Commentary by George W. Mantor
RISMEDIA, May 18, 2010—The prosecutions of both civil and criminal cases against financial intermediaries are being thwarted by defense attorney’s ability to shine the light away from the real evidence of fraud.
By focusing on the institutional side of the transaction, where all of the prosecutions have been, evidence is hard to get because so much of that activity was unregulated, took place with no transparency, and the players are unknown; consequently, following the money could be challenging.
And, while investors have been damaged by the conduct of the financial intermediaries, the greater victims were consumers who were targeted to provide the imploding loans that would push the pool into default.
Now that we know that financial intermediaries made way more on insurance than they did originating the loans, we no longer have to ask why did they make so many bad loans.
They went further than that. They designed loan products that would allow them to loan more and more money to more and more people with terms that would guarantee they would default.
Here are elements of the fraud upon consumers.
The Credit Score
A con man studies his “mark” down to the last detail of the smallest nuance of the “mark’s” behavior. He will weave a con that is all about the “mark” because he knows the “mark” as if he had grown up with him. A con man is a behavioral psychologist who understands what makes people tick.
Financial intermediaries do not dabble in economics or commerce, they dabble in exploitation. They employ teams of behavioral psychologists to tell them what your data means to them. The greatest tool with which to manipulate someone is their credit report. Based on the information contained in a credit report they can determine what you do, where you go, what you want, what you own, how you handle money, and what it will take to get you into a loan you cannot afford.
Designer loans…designed to fail.
“Have I got a loan for you? As a matter of fact, it was designed specifically for you. You’re an up and comer and we believe in you. So, we are going to give you this fabulous loan that will put you on the hook for the greatest amount of our investor’s money that we can possibly shove down your throat.”
The stretch it ’til it breaks loan.
“In order to put you into one of the most over-priced homes in the community, we have an adjustable rate; pick a pay option, neg-am indexed to the LIBOR with an initial payment of only $400 a month. This, as your income goes up and your home appreciates, will adjust to $9,763 a month. But heck, that’s a whole two years from now. Good luck.”
One way to drive up loan amounts is to create a loan that overcomes the affordability limitation. The loans themselves were designed in such a way that they overcome what would have been a limiting factor, a community’s affordability index.
By comparing wage and housing price data, it is possible to project what percentage of households can afford the payments on a median priced home. Financial intermediaries knew that in many important markets, buyers were being priced out of the market.
Because of stagnating wages, both loan volume and the dollar amount of those loans would have been limited and not nearly as profitable for the financial intermediaries.
Predatory lending and the use of subprime loans exploded around new home construction.
Consider the boom in Riverside and San Bernardino Counties in inland Southern California. In 2004, when affordability was high, just 6% of first loans were sub-prime. By 2006, that number had jumped to 36%.
Appraisers do not set prices, sellers do. Appraisers try to justify the agreed price by providing evidence to demonstrate that the price is supported by current comparable sales.
And, buyers do not want to pay $600,000 for a $250,000 house.
It is important to note that the hardest hit areas in terms of declining values and foreclosures are those areas that saw the greatest amount of new home construction.
Here, builders and financial intermediaries colluded to inflate values so that builders would reap the highest possible profits, and financial intermediaries could take huge chunks of investor’s cash.
For an appraiser, new construction often presents a bit of a challenge in finding recent comparable property sales. And, builders understand that the first few sales will be critical in obtaining the profit objectives anticipated by the builder.
In addition, buyers are attracted to those developments posting strong sales; so getting off to a fast start will allow the builder to raise prices in future phases.
As a result, the first buyers are often members of the “inner circle”. Often they are employees of the builder who might be given a premium lot and substantial interior customization as an incentive to pay an above market price.
23% of homeowners now owe more on their homes than they are worth. And, most of that came from new construction. States that had the greatest amount of large scale new home construction also had the fastest appreciation rate despite the fact that you would think that all that over building would keep prices flat or drive them down—but, no.
Prices did not rise so high. so fast and then fall all the way down on their own.
Paying Moody’s to rate junk as triple A is just part of inflating the entire transaction.
At one end, they are defrauding the institution by over-valuing the security while at the other, they defrauded the homeowner out of hundreds of thousands of dollars and often their home.
By deflating prices now, they create more defaults.
If inflated appraisals and Credit Default Swaps weren’t enough, they also figured out a way to pocket large amounts of the money intended for safe and secure home loans. Make unsafe loans instead.
The pension funds who bought mortgage backed securities did so believing that security of the principal was foremost.
The goal was a steady revenue stream and a return of the principal at maturity. Assume a loan of $500,000 at 5%. That would yield $25,000 annually. But, by making a subprime loan, the same return could be generated by loaning $320,000 at 7.8%. The higher the rate the financial intermediary could convince a borrower to take, the more money they could skim off the top. Hey, it’s all deductable, right.
And, so long as the buyer defaults, the loan doesn’t reach maturity and the investor’s principle is lost. The default protection pays off and no one is the wiser. That is why the designer loan is the key piece in this entire fraud.
It wasn’t the borrower who was sub-prime, it was the design of the loan.
For there to ever be any meaningful prosecutions, we need to follow the money from the investor to its final destination. This will reveal that only a portion of the investor’s money went to fund loans. But, that will be very difficult as the records of the transaction are scattered about, and MERS was invented to make it difficult to find them as a way to shield predatory lenders from prosecution.
MERS stands for Mortgage Electronic Registration Systems which is a computerized registry that bypasses county recording systems, creates a cloud on title, and obscures what, if any, lender is owed any money in connection with a mortgage.
MERS has illegally inserted itself into about 60 million mortgages, and the affects of this are being sorted out in courts across the country.
MERS was created by financial intermediaries to facilitate the process of securitizing loans and to make it virtually impossible for anyone with claims against the holder of the note to ever serve a complaint on the true party.
The Graham-Leach-Bailey Act
In November of 1999, financial intermediaries finally won repeal of the post-depression Glass-Steagall Act with the passage of the GLBA. In just the ten years since, financial intermediaries have ripped off everyone they could get their hands on. The results are apparent; the convictions not so certain.
But, even then little is being done to prevent the millions of people who will lose their home to a fraud so complicated that investigators don’t even know which end to start at.
George W. Mantor is known as “The Real Estate Professor” for his consumer education efforts including a long-running radio program, monthly workshop series, public appearances, and frequent articles.
During a career dating back to 1978, he has amassed experience in new home and resale residential real estate, resort marketing and commercial and investment property.
Prior to starting his own real estate and mortgage brokerage in 1992, he had been Director of Training and Customer Service for Great Western Real Estate. In addition, he has served on virtually every real estate committee, including a term as a Director of the California Association of REALTORS.
George is a nationally respected authority on all areas of real estate and is frequently quoted in a wide range of publications. He is an oft invited guest of Fox Business Network and for many years, he was the host of “Keepin’ It Real…Real talk about the real thing, real estate” on KCEO radio.
The Real Estate Professional includes him in “a directory of the Nation’s outstanding authors, columnists, and speakers. His articles have also recently appeared in Real Estate Finance, The Real Estate Professional, National Real Estate Investor, Broker Agent News, and Realty Times. His blog is http://www.realtown.com/gwmantor/blog.