BFCSA Members WARNING: Crooked BANKERS using MASS FRAUD in Australia ....US & UK Banks caused GFC. Evil Bankers should be jailed!

Liar loans: How mortgage fraud helped trigger the GFC

February 13, 2015

Binyamin Appelbaum

Low-income homebuyers borrowed more than they could afford - helped by the lenders' "art departments" fudging their wage statements.

Low-income homebuyers borrowed more than they could afford - helped by the lenders' "art departments" fudging their wage statements. Photo: Ronda Churchill

The global financial crisis was caused in part by widespread fraud, which may seem like an obvious point. But it remains surprisingly controversial.

US President Barack Obama and other public officials, seeking to explain why so few people have gone to jail, have argued in recent years that much of what happened on Wall Street in the go-go years before the crisis was reprehensible but, alas, legal.

You will not be surprised to learn that many financial executives share this view - at least the part about the legality of their actions - and that a fair number of academics have come forward to defend the honour of lenders.

New academic research therefore deserves attention for providing evidence that the lending industry's conduct during the housing boom often broke the law.

The paper by the economists Atif Mian of Princeton University and Amir Sufi of the University of Chicago focuses on a particular kind of fraud: the practice of overstating a borrower's income in order to obtain a larger loan.

Magic wage growth

They found that incomes reported on mortgage applications in postal area codes with high rates of subprime lending increased much more quickly than incomes reported on tax returns in those same areas between 2002 and 2005.

"Englewood and Garfield Park are two of the poorest neighbourhoods in Chicago," they wrote. "Englewood and Garfield Park were very poor in 2000, saw incomes decline from 2002 to 2005, and they remain very poor neighbourhoods today." Yet between 2002 and 2005, the annualised increase in income reported on home purchase mortgage applications in those areas was 7.7 per cent, strongly suggesting borrowers' incomes were overstated.

The study is particularly noteworthy because in a study published this year, three economists argued the pattern was a result of gentrification rather than fraud. "Home buyers had increasingly higher income than the average residents in an area," wrote Manuel Adelino of Duke University, Antoinette Schoar of the Massachusetts Institute of Technology and Felipe Severino of Dartmouth.

The three economists also argued that lending in lower-income areas played only a small role in the crisis. Most defaults were in wealthier neighbourhoods, where income overstatement was less common.

"The mistake that the banks made was not that they overlevered crazily the poor in a systemic fashion," Schoar said. "The banks were not understanding or not wanting to understand that they were increasing the leverage of the country as a whole. They were forgetting or ignoring that house prices can drop."

The new paper by Mian and Sufi is a rebuttal. Their basic point is that the incomes reported on applications should not be taken seriously. They note that income reported to the US tax office in these area codes fell in subsequent years, a pattern inconsistent with gentrification.

Moreover, the borrowers defaulted at very high rates, behaving like people who borrowed more than they could afford. And the pattern is particular to areas of concentrated subprime lending. There is no income gap in area codes where people mostly took conventional loans.

"Buyer income overstatement was higher in low-credit score [area] codes because of fraudulent misreporting of buyers' true income," Mian and Sufi wrote.

Liar loans

The paper also notes the wealth of other sources that have accumulated since the crisis showing the prevalence of fraud in subprime lending. (I was given an early version of the paper to read and provided the professors with some of the examples cited.)

In a study published last year, for example, researchers examined the 721,767 loans made by one unnamed bank between 2004 and 2008 and found widespread income falsification in its low-documentation loans, sometimes called liar loans by real estate agents.

More colourfully, the journalist Michael Hudson told the story of the 'Art Department' at an Ameriquest branch in Los Angeles in "The Monster," his 2010 book about the mortgage industry during the boom:

"They used scissors, tape, Wite-Out and a photocopier to fabricate W-2s, the tax forms that indicate how much a wage earner makes each year. It was easy: Paste the name of a low-earning borrower onto a W-2 belonging to a higher-earning borrower and, like magic, a bad loan prospect suddenly looked much better. Workers in the branch equipped the office's break room with all the tools they needed to manufacture and manipulate official documents. They dubbed it the 'Art Department.'"

Mian and Sufi argue that large numbers of early subprime defaults helped to catalyse the crisis, a case they made at length in their influential 2014 book, "House of Debt."

Broad pattern

The prevalence of income overstatement is sometimes presented as evidence that borrowers cheated lenders. No doubt that happened in some cases.

But it is not a likely explanation for the broad pattern. It is far-fetched to think that most borrowers would have known what lies to tell, or how, without inside help.

And mortgage companies had not only the means to orchestrate fraud but also had the motive. Mian and Sufi have argued in previous papers that the mortgage boom was driven by an expansion of credit rather than a rise in demand for loans.

It makes sense that companies eager to increase lending would have also developed ways to manufacture ostensibly qualified borrowers.

We do not have a comprehensive accounting of the responsibility for each instance of fraud - how many by brokers, by borrowers, by both together.

Some fraud was clearly collaborative: Brokers and borrowers worked together to game the system. "I am confident at times borrowers were coached to fill out applications with overstated incomes or net worth to meet the minimum underwriting requirements," James Vanasek, the chief risk officer at Washington Mutual from 1999 to 2005, told Senate investigators in 2011.

In other cases, it is clear that the borrowers were in the dark.

Some of America's largest lenders, including Countrywide, Wells Fargo and Ameriquest, overstated the incomes of borrowers - without telling them - to qualify them for larger loans than they could afford.

New York Times

Read more:

$100 Billion in Toxic Lending, Evil Bankers, Fraud in Bank Toxic Mortgages, FULL DOCS TOXIC