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Showing posts with label Mortgage Fraud. Show all posts
Showing posts with label Mortgage Fraud. Show all posts

Tuesday, June 10, 2008

Housing: Buy and Bail

by Calculated Risk on 6/10/2008 11:04:00 PM

From the WSJ: Some Buy a New Home to Bail on the Old

Next month, Michelle Augustine plans to walk away from her four-bedroom house in a Sacramento, Calif., subdivision and let the property fall into foreclosure. But before doing so, she hopes to lock in the purchase of another home nearby.

"I can find the same exact house as what I live in right now for half the price," says Ms. Augustine ...

In markets hit hardest by falling home prices and rising foreclosures, lenders and brokers are discovering a new phenomenon: the "buy and bail," in which borrowers with good credit buy a new home -- often at a much lower price -- then bail out of the "upside down" mortgage on their first home.
...
The mortgage industry is starting to wise up to the practice and is scrambling to fight back. Buy-and-bail is "certainly fraudulent and unfortunately on an uptick," says Gwen Muse-Evans, vice president for credit policy and controls at Fannie Mae.
...
Under revised Fannie Mae guidelines, which could take effect next week, loan applicants who claim they will rent out their first home will have to produce supporting evidence, including an executed lease agreement. Borrowers also will have to prove that they can pay the mortgage, property taxes and insurance for both residences.
So far there are only a few anecdotal reports of "buy and bail", so this might be much ado about nothing. This is certainly fraud (if they sign a false loan document). But just like fraud for housing (when people lie about their income to buy a home), this type of fraud is almost never prosecuted - and extremely difficult to prove, unless someone tells a reporter what they're going to do.

Tuesday, June 03, 2008

"House of Pain"

by Tanta on 6/03/2008 08:31:00 AM

Several readers have sent me the link to this Milwaukee Journal Sentinel story about a wretched tale of mortgage fraud. It's worth reading, both for an understanding of how many parties need to be complicit for such a blatantly fraudulent transaction to occur, but also for the way it tracks the hardening of attitudes of the lender over time, from an initial spontaneous recognition that this borrower got fleeced but good to a later tendency to blame the victim. Kudos to the Journal Sentinel for digging into the details of this one.

Thursday, May 29, 2008

BK Judge Rules Stated Income HELOC Debt Dischargeable

by Tanta on 5/29/2008 07:10:00 AM

This is a big deal, and will no doubt strike real fear in the hearts of stated-income lenders everywhere. Our own Uncle Festus sent me this decision, in which Judge Leslie Tchaikovsky ruled that a National City HELOC that had been "foreclosed out" would be discharged in the debtors' Chapter 7 bankruptcy. Nat City had argued that the debt should be non-dischargeable because the debtors made material false representations (namely, lying about their income) on which Nat City relied when it made the loan. The court agreed that the debtors had in fact lied to the bank, but it held that the bank did not "reasonably rely" on the misrepresentations.

I argued some time ago that the whole point of stated income lending was to make the borrower the fall guy: the lender can make a dumb loan--knowing perfectly well that it is doing so--while shifting responsibility onto the borrower, who is the one "stating" the income and--in theory, at least--therefore liable for the misrepresentation. This is precisely where Judge Tchaikovsky has stepped in and said "no dice." This is not one of those cases where the broker or lender seems to have done the lying without the borrower's knowledge; these are not sympathetic victims of predatory lending. In fact, the very egregiousness of the borrowers' misrepresentations and chronic debt-binging behavior is what seems to have sent the Judge over the edge here, leading her to ask the profoundly important question of how a bank like National City could have "reasonably relied" on these borrowers' unverified statements of income to make this loan.

And as I argued the other day on the subject of due diligence, it isn't so much that individual loans are fraudulent than that the published guidelines by which the loans were made and evaluated encouraged fraudulent behavior, or at least made it "fast and easy" for fraud to occur. Judge Tchaikovsky directly addresses the issue of the bank's reliance on "guidelines" that should, in essence, never have been relied upon in the first place.

*************

Here follow some lengthy quotes from the decision, which was docketed yesterday and is not, as far as I know, yet published. From In re Hill (City National Bank v. Hill), United States Bankruptcy Court, Northern District of California, Case No. A.P. 07-4106 (May 28, 2008):

This adversary proceeding is a poster child for some of the practices that have led to the current crisis in our housing market.
Indeed. The debtors, the Hills, bought their home in El Sobrante, California, twenty years ago for $220,000. After at least five refinances, their total debt on the home at the time they filed for Chapter 7 in April of 2007 was $683,000. Mr. Hill worked for an automobile parts wholesaler; Mrs. Hill had a business distributing free periodicals. According to the court, their combined annual income never exceeded $65,000.

In April 2006, the Hills refinanced their existing $100,000 second lien through a mortgage broker with National City. Their new loan was an equity line of $200,000; after paying off the old lien and other consumer debt, the Hills received $60,000 in cash. On this application the Hills stated their annual income as $145,716. The property appraised for $785,000.

By October 2006 the Hills were short of money again, and applied directly to National City to have their HELOC limit increased to $250,000 to obtain an additional $50,000 in cash. On this application, six months later, the Hills' annual income was stated as $190,800, and the appraised value was $856,000.

At the foreclosure sale in April 2007, the first lien lender bought the house at auction for $450,000, apparently the amount of its first lien.

The Hills claimed that they did not misrepresent their income on the April loan, and that they had signed the application without reading it. The broker testified rather convincingly that the Hills had indeed read the documents before signing them--Mrs. Hill noticed an error on one document and initialed a correction to it. No doubt because the October loan, the request for increase of an existing HELOC, did not go through a broker, the Hills admitted to having misrepresented their income on that application. The Court found that:
Moreover, the Hills, while not highly educated, were not unsophisticated. They had obtained numerous home and car loans and were familiar with the loan application process. They knew they were responsible for supplying accurate information to a lender concerning their financial condition when obtaining a loan. Even if the Court were persuaded that they had signed and submitted the October Loan Application without verifying its accuracy, their reckless disregard would have been sufficient to satisfy the third and fourth elements of the Bank’s claim.
This is not an excessively soft-hearted judge who fell for some self-serving sob story from the debtors. "Reckless disregard" is rather strong language.

Unfortunately for National City, Her Honor was just as unsympathetic to its claims:
However, the Bank’s suit fails due to its failure to prove the sixth element of its claim: i.e., the reasonableness of its reliance.6 As stated above, the reasonableness of a creditor’s reliance is judged by an objective standard. In general, a lender’s reliance is reasonable if it followed its normal business practices. However, this may not be enough if those practices deviate from industry standards or if the creditor ignored a “red flag.” See Cohn, 54 F.3d at 1117. Here, it is highly questionable whether the industry standards–-as those standards are reflected by the Guidelines–-were objectively reasonable. However, even if they were, the Bank clearly deviated to some extent from those standards. In addition, the Bank ignored a “red flag” that should have called for more investigation concerning the accuracy of the income figures. . . .

Based on the foregoing, the Court concludes that either the Bank did not rely on the Debtors representations concerning their income or that its reliance was not reasonable based on an objective standard. In fact, the minimal verification required by an “income stated” loan, as established by the Guidelines, suggests that this type of loan is essentially an “asset based” loan. In other words, the Court surmises that the Bank made the loan principally in reliance on the value of the collateral: i.e., the House. If so, the Bank obtained the appraisal upon which it principally relied in making the loan. Subsequent events strongly suggest that the appraisal was inflated. However, under these circumstances, the Debtors cannot be blamed for the Bank’s loss, and the Bank’s claim should be discharged.
In short, while the Court found that the Hills knowingly made false representations to the lender, the lender's claim that it "reasonably relied" on these representations doesn't hold water, because "stated income guidelines" are not reasonable things to rely on. In essence, the Court found, such lending guidelines boil down to what the regulators call "collateral dependent" loans, where the lender is relying on nothing, at the end of the day, except the value of the collateral, not the borrower's ability or willingness to repay. If you make a "liar loan," the Judge is saying here, then you cannot claim you were harmed by relying on lies. And if you rely on an inflated appraisal, that's your lookout, not the borrower's.

This is going to give a lot of stated income lenders--and investors in "stated income" securities--a really bad rotten no good day. As it should. They have managed to give the rest of us a really bad rotten no good couple of years, with no end in sight.

Read on . . .

Tuesday, May 27, 2008

NPR on Mortgage Quality Control

by Tanta on 5/27/2008 04:49:00 PM

This is a sobering, if rather overstated, segment on mortgage loan sale due diligence and the pressures to accept even the most dubious of loans.

Tracy Warren is not surprised by the foreclosure crisis. She saw the roots of it firsthand every day. She worked for a quality control contractor that reviewed subprime loans for investment banks before they were sold off on Wall Street. . . .

Warren thinks her supervisors didn't want her to do her job. She says that when she would reject, or kick out, a loan, they usually would overrule her and approve it.

"The QC reviewer who reviewed our kicks would say, 'Well, I thought it had merit.' And it was like 'What?' Their credit score was below 580. And if it was an income verification, a lot of times they weren't making the income. And it was like, 'What kind of merit could you have determined?' And they were like, 'Oh, it's fine. Don't worry about it.' "

After a while, Warren says, her supervisors stopped telling her when she had been overruled.
I have no particular reason to question Ms. Warren's abilities or her take on the situation; I have no doubt that for any number of reasons marginal loans were pushed back into pools over the objections of perfectly competent auditors. I have also had experience with staff whose supervisors stopped telling them when they had been overruled, because . . . life is too short. I suspect I am not the only one who has had this experience. Whatever the merits of this story may be, this I think is an overstatement:
"This is a smoking gun," says Christopher Peterson, a law professor at the University of Utah who has been studying the subprime mess and meeting with regulators. "It suggests that auditors working for Wall Street investment bankers knew how preposterous these loans were, and that could mean Wall Street liability for aiding and abetting fraud."
Forgive me for being a shill for Wall Street, but this strikes me as silly. The investment banks, including Bear Stearns, published loan underwriting guidelines detailing what they would accept in mortgage pools, and everybody in the industry had a copy at the time. The things came right out and said that things like stated income for a wage earner were acceptable. Was Mr. Peterson calling that "preposterous" at the time? I was. And I never had to look at a single loan file.

What I suspect Ms. Warren is overlooking is, precisely, that the due diligence on those Bear Stearns pools--like every other pool for every other investor--was based on evaluating the individual loans' compliance with the specific guidelines agreed to for the pool. If the guidelines allowed utter stupidity, it isn't likely that the project supervisors would kick out a loan for displaying that particular kind of stupid. If there's something preposterous here, it was in plain sight in the prospectuses to every one of these loan deals. I am having a hard time with the idea that "the smoking gun" didn't show up until this week.

And then there is this part, which has made it all over the web today:
A bankruptcy examiner in the case of the collapsed subprime lender New Century recently released a 500-page report, and buried inside it is a pretty interesting detail. According to the report, some investment banks agreed to reject only 2.5 percent of the loans that New Century sent them to package up and sell to investors.

If that's true, it would be like saying no matter how many bad apples are in the barrel, only a tiny fraction of them will be rejected.

"It's amazing if any investment bank agreed to a maximum number of loans they would kick back for defects. That means that they were willing to accept junk. There's no other way to put it," says Kurt Eggert, a law professor at Chapman University.
Now, I actually plowed my way through that New Century report, and I have to say that there's a reason this claim was, um, "buried" therein. From page 135 of the report (Warning! Big Honkin' pdf that will take forever to download!):
[K]ickout data may not be a true indication of loan quality trends because New Century was able, particularly when the subprime market was strong and housing prices were rising, to negotiate understandings with certain loan purchasers to limit kickouts to a maximum rate, such as 2.5%. Flanagan [NEW's former head of loan sales] was explicit in stating to the Examiner that such understandings were reached. The Examiner was unable to establish corroboration for this statement. Nevertheless, such understandings may have limited kickouts, masking loan quality problems that existed but were not reported.
The report goes on to document that NEW's typical kickout rate was north of 5.00% and in many months much higher than that; except in securitization (not whole loan) deals where NEW retained residual credit risk, the kickout rate of 2.5% was, to quote the report, "probably more aspirational than real." The fact that no one could produce a contract or set of deal stips or e-mail or sticky note "corroborating" this claim suggests to me that it may have existed only in Mr. Flanagan's mind.

There are, of course, situations in the whole loan sale world in which people have perfectly respectable reasons to agree to limit "kickouts" up front. Occasionally pools are offered for bid with the stipulation of no kickouts: these are "as is" pools and it is expected that the price offered will reflect that. I have myself both offered and bid on no-exclusion loan pools. This is mostly an issue in the "scratch and dent" loan market, where one might have a mixed pool of pretty good and pretty botched up loans to sell. Allowing a buyer to "cherry pick" the deal just leaves you with all the botched up loans to sell separately, which is never anyone's preferred approach. Of course any buyer of loans can decline to bid on a no- or limited-kickout basis. Those who do bid on these deals tend to lower the bid price accordingly. The NEW report also documents the steady deterioration in NEW's profit margin on its whole-loan sales, and trying to get investors to take packages of loans with limited or no kickouts might explain some of that. My guess, from reading the report, is that while NEW might have thought it wanted a 2.5% kickout rate, it ended up accepting a much higher one because the price discount was more than it could face.

I am not trying to suggest that anyone is particularly innocent here. This all just has a sort of Captain Renault quality to it: we are shocked, shocked! that gambling went on in these casinos. The published underwriting guidelines that were available to everyone involved made explicit what was going on with these loans, and those guidelines were published with the deal prospectuses. Now we have a bunch of investors--including institutional ones with absolutely no excuse--wanting to grab hold of stories like Ms. Warren's about cruddy individual loans, as if the pool guidelines weren't themselves a big flaming hint that the loans were absurd.

Sunday, May 18, 2008

The Mortgage Fraud Employee Benefit Program

by Tanta on 5/18/2008 05:25:00 PM

Thanks to Clint for this terrifying story in The Oregonian:

Fitzsimons, of Prineville, started his first residential construction company, called Sunrise Northwest, when he was 19. In August 2004, he joined forces with close friend Shannon Egeland, co-founding Desert Sun. . . .

At its peak, Desert Sun employed more than 110 people. The company's success enabled Fitzsimons to buy expensive toys, including a 2006 Ferrari 430 Spider, boasting a base ticket price in excess of $200,000.

Desert Sun had no retirement plan, but it did offer the employee homeownership program, which its Web site likened to a 401(k).

The plan seemed straightforward enough: Desert Sun would build a home for employees, taking care of design, materials and construction. Employees could buy the completed home from Desert Sun at cost and assume monthly mortgage payments, or sell it and split proceeds 50-50 with the company. . . .

The Desert Sun plan was not without risk for participants. The company pledged to cover all costs, but to fund the building, employees had to take out construction loans in their own names. . . .

Deschutes County property records indicate that the company enjoyed six-figure profits on the sales of some of the lots.

On July 5, 2007, for example, Desert Sun Holdings bought lot 24 in the Village Meadows subdivision in Sisters from Redmond-based Allen-Rose Homes for $155,000. That same day, the company flipped the lot to employee Roger Howell for $269,900.
And, of course, this all seems to have been effected by fraudulent mortgage applications. Read the whole thing, but put down your drink before the last paragraph.

Wednesday, May 14, 2008

FBI 2007 Mortgage Fraud Report

by Tanta on 5/14/2008 07:49:00 AM

I didn't think there was anything particularly earth-shattering in this report, but I did think some of you might be amused by this:


According to the FBI:
The above photos are from condos that were involved in a mortgage fraud. The appraisal described “recently renovated condominiums” to include Brazilian hardwood, granite countertops, and a value of $275,000.
It does make you wonder whether some of these reports of pre-foreclosure "trash outs" don't involve a few properties that were trashed from the get-go.

Sunday, April 13, 2008

The Sorry Mess That Is Alphonso Jackson's HUD

by Tanta on 4/13/2008 08:50:00 AM

A long piece from the Washington Post, which I recommend reading in its entirety.

In late 2006, as economists warned of an imminent housing market collapse, housing Secretary Alphonso Jackson repeatedly insisted that the mounting wave of mortgage failures was a short-term "correction."

He pushed for legislation that would make it easier for federally backed lenders to make mortgage loans to risky borrowers who put less money down. He issued a rule that was criticized by law enforcement authorities because it could increase the difficulty of detecting and proving mortgage fraud.

As Jackson leaves office this week, much of the attention on his tenure has been focused on investigations into whether his agency directed housing contracts to his friends and political allies. But critics say an equally significant legacy of his four years as the nation's top housing officer was gross inattention to the looming housing crisis. . . .

In speeches, he urged loosening some rules to spur more home buying and borrowing. "I'm convinced this spring we will see the market again begin to soar," Jackson said in a June 2007 speech at the National Press Club to kick off what HUD dubbed "National Homeownership Month." He also told the audience that he had no specific laws to recommend to prevent a repeat of the lending abuses that caused the mortgage crisis.

"When Congress calls up and asks us, we'll give them advice," he said. "You have 534 massive egos up there, so unless they ask you, you don't volunteer anything."

HUD spokesperson D.J. Nordquist defended Jackson's record in pushing for more flexibility in government-backed loans. "Secretary Jackson is a big believer in the U.S. housing market and won't apologize for saying so," Nordquist said. . . .
I once opined that it would take Armageddon to get Jackson's attention. It turns out I was wrong; all it took was a shrimp buffet.

Friday, March 28, 2008

More On Chase and the Zippy Tricks

by Tanta on 3/28/2008 10:19:00 AM

Which, as Dave Barry always says, would be a great name for a band.

CR posted this shocker yesterday, a memo with a Chase logo attached (which doesn't mean much in these copy & paste days), sent via e-mail to mortgage brokers in what appears to be a "package" of "training documents," that provides tips on how to "cheat" and "trick" Zippy, Chase's AUS (automated underwriting system), into approving loans it would not normally approve. (Or, possibly, allowing loans to be documented or priced in a way they would not have been had the loan been submitted properly. It's hard to say exactly.)

I am not especially interested in the debate over whether it was "official Chase policy" (undoubtedly it was not) or whether it was a "joke" started by some wag at Chase ("this is how we oughta be training the brokers, ha ha!"). My own hunch is that it did start out as a joke, but there was at least one Account Executive at Chase who either didn't "get" the joke--which is scary--or who didn't have the sense to realize that certain forms of satire shouldn't leave the building.

But that's the thing: it works for me as a "joke," of the black humor deadpan sort, because, well, it isn't that far off "official policy." "Official policy" is simply couched in ponderous language, hedged about with earnest exhortations not to "misuse" the system that everyone ignores, and mostly "functional" in the sense that it covers certain raw acres of corporate butt, not in the sense that it really communicates clearly to a worker-bee what you're actually supposed to do when certain things--cough, cough--cross your desk.

I say this with complete confidence even though I haven't read Chase policy documents for years, and I have never read internal use only Chase policy documents. I have read hundreds of documents produced by dozens of institutional lenders, wholesalers, and aggregators describing credit policy and acceptable origination practices. I have written quite a few of them, to tell the truth. For that reason I have been in plenty of arguments over the years about those documents, since I have this thing about using language people can actually understand, explaining things clearly, and making policy documents actually useful to everyday operations rather than merely having them around in a file cabinet in case the regulators show up, and entirely ignored by everyone in-house unless and until that day arrives. So I am not speaking with actual detailed knowledge of Chase policy or the likely tone or content of Chase policy documents in particular. I am generalizing based on years and years of having to wade through that crap because no one else will.

What I really got interested in was not where, exactly, this document came from, but why, precisely, it says what it says. I mean, you can see this as a Chase Account Executive (or whoever authored it) simply baldly encouraging fraudulent misrepresentation, and that of course is what it is. But you also have to see that it does appear to require some misrepresentation to get past Zippy in some respects. That much is to Chase's credit.

Also, the way these things tend to work is that the "cheats and tricks" that people come up with--and no, this isn't the only one out there by a long shot, it's just the only one I know of so far that got to a reporter--tend to focus on routine problems. Nobody writes "cheat sheets" to deal with obscure complex things that only arise on one out of 200 loan applications. People write "cheat sheets" to deal with the problems you are most likely to have. And yes, I am using this term "cheat sheet" in its commonplace sense of a "dumbed down" policy or procedure, a set of "short cuts." The term has always been ambiguous: is a "cheat sheet" directions for breaking the rules, or just directions for following them faster and more easily? "Efficiency" and "user friendliness" have always been in danger of converging on the unethical. This is not a new problem. Perhaps our apparently willful lack of attention to this problem over the last several years is what was, in fact, different this time.

Besides the "most common problems," I have often found "cheat sheets" appearing in contexts where it's not so much that the issue at hand is "common," it's that this particular lender has a "thing" about that particular issue. If you ask a bunch of industry participants who are willing to tell you the truth, I suspect you'll find a high degree of consensus on what the "preoccupations" or "hot buttons" for any given wholesaler are. "Everybody knows," the story will go, that X is touchy about gift funds and Y is the hardest to deal with on short-form appraisals and Z isn't the place to go if you want a high-rise condo loan approved. And so on.

That kind of "eccentricity" is less common than it used to be, given nearly universal securitization of loans (which tends to "homogenize" the industry and make lenders willing to write loans they wouldn't touch for their portfolio) and competitive pressures that spawn "races to the bottom" all over the place. In the early years of the boom (until 2005 or so) I used to actually keep spreadsheets in which I tracked policy of ten major correspondent/wholesalers on a couple of dozen selected issues. I did not necessarily select the "common ones"; I was precisely interested in the more offbeat. Like condos with less than four total units in the project, or the rarer forms of temporary buydowns, or non-arm's-length transactions, or foreign national borrowers. ("Foreign national" in this context does not mean undocumented immigrant. It means someone who is not only not a U.S. citizen, but also not even a U.S. resident.) In other words, "niche" stuff that was once simply not allowed at all in the "prime" world, but which increasingly crept into "expanded criteria" programs--the precursor of what you all know as "Alt-A"--and then even into so-called "prime jumbo" or "prime non-agency."

What my little spreadsheet showed was that, over time, we went from an environment in which "go to Lender X if you have a small condo project" was the way it worked, to "just about everyone does small condo projects these days, so why shouldn't we?" It also showed that certain things were "migrating" from "expanded criteria" programs into "mainstream" programs. The race was on. Back in 2005 I was arguing strenuously that it was a race to the bottom, but that was of course a minority view.

Way too many people were convinced that we had the technology that would allow us to "race to the top." The idea was that in the Days of the Dinosaurs, doing 2-flats turned into condos or non-arm's-length deals or what have you was really very risky, but not any more, because now we have all these computer models that can much more finely-tune our risk assessments. Plus there was always the supplementary argument that hey! if someone like Chase is willing to do it, that must mean it's "respectable." That last argument wasn't always stated in such an unvarnished fashion, but that was the drift.

So this brings us back to the Zippy tricks, and the specific content of the infamous memo. If you read it from a certain angle--just for the sake of analytical clarity, not in aid of "defending" what is obviously indefensible--you can see it as some evidence that Chase's system, Zippy, has been correctly programmed to weed out a couple of serious problems:

1. Unstable income. The "trick" of putting all income in "base," instead of breaking it out (as the application form is designed to get you to do) into base salary, bonus, commissions, etc., is partly about getting the AUS to "let you by" with only a paystub to verify current income, if that. This is because it has been recognized since about the end of the last Ice Age that base salaries tend to be fairly stable, but bonuses and commissions tend to be rather volatile. This "other" income is, traditionally, used to qualify borrowers only when they can verify a history of having received it regularly, typically for a minimum of two years, and prospects for continuing to receive it, typically for at least the next three years. It is difficult to verify prospects; in most cases lenders digged so deeply into the past history of the income because that was the best clue to its likely continuation. The theory, for instance, was that an employer who regularly paid bonuses for the last several years was more likely to continue to pay them in the future than an employer who only just paid its first bonus a few weeks ago. Of course, stability of income projecting into the future was important because, well, we expected loans to repay out of income, not refinance money or sale of the home.

You can, if you like, theorize that Zippy has some "rules" built into it that involve a different set of parameters or a higher degree of scrutiny or possibly even a different "rate sheet" when the loan has substantial qualifying income other than base salary. It should. So the instructions to defeat that purpose by lumping everything into "base" is not just saving some idiot some keystrokes. And it's not a trivial thing involving some fussbudget who wants the forms filled out properly for no real reason. There's a real reason here.

2. Gift funds. We have been banging on for years now about borrowers having no "skin in the game." Lenders need to know--have always required to know--what the source of the down payment money is. It isn't just that loans with gifted down payments default more often, although they do. It's also that a lot of fraudulent "straw borrower" deals require "gift funds" to work out. Zippy was programmed to require this information for very good reasons.

3. "Inching up" income. Well, that one's pretty obvious. It is, however, the point at which I for one conclude that Zippy was probably not programmed correctly.

The fact of the matter is that an AUS should simply ignore DTI or cash reserve calculations when income or assets are or can be unverified. In fact, using DTI or months of reserves in your underwriting decision will inevitably produce worse results on a "stated/stated" loan than ignoring them will. They mislead you. I have known good, experienced, savvy human underwriters to fall into this trap, in spite of themselves: they see those "nice-looking" numbers and can't stop themselves from using them as a "compensating factor" on the loan.

There are people in the industry who think that "NINAs" are "worse than" stated income/stated asset loans, but I have never been one of them. What distinguishes them is that in a NINA, you don't even state numbers. You literally leave those boxes on the application blank. The loan is qualified with a credit report and an appraisal.

Now, I'll agree that NINAs are stupid--no problem there. But they're less stupid than "stated" deals. They don't "distract" you with made-up numbers. Actually, they often result in much better analysis of the appraisal and the credit report than you get in a "stated" deal. After all, the appraisal and the credit report are all you got in a NINA: you work 'em over. In the "stated" world people--and apparently some computers--keep getting sidetracked by those unverified numbers.

So I got the impression, for what it's worth, that Zippy is a mixed bag: it seems to have some responsible programming and some stupid programming. As I remarked in the comments to yesterday's post, the fact that it doesn't flash red lights and immediately refer the loan to the fraud-detection squad when it notices that a file keeps getting "resubmitted" with "refreshed" income and asset numbers is a huge problem. If this AUS really does allow multiple resubmissions with increasing stated income each time without setting off the red fraud flags, this is a very big deal for Chase. I'm here to suggest that Chase's regulators need to look into that. As I said, given the chance that the memo is a "joke," it's possible that the thing handles re-runs better than it sounds like it does. But Chase should have to answer this question now that the memo is on the table.

The final question for me, then, is what if anything is likely to be "unique" to Chase here. My answer is "not much." This just isn't in the same class as small condo projects or foreign nationals. We're talking Underwriting 101 stuff that brokers can, apparently, defeat by just putting a number in the wrong data-field or putting a "no" in the gift funds field or getting the system to keep "recalculating" DTI or cash reserves until you have forced it to reveal to you where its cutoffs are.

We all know why people do those things. What somebody needs to explain to me is how, after all this time, it's still so easy to do it. Where are the internal plausibility checks? Where is the "behavioral" logic that notices not just the content of the datafile but the manner in which it was submitted? Where's the basic randomly-selected pre-closing QC that snatches files out of the AUS queue and matches up the data submitted to the AUS with a quick phone call to the borrower?

Where, in other words, is the "high" tech? We've had AUS since the green-screen mainframer days of the 80s, kids. Thirty years down the road and these things are as easy to fool as Barbie's My First Laptop? After all the money these lenders have spent over the years on IT? There's something else that doesn't add up here besides a borrower's paystubs.

Technology aside, where, we also have to ask, are the "real" writers of policy and procedural and training documents? My own sense is that you find "cheat sheets" in companies that don't provide "real sheets" that are usable or comprehensible or updated or easily available on the website. We are, you know, in the "cut & paste" days. It's just no longer difficult to provide your people--or your broker clients--with the "real thing." Anyone who used to prepare policy with a Selectric and an old slow photocopier has a right, I think, to ask just what we're getting out of the "information" part of the "IT revolution." We just shouldn't have to have "cheat sheets" any longer; the "search" button takes care of the difficulties of looking things up. It matters, and it matters because asking people to look at the "real" policy instead of some dumbed-down "cheat sheet" written up by an Account Executive is not too much to ask. You think you will ever control for unethical behavior when you don't even demand moderate amounts of effort?

The whole industry has some explaining to do.

Thursday, March 27, 2008

Zippy Cheats & Tricks

by Calculated Risk on 3/27/2008 11:51:00 AM

The Oregonian is reporting this morning on a JPMorgan Chase memo titled "Zippy Cheats & Tricks". The Oregonian obtained a copy of the memo, and the memo apparently offers tips on how to get loans through Chase's in-house automated loan underwriting system:

The document recommends three "handy steps" to loan approval:

Do not break out a borrower's compensation by income, commissions, bonus and tips, as is typically done in a loan application. Instead, lump all compensation as the applicant's base income.

If your borrower is getting some or all of a down payment from someone else, don't disclose anything about it. "Remove any mention of gift funds," the document states, even though most mortgage applications specifically require borrowers to disclose such gifts.

If all else fails, the document states, simply inflate the applicant's income. "Inch it up $500 to see if you can get the findings you want," the document says. "Do the same for assets."
...
"This is not how we do things," [Chase spokesman Tom Kelly] said. "We continue to investigate" the memo, Kelly said. "That kind of document would neither be condoned or tolerated."
Added: the article very clearly states this was for stated income loans - and that Chase no longer offers these loans. In no way do I think this was Chase's policy - instead this shows how some people (possibly Chase insiders) were helping borrowers (or mortgage brokers) commit mortgage fraud.

Sunday, March 23, 2008

Renters Beware

by Tanta on 3/23/2008 10:07:00 AM

Since it's Easter Sunday, and you don't have anything better to do than munch on Peeps and read about relitter perfidy, another in our continuing series on real estate fraud.

Via Mish, this story of renters in a bind:

When the Hays found their rental home last June they were pleased. Not only could they move in right away, the landlord asked them what they could afford for a deposit. There was even the chance to buy the home at some point in the future.

But that would all change in less than seven months. There's no forgetting the day Jennifer and Travis learned something wasn't right with their rental home. Their landlord called January 15, a memorable day. It was the same day Jennifer was headed into surgery.

"She called to tell me I should start looking for another place, that she could sell me a house," Jennifer explains. "And that's when I figured out that not only am I going through a miscarriage, but I was also going to lose my house."
You really want to read the whole thing, including the unbelievable text messages the relitter-landlord sent to the renters, trying to get them to pay February rent (after the bank took the house at the foreclosure sale in the end of January).

What I don't think is necessarily clear in the story as reported is the timeline. A "perfect" foreclosure in Nevada--that is, one without unusual delays, that uses basically standard servicer approaches for when to start FC proceedings--takes around 270 days from the last payment made. Nevada has a 90-day reinstatement period in the statutes, meaning that once the initial Notice of Default is filed, the borrower has the next 90 days to bring the loan current and avoid FC. After the 90 days, if the loan isn't reinstated, the notice of sale must be published three times over three consecutive weeks. Including time for processing the original FC referral (before the NOD is filed), it takes about 120 days to get through the process to the sale of the property. If the servicer does not initiate the FC process until the 120th day of delinquency (the 150th day since a payment was made), the whole thing is 270 days.

In our case at hand, that means that the owner of the property probably made her last mortgage payment on May 1, or possibly June 1 if the servicer started FC after the 90th day of delinquency. (This is assuming she ever made a payment; the article doesn't tell us when she bought the property.) She rented the place to the Hays in June. In other words, we don't have a case here of a landlord who gets into financial difficulties at some point in time after renting the place to tenants. We have someone who appears to have intended from the start to "skim off" rents without paying the mortgage.

I really don't know how the Hays could have spotted this up front; there are no public records that will tell you if your landlord is delinquent the day you sign your lease, or is going to be delinquent thereafter. Tenants can check public records to see if a landlord is in foreclosure--if that Notice of Default or whatever it is in a specific state has been filed--but there's nothing to see until that document is filed. In the case at hand, it appears that nasty letters from the servicer were actually coming to the property address, but these tenants were apparently unwilling to open mail not addressed to them, and fell for the landlord's "explanation" of what that flurry of certified mail was all about. I'm sure it never occurred to the Hays that while some legitimate landlords will have servicer mail directed to the property address, that can also be a good indication that the property was obtained under occupancy fraud (that is, that the landlord claimed to the lender that the property would be the landlord's principal residence). Sadly, there's no sure-fire way for people who rent single-family homes from an individual to really verify whether or not they're getting caught up in a rent-skimming scam.

There is also no sure-fire way for servicers to know that this is going on, although there are steps that can be taken. A while ago we were confronted with a rant from our favorite Gretchen Morgenson, railing about servicers hitting delinquent borrowers with "unnecessary" property inspection fees. I have no way of knowing if the servicer in the Hays' case did inspections at all, if the inspector saw signs of occupancy and assumed the occupants were the owners, or if the inspector did catch on and the FC was actually accelerated because the servicer feared that rent-skimming was, indeed, transpiring. I do always fear, when the delinquent owner is a member of the local RE establishment, that the "inspector" might have eyes wide shut. I do actually claim to know that this is why delinquent borrowers find themselves with a bill for periodic inspections.

I make no claims that scams like the one perpetrated against the Hays--and it is a scam to enter a rental agreement with someone while not disclosing that you're about to lose the property to FC, that's kind of a material fact--are common or usual or an "epidemic." I am, however, convinced that a lot of "speculators" are suddenly trying to convert themselves into "landlords," and that the results aren't going to be good for anyone--not for the tenants, and not for the lenders. There's a problem with market-comparable rents not being high enough to satisfy the mortgage payment, and then there's the problem that it may not be anyone's intention to satisfy the mortgage payment anyway.

Nonetheless, I've seen some people lately encouraging renters to "take advantage" of the ability to rent nice big houses on the cheap from an amateur landlord these days, given the distress in the RE market. I'm merely observing that there is some room for caution, yet again, when the deal sounds "too good to be true." I am also observing that folks who have no experience with being landlords, and who are tempted to buy properties "on the cheap" in a foreclosure or short sale and rent them out, might want to stop and consider that they might have to "compete" with "distressed" landlords who can offer prospective tenants a "better deal"--no or minimal deposit, short-term or flexible lease terms, low rent--since they have no intention of making mortgage payments. In the current environment, you had better make sure you can carry the PITI and maintenance on a rental property you buy with a very high "vacancy factor." Any "RE guru" who is telling you different may well have, shall we say, ulterior motives.

Saturday, March 22, 2008

A Tale of Real Estate Predation

by Tanta on 3/22/2008 10:02:00 AM

I recommend this story in this morning's Washington Post, "My House. My Dream. It Was All an Illusion," by Brigid Schulte. It's a good article, although I'm going to offer some criticism. I know; you're all shocked.

As is so often the case, I find these stories hard to read. For one thing, there's that habit reporters have of just not recapitulating a complex narrative in order. This story isn't as bad as some in that regard, but there's still this habit of breaking off the narrative to get a quoted generalization from an expert or just generalizations provided by the reporter that break the narrative flow. On a story this complicated, it would help to try to avoid that.

The other problem is that I end up not being sure the reporter is using terminology terribly accurately. Is this nitpicky? Not if the idea of these stories is to help people spot similar scams in the future, should they be so unfortunate as to run into one. For instance, part of this scam seems to involve a homebuyer convinced she was making a "down payment" when it appears she was only covering (excessive) closing costs. It doesn't help much for the reporter to perpetuate the confusion by continuing to refer to a "down payment." I think most consumers believe that a "down payment" translates into "equity." If all you are doing is paying closing costs, you are starting out with zero equity (100% financing). We need to be making this clearer, not falling into the trap.

But there is also one ringing silence in this story--it's something I see in 99% of these kinds of news stories, and frankly I'm getting tired of it. Let me do my usual re-cap of the narrative, and see if you all can hear the dog that didn't bark.

In 2005 Glenda Ortiz fell afoul of a fast-talking door-to-door salesperson, Salgado, who besides being a Mary Kay peddler was also a "sales assistant" for a relitter, Aguilar. In this context "sales assistant" means the person Aguilar was paying illegal "referral fees" for reeling in marks. Salgado is not a licensed relitter and both Virginia RE regulations and HUD rules prohibit this kind of "kickback."

Someone--Salgado or Aguilar, it isn't clear--showed Ortiz one house and only one house, a "run-down one story duplex" listed for $425,000. Ortiz ended up signing a contract for $430,000. (In this context, "duplex" appears to mean a single-unit structure that is attached to another single-unit structure with a shared firewall and a lot line running down the middle of the house, not a two-unit structure on a single parcel of real estate.)

Ortiz didn't have the money "for a down payment," and did not have a good credit record, but Salgado offered to lend her "half" of what is said to be an $11,000 down payment and be a joint applicant on the loan (presumably to "bump up" the qualifying FICO by using Salgado's). (Unmentioned in the story: half of $11,000 would be very nearly the amount of the sales price in excess of the list price, no?) The "deal" Ortiz was presented with is that in "a year," when the house had appreciated by 20% or so, Ortiz would refinance, extract $70,000, and pay half of that to Salgado "for her share of the down payment and for allowing Ortiz to use her credit." Lend someone $5,500, get back $35,000 in a year? Nice work if you can get it.

When Ortiz, whose spoken English appears minimal and who cannot read English, got to the closing in August 2005, she found that Salgado wasn't her "co-buyer," Salgado's brother Hernandez was. Ortiz ended up signing documents that made her the buyer of the home--her name was on the deed along with Hernandez'--but not a borrower on the loan: only Hernandez was actually on the note. (Presumably because only Hernandez "qualified" for the loan.) Ortiz was induced to sign a statement that she was Hernandez' wife, although she seems to have met him for the first time at closing and she's already married to someone else.

Salgado says her own credit wasn't good enough to help Ortiz--there's a surprise--and that she was just "helping out a friend." It appears that "the woman handling the loan" (I don't know if that means the mortgage broker or the title company settlement agent, in context) was the wife of Aguilar, the licensed relitter for whom Salgado worked. Ortiz was told that Hernandez would be taken off the title in one year and she would own the home outright.

The Post got an unrelated mortgage broker to look at the documents on the loan, and he found "junk fees and an overpriced appraisal," with "'excessive' closing costs . . . upward of $10,000." I suspect the appraisal was "overpriced" because someone had to be bribed to bring the value up to the sales price. In any event, this is why I'm a bit befuddled by the reference to the "down payment." It sounds to me like Ortiz paid closing costs of $11,000 or thereabouts, with half of it from Selgado or Hernandez, resulting in a 100% LTV loan.

The reporter says she got a "high interest" loan with a payment of "more than $3,000 a month" that was 70% of Ortiz's (and her real husband's) gross monthly income. I really wish reporters would stop doing things like that--if the point here is to help readers understand what a "high interest" loan is, it would be useful to know what rate it was and for what kind of loan, and whether that "payment" is P&I or PITI (that is, whether it includes taxes and insurance as well as principal and interest). I assume it's P&I only, and using $3,000 as the payment and $430,000 as the loan amount and a 30-year term, I get an interest rate of just under 7.50%. Quite honestly, for a 100% purchase on a nonconforming loan that's not such a bad rate. This frustrates me to no end, as I complain regularly about borrowers who do not understand a rate that is "too good to be true." No doubt it was an ARM and Ortiz didn't know that; possibly it was a 40-year term. But it hardly matters: she couldn't afford the start rate. She could never have been anywhere close to affording the true "risk-based pricing" she'd have gotten if the scumballs hadn't substituted a "straw borrower" in her place. But I don't think we're helping people by giving them the impression that 7.50% or so is a "high rate" for the terms of this deal.

Inevitably, Ortiz couldn't keep up the payments, after having sold belongings, gotten behind on other bills, and borrowed more money to make payments as long as possible. Salgado didn't come through with the promised refi, of course, and when Ortiz tried to work something out with the bank, she only then learned that she wasn't on the note, was not the legal borrower, and hence had no "standing" to work anything out with the lender. When she asked Hernandez to help, "he told her to leave the home."

Ortiz ended up deeding the house over to Hernandez, in an agreement that "prohibit[s] Ortiz from suing Salgado and Hernandez for fraud." She received nothing for having made mortgage payments and paid half the closing costs. Hernandez "sold the home in December [of 2007] for $380,000." There is no mention of who the sucker (or co-conspirator, you never know) was who paid that much for this home. Or who financed it. We talk a lot about short sales and current owners getting out, and we never seem to worry much about who is getting in.

The money quote is from Aguilar the relitter:

Aguilar said he saw nothing amiss in the transaction. Ortiz wanted a house, and Hernandez wanted an investment.

"Everybody was fine. Everybody was happy. But now that the market's gone down, everybody's got a problem and wants to blame it on the realtor, saying we guided them to bad loans," he said. "Everybody's blaming everybody else. But everyone contributed to the housing bubble, the banks, the real estate agents, the appraisers. Everyone's to blame."
Too funny, Mr. Scumbucket. Ortiz wasn't in a bad loan. Ortiz never got a loan. Ortiz got suckered into making someone else's mortgage payments.

So what is this missing detail that is driving me crazy? Where's the seller? Who was the seller? Who listed a run-down property for the outrageous sum of $425,000, and then accepted a bid of $430,000 from a buyer whose ability to understand the transaction was pretty clearly dubious and who wasn't represented by an attorney at closing? Why did the relitter (or the "sales assistant") make a beeline for that house, and show Ortiz only that house?

I seriously wonder about this, I guess because I assume (possibly quite incorrectly) that if the original seller had been in cahoots with (or an alternative identity of) the RE agent, we'd have heard about it in the article. I fear that the seller was truly an unrelated party--who may or may not have kicked the $5,000 in excess price to Salgado in order for her to "pay half" the "down payment." I fear this because there is this idea floating around in the world that that makes the seller "innocent."

What's so "innocent" about taking advantage of a naive, uninformed, and unrepresented buyer to profiteer off real estate? We have the word "profiteer" in English, as well as the word "profit," because we have long recognized that there is a difference between simply selling an asset that has appreciated in value, on the one hand, and taking advantage of the desperate on the other. But that distinction simply disappeared during the boom: everybody got behind the idea that it was perfectly "respectable" to screw the next guy in line and not look too closely into the identity or capability of the prospective buyer. It is, of course, not illegal to sign a sales contract with a counterparty whom you know nothing about, and whose capacity to perform under the contract ought to be dubious to anyone with one or two good brain cells. That's just how the free market is, ya know?

We just looked the other day at a case of outright journalistic malpractice in the New York Times, where some hustler who advocates "illegal assumptions" of upside down loans was given credibility by a reporter. I'm not including the Post reporter in that league, by any means. The Post story is a good one, on the whole.

But it still leaves me with a lot of questions, particularly given our recent brush-up with a shady RE broker who advocates that buyers talk desperate sellers into "assumptions" that work only if the lender is defrauded by not being informed. But is this scam really being directed at "desperate sellers"? Or is there some RE agent who owns a bunch of upside-down homes, who is trying to recruit "smart" buyers who will make payments on a stupid loan that isn't even in their name and let the upside-down owner "walk away" from the mess?

I'm asking you journalists who write about this stuff to keep digging, because the reality of the situation is that we're kind of past the historical moment for the kind of scam Gloria Ortiz got sucked into. The lenders are going bankrupt, and the ones left aren't making these loans any longer. But that means we are very, very much in the historical moment for massive seller fraud. There are way too many operators out there who own these upside-down properties, want out, and are looking for marks again.

Surely, many of the "desperate sellers" these days were themselves victims of fraud, and it's not inappropriate to have some sympathy for them. But all the stories I've been reading about "short sales" and "preforeclosure sales" and this "subject to sale" thing have simply assumed that the seller is the victim and that it's a good financial move for the buyer to take this "discounted" property. Well, I've got my doubts that whoever took the property from Hernandez in the Post story for $380,000 got a deal.

Nobody wants to have to report on "foreclosure avoidance scams" or "subject to" ripoffs after the fact, like we're only now reporting on predatory lending and predatory RE sales practices after the fact. Please, please. Let's get ahead of the curve on this one. Literally, we might prevent a few of them from happening, which is so much more satisfying than reporting on them after the fact.

There is predatory lending. There is predatory real estate selling. Let us not focus on the former to the exclusion of the latter.

Tuesday, January 29, 2008

WSJ: More Criminal Inquiries into Mortgage Related Companies

by Calculated Risk on 1/29/2008 04:04:00 PM

From the WSJ: U.S. Probes 14 Companies In Subprime Investigation

Federal investigators have opened criminal inquiries into 14 companies as part of a wide-ranging investigation of the subprime mortgage crisis, focusing on accounting fraud, securitization of loans and insider trading ... The FBI wouldn't identify the companies under investigation but said that generally the bureau is looking into allegations of fraud in various stages of mortgage securitization, from those who bundled the loans, to the banks that ended up holding them.
This reminds me of Tanta's excellent piece last March: Unwinding the Fraud for Bubbles
There is a tradition in the mortgage business of distinguishing between two major types of mortgage fraud, called “Fraud for Housing” and “Fraud for Profit.” The former is the borrower-initiated fraud—inflating income or assets, lying about employment, etc.—that is motivated by the borrower’s desire to get housing (not the same thing as “real estate”), by means of getting a loan he or she doesn’t actually qualify for.
...
Fraud for profit is simply someone trying to extract cash—not housing—out of the transaction somewhere.
This new investigation is once again going after those involved in "Fraud for Profit", possibly with a new emphasis on those involved in the securtization process. See also this recent NY Times report by Jenny Anderson and Vikas Bajaj: Reviewer of Subprime Loans Agrees to Aid Inquiry

Tuesday, January 15, 2008

Mortgage Broker Spam

by Tanta on 1/15/2008 11:34:00 AM

This showed up in my email yesterday:

Is your current mortgage turning out to be too good to be true? Financing your current mortgage into an FHA loan can help save your home. New legislation will allow homeowners in danger of foreclosure to refinance into a low, fixed rate FHA mortgage. To learn more about this new program, give me a call today.

Respectfully,
Toby Spangler
TJS Financial LLC
407-733-8962
www.homestarfla.com
So what? So this was the subject line of the email:
Skip your mortgage payment for 3 months
I hereby invite any reader of Calculated Risk, including of course any of you who happen to work for HUD and have enforcement authority, to correspond with Mr. Spangler and explain to him the meaning of the following:
The FHASecure initiative for refinancing borrowers harmed by non-FHA ARMs that have recently reset is not to be used to solicit homeowners to cease making timely mortgage payments; FHA reserves the right to reject for insurance those mortgage applications where it appears that a loan officer or other mortgagee employee suggested that the homeowners could stop making their payments, refinance into a FHA insured mortgage, and keep, as cash, the amount of payments not made on time.
I would of course be happy to forward the original message to anyone with a .gov email address; just drop me a line.

If you, a Calculated Risk reader, do not feel particularly motivated to correspond with Mr. Spangler, perhaps you could give some thought to corresponding with your members of Congress on the subject of "modernizing" FHA to allow more "streamlined" participation by mortgage brokers.

If you happen to be an idiot mortgage broker cruising sites like this one to find email addresses to add your sleazy spam lists, why go right ahead. Add me to your list. I'm here to help you get the recognition you deserve.

Thursday, January 03, 2008

Foreclosure Fraud

by Tanta on 1/03/2008 01:00:00 PM

As a public service and because I like the very end of this, here is Freddie Mac's new anti-foreclosure scam video:





To summarize: if you're in the situation you're in with an unaffordable mortgage because some fast-talking guy in a suit asked you to sign a bunch of papers you didn't understand, you are not going to be in a better situation because some other fast-talking guy in a suit asked you to sign a bunch more papers you don't understand.

Thursday, November 29, 2007

Fitch Opens Loan Files: Results Not Pretty

by Tanta on 11/29/2007 09:53:00 AM

Regular readers of this site will remember more or less constant outbursts of complaining about the lack of full-file due diligence in the securitization process. People look at data tapes and write contract warranties; people don't actually open up loan files and assess the accuracy of those data tapes, let alone go beyond the tape elements (quantifiable information like LTV and DTI and FICO) to qualitative aspects and conformity with "soft guidelines" (the rules of processing or evaluating documents or information that generates the quantities).

Well, glory be. Some analysts at Fitch rolled up their sleeves and sat down with a pile of loan files (45 of them, to be precise). What they discovered are the parameters of the the most innovative product the industry has ever offered, the NUNA (No Underwriting, No Accountability).

While we realize this was a very limited sample, Fitch believes that the findings are indicative of the types and magnitude of issues, such as poor underwriting and fraud, which are prevalent in the high delinquencies of recent subprime vintages. In addition, although the sample was adversely selected based on payment patterns and high risk factors, the files indicated that fraud was not only present, but, in most cases, could have been identified with adequate underwriting, quality control and fraud prevention tools prior to the loan funding.
I suggest reading the whole thing, if you've got a few minutes to blow on mortgage credit risk assessment arcana. What is happening here, although Fitch doesn't state it in these terms, is that someone went through a pile of loan files that were originally processed and underwritten in the "innovative" (cheap) way, and subjected them to processing and underwriting in the traditional (less cheap) way. As far as I can tell, the results here did not come from "extraordinary" levels of investigation or even much in the way of hindsight data (that is, by working back from events that took place after the loan was closed).

What this little exercise of Fitch's shows is that doing things like working through a credit report, looking carefully at the ownership of accounts (sole, joint, authorized user) and the relationship of tradelines to the information listed on the application (matching mortgage tradelines to real estate owned and matching general debt usage and spending patterns to income claimed) provides you with vital information that leads you to reject a mere FICO score as either a sole determinant of credit quality or as a "magic offset" that can let you ignore other weaknesses in the deal. No, really. All that is what we used to do before we started relying on FICOs and AUS.

But don't think this is just an anti-technology rant: 22% of the files Fitch looked at had a "HAWK Alert" right there on the original credit report, visible to anyone who reads English. What's that? It's a warning message that the credit repositories print on a report when some combination of facts or transactions trigger one of its potential fraud algorithms. It does not prove fraud, but it is designed to make your average human underwriter sit up straight and start poring over documents at a much greater level of detail and skepticism than might be usual.

Computers are great for this kind of thing: they help you put your work into "buckets" right off the bat. Any loan with a HAWK Alert should be immediately routed out of the "automation" pipeline and onto the desk of a senior underwriter. The technology helps you direct your human expertise where it really pays off.

Yeah, right, except that as Fitch notes, there is no indication in any of these files that anyone even noticed the HAWK Alert. And the problems that caused that Alert were, apparently, quite visible in the original file documents, if you looked past the FICO score to the details of the tradelines or the relationship of the tradelines to the loan application. (Loan app says borrower is a first-time homebuyer, credit report says there are existing mortgage tradelines. Duh.)

And of course the ridiculousness of the whole stated income thing is here on display, but Fitch never quite gets to asking the question raised by it all: if stated income is such high risk that you need to develop all sorts of processes and practices for testing it, contextualizing it, and subjecting the rest of the file to a fine-toothed review to compensate for it, what, exactly, is the benefit, in cost and speed, of doing it in the first place? At some level Fitch's analysis reads like a medical school textbook on using expensive fifth-generation antibiotics to treat staph infections caused by failure of doctors and nurses to wash their hands between patients. It's nice to know that can be treated, but it would be even nicer--not to mention cheaper--if hand-washing became more popular in the first place.

The fact is that many mortgage shops did, actually, put all kinds of practices and processes and "risk management control points" in place over the last several years to compensate for the risk created by their reliance on AUS, stated income, FICO scores, AVMs, and so on. For a lot of these shops, all that compensating was at least as expensive as just doing it the old way from the beginning. Certainly it remains to be demonstrated what kind of originator the files Fitch found came from: newbies who never learned the old ways and hence never saw the risk? Thinly-capitalized budget operations who just couldn't afford to produce anything except NUNA loans? Cynical players who knew the stuff was junk but who also knew that neither the security issuers nor the rating agencies would notice, and who also knew that the game of representations and warranties, properly played, would insulate them from having to take it back?

The whole thing really begins to take on an amazing Rube Goldberg quality once you refuse to accept the beginning premise--that these "innovative" ways of underwriting loans are a given, it's the compensation mechanisms that are the question. You do not have to believe that traditional human underwriting is perfect to wonder whether the cure is worse than the disease when it comes to compensating for automation.

(Hat tip to some awesomely cool dood)

Thursday, November 15, 2007

GM Watch: The Flap Continues

by Tanta on 11/15/2007 08:24:00 AM

So there was a pretty breathlessly hyped story on a blog about how the dismissal of a foreclosure filing meant that the entire MBS market is more or less toast. Then there was a tedious attempt by Tanta to sort through it and figure out what the real issue was and perhaps cool down some of the rhetoric. You know what had to happen next. Gretchen Morgenson got ahold of it.

Do read the whole piece. Perhaps I have gone temporarily blind, and there is somewhere in this article an acknowledgement that this story was "broken" on a blog. (Not mine, by the way: I Am Facing Foreclosure.com "broke" the story. I ignored it as long as I thought I could.) Query: is this where GM has been getting a lot of story juice lately? Could that be why some of her recent reporting, especially on Countrywide, is such a noxious mixture of fact and hype, information and innuendo?

All I know about journalistic practice tells me that if this story had originally been reported in the Podunk Inquirer, GM would have credited the ol' PI in her story. But you can fish in the blogs, it appears, without having to admit it. And without identifying the blog-source of your stories, you avoid having to confront the evaluation problem. There are great blogs and terrible blogs out there. There is carefully gleaned and analyzed information, and there is rumor, garbled gossip, and speculation masquerading as fact. There are people whose agenda and biases are perfectly clearly spelled out, and there are those who are talkin' a book or just shilling. If you want to seine the blogs for NYT material, you have to deal with this problem for yourself and for your readers. Identifying your sources is not simply professional courtesy, it's the beginning of the process of evaluating the source. Yes, I am not a professional reporter and this is a blog and I am lecturing the NYT on Journalism 101. I'm afraid to open the fridge to get milk in case there's a trout in there.

I said most of what I want to say about the issue yesterday. Let me just pause over this one tidbit in GM's article this morning:

When a loan goes into a securitization, the mortgage note is not sent to the trust. Instead it shows up as a data transfer with the physical note being kept at a separate document repository company. Such practices keep the process fast and cheap.
I rail endlessly about mortgage industry practices that are "fast and cheap" and that sacrifice risk management. You all have never heard me complaining about the practice of third-party document custody because it is one of the very few old-fashioned slow expensive risk management processes that the New Paradigm people have not yet managed to do away with. Document custodians are the Nerdiest Nerds there are, and their nerditude is in so many cases the only thing separating the current secondary market from a Wild West clown show. They are the thin red-tape line between us and chaos. I have never met anyone having anything to do with mortgage loans who has not at least once indulged in a major bitch-fest about dealing with some Iron-Fisted Custodian who won't just certify pools or mail notes around or change reports because some punk says to. They want appropriately-signed authorizations. They want Trust Receipts. They want originals, not copies; they want letters, not phone calls. They are, personally and institutionally, the kind of people who count the teaspoons after the dinner party guests leave.

And it costs money to use document custodians, who are, if you want to know, required to be financial institutions with a trust department that has direct authorization from its regulator to offer trust services. That does not make them perfect, but to call them "document repository companies" may give you all the impression that we're dealing with some fly-by-night Docs R Us outfit. I don't have exact numbers handy, but I would guess off the top of my head that after Fannie and Freddie, who are the custodians of most but not all of their own notes and mortgages, the single largest concentration of custody docs in this country is probably Wells Fargo. (I invite correction if I'm wrong about that.) Like anyone else who has ever certified pools, I've visited Wells's custodial operations center. I don't remember having to take my shoes off and put them in a basket before they let me in, but then again it was several years ago. At the time, Well's security was better than most airports'.

It has to be. Not only do they hold the documents collateralizing trillions of dollars of debt that belongs to someone else, but they do, in fact, hold those notes I was talking about yesterday that are endorsed in blank. Such a thing is rather more secure than a simple bearer bond, but not by much.

In the case of the DB foreclosure suit dismissal we looked at yesterday, there should have been a set of original notes and original recordable-form (but possibly not actually recorded) assignments of mortgage in the physical custody of a document custodian when DB went to file its FC action. It should therefore have been a matter of DB requesting the pertinent docs from the custodian, who would send them to DB's legal people in order to prepare the filing. Either this did not happen, or the custodian lost the docs, or DB lost the docs, or the docs were never there in the first place. If that last part is true, I want to know how a custodian certified those pools at issuance. If the custodian certified the pools on condition that some missing assignments get turned in later, then when and how did the custodian follow up on that? This is Deal, Big.

It is, mind you, possible that DB is acting as its own custodian. It's a bank, it has a trust department, it qualifies as a custodian. And if DB is acting as its own custodian, and certifying pools without having its hot little hands on the docs first, or it is misplacing those docs it had when it certified the pool to start with, then that, my friends, is a Story. It is a story that Deutsche Bank's regulators might be really really interested in. I know I am.

But this story will not get written by anyone who misunderstands what custodians are, how much they cost (real fee dollars), and how they are supposed to act like the Gatekeepers and SuperNerds of the whole process. In other words, they are supposed to be a check against "fast and cheap," not part of "fast and cheap."

Wednesday, November 14, 2007

In Re Foreclosure Cases

by Tanta on 11/14/2007 12:00:00 PM

First of all, thanks to Anne and NYT Junkie and Lyndal who immediately sent me the Opinion and Order. You guys rock.

Second of all, sorry that it took a while to get this updated post written. I'm still convulsing in helpless laughter over one of the footnotes. If you don't know how to have a good time over footnotes to a court order, I can't help you. If you do, you'll love this.

If you don't know what this is about, read this post from earlier today first.

Here's what Judge Boyko (my new personal Snark Hero) had to say on October 31, 2007 regarding some Deutsche Bank FC filings:

On October 10, 2007, this Court issued an Order requiring Plaintiff-Lenders in a number of pending foreclosure cases to file a copy of the executed Assignment demonstrating Plaintiff was the holder and owner of the Note and Mortgage as of the date the Complaint was filed, or the Court would enter a dismissal. After considering the submissions, along with all the documents filed of record, the Court dismisses the captioned cases without prejudice.
Yes, the bold italic underscoring is in the original. This means that the judge wanted Deutsche Bank to show it had standing to foreclose on the day the foreclosure suit was initiated, which seems reasonable. Further, this suit was dismissed "without prejudice," meaning that DB can refile if and when it gets its ducks in a row. So right off the bat, we are not dealing with a case in which there is no hope of this foreclosure ever getting completed.

So what happened here?
In each of the above-captioned Complaints, the named Plaintiff alleges it is the holder and owner of the Note and Mortgage. However, the attached Note and Mortgage identify the mortgagee and promisee as the original lending institution — one other than the named Plaintiff. Further, the Preliminary Judicial Report attached as an exhibit to the Complaint makes no reference to the named Plaintiff in the recorded chain of title/interest. The Court’s Amended General Order No. 2006-16 requires Plaintiff to submit an affidavit along with the Complaint, which identifies Plaintiff either as the original mortgage holder, or as an assignee, trustee or successor-in interest. Once again, the affidavits submitted in all these cases recite the averment that Plaintiff is the owner of the Note and Mortgage, without any mention of an assignment or trust or successor interest. Consequently, the very filings and submissions of the Plaintiff create a conflict. In every instance, then, Plaintiff has not satisfied its burden of demonstrating standing at the time of the filing of the Complaint.

Understandably, the Court requested clarification by requiring each Plaintiff to submit a copy of the Assignment of the Note and Mortgage, executed as of the date of the Foreclosure Complaint. In the above-captioned cases, none of the Assignments show the named Plaintiff to be the owner of the rights, title and interest under the Mortgage at issue as of the date of the Foreclosure Complaint. The Assignments, in every instance, express a present intent to convey all rights, title and interest in the Mortgage and the accompanying Note to the Plaintiff named in the caption of the Foreclosure Complaint upon receipt of sufficient consideration on the date the Assignment was signed and notarized. Further, the Assignment documents are all prepared by counsel for the named Plaintiffs. These proffered documents belie Plaintiffs’ assertion they own the Note and Mortgage by means of a purchase which pre-dated the Complaint by days, months or years. . . .

Despite Plaintiffs’ counsel’s belief that “there appears to be some level of disagreement and/or misunderstanding amongst professionals, borrowers, attorneys and members of the judiciary,” the Court does not require instruction and is not operating under any misapprehension. The “real party in interest” rule, to which the Plaintiff-Lenders continually refer in their responses or motions, is clearly comprehended by the Court and is not intended to assist banks in avoiding traditional federal diversity requirements.2 Unlike Ohio State law and procedure, as Plaintiffs perceive it, the federal judicial system need not, and will not, be “forgiving in this regard.”3
Okay, before we get to footnote three, here's the plain English version: DB was ordered to produce evidence of standing, but the copies of notes and mortgages it included with its filings don't show ultimate endorsement/assignment to DB. Judge ordered DB to fix this. DB did so by having its attorneys draft after-the-fact assignments, undoubtedly because nobody could find the original assignments. This pissed Judge Boyko off, and rightly so. From His Honor's response to the oral arguments, one has the impression that somebody from DB said, basically, "hey! The dog ate our homework!" There was never really any question that the loans weren't legally sold or assigned to DB; there seems to be a question about the arrogance and audacity of a lender telling a judge to ignore its sloppy paperwork and just get on with a foreclosure.

So here's footnote three:
3 Plaintiff’s, “Judge, you just don’t understand how things work,” argument reveals a condescending mindset and quasi-monopolistic system where financial institutions have traditionally controlled, and still control, the foreclosure process. Typically, the homeowner who finds himself/herself in financial straits, fails to make the required mortgage payments and faces a foreclosure suit, is not interested in testing state or federal jurisdictional requirements, either pro se or through counsel. Their focus is either, “how do I save my home,” or “if I have to give it up, I’ll simply leave and find somewhere else to live.”

In the meantime, the financial institutions or successors/assignees rush to foreclose, obtain a default judgment and then sit on the deed, avoiding responsibility for maintaining the property while reaping the financial benefits of interest running on a judgment. The financial institutions know the law charges the one with title (still the homeowner) with maintaining the property.

There is no doubt every decision made by a financial institution in the foreclosure process is driven by money. And the legal work which flows from winning the financial institution’s favor is highly lucrative. There is nothing improper or wrong with financial institutions or law firms making a profit — to the contrary , they should be rewarded for sound business and legal practices. However, unchallenged by underfinanced opponents, the institutions worry less about jurisdictional requirements and more about maximizing returns. Unlike the focus of financial institutions, the federal courts must act as gatekeepers, assuring that only those who meet diversity and standing requirements are allowed to pass through.

Counsel for the institutions are not without legal argument to support their position, but their arguments fall woefully short of justifying their premature filings, and utterly fail to satisfy their standing and jurisdictional burdens. The institutions seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance. Finally put to the test, their weak legal arguments compel the Court to stop them at the gate.

The Court will illustrate in simple terms its decision: “Fluidity of the market” — “X” dollars, “contractual arrangements between institutions and counsel” — “X” dollars, “purchasing mortgages in bulk and securitizing” — “X” dollars, “rush to file, slow to record after judgment” — “X” dollars, “the jurisdictional integrity of United States District Court” —“Priceless.”
I say, Judge Boyko For President! I couldn't be any snarkier than that if you gave me a two-week head start.

To summarize: there were dollars on the table encouraging secondary market participants to get real sloppy. Judge Boyko is making them pay now for what they didn't pay then. So the big news here is not that securitized loans cannot be foreclosed. The big news here is that the true cost of doing business is belatedly showing up. I happen to think that's a more important story than was originally reported.

Deutsche Bank FC Problems and Revenge of the Nerd

by Tanta on 11/14/2007 09:30:00 AM

I have been asked literally dozens of times in comments of this blog, in emails, and even in posts on other blogs, to comment on this post on I am Facing Foreclosure.Com regarding the dismissal of a foreclosure suit filed by Deutsche Bank. I will tell you right now that it's just too hard to know where to begin: that blog post is so badly written that I don't even know exactly what facts are being alleged to be in evidence. Sorry, but these folks let their outrage run ahead of their reportage, and the result is chaos. So I'm not going to opine on the subject of whether this is an "important" court ruling unless and until one of our kind readers with PACER access emails me a copy of the Order in question. If someone does that, I promise I will make every possible effort to understand it and report back to you all.

Until then, I intend to amuse you (or perhaps just myself) with a story. The first point of this little exercise is to convince you that sometimes things happen because somebody screwed up a bit of paperwork; it is not always a case of things happening because of Organized Predatory Conspiracy to Defraud mortgagors. The second point is to indulge myself in a few minutes of childish vindication of my years spent as Detail Obssessed Literal-Minded Small Picture Pain in the Ass Who Doesn't Play Ball. To everyone who has ever jumped my personal case in the last 20 years about my habit of making a big deal over "technicalities," I have a message to send. Via Deutsche Bank's foreclosure department.

Several years ago I represented a large bank in the process of securitizing a big chunk of its seasoned portfolio loans. Among other things that meant I reviewed several thousand notes. Now, when a loan changes hands, this is effected on the note by an endorsement. It's very much like a check endorsement: you slap a stamp on the back of the note that says "pay to the order of [endorsee] without recourse [endorsor] by [person] its [officer title]," under which is "signature." Each subsequent time a loan changes hands, a new endorsement is made from the prior endorsee to the new endorsee. When loans are securitized, the last endorsement is often "in blank," meaning that the new endorsee is not named. The entire original note goes into the physical custody of the new endorsee or its legal custodian with that blank endorsement, that can be subsequently completed if necessary by the security sponsor. This is a very common and uncontroversial practice.

So I had a couple thousand notes to look at, and about a third of them had an endorsement chain that looked like this: first endorsement from Bank of the County, the original lender, to Bank of the State. Second endorsement from Bank of the State to Bank of the Region. Third endorsement from Bank of the Country to Bank of the Nation. My job was supposed to be to endorse these things on my client's behalf (from Bank of the Nation to blank).

Well, there's a big problem. There was no endorsement from Bank of the Region to Bank of the Country. (The same problem occurred with the chain of assignments of the mortgage.) With a missing link in the chain, there are grounds to question the current owner's rights to endorse this note over to someone else.

Aha! You say. That Tanta: she single-handedly brought down a major banking fraud ring! She blew the whistle on a big name bank who tried to pass off millions of dollars worth of someone else's loans as its own, for ill-gotten gains! How exciting! Will Julia Roberts play Tanta in the movie version?

Hardly. As a matter of fact I knew perfectly well, as did everyone else involved, that Bank of the Country had merged with Bank of the Region, and was legally its successor in interest to these mortgage loans. That wasn't a secret; it had been in the newspapers. The problem was that some dweeb had failed to write the endorsement correctly (it should have been Bank of the Country, successor in interest to Bank of the Region, to Bank of the Nation. Or perhaps someone should have used one of Bank of the Region's old stamps to endorse the note from Region to Country on the same day that it endorsed it from Country to Nation).

There are ways you can fix stuff like that. In this particular case, it ended up involving getting my hands on copies of board resolutions (with an original seal, thank you) showing the successorship, plus a copy of another board resolution (and another original seal!) showing that the officer of Country was also an officer of Region, plus an original board resolution (and seal) giving one Tanta a power of attorney that allowed her legally to void an incorrect endorsement and execute a new one on original notes that didn't actually belong to Tanta. All this had to be done in less than 48 hours, because somebody had already made a commitment to settle tens of millions of dollars and there were some Extremely Unhappy People on both sides of that trade who really really wished that this Tanta person punk had just ignored this problem and certified the pool. One vice president of my client who had had to drag the secretary of the board off the golf course on a sunny Saturday afternoon was good enough to tell me just exactly how unlikely I was to ever get work in this town again.

If I recall correctly the whole episode, which included flying Tanta half-way across the country on a few hours' notice to visit the vault where these original notes were kept, cost the seller about $20,000. It would have cost somebody about $20 to have had a new endorsement stamp made after the merger that included the "successor in interest" verbiage. Throughout the whole thing, Tanta kept explaining that one can spend a whole lot more than $20,000 if one of these puppies goes to foreclosure and some sharp-eyed attorney notices a bad endorsement/assignment chain.

The seller didn't want to spend that money, but the seller's counsel told its executives that once this problem had been brought to the notice of the buyer of the loans, which it had, there was no real choice. After all the dust settled, Tanta managed to re-establish a decent relationship with her client, and so it ended well enough.

However, Tanta knows plenty of people in this business for whom it did not end well. Plenty of insitutions who won't pay the $20,000 to fix their own error because "it's just a technicality," which of course it is. Just a technicality. Tell it to Deutsche Bank.

Allow me to drive home the point, please: before everyone gets all fired up about OMG! Securitized loans can't be foreclosed! Fraud!, please back up a few steps. As I said, I don't have a copy of the court documents, and I'm not going to rely on an amateur paraphrase thereof to make claims about what, specifically, happened in the DB case. But all my years of experience tell me that somebody somewhere used a bad endorsement stamp, pulled the wrong boilerplate verbiage for an affidavit, recorded a lis pendens and an assignment of mortgage in the wrong order, failed to provide a schedule attachment to a blanket assignment showing which loans were covered by it, or something like that. Or perhaps there was a copy board resolution without an original seal, if you can imagine such nefariousness. These kinds of screwups go on all the time in this business.

On the one hand, mistakes just do get made, in any business. On the other hand, the mortgage industry's back room got incredibly sloppy during the boom. You had experienced closing and post-closing staff laid off and replaced by temps who don't know an endorsement from a box of Wheaties, you had loans being sold by brand-new entrants into the business with no experience in these legal transactions, you had gigantic pressures to move loans through the pipeline into a security as fast as possible and paperwork be damned, you had a business too comfortable working on reps and warranties and indemnifications--on a promise to make it good if it ever blows up rather than fixing it now. You had regulators of big depositories that were sound asleep when it came to such operational "trivia."

And this kind of thing with Deutsche Bank and the foreclosure mess is the result. And when Wall Street analysts stand up and demand that companies beef up back rooms, pay veteran employees rather than outsourcing, and slow the hell down so that things are done right the first time, I'll eat every promissory note I've ever endorsed. For every little Tanta with her hands on her hips demanding competent but expensive operations, there's some Chainsaw Al out there "streamlining" the company.

So here's my message to my fellow bloggers: sensationalist stories about LEGAL HANKY PANKY are fun to write and get you a lot of attention. No doubt you have frightened (or pleased) a whole bunch of people with the idea that foreclosures will all grind to a halt nationwide because one fouled-up filing by one Master Servicer of one security in one state means that "They Own Nothing!" Of course they own plenty, and they'll end up establishing it. It might cost them an additional $20,000 or so, but that's the punishment meted out to cost-cutters.

The difficult story to write is the one about how this happens, and what it really means, and who are the hidden victims (all those laid-off employees or non-working consultants whose bad news isn't welcome, plus some shareholders) and hidden villains (like everyone who applauded every time some big bank announced more operational cutting and expertise-dumping). Even if you don't want to write that story, I'd suggest not hyping a story with a hysterical headline based on one email from one interested party. As far as I can tell, the writers of that blog post never even saw the court order itself; the entire post seems to be based on the hyperbolic burbling of a lawyer whose job is to delay foreclosure filings.

I have no particular beef with lawyers who represent homeowners in a foreclosure trying every trick in the book, including exploiting the lender's paperwork errors, in an attempt to stave off the foreclosure or force the lender to work out the loan. That's how the court system works, and frankly, when lenders know this can happen to them, they get smarter about doing their homework correctly.

I do, however, have some problem with lawyers who take their own smoke-blowing tactics too seriously. It's one thing to get a case dismissed because the plaintiff's affidavit is in error; why shouldn't you do that if it's in your client's best interest? It's another thing entirely to smoke your own dope and call this "rampant foreclosure fraud," and for a blogger to claim that this will single-handedly bring down the securitization market. That's fighting bongwater with bongwater. I did a quick Google search this morning to look for any follow-ups to this post, and found the following: "It appears that the holders of CDO's do not have legal title to the properties that have been defaulted on, so they cannot foreclose, so they get a big fat NOTHING." That this is not about CDOs, not about title to real estate, and not about anyone getting NOTHING isn't stopping the internet-chain of conclusion-leaping that make my client's endorsement-chain problems look like a careful business practice. Now a bunch of vocal people "know" something that they do in fact not know. And people like me will be trying to swat this fly forever in the interest of having a useful conversation.

As I said, I might be wrong about the specifics of the DB case, because I haven't seen the actual court order. If someone sends me a copy and it turns out that I'm wrong and this is a Big Deal instead of a Little Deal, I'll be the first to post a mea culpa. Until then I will ask everyone to develop the habit of reading past the hype and evaluating the credibility of a source. Me included.

Tuesday, November 13, 2007

Hot Potato

by Tanta on 11/13/2007 11:55:00 AM

From Triad's 10-K (thanks, Clyde):

On November 5, 2007, American Home Mortgage Investment Corp. and American Home Mortgage Servicing, Inc. filed a complaint against Triad Guaranty Insurance Corp. in the U.S. Bankruptcy Court for the District of Delaware. The plaintiffs are debtors and debtors in possession in Chapter 11 cases pending in the U.S. Bankruptcy Court. The lawsuit is an action for breach of contract and declaratory judgment. The basis for the complaint’s breach of contract action is the cancellation by us of our certification of American Home Mortgage’s coverage on 14 loans due to irregularities that we allegedly uncovered following the submission of claims for payment and that existed when American Home Mortgage originated the loans. The complaint alleges that our actions caused American Home Mortgage to suffer a combined net loss of not less than $1,132,105.51 and seeks monetary damages and a declaratory judgment. We expect to rescind additional loans originated by American Home Mortgage and we intend to contest the lawsuit vigorously.
Something to keep in mind: these days a lot of mortgage insurance works on the same "representation and warranty" business that everything else in mortgage-land does. The insurer does not necessarily or even usually underwrite the loan file itself prior to issuing a certificate; it "delegates" this to the lender. However, that means that the insurer can refuse to pay if it believes that the lender knew or should have known that the loan did not meet the insurer's requirements. The insurer generally doesn't find this out unless 1) the file is subject to routine QC audit or 2) the worst happens and a claim is filed.

So it's another episode of Finding Out Later, and the MIs don't want to hold the bag for it.

Saturday, November 10, 2007

What's Wrong With Approved Appraiser Lists

by Tanta on 11/10/2007 02:11:00 PM

My recent posts on WaMu’s Very Bad No Good Rotten Day involving inflated appraisals have drawn a lot of questions. One question I keep getting is a variant of “What’s so wrong with the alleged conduct anyway? Why is it such a big deal for WaMu to insist on a list of approved appraisers? Isn’t that just good risk management on WaMu’s part?”

Possibly it is just good risk management on WaMu’s part: an indictment is, after all, an allegation of misconduct, not a verdict. However, what WaMu is alleged to have done is itself the kind of conduct that is an automatic “red flag” for anyone who knows anything about how the appraisal management business works. Since most of you are fortunate enough to be entirely innocent of that, I thought I’d go through some issues here.

First off, I’m talking about how the business works, not about how the principles of appraiser independence are derived by the Appraisal Foundation or why they matter so much. I’m taking as a given that we accept the axiom that when an appraiser’s compensation is based on his or her willingness to come up with the answer an interested party wants, instead of the answer he or she thinks the facts of the subject property, the transaction requested, and the local real estate market warrant, an appraisal is nothing more than a ratification of the loan amount someone has already decided on, and that “someone” isn’t the ultimate bagholder. The real bagholder wants to know whether it is lending too much or risking owning an unsalable piece of REO. That an individual loan officer or broker just wants to know how high we can make the loan amount—and thus a commission—is an artifact of a business structure in which a lender’s own employees or agents are not aligned with its own corporate best interests. At some level the appraisal problem will never get solved until the compensation of loan processing employees and intermediaries gets solved, but that’s not today’s argument.

In the olden days of local lenders, you had either staff appraisers or “fee appraisers.” You could actually have appraisers on your payroll because you lent in a defined local area: you didn’t have to worry about needing an appraisal for a property six states away that your staff appraisers couldn’t get to, even if they were licensed in that state. If you relied on fee appraisers, possibly because it was too expensive to keep appraisers on the payroll during down-cycles in RE, you still worked in a local market, you got to know all of them, and you could order appraisals from people whose work was familiar. If you were smart, you worked with the best appraisers there were. If you were stupid, you channeled business to your golf buddies. A number of S&Ls did the latter, and they did not live happily ever after. We have this thing called FIRREA, which brought into being USPAP, in large part because of that second option.

Once local lenders became regional lenders and then national lenders, the distance between corporate headquarters, the Appraisal Department, and the actual properties and markets grew to the point that having staff appraisers was impractical and hiring fee appraisers was a crap-shoot. You can pick up the Yellow Pages to find an appraiser in a market you just entered, but this means you will learn by doing in terms of quality. That goes double if you entered this market via wholesale lending: you now have a broker you don’t know much about hiring an appraiser you don’t know anything about in an RE market you’ve never done business in before.

The early years of national wholesale lending supplied lots of excitement, as Podunk National Bank changed its name to Ubiquitous, Inc. and charged into market areas about which it knew nothing, on the assumption that, say, Miami is just like Podunk except the loan amounts are bigger. Sometimes this was actually retail lending: Ubiquitous, Inc. started buying up branches in all these new and exciting markets, with the plan of managing them long-distance from corporate headquarters. Often those branches (complete with their employees) could be acquired for amazingly cheap sums of money. The Lender Formerly Known As Podunk often didn’t ask itself why the current owner of that branch wanted out so badly, but that’s hardly a problem unique to mortgage lending or banking.

Eventually, everyone had to deal with the hard knocks. You might be able to justify taking risks on the unknown when you move into a new market, but you still have to do something about the problems that crop up. Everyone got at least some really bad appraisals from the Yellow Pages approach, and had to start making some lists. I really think that a major problem lurking in the industry happened right here, when wholesalers and correspondent lenders made a decision about what kind of list to make. Do you make an “Approved Appraiser” list of the ones you haven’t had problems with, or do you make an “Excluded Appraiser” list of the ones you have had problems with?

There is no question that logically, the most efficient thing to do is make the exclusion list. Even if you believe that there are more than just a few bad apples, you don’t get into the national mortgage lending business if you believe that bad appraisers outnumber good appraisers by a wide margin. Exclusionary lists are just shorter and easier to administrate.

If you’re still a retail lender (just a long-distance one), you can keep the shorter exclusionary list internal to your own organization. The major disadvantage of exclusionary lists developed for the wholesale and correspondent lenders, and for any lender in the “originate and sell” rather than “originate and hold” business. If you are contracting with brokers, correspondent lenders, third-party investors and servicers and other folks who need to conduct due diligence on your loans, you end up having to make your list available to all those parties. It becomes nearly impossible to keep it confidential.

And that started the defamation fear. Too many lenders faced real or imagined threats of lawsuits from appraisers who did not want their names appearing on what had basically become a public hall of shame list. (I hasten to add that these things were not “public” to you, the consumer. They were an open secret to everyone in the business except the consumer.) So even though an approved appraiser list was a much more expensive, time-consuming, cumbersome way to get there, more and more big operations started keeping one. (Why not go to the regulators and beg for a "safe harbor" against defamation liability for exclusion lists? Because lenders are almost never long-sighted enough to ask for regulation that benefits them. They're too afraid that it always comes with the wrong strings attached. Then after the criminal probes and class actions and general shirt-losing, we look back wistfully on those strings we were so afraid of, wondering why we didn't snap that deal right up.)

The alternative to exclusionary lists opened up the problem of what it means to be “approved.” The handy thing about the exclusionary list was that its criteria were easier to understand: anyone on that list gave me at least one bogus appraisal, or a series of very weak appraisals, or did some other bad thing like turning in all assignments late and never answering the phone. The lender would have documentation of this, since that’s where the exclusionary lists came from: a review of the lender’s internal notes and logs and quality control reports and so on. The approved appraiser list, however, didn’t just include appraisers whose work you really liked; it included appraisers whom you hadn’t yet caught red-handed, at least in theory. Many people became a bit queasy about the potential liability of appearing to put the Good Housekeeping Seal of Approval on a bunch of appraisers when the actual purpose of the list was just to indicate ones that could still be hired by the branches or brokers because we don’t know any reason why not yet.

Furthermore, these lists were (and are) huge work projects. It’s not just that a national lender has thousands and thousands of appraisers to deal with. It’s that if you’re any kind of conscientious about risks, you don’t limit your internal appraiser management functions to sitting around waiting for your QC department to find an obviously bogus one. You get a giant database going of all your appraisals, including the appraiser’s name and license number and a bunch of other facts, and you manipulate that information looking for patterns. A lot of lenders actually started stratifying the approved appraiser list: there was the A-team, whose appraisals got normal review, and the B-team, whose work could be ordered by a branch, but which had to undergo an extra layer of review or an AVM backup or something. The results of that had to be fed back into the model to see if anybody qualified for upgrade or downgrade. Plus you had to have a “probationary” list or some way of dealing with a new appraiser you’d never done business with before. Plus somebody had to monitor state licensing boards and other sources to pick up on appraisers with invalid or expired licenses or insufficient certification to handle large jumbo loans and so on.

Even worse, every big national lender was doing the same tedious expensive administrative work independently. This is why companies like eAppraiseIT exist. It didn’t take all that long for the lenders to figure out that this work could be outsourced, and for some enterprising party to offer to do it. Besides offloading the liability onto the vendor, the big lenders offloaded a whole bunch of those back-office corporate mouths to feed in the appraisal analysis department.

So fast forward to the specific allegations about WaMu and eAppraiseIT. It is utterly normal in the current environment for a big national wholesaler/correspondent buyer like WaMu to outsource appraisal administration. It is not usual for a lender to pay a vendor to make up a list of approved appraisers, and then for that company to continue to make its own list, and to demand that the vendor use the lender’s list. The whole idea is getting out from under having to make and maintain these lists, not to pay someone to do something and then incur all the expenses of doing it yourself at the same time. This would be a bug, not a feature.

I am theorizing that this is one reason why what WaMu wanted struck at least one manager at eAppraiseIT as out of line. It doesn’t have to involve any evidence anywhere that any individual appraisal is bad: you have to wonder what’s in it for WaMu to do business this way. From the facts alleged in the indictment, it sounds like eAppraiseIT asked why this was happening, and WaMu admitted that it was happening because WaMu wanted to make sure that one criterion for the “real” approved appraiser list was “the ones who hit the numbers we like,” not the ones eAppraiseIT’s database shows are not subject to documented lender or licensing board complaints.

You have to be aware that eAppraiseIT and its competitors do not base their management of individual appraisers on just one lender’s experience: that’s the beauty of the service they offer. To an individual lender, the sales pitch is something like this: why should you make the same mistakes Ubiquitous, Inc. has already made? With a third-party vendor, you get the benefit of the collective experience of every client. No appraisal management vendor expects a client to pipe up and say we want an “approved panel” that includes appraisers we know will wag their tails, roll over, and show us their bellies when one of our loan officers or correspondents or brokers asks for a certain value. Or if they do, they expect some circumspection about it. I don’t know if WaMu’s request was unusual because of its nature or because of its brazenness, but it seems to have struck someone at eAppraiseIT as a downright regulatory violation. Given the amount of interpretation and so on of a lot of regulations, many practices can be considered kinda squirrelly but allowable. It’s not that common for an outfit like eAppraiseIT to baldly assert that what’s going on is a clear violation of FIRREA.

That’s actually why I find those emails quoted in the indictment to be so explosive. I have spent a lot of years learning to decipher coded language about regulatory-not-exactly-improprieties-but-perhaps-areas-of-concern and other corporate-speak ways of putting it that I’m utterly blown away by the unvarnished language being used here. You just don’t accuse a major account like WaMu of out-and-out violation of safety and soundness regulation unless the conduct is egregious in the extreme, or you think it is clear that you are being lined up for bagholder duty, or both. It sure sounds to me like WaMu wanted to tell eAppraiseIT what to do, while having eAppraiseIT do the scut work plus the small matter of making all the relevant warranties in the utterly certain event it backfired. Mortgage market participants can be so amazingly short-sighted sometimes it’s hard to believe, but somebody at eAppraiseIT seems to have figured out who the sucker at the table was. No doubt they wouldn’t be on the receiving end of a civil suit from Mr. Cuomo if someone higher-up had listened to whatever internal employee called bull on this one.

Why didn’t they listen? Why doesn’t any corporation ever listen? Because the WaMu account is huge, and nobody wants to stop a gravy train. The indictment also includes snippets of emails suggesting that WaMu dangled other business relationships outside the appraisal management function in front of First American if it rolled over. Which is more or less exactly what lenders to do appraisers all the time: offer repeat business if they play ball, or being kicked off the team if they don’t.

I don’t want to sound too terribly nostalgic for the old days. Was it impossible to manipulate a staff appraiser? Of course not. They worked for you. You could saunter down the hall to their cubicles and make their lives a living hell in a very direct and personal way. As long as you didn’t think of yourself as the bagholder. And staff appraisers would roll over because you do that for the party paying your health insurance premiums. Especially when you believe that if it blows up, your employer, not you personally, is going to be liable.

These days appraisers have the same pressures to play ball and absolutely none of the protections of being employees. I wonder if we haven’t gotten to that point where someone with nothing left to lose has nothing left to lose. The lenders are asking appraisers to take personal liability for inflated appraisals, while offering them no salary (protection from falling volume cycles), no benefits, no institutional legal or compliance support. Even the per-deal fee we pay has become typically paid only out of closing proceeds. (We used to pay for the appraisals up front out of an application fee, so the appraiser got paid even if the loan didn’t close. These days the appraiser often never gets paid if the loan doesn’t close because the broker has nothing to pay it with.) And guess who is the target of the Cuomo indictment? Not the lender doing the bullying. At some point these appraisers have to realize that they don’t lose much by going state’s evidence and providing the other half of those email chains. And that would mean a Very Bad No Good Rotten Day for everybody.