something to do with the fact that I expected to retire from my bank and wanted it to be around for the long haul. But you know all that.
Jim, loans don't get allocated to tranches. Tranches are basically just positions in the cash-flow (and loss) cascade: the A tranches get paid first, the Cs get paid last; the Cs take the first losses, the As take whatever the subordinate tranches don't absorb. But the cash-flow and the losses are based on the entire underlying pool. Or poo, as the case may be. So subprime loans are never "investment grade." But a senior tranche of a security backed by subrime loans can be investment grade, just because it is "credit enhanced" by being first in line for payments and last in line for losses.
Arguably, fraud for housing serves as a guard agains excessive credit tightening. IF (and that's a big if) the people engaged in it DO manage to make their payments successfully, everyone goes away in presumably better shape than if they couldn't get a loan.
Jim, I don't think you can make a case for fraud-for-housing as a guard against a credit crunch, and I'm sure you don't want to.
I will only say that FHA, VA, state and county bond programs, the GSEs' affordable housing programs, all of those have functioned, during past credit crunches, as a wedge for the first-time and moderate income borrowers (and refinancing owners) to get through the crunch. I will happily make the argument that this is a necessary part of our--society's--arsenal.
Which is why I don't want them shooting off all their ammo in the battle to keep the party going. We will need them after the party stops. And it's a hell of a lot better than relying on fraud.
Fraud may be part of the problem, but what is the cause of it becoming more rampant. Two things come to mind.
1)A general environment at the top of government that regulation gets in the way of good business.
2) Someone needs to buy risky investment vehicles. The article Vader linked above explains who this is-everyone who is going to retire and the governments and businesses who will pay the retirement benefits. The squeeze on workers has begun, it is not just taking away of benefits, it is forcing many to quit, through various means, either reducing or eliminating their retirement benefits. Link again.
Why the debt bubble hasn't burst -- yet
Tanta, great post.
Some of my own thoughts.
True story:
My mom had a good friend and handyman neighbor come in and do some minor remodeling. She paid him with a personal check, which he dutifully took to his favorite bar. "Hey, I can't cash this check" the bartender said. "Why not?" he replied increduluously. "Becaused it's signed 'Mickey Mouse'".
Tanta,
You were much to kind and easy on these individuals and institutions.
The paper trails on real estate make it very easy to go after the perpetrators. Their acts are willful, intentional and malicious! (And in writing)
Separating the fraud for legitimate home borrowers is a very slippery slope. Is it okay to fudge your income 10%; 24% or 50%. What about whiting out a W-2 or bank statement?
I concur that the institutions have been complicit and an unindicted co-conspirator who have encouraged this behavior.
The amazing part of the whole story is where have the Regulators been. Fremont Cease & Desist Order is to little too late.
Even more amazing is that Wall Street continues to buy MBS and that spreads have not increased.
It almost seem as though everyone was doing 95 mph on the highway, saw a cop, a few got pulled over and the rest of the pack speeds on.
That Wall Street still wants the product and the originators leads me to believe that not much will change over the long term in regards to the paperwork.
I spoke to an appraiser the other day at a fraud seminar,he was from the modesto area,and mentioned a large subdivision that had had a gang of realtors,loan brokers,and crooked appraisers work it over so thoroughly that he refused to even try to appraise a property there.he didn't bother to report it to OREA,because they are so understaffed and toothless,with only 8 investigators statewide.I referred him to MortgageFraudWatchlist.com.the Dollar amount of this fraud exceeds 2 billion Dollars.in one large subdivision.in modesto.Houston,we have a problem.
Link their track records to their SSN
I'm all in favor of tracking the performance of market participants. Let me just say that this business of using SSNs for public purposes is what has enabled a huge amount of this fraud. You must be willing to pay the additional costs of assigning another identifier--HUD uses a "mortgagee number"--that can be tracked, but is not used in other transactions. If I were a HUD DE Underwriter--which I'm not--my underwriter number would be used to track my activities. But I would never use my DE number to get a loan or open a checking account, so I wouldn't care if you had my DE number for that reason. Of course I'd care if you were a fraudster who "borrowed" my DE number to approve fraudulent loans. So you must also put up with the additional costs to the system of controlling for that kind of thing. It can be done with good systems--think of the VISA people who call you when their system notices that unusual things are happening with your account. I'm never bothered by that; back when I was on the road a lot it would happen to me a lot.
The sad fact--which I'm sure tom stone could verify--is that I could steal an appraiser's license number and facsimile signature to paste into a fake electronic appraisal in a few minutes, and I'm not even much of a hacker. If you accept electronic appraisals without e-verification technology, backed up with routine QC like calling the licensed appraiser to verify the source, you are at huge exposure. I have been involved--as the "business expert," not the programmer--with building appraisal tracking databases for lenders. They can be very effective. They cost money. This quarter's bottom line always beats next year's bottom line for some people.
Tom, I'm old enough to remember the days of staff appraisers. That setup had its problems, but there is nothing like being able to walk over to the appraiser's office, wiggle your finger a little, and stalk off into that nasty little conference room with a terrified appraiser trailing you for solving certain problems in a direct and timely fashion. As someone whose signature has appeared on some loan approvals--not to mention some big-assed loan sales--I can assure everyone that there's really no place to hide in the "back office," unless the back office itself is corrupt. Which is becoming the problem here.
tanta thank you for sharing your wisdom on the re stuff.i would gladly pay for such great insight
its early in the am. but this has to be said somewhere we all (most of us ) just got lost chasing the dollars. dindnt we ????
Tanta,
Thanks for all of the good work (along with CR, of course!). You state the following:
"My theory of the Fraud for Bubbles is, in a nutshell, that it isnt that lenders forgot that there are risks. It is that the miserable dynamic . . . simply masked fraud problems sufficiently, and delayed the eventual feedback mechanisms . . ."
I think you have hit the nail almost on the head. (My perspective is corporate strategy and industry dynamics.) Over the last ten years, with the development of new (better?) investment tools (e.g. derivatives, credit swaps, hybrid ARMs, securization of everything imaginable, even future works of art . . .) we have come to believe that we are now effectively "managing risk." However the mortgage industry is making three big mistakes 1.) Not seeing how the kinds and degrees of risk in the game have changed substantially, 2.) Thinking that "managing risk" means "removing risk," and 3.) equating risk and uncertainty. Risk is a hot potatoe. Every level of risk taker, at each stage of the mortgage chain, wants to dump off the bottom tranche. How all of these bottom risk slices richochet is yet to be seen. I don't think the industry has begun to understand how new financial tools, along with the changing mortgage industry, have actually dispersed and hidden risk AND uncertainty . . . while blithely assuming they are really "managing" it. Risk is not just economic. But economic risk is the type of risk most easily rendered mathematical, and hence thought to be precise and manageable. Growth in an industry hides incompetence and ignorance. How all of this interacts, in a time of lowering asset prices, tightening credit, and hot potatoes being stuffed down organizational pants, is yet to be seen. It will be interesting . . .
We should have a pool where we guess at the number of houses that will be destroyed (demolished because they are vacant and worth less than the taxes, can't be given away, etc.) before this is all over.
Tanta,
What a brilliant piece you have written. My kudos and thanks to you.
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Ask the Chinese How to solve the American Problem
Ant Fraud Yields Death Sentence - washingtonpost.com
or
avenue-s.org/eipingoutfraudinchina.html
Fremont? The same owners as back when they were a Workers Comp insurance company:
In this case, auditors were investigating allegations that Fremont Compensation Insurance Group had illegally falsified dates on benefit notices to injured workers, backdated checks to avoid paying penalties, and altered medical bills and invoices at several of its adjusting locations, including San Francisco, Glendale, and Fresno.
In June, 1998, the company abruptly denied DWC further access to claims files and filed a lawsuit in San Francisco Superior Court, requesting the court to require the agency to obtain a subpoena before releasing records to auditors.
In his opinion denying the preliminary injunction, Judge Raymond D. Williamson, Jr. found that: "The procedures used by DWC to audit and investigate Fremont are clearly constitutional on their face and as applied." At a later point he added that if a preliminary injunction were to be issued, "it is clear that the Audit Unit would be prevented from carrying out its legislative mandate...to ensure payment of compensation to injured workers."
"This action will allow the audit program to continue to do its job," said Sugarman. "The audit program is a critical element in the state's efforts to ensure that all parties in the workers' compensation system are carrying out their responsibilities as mandated by law and plays a major role in the state's anti-fraud efforts."
The court order denying the preliminary injuction is Fremont Compensation Insurance Group v. Department of Industrial Relations, et al, San Francisco Superior Court Case No. 996193, filed Aug. 20, 1998.