How To Reduce Mortgage Fraud

August 21, 2013 at 8:10 am 1 comment

A report released yesterday by the Financial Crimes Enforcement Network (FinCEN) underscores one of the key areas for policy makers to consider as they grapple with housing reform. If we’re going to have a vibrant secondary market, whatever form that market takes, more emphasis has to be placed on sharing the burden of both preventing and recognizing mortgage fraud.  In the meantime, I would rechristen your originators your quality assurance supervisors to underscore just how important they are to your mortgage process.

According to FinCEN, the bulk of its mortgage related suspicious activity reports (SARs) deal with activity that began in 2006 and 2007.  Furthermore, a little less than half of all the mortgage related SARS received by FinCEN over the last decade came in to the agency over the last three years.

On the bright side, the worst seems to be over since this year there was a 25% decrease in mortgage related SAR filings.  On the face of it, the statistics aren’t all that informative beyond confirming what many people already knew, which is that there was a lot of reckless lending going on.  But unless you believe that mortgage fraud just started in 2006, what the statistics also show is that it is relatively easy to get away with mortgage fraud when times are good:  as long as the check is in the mail, chances are no one is going to catch their malfeasance.  This is what has to change.

To me the more interesting question is how do we reduce the lag time between the actual suspicious activity and the identification of the mortgage fraud.  One of the most basic steps that can be taken is to impose a statute of limitations on the ability of Fannie and Freddie, and whatever entity replaces them, to force originators to buy back mortgages.

The warranties originators make for selling mortgages to these entities amount to imposing open-ended strict liability for mortgage mishaps on the originator.  In other words, if your credit union has sold a mortgage to Fannie or Freddie, or to a servicer who will execute the sale for you, you may find yourself having to repurchase that mortgage three, five or even ten years down the line if Fannie or Freddie discovers a breach of one of the numerous warranties agreed to when they purchased the mortgage.  On a practical level, this means that when a Fannie or Freddie loan goes into foreclosure, the lending file is going to be scoured and so long as they can find an “i” that wasn’t dotted or a “t” that wasn’t crossed, the mortgage seller is on the hook for the unpaid balance on a mortgage that they sold years ago.  It’s a system of seller beware where the secondary buyer of mortgages doesn’t have enough skin in the game.

Now, don’t get me wrong, it makes sense to make originators responsible for the quality of the mortgages they underwrite.  This is the basic premise behind documenting that borrowers have the ability to repay a mortgage loan.  However, the existing system has indirectly tightened lending standards because banks and credit unions have to guard against the possibility that no matter how much emphasis they place on sound underwriting practices, and how much they try to appropriately manage their balance sheets, there are a certain number of mortgages that are going to go bad, and they have to account for that cost.

So, what’s the solution?  The housing reform legislation should codify baseline warranties making originators responsible for non-technical violations.  Second, there should be a maximum number of years the secondary market buyer has to force the repurchase of a mortgage.  This will force the secondary market buyer to emphasize the up front evaluation of mortgage quality and periodic audits of portfolios, rather than simply waiting for foreclosures  to point out mistakes that were made by the originator.

Fannie and Freddie are making slight movements in this direction, but much more needs to be done.  In the meantime, I would suggest reminding your originators that they do much more than qualify people for mortgages, they are your front line quality control staff, who are your best protection against mortgages gone bad.

Entry filed under: Compliance, Legal Watch, Regulatory. Tags: , , .

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1 Comment Add your own

  • 1. Kam  |  May 28, 2014 at 8:50 am

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    Reply

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Authored By:

Henry Meier, Esq., General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association.

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