Wednesday, August 17, 2011

FBI: Mortgage fraud still prevalent, hard to catch - USATODAY.com

FBI: Mortgage fraud still prevalent, hard to catch - USATODAY.com

With all of the public attention paid to the complex web of failures that led to the mortgage crisis and resulting economic meltdown, you would think that the mortgage biz would now be squeeky clean. If you've tried to get a home loan or refinanced your house lately, you've probably seen a tightening in the eligibility rules; stricter documentation requirements; and a significant "raising of the bar" in underwriting standards. Gone are the days of "no-doc" loans, 125% financing, and mortgages handed out like candy without regard to ability to pay them back, right?

According to the news article above from USA Today, fraud is still running rampant in the mortgage industry. How can this be? The FBI's annual report on mortgage fraud said such schemes are particularly resilient and hard to discover, and their total cost is unknown. Real estate firm CoreLogic says more than $10 billion in loans were made with fraudulent application data in 2010, the report noted. In spite of all of the additional public attention and oversight, fraud last year stayed at levels seen in 2009 as the housing market remained in distress, providing ample opportunity for schemes, the FBI report said. It predicted that perpetrators would "continue to seek new methods to circumvent loopholes and gaps in the mortgage lending market."

The most prevalent schemes involve falsifying financial information to qualify buyers who otherwise would be ineligible for a loan. Other crimes involve inflated appraisals, including schemes that use dishonest appraisals to sell homes at elevated prices. Some get-rich-quick schemes persuade investors to buy rental property or land believing the price will appreciate quickly. The FBI report indicates that the crimes are committed by licensed and unlicensed brokers, loan officers, real estate agents, appraisers and other industry insiders who use their expertise to exploit vulnerabilities in the system. Organized crime groups are also behind some of the fraud, the report said.

Perhaps the most disturbing conclusion from the FBI is that "mortgage fraud enables perpetrators to earn high profits through illicit activity that poses a relative low risk for discovery." A low risk of discovery? Haven't we learned anything from the bedlem over the last few years?

The perpetual problem with virtually every area of government regulation is that there are, and never will be, enough examiners, inspectors, auditors, and investigators to enforce all of the regulations. Regulated industries such as the mortgage industry know this, which drives the game of "playing the odds", calculating the enormous gains of skirting the rules with the low probability of getting caught. As government budgets at the federal, state, and municipal level continue to decline during this period of austerity (which will likely last for decades to come), traditional methods of government oversight and enforcement need to be augmented by new and more creative approaches.

First and foremost, government regulators need to focus their attention on the credibility and effectiveness of the regulated industries' own Ethics and Business Conduct programs. Such programs need to be a comprehensive, real, and recognized method for companies to conduct their own self-policing. They must have a values-based emphasis on promoting ethical culture and behavior, as well as contain mechanisms to ensure compliance with the myriad of government regulations and requirements. Key elements include a user-friendly code of thics and business conduct; ethics training that includes a combination of both live and computer-based methods; constant corporate communication on ethics and integrity matters and an unequivocal "tone at the top" of the organization (which includes board of directors involvement); a credible, anonymous employee reporting hotline; and a professional, internal investigative capability. There are many more elements involved, but the basic message is that industry needs to develop its own internal self-policing capability, and government agencies need to focus on evaluating these programs.

Another way to expand the breadth and depth of government oversight is through independent compliance monitoring. The independent compliance monitoring model has been typically used as a reactive alternative to punitive government actions, such as suspension, debarment, or prosecution. In this model, a company, contractor, or regulated entity is found to have violated rules, but the government entity agrees to forgo more punitive action in favor of something akin to "corporate probation". The wayward company or regulated entity pays the monitoring bill, but the private monitor takes direction from, and reports to, the government regulator on whether the company is meeting its responsibilities by fixing the problems that have been identified. This model can be highly remedial and productive by helping regulated entities improve their internal processes and capabilities, thereby preventing future infractions.

Recently, some federal, state, and municipal government regulators have found that independent corporate compliance monitoring can offer more proactive benefits by engaging monitors, as a matter of course, in all high risk contracts in a particular initiative or industry. Monitors, for example, are used frequently in government construction programs (the Port Authority of New York/New Jersey is a great example). Given the high risk of fraud in the mortgage industry, coupled with massive decentralization and a tangled web of requirements and regulations at every level, the placement of independent monitors (at industry expense) could provide the government with just the kind of insight, and oversight, that is badly needed in order to prevent yet another mortgage crisis.