Viewpoint: Finding Fraud, and What it Really Means for Loss Mitigation
Various state AGs and the Conference of State Bank Supervisors put out an update Tuesday to a study originally released in February that found that seven of 10 seriously delinquent loans "were not in any sort of work-out process." The new report sings pretty much the same song -- 70 percent of seriously delinquent subprime borrowers aren't in any stage of loan workout or modification efforts -- and essentially then takes servicers to task for failing to prevent what it calls "unnecessary foreclosures." HW readers can feel free to read the full report if they like. It finds that two-thirds of loss mitigation efforts are taking more than 30 days to complete, and suggests too that states should look to uniformly lengthen foreclosure timelines. The crux of the entire report, however, lies in the snippet below -- the problem is that none of the state AGs, or anyone else in the State Foreclosure Prevention Working Group for that matter, seemed to realize it:
In our first report, we highlighted the high level of delinquency for adjustable rate subprime loans before any “reset” of their interest rate to a higher level. The most recent data identifies a worsening of this trend, as more subprime loans are delinquent prior to any payment change. For instance, the percentage of loans facing reset in the 3rd Quarter of 2009 that are currently delinquent jumped from 21.4% to 28.5%. While delinquency rates increase during the early life of a loan pool, this worsening trend confirms our initial assessment that very weak underwriting and mortgage origination fraud, and not simply payment resets, has been the primary cause for elevated subprime loan delinquencies for loans originated through at least the middle of 2007.It depends on who you believe, but fraud was so rampant in Alt-A and in subprime lending during the boom that I've seen estimates suggesting that anywhere 40 percent to 70 percent of the original balance of entire loan pools from 2006 and 2007 were fraudulent originations. Is that extreme? You bet. Is it reality? Just look at the numbers above again. 28.5 percent of subprime mortgages one year away from a payment reset are delinquent. That sort of failure only happens when you're talking about rampant, across the board, pervasive fraud -- fraud that is as hopelessly intertwined with the borrower who didn't know or care what terms came with their mortgage as it is with the lender who decided to make the loan because investors were willing to buy it. That's the real reason Alt-A borrowers are defaulting in droves, too, even in the similar absence of a payment resets. And it's also a big reason why so many borrowers aren't engaged in a loan workout. What incentive do they have? Offering strong and credible proof that they were party to mortgage fraud? Yet the state AGs see that seven of ten severely delinquent subprime borrowers aren't engaged in loss mit and automatically assume that the problem lies solely with servicers failing to "do enough." Are servicers stretched thin? Sure. Does more need to be done, and in particular, do lenders need to start writing off principal amounts? Absolutely. But what number would represent "doing enough" in this case? There isn't an effective loss mitigation strategy I know of that can solve for fraud. Extending foreclosure timelines, or introducing more uniform standards for loss mitigation -- both "solutions" proferred by the state AGs in their report -- will actually serve to make fraud even more costly for everyone involved. And that's the last thing anyone who wants to see housing recover should be rooting for. By everyone, I'm even referring to would-be new homeowners looking to get into the housing market. I recently did an interview on American Public Radio's Marketplace that discussed how a couple in suburban Chicago, Rachel Unruh and Doug Schenkelburg, found themselves locked out of the housing market due to the so-called "declining market policy" put into place by Fannie Mae. They could afford 5 percent down, but not the ten percent now required -- which consumer groups promptly and predictably said was a new form of redlining. I suggested that if anyone wanted to see the real victims of mortgage fraud, one needed look no further than Rachel Unruh and Doug Schenkelburg. It's a response that was relegated to the cutting room floor when the segment aired, BTW, because I don't think many have yet really grasped just how pervasive an effect fraud has had on the mortgage market. To be sure, there are a myriad of other reasons borrowers lose their home -- the quadruple threat of death, divorce, disability, and dumb applies as much to subprime as to any other credit category, not to mention growing job losses to boot. Given price declines in key markets, as well, even prime borrowers are now finding that their padding for error when life throws its inevitable curveball is less than they'd expected -- the CSBS report even goes so far to note that prime delinquencies are increasing, but fails to connect the dots. In no small part, fixing the current mess is tied to fixing fraud; and that means fraud at all levels, from borrower to broker to lender. It's both as simple and as complex as that. Which means that it's time borrowers, consumer groups and erstwhile working groups stop floating a revisionist history of the "hapless borrower" -- you know, the one where greedy, mean lenders duped those innocent and pure borrowers? -- as a substitute for what's really going on in the real world. The reality of the situation we're now in, as with most difficult issues in life, is far more complex than that.