The FBI is apparently having a record-breaking year. It recently announced that it received 30,000 “suspicious activity reports” from Federally chartered financial institutions – just for the first half of the 2008 fiscal year (July 1, 2007 – December 31, 2007). For the entire 2007 fiscal year, it received 46,000 such reports. In other words, potential fraud at banking institutions was 50% higher than the preceding year.

What is “fraud?” The law defines fraud as an intentional act of deceit. Most of the fraud prosecutions (and convictions) to date have been aimed at teams of real estate “professionals” creating sham transactions. In this scenario, a fake seller and buyer team up with a crooked appraiser (and sometimes real estate agent and attorney) to cook up a pretend transaction at a price of $X (much higher than true value). An unsuspecting lender makes a loan of say 80% of $X and the team sooner or later disappears with lots of excess mortgage money.

Since the government has limited resources, what has not been extensively investigated or pursued are individual acts of deceit – perpetrated by knowing actors (i.e. with intent) – causing
others harm. Let’s look at two situations, not unheard of in the real estate world, and decide for ourselves whether these acts are criminal fraud, or just a little bit of overreaching.

1. John and Jane Doe move into town and make an offer on a house. On the recommendation of their real estate agent, they consult with Morty Mortgage, a local mortgage broker. Morty tells them that he has relationships with 50 or so lenders and is going to do his best to “obtain for them the best mortgage product available.” Morty does not, however, explain to the Does that his compensation depends upon the spread between wholesale rates and terms (what banks will accept) and retail rates and terms (what the borrower signs on for). Morty convinces the Does to take a 3-year Adjustable Rate Mortgage instead of their initial preference for a 30-year fixed rate. As it happens, Morty has several lenders pushing the 3-year ARM and, as a result of the Does taking this loan, he makes a big fee. Fast forward three years to today and the interest rate on the Does ARM spikes way up. Because housing values are dropping and lenders are skittish, the Does cannot refinance. As a result, they have a
big problem. Did Marty commit fraud?

2. What about the lender who originates loans and then sells them into the secondary market, and who creates products that require no income verification? These “liar loans” were very popular and encouraged some borrowers to … well, lie about their income. The lender was well aware of this possibility yet looked the other way (by not checking income when it could have) since the lender was making nice fees selling these loans in syndicates to investors. Then investors got hurt when lying borrowers defaulted. Fraud?

In my judgment much of what became “standard operating procedure” during the housing boom is not far from the law’s definition of fraud. This conduct will never be prosecuted but all in the industry – those who acted and those who ignored deceit – all bear some responsibility for the housing and credit headache our country is suffering today. return to front