By Jessica Swesey
Inman News Features
Mortgage fraud is complex, technologically sophisticated and, like many white-collar crimes, hard to spot. Sadly, too many financial institutions don't even disclose publicly when they've been defrauded. Instead they sweep these crimes under the rug and record them on their accounting books as "economic losses."
It sounds like the old ineffective "don't talk about it and it never happened" solution.
The mortgage system is rigged with disincentives for lenders to report mortgage fraud. The biggest disincentive is that the lender would be out the money that would be paid back to the secondary market investors and mortgage insurers.
But how can regulators and law enforcement officials get a handle on the mortgage fraud epidemic when the victims are so tightlipped?
It's time for lenders to step up and call mortgage fraud what it is even when it means a financial loss for them. It's in the bigger interest of the financial system that these crimes be recognized and prosecuted. Otherwise, the perpetrators will continue to walk away millions of dollars richer and lenders will continue to pass along the losses to borrowers through higher fees and stricter underwriting guidelines.
Mortgage fraud isn't a victimless crime. It leaves a trail of deteriorating neighborhoods, destroyed personal credit histories and artificially inflated home value on the public record.
Lenders aren't the only ones suffering the loss, but they certainly are in the best position to take action.
True, some lenders train their employees in early mortgage fraud detection. And true, some lenders have notified the FBI after they've realized an excruciating loss. These actions are commendable and deserve recognition, but much more is needed.
Lenders should know their mortgage brokers, real estate appraisers and closing officers. They should lobby for mandatory state licensing programs that include thorough background checks and educational requirements.
Lenders should record fraud as fraud, instead of utilizing creative accounting that only hides the problem and makes it even harder for investigators to figure out. Lenders should double- and triple-check their loans before they hit the send key, and they should know who's writing their mortgages.
It's time lenders realize they have the power to choke fraud at its source. They owe it to borrowers, investors and other lenders to at least blow the whistle when something seems awry. They owe it to themselves to stop fraud from happening again.
The victim isn't responsible for the crime. But the victim at least needs to lock the windows and doors against the criminals who lurk outside.
Mortgage fraud is spreading and the stakes are high. If lenders don't stand up and take action to stop it, regulators may soon step in and force them to do so.
It took the FBI nine years to nail 35-year-old William Lee Cranston for orchestrating a $20 million mortgage fraud ring in Southern California. This year, a judge sentenced the fraud mastermind to seven years in prison and ordered him to pay restitution. Prosecutors also convicted 19 co-conspirators, including Cranston's partner Tony Leong, five loan brokers, three bank employees, three loan representatives, two purported borrowers, an escrow officer, a real estate appraiser and a tax preparer who were connected to the phony home-buying scams.
Cranston's fraud ring enabled him to obtain loans worth more than the houses he bought, then walk away with the extra cash after he paid the home sellers. He defrauded 26 lending companies out of $3.5 million between 1990 and 1993, according to a Department of Justice statement.
Cranston paid people for the use of their names on more than 100 falsified home loan applications. The fake loan applicants are known as "straw buyers" and they may be in on the fraud conspiracy. In some cases, the ringleader pays the straw buyer for his or her name, but the person doesn't know how the name will be used. In other instances, the schemer uses deceptive sales tactics to trick the buyer into purchasing a high-cost property with little value. Sometimes the crooks simply steal the buyers' identities without their knowledge.
Mortgage fraud is a sophisticated white-collar crime that's been around for decades, but technology has made the scams easier to pull off and enabled fraud to proliferate. Perpetrators of the phony home-buying schemes are attorneys, closing agents, mortgage brokers, real estate appraisers, real estate agents and title insurers.
Cranston's straw borrower schemes relied heavily on technology to generate phony pay stubs, tax records and bank statements to create false employers for the straw buyers and to inflate their income and assets so lenders would believe they were lending money to qualified borrowers. The conspirators even made up sham employers and investment companies and rigged toll-free telephone numbers to ring in their own offices so they could falsely verify information submitted on the fraudulent loan applications.
Steven Olson, assistant U.S. Attorney for the Central District of California and a prosecutor in the Cranston case, said Cranston and his partners kept Web pages displaying national weather conditions on hand so they could produce small talk when the lenders called and make the bogus businesses seem even more realistic.
Olson said some of the buyers in the Cranston fraud ring knew exactly what they were doing. Cranston typically paid these buyers about $2,000 for the use of their identities and credit histories, although the buyers had no involvement in the loan transaction and did not occupy the homes purchased.
But a lot of the borrowers didn't know they were partaking in mortgage fraud, according to Olson. These unsuspecting straw buyers weren't indicted, but their personal credit histories were ruined as a result of the mortgage scams.
"These (borrowers) didn't have a lot of sophistication in mortgage practices and weren't aware of what was happening so we didn't prosecute them," Olson said.
Olson believes more mortgage fraud cases will be uncovered when the housing market takes a turn because lenders often don't uncover fraud until the property goes into foreclosure.
Technology promotes mortgage fraud because it distances the relationship between the borrower and the lender, according to Arthur Prieston, chairman of the Prieston Group, which provides lenders with insurance against mortgage fraud, due diligence and lender training to help detect and prevent fraud.
"The more faceless the relationship, the less obligation people have or feel to tell the truth," Prieston said.
Prieston, who co-authored a definitive book about mortgage fraud for the Mortgage Bankers Association of America, said his company recently discovered a fraud ring in Brooklyn, N.Y., in which the ringleader paid people for their Social Security numbers, then used them as straw buyers in a grand flip scheme where properties were bought and resold quickly at inflated prices. The crooks used the Social Security numbers to obtain approximately $35 million in fraudulent loans on about 70 properties, defrauding lenders and wrecking the straw buyers' credit histories.
"Lenders and borrowers are victims alike, and a lot of people don't know that," Prieston said.
He said the properties used in mortgage fraud schemes are of little to no value to start. Scammers will sometimes con buyers into thinking they are purchasing a sound investment property, then leave the buyers liable to repay a loan on a dilapidated property worth much less than they paid. In some cases, buyers discovered undisclosed liens worth up to 10 times the value of the property.
Olson said a damaging aspect of Cranston's mortgage schemes was what he and his partners did after they bought the properties. They approached low-income people who couldn't qualify for a home loan and offered them a deal in which they would make monthly payments in addition to a down payment to Cranston and later he would transfer title to the property into their name.
"These people would make these payments thinking that someday they would achieve their dream of owning a home in California," Olson said.
But the lenders never transferred title to the prospective buyers because they didn't qualify for the financing and by that time the lender had figured out the loan was fraudulent.
Boarded-up apartment buildings and dilapidated single-family houses victimized by phony home buying schemes known as property flipping line the streets of many neighborhoods in Baltimore, where the practice has been widespread since the early 1990s.
A federal grand jury indicted eight people this year connected to Baltimore property flipping schemes in which the perpetrators buy low-cost properties then use deceptive sales tactics and bogus appraisals to sell them at two or three times their value within a short time frame, often the same day. Targeted properties usually end up in foreclosure because the ultimate buyers are typically low-income residents who can't afford to pay back the loans or amateur investors who bought groups of houses with promises of large cash returns and no money down.
In one flipping scheme, 64-year-old William Schmidbauer of Perry Hill, Md., faces up to five years in prison after he pleaded guilty this spring to mortgage fraud in Baltimore. Schmidbauer's flipping ring was typical, with many of the loans insured by the Federal Housing Administration, causing the agency to lose $2.5 million.
Property flipping rings often involve dozens and even hundreds of low-cost properties and can wreck whole neighborhoods, leaving a trail of abandoned houses and tenant controlled buildings when the owners skip town. Home loan fraud is growing as technology enables schemers to easily steal a person's identity or fabricate real estate appraisals, phony closing documents and bank statements. The white-collar crime is complex and usually involves dozens of professionals who know how the real estate transaction works.
Property flipping relies on collusive relationships between mortgage brokers, real estate appraisers and settlement agents.
Inflated property appraisals are essential to most property flipping schemes, enabling crooks to buy cheap and make back two or three times their investment.
Connie Wilson, executive vice president of mortgage fraud detection software company AppIntell, said the neighborhood domino effect from property flipping begins with the faulty appraisal.
One property flip might pass by unnoticed, said Wilson, but 20 flips in one area, each carrying an appraisal for three times the home's worth, might prompt the property tax assessor's office to raise property taxes because the value of the neighborhood has artificially increased. When homeowners insurance companies notice the dollar value of the neighborhood increasing, they too will raise premiums to residents.
"This goes on for a few years, then the 20 homes go into foreclosure. So now the (homeowners) pay triple the assessed value of their homes in taxes, the homeowners insurance costs went up and now the value of the property goes down because (there are) all these foreclosed homes in the neighborhood," Wilson said.
Many of the end buyers in flipping schemes are innocent people that were tricked into buying multiple properties, according to Wilson.
"Now these people own these properties that are condemned and going into foreclosure and their credit is being destroyed," she said.
Arthur Prieston, chairman of the Prieston Group, a company that provides training in mortgage fraud detection, said no mortgage fraud prevention tool can stop property flips at their source, but making real estate settlement agents or escrow officers more responsible for speaking up when they see irregularities may be a step in the right direction.
"Settlement agents are acutely aware that these are illegal transactions," Prieston said.
In some instances the title or closing officer may not be involved in the mortgage fraud conspiracy, but they facilitate the closing of a property sale knowing the seller bought the property earlier that day or just a few weeks before at half the price. In other instances, perpetrators offer a cut of the loan proceeds to the agent.
Prieston believes certain provisions in the U.S. Patriot Act could fill this hole in the real estate transaction by making the settlement agent responsible for reporting suspicious property sales.
The U.S. Department of Housing and Urban Development this year initiated an anti-flipping rule in an attempt to crack down on lax regulation. The rule makes properties that have been bought and resold within 90 days ineligible for Federal Housing Administration-insured loans.
HUD's rule shows promise that regulators are paying attention, but it only accounts for FHA-insured loans.
Wilson said some lenders set their own time guidelines for property-flipping redflags, such as homes bought and sold within six months or a year, but mortgage crooks know this and find ways around it or keep the property for a month longer than the time parameters before reselling.
"Unfortunately, we haven't been good as an industry at pursuing fraud cases," Wilson said.
She said the chances of being prosecuted for mortgage fraud where the loss amounts to hundreds of thousands of dollars are far slimmer than the chances of being prosecuted for credit card fraud, where the loss amounts to only hundreds of dollars.
A two-year investigation by the FBI and Internal Revenue Service this year uncovered real estate appraiser Melvin Girton as a player in an $8 million mortgage fraud conspiracy in Indianapolis, in which Girton appraised properties for two or three times their value.
Phony appraisals are the crux of most fraudulent home-buying scams. A mortgage broker finds a borrower with good credit to buy a home for, say, $50,000 and an appraiser who's willing to inflate the value of the property to, say, $100,000. The mortgage broker secures an 80 percent loan for the buyer, pays the seller the $50,000 asking price, then splits the extra $30,000 with the appraiser and the fake buyer.
Mortgage fraud is growing rampant nationwide and can damage comparative market values in whole neighborhoods where inflated property appraisals have occurred. The faulty appraisals determine how much cash the schemers swindle out of lenders and leave unsuspecting home buyers to pay twice the true value of their homes.
These white-collar crimes have become more sophisticated, and regulators can't keep up with savvy perpetrators who use scanners and desktop publishing to steal people's identities and create bogus closing documents, bank statements, income verification and property appraisals.
A more subtle form of appraisal fraud occurs when an appraiser inflates a home's true value by five or 10 percent to match the number the mortgage broker and real estate agent want. The result is an artificially inflated housing market that could harm Wall Street investment portfolios because the valuation of underlying mortgage securities relies on home appraisals.
Sham home-buying schemes stamp sleazy reputations on mortgage brokers and appraisers, but the appraisers caught in fraud rings usually are uneducated and inexperienced and didn't intend to participate in fraud, according to Alan Hummel, president of the Appraisal Institute, an association of real estate appraisers.
"The appraiser typically isn't even involved in the money part of the scheme. Most of the time he is just supplying an appraisal for a fee," said Hummel, who has testified as an expert in mortgage fraud cases.
The mortgage broker bullies the appraiser into cooperating and may promise future work in exchange for the appraiser's cooperation.
A General Accounting Office study of the appraisal industry's regulatory system released this year found a high percentage of mortgage fraud occurs in states where appraiser licensing is voluntary.
Regulatory agencies reported a lack of funds as the main stumbling block to carrying out their licensing and other oversight responsibilities, according to the GAO study.
"Every state has a different level of funding, so there is no consistency in how (fraud) cases are handled," Hummel said.
State licensing boards need adequate resources to ensure proper licensing, investigate fraudulent activities and discipline appraisers who engage in dicey real estate transactions, he said.
Appraisers have long been under fire for giving in to pressure from real estate agents and mortgage brokers to match the home's value closely with the seller's asking price or the sale price of the home.
The real estate industry has pushed the use of automated valuation models, known as AVMs, in place of in-person appraisers to curtail faulty work. But schemers can use computers to rig AVMs and manipulate a home's value without an appraiser visiting the property to verify its condition.
Hummel said the Appraisal Institute has a partnership with AI Direct Connection, a company that acts as a firewall between mortgage brokers and appraisers.
"(This system) allows the appraiser to report honest opinions independent of the broker," he said.
The mortgage broker hires an appraiser through the firewall system. The appraiser then values the property and enters the appraisal into the system, which verifies whether it is legitimate and delivers it to the broker. There is no direct contact between the broker and appraiser.
Faulty appraisals can cause problems outside the real estate transaction where they originated. An appraiser unknowingly could inflate an appraisal on a home when looking at neighboring properties that carry faulty values, according to Hummel.
When perpetrators engage in property flipping, in which they buy low-cost properties, then quickly resell them at two or three times their true value with little or no renovations, the faulty inflated appraisal remains with the property through multiple transactions and later makes it difficult to determine the property's true worth.
"If flipped properties are used as comparable market values, property owners using that as a basis for their appraisal are also victimized," Hummel said.
Inflated home values are key to fraudulent home-buying schemes, but mortgage fraud can occur without an appraiser's direct involvement.
Donna Eide, assistant U.S. attorney for the southern district of Indiana, said investigators have found mortgage fraud cases in which the schemers stole an appraiser's name and license number, made up their own appraisals, then forged the appraiser's signature.
"These guys are very bold and will forge any document," Eide said.
Mortgage fraud is complex, technologically sophisticated and, like many white-collar crimes, hard to spot. Sadly, too many financial institutions don't even disclose publicly when they've been defrauded. Instead they sweep these crimes under the rug and record them on their accounting books as "economic losses."
It sounds like the old ineffective "don't talk about it and it never happened" solution.
The mortgage system is rigged with disincentives for lenders to report mortgage fraud. The biggest disincentive is that the lender would be out the money that would be paid back to the secondary market investors and mortgage insurers.
But how can regulators and law enforcement officials get a handle on the mortgage fraud epidemic when the victims are so tightlipped?
It's time for lenders to step up and call mortgage fraud what it is even when it means a financial loss for them. It's in the bigger interest of the financial system that these crimes be recognized and prosecuted. Otherwise, the perpetrators will continue to walk away millions of dollars richer and lenders will continue to pass along the losses to borrowers through higher fees and stricter underwriting guidelines.
Mortgage fraud isn't a victimless crime. It leaves a trail of deteriorating neighborhoods, destroyed personal credit histories and artificially inflated home value on the public record.
Lenders aren't the only ones suffering the loss, but they certainly are in the best position to take action.
True, some lenders train their employees in early mortgage fraud detection. And true, some lenders have notified the FBI after they've realized an excruciating loss. These actions are commendable and deserve recognition, but much more is needed.
Lenders should know their mortgage brokers, real estate appraisers and closing officers. They should lobby for mandatory state licensing programs that include thorough background checks and educational requirements.
Lenders should record fraud as fraud, instead of utilizing creative accounting that only hides the problem and makes it even harder for investigators to figure out. Lenders should double- and triple-check their loans before they hit the send key, and they should know who's writing their mortgages.
It's time lenders realize they have the power to choke fraud at its source. They owe it to borrowers, investors and other lenders to at least blow the whistle when something seems awry. They owe it to themselves to stop fraud from happening again.
The victim isn't responsible for the crime. But the victim at least needs to lock the windows and doors against the criminals who lurk outside.
Mortgage fraud is spreading and the stakes are high. If lenders
don't stand up and take action to stop it, regulators may soon
step in and force them to do so.
Inman News Features