How the Banks Were Fleeced -- A Primer to Mortgage Fraud

by Xin Lu on 13 January 2008 8 comments

I was tempted to title this article "How to Commit Mortgage Fraud" in the fashion of  Philip Brewer's extremely popular articles "How to make moonshine" and "How to launder money". However, I just hate mortgage fraud way too much to endorse it in any form. In this article I will explain some common methods of mortgage fraud, and introduce you to some infamous criminals behind these schemes.

The Basic Scheme: Lie on the Loan Application

Traditionally, a person's income and debt ratios are crucial in deciding whether or not they qualify for a loan.  This is still the case, but in the past few years lending standards have become so loose that literally anyone with a pulse can get a loan even if they are a NINJA (No Income, No Job, and Assets).  These loans are usually called "stated-income loans", but another common name is just "liar loans".  You could say that the banks were asking for people to lie, but it is still fraud to prepare loan documents with errant information. In these cases of fraud people usually willingly inflate their income and assets in order to qualify for a loan. 

Besides lying about income and employment, some people lie about occupancy.  The reason is that generally if you buy a house to live in you would get a lower interest rate than if you were an investor who will be renting or flipping the property.  In certain areas of the country you would also need to pay a larger downpayment on a property if you were an investor and the house is not your primary residence. So in most of  these cases of fraud people lie to save money. 

Casey Serin is an infamous example of a person who repeated lied about his income and occupancy status on his loan applications and was approved for eight homes.  He managed to flip one of his homes, but all the rest went into foreclosure because housing prices came down drastically and he was not able to flip them in time.  So for Casey, lying did not pay.  However, compared to the rest of the criminals you will meet in this article, Casey is really not a criminal mastermind. 

The Professional Scheme -- A Ring of Realtors, Loan Officers, and Appraisers Working Together To Rob the Lenders

When a group of real estate insiders start to work together to defraud the banks, they can manage to steal millions without waving a single gun.  The garden variety scheme works like the following:

  • One of the conspirators finds a person with good credit that is willing to join the scheme as a "straw buyer".  In some cases these buyers are victims of identity theft, and sometimes they are the friends and family of the co-conspirators.
  • The ring of thieves finds a cheap property that is for sale and someone related to the ring buys it.
  • The property is reappraised at a much higher value by an appraiser on the inside or an appraiser who was bribed.
  • A loan is taken out by the straw buyer for the new elevated price. 
  • Sometimes a loan officer is part of the ring and pushes the loan through.
  • The bank approves the loan and pays the ring the new price for the house.
  • The ring stops making payments on the house and the house goes into foreclosure
  • The ring of thieves take the bank's money and split it amongst themselves. 

There are some variations to this process.  For example, sometimes the thieves work out a deal with a loan officer to approve a loan that is much larger than the price of the property they are trying to buy.  Then they take the difference between the amount of the loan and the price of the property as cash and walk away.  In either case, the lenders are always left holding the bag when the properties go into foreclosure.

Here are some of the real estate professionals and other fraudsters that made headlines in recent months for mortgage fraud:

Crisp & Cole: David Crisp and  Carl Cole were flying high with industry accolades and expensive mansions.  Now they are being investigated by the FBI for their business practices and fraud. Practically all of David Crisp and his family's personal properties have gone into foreclosure and the state Department of Real Estate filed a complaint that alleged the agency misled lenders on at least $12 million worth of loans.  The real estate office is now gone and is ironically replaced by a real estate office that specializes in bank owned properties.

Wings, Smith, and Wright:  This is a story about how a few people managed to steal more than $6 million dollars from Bear Stearns.  They were not real estate insiders, but they managed to get quite a few of them on board.  As the Wall Street Journal article states, "it didn't take a rocket scientist to steal a fortune from mortgage lenders in recent years". The article also contains a pretty nice diagram on how the scheme was done.

Fitzgerald and Abrams: These two successful realtors in the affluent Beverly Hills area managed to  secure more than $140 million in fradulent loans from Lehman Bros. Bank.  This is an extremely professional ring that included people in every step of the mortgage process.  This pair also managed to recruit "straw buyers" in Utah through friends and family at a price of $15,000 per pop.  Finally, other realtors who were jealous of their "success" in selling house for ridiculously high amounts of money became suspicious and reported their concerns to the authorities.

Why Should You Care? 

The problem with organized mortgage fraud is the aftermath of a few peoples' greed impacts  entire communities.  In the case of Crisp and Cole they definitely managed to inflate the prices in Bakersfield and directly contributed to the rising foreclosures there.  Long standing foreclosures reduces the safety and value of any neighborhood.  When there are too many vacant houses in a block, drifters and other types of criminals do show up.  Additionally, the price of homes are determined by comparables nearby, so mortgage fraud could first inflate the price of an entire neighborhood, and then drag it down significantly after the fradulently obtained homes go into foreclosure.  This greatly affects the legitimate homeowners' near these properties.

Another problem is that some people feel that mortgage fraud is not really a crime.  It seems like just any other business dealing and it seems clean.  One person said to me, "if I sell my house to my brother for a million dollars and he gets the loan and lets the house go into foreclosure then that is a crime?"  My answer is, " if the brother lied on his loan application and you promised that you would give him part of the money, then it is a conspiracy to defraud a bank." We should not tolerate people who lie to procure large sums of money, and neither does the law.

What Can You Do About It?

There are literally hundreds of variations in how these white collar criminals manage to defraud lenders, homebuyers, and the government.  The end result is almost always ruined credit, destroyed lives, and neighborhoods with unreasonably inflated home prices.  This crime is hideous and silent but it can be spotted if you are vigilant in your neighborhood.  Have you seen any shacks selling for double or quadruple their original value in a matter of months? In the current real estate market, such price appreciation is certainly fishy. It never hurts to report suspicious activity  to the authorities and perhaps you will help your neighborhood from destructive foreclosures or at least catch the culprits who brought mayhem.  An inspirational example is a group of Atlanta women called the All-Broad Fraud Squad who did their own research about the questionable home sales in their neighborhood and finally got the attention of the authorities.  If there were more people like them in the past few years perhaps the current number of foreclosures we are seeing would be reduced. 

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Greg Go's picture
Greg Go

Thanks for the really interesting read!

I wonder how big of an impact fraudulent loans have had on the current lending crisis. Does anyone have an estimate of the total amount of dollars that have gone to fraudulent loans over the last few years?

Oh, and welcome aboard, Xin!

Guest's picture
Guest

The current sub-prime mess and all of the credit problems worldwide comes from fraud starting with the borrower all the way to the investment banks that created ABS and CDOs linked to these mortgages. In fact, it even goes slightly further to the investors who should have known better but continued to play the game thinking the problems would never surface so long and housing prices continued to rise.
Everyone knew that this was a house of cards and they just wanted to make a quick buck by playing their part in the whole affair.
To me, the sub-prime mess is much bigger and more criminal than the Enron fiasco; the problem being it is too disperse.

Guest's picture
Ginger

The chickens have come home to roost. It was all a matter of time before this caught up with everyone. People are losing their homes, credit ruined and banks losing money going bankrupt. But I dont feel sorry for the banks. On some level they knew what was going on and padded themselves by investing in sub prime loans. I feel sorry for the people who didnt educate themselves and got fleeced in the process.

Guest's picture

It is amazing what greed will drive people to do! This is a very informative article. The thought to construct such an elaborate scheme of fraud would never cross my mind. Where do these people come from and why don't they concentrate on applying their talents on accomplishing positive things? I guess that working for wealth takes too long in our get-rich-quick society.

Xin Lu's picture
Xin Lu

The criminals banked on the fact that banks usually don't inspect the properties the loans are being taken out for.  The banks are not in the real estate business, and in some cases the banks did get greedy.  However, when you have bank/loan industry insiders in your ring, the bank is compromised from the inside.  So yes, the lenders should have been much more vigilant and tightened their lending standards, but in some cases it is hard to prevent an extremely professional ring.  Anyway, I hope all parties involved have learned their lessons.

Guest's picture
fathersez

Don't the banks go after the borrowers for the difference between the loan outstanding and the final realized value of the property?

So there should be a number of bankruptcies.

I hope that the legal agencies pursue these cases deeper and bring criminal cases against these guys. Some years in jail should be good for them.

Guest's picture
0zzarkie

Where there is greed there is a way.

Guest's picture
Guest

Don't fool yourselves; the banks knew exactly what was going on and in most cases (some that I am personally aware of) initiated the fraud. Bottom line is that the banks made oodles of commissions off these loans and pressured the mortgage people to make these unscrupulous loans - they paid them double commission for doing so, and threatened the jobs of those who wanted to stick with the tried and true lending practices. They got bailed out and we got stuck with homes worth crap. They should be made to go back and re-set each and every mortgage principle for anyone who bought between 2002 & 2007 for those of us WHO HAVE KEPT ON PAYING ON TIME EVERY TIME because we don't want our credit ruined.