What Mortgage Fraud?
Posted by: Ed Chernoff
February 12, 2008

It is part of my routine each day to log onto the Internet and check current mortgage rates. Lately I have been interested in refinancing my house and the federally insured rate has been in free fall, approaching the rates we saw in the early years of this decade, when the Houston home market was in frenzy. I remember it well, especially since I was looking to buy a house back then. Unfortunately, the neighborhood in which I wanted to live was particularly hot and it was deep into 2004 before I was able to pull the trigger. By then, things were already changing.

Fast forward to February 2007. I was three weeks into a bank fraud trial. My client was accused of being part of a group that illegally "flipped" commercial properties in 1999 and 2000. Essentially, it was alleged that shell purchasers were employed to purchase and then immediately sell properties, using bank funds given on the second sale to fund the first purchase. The net proceeds on the second sale were divvied up among the conspirators.

During a break I conversed with one of the FBI agents on the case. He solemnly told me that there would soon be many, many more cases like this one prosecuted at the Federal and State level. He warned me that the fraud on the commercial side would pale in the shadow of what would be uncovered in the residential lending arena. I rarely take what a FBI agent says at face value, no matter how earnest he seems, but this fellow was very soon proven omniscient.

The first mortgage fraud case came into my office barely a month later. She was a real estate agent, accused of setting up a shell buyer scheme. A fee lawyer for a Title Company hired me two weeks later, because she was being looked at for her involvement in a fishy deal. Soon thereafter a mortgage broker hired Stradley, Chernoff and Alford to defend him on a State accusation that he had lied about the income of some of his borrowers on various sub-prime loans. Then an alleged shell borrower on a different scheme hired us. This man was working as a concierge at a downtown high rise and was paid by a resident to buy property with fictitious income information. Various targets and witnesses came to see us after that. So many in fact, that a good number we had to refer out because of conflict.

Our most recently accepted client is a contractor. He is one of two people who came to hire us on a Houston mortgage fraud prosecution that wound up indicting 37 individuals. I was at the DA's office reviewing his file last week. I sat in the waiting area, wading through the voluminous documents and I observed a strange parade of bank fraud investigators approaching the receptionist and announcing their presence for their meeting with a prosecutor in the Special Crimes Bureau. As they waited, I couldn't help but overhear their conversations. It appeared that whatever case they wanted prosecuted on that day was only one of many they were investigating and close to presenting. Clearly, all hell is breaking loose in the residential mortgage banking industry!

I am always wary of prosecutorial waves. As I remember, the war on drugs that preoccupied the minds of prosecutors in the 80's not only captured the guilty, but injured the innocent and ultimately filled the prisons to such an extent that violent criminals found themselves back out on the streets after only 10% of time served. This new wave is focusing on all the people who took advantage of the banks extreme willingness to lend money in even the most tenuous circumstances. It is the mortgage lenders who are crying foul, but who is the real victim here? Why were the banks so eager to lend? Because they made money doing it!

Government entities like Fannie Mae and Freddie Mac insured nearly all of these loans, bundling them into bonds and selling them to mostly foreign investors or larger banks like Citibank. No mortgage lender would have been willing to lend the money had they not been assured that they could sell them on the secondary market. The banks - and more importantly their officers - made money in fees, points and service agreements. When these homes were foreclosed on, these large entities who purchased the mortgages no longer received their interest payments but still had to fork over interest on the bonds. Ergo, the mortgage lending crisis everyone is talking about.

Of course, these lenient lending practices were not limited to mortgages but also home equity loans that were used to pay off other credit. A lot of these loans were tied to the prime rate, which in turn is tied to the short term fed rates. Before this crisis, the Federal Reserve was loathe to reduce rates, because the dollar had tanked and reasonable concern existed that inflation would result from the overheated economy mainly due to the ease of credit. But now, in this election year, fear of recession has overtaken common sense. As of the time of this writing, the fed has reduced its short term rate by 75 basis points and I am looking to refinance my first mortgage.

And so it goes... What's my point? In many of these cases, prosecutors like to tell jurors "to follow the money" in determining culpability. The problem with that is that they want the trail to end with my clients.

I won't forget the local bank officer who testified for the government in my bank fraud trial in 2007. On cross-examination he admitted to doing two deals with one of the co-conspirators in the case. Without his signature, no loan could have been made. He admitted to meeting the co-conspirator each time at Treasures, a local strip club and each time collected a fat manila envelope ostensibly containing "documents". He had no explanation as to why these "documents" couldn't have been delivered to the bank or faxed. He had no explanation as to why he signed off on these clearly suspicious deals or why he expedited them past the underwriter. Since he was the government's witness, they didn't bother to inquire into it. The jury, though, understood the truth. Everybody is culpable here.

So who is the victim? When all this shakes out, it won't be the banks, despite what their hired fraud investigators have to say. In fact, with the drop in interest rates, they will make even more money. Further, the Government won't let Freddie Mac fail, or the PMI providers for that matter. Actually, no entity who encouraged this lending freak show will ultimately suffer. The blame though will fall down on our clients and it looks like I'll be very busy in 2008.

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