Mortgage Default and the Fraud Fandango

Tyler Cowen has an interesting post up about the scope of mortgage fraud, although I am not sure it says what it may think it says (link):

BasePoint Analytics LLC, a recognized fraud analytics and consulting firm, analyzed over 3 million loans originated between 1997 and 2006 (the majority being 2005-2006 vintage), including 16,000 examples of non-performing loans that had evidence of fraudulent misrepresentation in the original applications. Their research found that as much as 70 of early payment default loans contained fraud misrepresentations on the application.

That is from a Fitch Ratings report (summary here, with an eventual link to buy it), the rest makes for very gory reading as well. ...

Fine as far as it goes, but old time bankruptcy lawyers will remember the “fraud fandango” as it played itself out back before some important law changes around 1970. The consumer debtor would look at the application form where it says “list all your debts;” there were only three blank spaces. “But I have more than three creditors”—“oh, not to worry, we only use that for the credit check.” So the customer would list only three and then when she defaulted, the creditor would profess to be shocked, shocked to learn that there were really 17.

Sometimes, you could persuade the judge to hear these grisly details. So, no fraud because no intent to defraud Even better, sometimes you could show him that the lender would have made the loan even if the debtor had told the whole truth. So, no fraud because no reliance.

I wouldn’t be at all surprised to find that some version of this caper played itself out in the late mortgage uproar. In a good many of these cases it was the brokers, I suspect, who were the initiators of the fraud, rather than the victims. The interesting question is: how far up the line does this go? Wasn’t anybody auditing the brokers? Auditing the auditors? Or was it all just one big clambake where everybody knew there wasn’t enough to go around, but everybody hoped they would get theirs off the table before the bell rang.