A few weeks ago, I asked readers for suggestions as to what they would bring to the state Attorneys General offices. This led to a very interesting discussion with Michael White, formerly of CountryWide Subprime Unit, who now blogs at housingstory.net.

I worked one of the more fascinating observations he made into my presentation to the AGs last week:

“Eliminate the verification of income for a mortgage borrower, and you eliminate your ability to predict the likelihood of repayment or default.”

-Michael White, CountryWide Subprime Unit

Consider what that statement implies: The banking industry’s decision to voluntarily abstain from income verification amounts to what Mike called “Origination Fraud.” More than just an example of groupthink, it was the willful decision to make a substantial number of loans that the banks knew would go into default in much higher than usual numbers:

“You can’t issue 1 or 2 trillion dollars of mortgages and knowingly encourage fraudulent claims of income. The basic fact check which every lender should have used is the 4506t — the document which is presented to the IRS for direct verification of what the borrower reported as income. The fraud depended upon the lender knowingly failing to check W2s pay stubs and IRS records.”

Here is the key to understand credit and banking: It is the job of the banker is to decide who is creditworthy, and make loans accordingly. Throughout history, unqualified people have ALWAYS tried to get loans. But the bank had a fiduciary duty to their suppliers of capital, to the people that lent them money they lent out (depositors, gov’t, investors, etc.).

At the same time, the compensation for the employees, mortgage brokers, and senior management of these lenders was based on their total production. They managed to extract enormous bonuses based on making loans they knew (or should have known) were going to default.

This is where the term collective embezzlement comes from . .  .

Category: Bailouts, Credit, Legal

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

22 Responses to “Origination Fraud and Collective Embezzlement”

  1. Petey Wheatstraw says:

    “This is where the term collective embezzlement comes from . . .”

    It’s also why RICO statutes should be used to correct the imbalances created by the manifest criminality of the banking/finance industries.

    So, BR, any word from the State AGs (or Eric Holder) on what they plan to do about massive corporate criminality in this sector, or are the squirrels unable to find the forest for the trees?

  2. “…Skillful accounting lies in making the fullest possible use of original entries, at the same time having a check on all figures to guard against either error or fraud. Many young bank men have materially increased their salaries and rate of promotion by devising improved accounting methods.

    As has been said, every transaction ultimately affects the bank’s statement of condition by debit or credit…”
    http://chestofbooks.com/finance/banking/Elementary-Banking/Bank-Accounting.html

    Gee, straight from the ‘Textbook’..”…Many young bank men have materially increased their salaries and rate of promotion by devising improved accounting methods…”

    Woocoodanode?

  3. Richard R says:

    Thanks for raising the fiduciary responsibility to the supplier of the money. It is almost always ignored that the money lent out in these schemes ultimately belongs to teachers, workers, cops, etc. through various types of pension and investment funds. And nobody could care less about them or their money.

  4. Moss says:

    MEH.. Straight from the textbook ….. written in 1915… are you serious or simply an apologist?

  5. Moss,

    “…at the same time having a check on all figures to guard against either error or fraud…”

    it Works both ways..

    see this .. “…Many young bank men have materially increased their salaries and rate of promotion by devising improved accounting methods…”

    w/ this, from the Post .. “…At the same time, the compensation for the employees, mortgage brokers, and senior management of these lenders was based on their total production. They managed to extract enormous bonuses based on making loans they knew (or should have known) were going to default…”

    and, if you, really, ‘think’ that “the Basics” have changed, since c.1915, you care to Think, for the first time..

  6. and, I, “may” care to Proofread ~

    you care / to you (may) care ..

  7. Centurion 9.41 says:

    All true. And for the record, I am deeply angered at the fact that none of the CEO’s/CFO/Compliance folks are in jail, and that American’s are so ignorant and selfish to be led astray by politicians providing cover for the same.

    A fiduciary standard is a legal standard.

    Legal standards have hurdles far higher than the “probability to predict”…

    Or said another way, the ability to “voluntarily abstain” makes clear the underlying legal standards that gave/give the fiduciary standard “teeth”.

    So how does one lay legal fault sufficient to perp-walk “the banker” who has in place contracts with mortgage brokers that require policies/procedures to ensure such procedural basics are met? NINJA aside, these products were merely the outcome of the moral/ethical/business decay that lay beneath.

    However, Robo-signing proves a deeper problem, the level to which US moral/ethical standards have reached.

    A fundamental cause, the fruits of the PC “diversity” that took root in the 1980s. How can a nation expect standards of moral/ethical behavior when it raises up as its highest standard the embracing as equal all moral/ethical/cultural standards?

    India is where it is today, partly, due to it’s cast system. Those who hold their cultural values have no problem or hesitation with driving a truck through a legal window at the expense of others. There are many cultures throughout the world that embrace similar values that if the stereotypical/classic “Christian American” understood they would be shocked.

    However the question exists. If the players in a game live by different standards, and the rules of the game are written such that the penalties and INCENTIVES create a capital risk/reward that encourages, or at the least doesnt discourage unethical behavior then who is to blame?

    It is not like those who made the rules didnt know what was going on? Such arguments worked in the past, but certainly not after 1970.

    More importantly, it’s not like American’s didnt have the obligation of freedom to be so engaged to protect their freedom and fortunes.

    This is what the Founding Father’s knew when they said what was made was ours to protect and required a morally upright society to successfully work.

  8. Jim Greeen says:

    The banks had no interest in the loans once they were made. After production, they were sold sold with a fraudulent AAA investment rating. Then the banks wiped their hands of their tawdry handy work and move on to the next greater fool.

    Banks forever had a deep and abiding interest in making good loans. Once they figure out how to get paid by making loans without due dilligence all bets were off.

    This is one of the most sordid episodes in our financial history. And nothing appears to have been learned.learned.

  9. Lyle says:

    I think the bankers would say that they had found this magical number that did all the predicting for them the FICO score. It enables one to turn the brain off when making loans. Of course they all never listened to the banker J.P.Morgan (the man) of the early 20th century who said character was everything in making a loan, but they were far to busy to evaluate character. So to follow Mark Hoffers quote some bright young person decided that FICO was far better than the old fashioned methods and pushed it thru for a big bonus.

  10. traian says:

    Not very much at the subject of mortgage fraud, but a very good article:
    http://www.economist.com/blogs/democracyinamerica/2011/04/inequality

  11. AHodge says:

    i think Greeen is right
    absolutely no interest in being a defense lawyer,
    but origination fraud will only be indictable if there is fraud,
    like wrongly telling the security buyer you checked income
    everyone was calling them no doc loans and a whisper liar loans even when they being sold?
    i best like items where, as you put it, we can charge the the AGs with malfeasance for not acting

  12. Moss says:

    MEH,

    The basics did change that is the whole point. We are discussing the mortgage finance model. The securitization model fundamentally changed how banks operated. They had no skin in the credit worthiness of the debtor. If you believe there was no fraud by the originators that is your problem.

  13. Petey Wheatstraw says:

    Centurion 9.41 Says:

    “A fundamental cause, the fruits of the PC “diversity” that took root in the 1980s. How can a nation expect standards of moral/ethical behavior when it raises up as its highest standard the embracing as equal all moral/ethical/cultural standards?”

    How do you square that idea with the underlying concept of of personal freedom? It would seem that the “embracing as equal of all moral/ethical/cultural standards,” would be the highest standard of all. As long as the threshold of criminality (the legal standard) is not crossed.

    “But it does me no injury for my neighbor to say there are twenty gods or no God. It neither picks my pocket nor breaks my leg.”

    -Thomas Jefferson, Notes on Virginia, 1782

    There is no such thing as a morally upright society. That’s why we have laws (and as the old saying goes, “morality can’t be legislated”). Too bad those charged with writing and enforcing our laws didn’t have the personal integrity to do their duty. What we have here isn’t a failure of national morality, it’s a failure of our political system to work in the interests of the citizenry and/or our society.

  14. beaufou says:

    Not only did they choose not to verify incomes, in some cases they actually falsified the papers to make the borrower eligible.
    I think J.Green is right, they knew the loans were going to be passed along and they would collect a decent amount of late fees as servicers.

  15. dss says:

    The buck stops with the originators. Period, end of story. So much for blaming everyone but those whose decision to abdicate all financial responsibility created this mess.

    Does this mean we can’t blame the CRA, house flippers, or innocent people who were hoodwinked into obtaining mortgages they could never repay anymore?

    Really, this is such a novel idea in 2011 America, blaming those who were responsible for the crimes they committed.

    Now the next step is actually prosecuting and convicting them. Good luck with that.

  16. AG Sage says:

    If you restrict banks to appraisals based on equivalent rents, that would reduce the fallout across the board. Banks should not lend out more than an investor is willing to scoop up the house for later if the loan goes bust. Ever. With the system as it is now, with appraisals based on recent sale prices, banks will always loan into the upswing of the bubble and they will always go bust.

    It’s crazy the system we have now. One random uninformed sap, cheerled-on by realtors, brokers, and the press, gets to decide the value of a given house and therefore how much a bank will lend them for said house? That makes no sense. The house has an inherent value based on what it will earn in the open market as a rental. If people want to overpay for a house, that’s their problem. Make them bring their own money to the table to make up the difference. But given the implicit government guarantee on the system, the taxpayers should never be on the hook for more than the house is actually worth. Period.

  17. eliZ says:

    Two points re fiduciary responsibility:

    1. There were mortgage brokers and loan officers who, unbeknownst to the applicant, changed income and tax information on mortgage applications. As far as I know, no one has delved into this side of the fraud. I realize it would be difficult to prove, but it did occur.

    2. Real estate salespeople and brokers are also suppose to operate in a fiduciary capacity. All I can say to that is LOL.

    The bottom line is that most of the people involved in the mortgage scam were operating solely out of self-interest. To say that unabated self-interest is a good way for a market to operate overlooks the complexity of impersonal nature (i.e. the distance people – such as the depositors, gov’t, investors, etc. – are from the decisions that directly affect them) of our markets. Better decision making comes from access to relevant and essential information — without that, decision making is blind. In our complex world, laws, rules, and regulations – when enforced – serve as one alternative to the “perfect information” gap.

  18. cetacean101 says:

    My background- full time employment in the mortgage field since 1980, started my own mortgage brokerage firm since 1985 after running the wholesale division of a mortgage banking firm.

    Traditional no- income documentation loans had a legitimate place in the mortgage food chain. Max 60-65% LTV, excellent FICO scores, strong cash reserves, purchase or no cash-out refinance and a reasonable reason to believe normal income documentation was not accurate or available (complex financial situations, self-employed, short term residency or earnings history). Where it translated to fraud was around 2000 or so when lenders began allowed us to use no income documentation on ever increasing ranges of borrowers whose income could readily be documented (W-2 wage earners), and in inherently more risky transactions (cash-0ut refis, less than 20% down loans).

    While not accepting or excusing the individual failures of many loan brokers to act in an ethical manner, I think you need to look at the larger picture. BROKERS DO NOT LEND MONEY. Leaving aside the near institutionalization of outright fraud (in my experience aided, abetted and encouraged by lenders seeking to compete in an ever more debased underwriting environment), brokers deliver loan packages based on the loan programs and policies established by lenders. Lenders tell us what they will accept, and in fact have their own retail reps out there every day competing with us using many of the same (or looser) programs.

    At the time, there were few barriers to becoming a a broker (some states had no licensing system whatsoever). Given that, it seems odd to me that lenders could claim to be surprised about getting exactly what they were asking us to give them. The analogy I use it to imagine a bank putting a cardboard box or $100 bills on the street on Friday night, then claiming it was not their fault when they return Monday morning and find the money gone. In a perfect world, people would leave the money alone, but it’s the bank’s job to recognize the world we do live in. Here they clearly failed.

  19. Moss,

    this .. “…We are discussing the mortgage finance model..”, the ‘Model’ doesn’t matter.

    In a different Field, one finds GIGO (G*rbage In, G*rbage Out)

    Here, same diff.

    again, “…at the same time having a check on all figures to guard against either error or fraud…”

    “…“Eliminate the verification of income for a mortgage borrower, and you eliminate your ability to predict the likelihood of repayment or default.”

    -Michael White, CountryWide Subprime Unit

    “…“…Many young bank men have materially increased their salaries and rate of promotion by devising improved accounting methods…” …”

    LSS: in Agreement w/ the tenor of the Post, it’s Fraud. And, really, it’s better that that, it’s a series of Acts that should be prosecuted under RICO ..

    “…In the 1980′s, however, civil lawyers noticed section 1964(c) of the RICO Act, which allows civil claims to be brought by any person injured in their business or property by reason of a RICO violation. Any person who succeeded in establishing a civil RICO claim would automatically receive judgment in the amount of three times their actual damages and would be awarded their costs and attorneys’ fees. The financial windfall available under RICO inspired the creativity of lawyers across the nation, and by the late 1980′s, RICO was a (if not the most) commonly asserted claim in federal court. Everyone was trying to depict civil claims, such as common law fraud, product defect, and breach of contract as criminal wrongdoing, which would in turn enable the filing of a civil RICO action.

    RICO’s broad application was the result of Congress’ inclusion of mail and wire fraud as two crimes upon which a RICO claim could be brought. Given the breadth of activities that had historically been criminally prosecuted under the mail and wire fraud statutes, it was not difficult for creative civil attorneys to depict practically any wrongdoing as mail or wire fraud.

    During the 1990′s, the federal courts, guided by the United States Supreme Court, engaged in a concerted effort to limit the scope of RICO in the civil context. As a result of this effort, civil litigants must jump many hurdles and avoid many pitfalls before they can expect the financial windfall available under RICO, and RICO has become one of the most complicated and unpredictable areas of the law.

    Today, RICO is almost never applied to the Mafia. Instead, it is applied to individuals, businesses, political protest groups, and terrorist organizations. In short, a RICO claim can arise in almost any context…”
    http://ricoact.com/
    http://ricoact.com/ricoact/faq.asp

  20. DeDude says:

    Beaufou;

    “they knew the loans were going to be passed along and they would collect a decent amount of late fees as servicers”

    Yes they actually had an incentive and made more money on faulty loans after they found a way to pass the default risk onto others. All those fees and penalties from people struggling to regain financial footing are a gold mine for banks. That is why they want to make loans regardless of whether people can afford them or not.

  21. carpediem0496 says:

    In the old days, banks held loans on balance sheet. Credit losses were direct. The math in a balance sheet leveraged 10:1 required diligence and conservatisim.

    Likewise, investment banks were once partnerships. Partners could be held to account for malfesance.

    Under the modern construct, banks (in particular universal banks) and investment banks no longer hold the long term credit exposure. Securitization led to, among other things, a new *bagholder*, which ultimately are comprised of retail investors and taxpayers.

    With no skin in the game and a fee generating business model, it was off to the races without much care for the performance of the underlying credit.

    Perhaps the regulation of systemic risk is easier than we think.

  22. [...] low hanging fruit in terms of bank fraud that you should focus your efforts there: There was “Origination Fraud” that took place; Nonfeasant Regulators who refused to do their legal duty because it [...]