Mortgage Fraud Seen In Subprime Meltdown Mix

The extent of insurers' exposure to professional liability claims from the subprime mortgage crisis remains uncertain–and one factor that's fueled the collapse of that market is mortgage fraud, an expert has advised actuaries.

Ann Fulmer, vice president of Interthinx, an Agoura Hills, Calif.-based unit of the Jersey City, N.J. ISO, described the mechanics of mortgage fraud during a meeting of the Casualty Actuaries of Greater New York last week, noting that problems underlying subprime loans and mortgage fraud tend to cluster.

She went on to describe schemes related to “stated-income” loan products that helped to push down the quality of mortgage loan underwriting in recent years and helped to encourage borrowers to lie.

A “stated-income” product, she explained, is basically one where the lender doesn't verify the amount of income for a borrower. “We've seen cases where people literally made $6,000 per year and were able to get $150,000 mortgages.”

Mortgage fraud “is the 'X-factor' in the subprime meltdown,” Ms. Fulmer said, explaining that “the scope of mortgage fraud is unknown and it is not quantifiable.”

She noted that published reports from the Federal Bureau of Investigation peg the direct dollar loss to lenders in 2006 arising from mortgage fraud at $1-to-$4 billion, “which seems like a drop in the bucket in relation to $3 trillion in mortgage originations.”

Such figures are misleading, however, because they're based on suspicious activity reports that only about one-third of the lending industry is required to file. They also don't include the category “fraud for housing,” which involves borrowers stretching the truth or lying about their ability to afford a house.

“Fraud for profit” is less prolific, but instances of “fraud for profit” are more financially damaging and therefore these get the attention of law enforcement agencies, Ms. Fulmer reported.

From the lenders' perspective, she said that “fraud for housing” has been tolerated in recent years because loans tended to perform. When real estate values were rising, lenders were made whole even if they had to foreclose on properties, she noted.

At one point, Ms. Fulmer revealed that not only has fraud been tolerated, but that 80 percent of mortgage fraud involves collusion by industry insiders–mortgage brokers, real estate agents, loan officers, appraisers and settlement agents.

Interthinx, based on its real-time review of mortgage loan applications, flags 25 percent for indicators of fraud, she said, going on to describe “liar loans” of many varieties, including misused “stated income” programs.

She said that “stated income” loan programs were originally designed for a niche market of high-net-worth borrowers who didn't want to disclose all of their financial dealings. She said these programs were misused by brokers who used them to close loans for people who did not qualify at all and could not afford the loans.

Interthinx, she said, interviewed a Florida mortgage broker who submitted four applications for a single unqualified borrower, raising the stated income on each successive application, until all the qualifying ratios for the loan worked out.

“It was 'stated income' program. I thought I was supposed to 'state' whatever it took to get the loan closed,” the broker said in an interview conducted by Interthinx when the loan fell apart.

Whether such brokers will be sued for professional negligence or misconduct, and how much liability insurers could pay out, remains unclear.

Robert P. Hartwig, president of the Insurance Information Institute, who spoke prior to Ms. Fulmer at the CAGNY meeting, told the actuaries that it's too early to ascertain the extent of liability insurance risk related to errors and omissions coverage for mortgage brokers and other real estate professionals and directors and officers liability claims against firms suffering stock drops as a result of the mortgage crisis.

Responding to a question from one of the roughly 150 actuaries in attendance, Mr. Hartwig said, “We would expect that there would be significant litigation, but…because the subprime issue has not run its course, I don't think we can say at this point with any confidence, the extent [it] will cost.”

Ms. Fulmer also described situations where mortgage lenders make faulty assessments of risk. For example, they may not review fraud potential for borrowers that have high FICO (Fair Isaac & Co.) credit scores, she said, noting, however, that these scores can be manipulated.