Due diligence

Tanta caught this story from the Orange County Register:

In November, Wells Fargo issued a $289,275 mortgage for 920 W. Camile to an investor who had purchased the home at a foreclosure auction. In January, after the house was spruced up, Wells Fargo issued a $500,000 mortgage to the new owners, the Gomezes.

Tanta cuts through the details of this deal with her inimitable wit:

Ridiculous? Sure. It turns out that the seller provided the $125,000 down payment, and also executed an “addendum” to the sales contract agreeing to pay the buyers $30,000 in cash, cover the borrowers’ first three mortgage payments, and toss in a 52-inch TV. Subtract out all that, and the true sales price of the property was $460,000. But apparently nobody did subtract out any of that, because Wells Fargo made a $500,000 loan to these buyers to purchase this property.

The OC Register reporter, bless his heart, tracked down the various parties who had their hands in this transaction, and got the following comments:

From the mortgage broker who put the deal together: “Whatever agreement the buyer and seller made, it was between them.”

From the appraiser who dutifully came up with a value of $625,000: “Like Sanchez, she had no knowledge of the terms of the sale.”

From the escrow agent who closed this loan: “It sounds to me like the seller helped out,” she said. “If someone gave them $125,000, what’s the problem? That’s a beautiful thing, if you ask me.”

From Wells Fargo: “In many instances, borrowers are able to use gifts from family members or friends for a portion of their down payment, provided the amount and source of the gifts are documented.”

Excellent point, Wells Fargo. Too bad in this case the down payment didn’t come from friends or family members and wasn’t documented. Too bad that the broker who originated the loan seems to think the details of the purchase contract aren’t any of his business. Too bad your escrow agent doesn’t care where the down payment money came from, either. Too bad your appraiser has apparently never heard of the Uniform Standards of Professional Appraisal Practice, to which she is obligated to conform if she wants to do appraisals for Wells Fargo, that say she is required to inquire into “the terms of the sale.”

It’s hard to know what to make of anecdotal accounts like this. How widespread can such behavior be? But in retrospect, the biggest mistake I made in interpreting the housing boom two years ago was that I was putting too little weight on anecdotal accounts like this one.

In any case, I certainly reacted to this story with exactly the same question as Tanta:

If this is the level of elementary due diligence we can expect after the most atrocious mortgage blowup in history, what will it take to scare people into doing their jobs?



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18 thoughts on “Due diligence

  1. Charlie Stromeyer Jr

    Professor Hamilton, perhaps you might devise a new index of the incidence of mortgage fraud by tracking the total number of relevant complaints to the FTC. By late 2006, agents at the FBI said that loan fraud was pandemic across the U.S., but I don’t know what statistics the agents were using.
    As you already know, many individuals correctly warned that the housing boom would go bust, but I also learned a few years ago that European housing would go bust too because the Belgian economist Daniel Gros discovered that European housing tends to lag U.S. housing by an average 18-24 months.
    Disclosure: I recommended shorting the now infamous ABX index in early June 2007, and I am still short U.S. home prices.

  2. Joseph

    …and I wonder if Wells Fargo sold the loan to Fannie Mae
    Fannie Mae has a limit of $417,000 for single-family first mortgages.

  3. Jim D

    How widespread can such behavior be?
    Let me answer your question with a question: Is there any non-fraudulent reason for a no-doc loan?
    The only non-fraudulent reason cited by originator marketing, “convenience”, hardly seems a reason to pay an extra 1% in interest, doesn’t it?
    Essentially, if you’re taking a no-doc loan, one of three fraudulent actions are probably happening: 1) You are lying to the loan originator about your income 2) Your broker is lying to the loan originator about your income, or my favorite, 3) You are lying to the Federal Government about your income.
    There’s really no other reason. I’ve heard that no doc loans took up 30% of all loans in the SF Bay area in 2006.
    Hopefully that gives some idea of just how pervasive these problems are – and will remain, until we start seeing people go to prison for doing this stuff.

  4. Charlie Stromeyer Jr

    Now that we are stuck with this housing mess what should be done about it? I don’t know but I recently ordered via amazon.com a book by Professor Robert Shiller that is about to be released called “The Subprime Solution” so I’m hoping that he has some good ideas.
    For those who might not know, Tanta and my friend Siobain are probably the smartest women who observe the “progress” of U.S. housing. Keep up the good work, Tanta!

  5. BK

    And just think – Wells Fargo is one of the more conservative lenders out there in the last few years, and one of the less impacted by sketchy mortgage loans. Just imagine the stories you could dig up from the likes of Countrywide and many others!

  6. Old Bogus

    I don’t understand the last question; they WERE doing their jobs: getting loans made! Ya can’t make money (with borrowed money) with it just sitting around.

  7. Fat Man

    “‘Extreme Makeover’ house faces foreclosure” AP on Jul 29, 2008:
    LAKE CITY, Ga. (AP) – More than 1,800 people showed up to help ABC’s “Extreme Makeover” team demolish a family’s decrepit home and replace it with a sparkling, four-bedroom mini-mansion in 2005.
    Three years later, the reality TV show’s most ambitious project at the time has become the latest victim of the foreclosure crisis.
    After the Harper family used the two-story home as collateral for a $450,000 loan, it’s set to go to auction on the steps of the Clayton County Courthouse Aug. 5. …
    Materials and labor were donated for the home, which would have cost about $450,000 to build. Beazer Homes’ employees and company partners also raised $250,000 in contributions for the family, including scholarships for the couple’s three children and a home maintenance fund. …

  8. Carlomagno

    Fannie Mae has a limit of $417,000 for single-family first mortgages.
    Posted by: Joseph at July 30, 2008 03:04 PM

    The conforming limit for so-called high cost areas, which includes SoCal, was raised as follows:
    Fannie Mae and Freddie Mac conforming loan limits for the high cost areas below may rise on a temporary basis to the corresponding levels listed. These temporary jumbo conforming loan limits apply to loans originated from July 1, 2007 to December 31, 2008. For a one-unit property, the maximum temporary loan limit is calculated as 1.25 times the median house price for the highest priced county in the property’s metropolitan or micropolitan area or the median house price for the property’s county if it is in a rural county. Regardless of the area median home price, the loan limit cannot, in general, exceed $729,750 (1.75 times the 2008 conforming loan limit). The exceptions are properties in Alaska, Hawaii, Guam, and the Virgin Islands, where that range is 50 percent higher ($625,500 to
    $1,094,625). The 2008 conforming loan limit of $417,000 remains in place everywhere else.

    See http://www.ofheo.gov/media/hpi/AREA_LIST_5_2008.pdf.
    This change was enshrined in the recent housing bill.

  9. Dan Weber

    Let me answer your question with a question: Is there any non-fraudulent reason for a no-doc loan?
    People who are self-employed or are contractors aren’t going to have convenient forms, and maybe they don’t want a vendor going through their books.
    It’s obviously very subject to abuse.

  10. Fat Man

    “People who are self-employed or are contractors aren’t going to have convenient forms”
    Its called Form 1040. The only reason not to use it is that you have been cheating the IRS. If so my sympathies are limited. Very limited.

  11. Dan Weber

    I can easily structure my DBA so that it rolls all of its profits into the business, making its profit appear very small even though it’s doing very well. And this is extremely legal, I’ll add.
    I extract only what I need for my living expenses. In return it looks like I live on 100% of my income and am not saving anything, but all my assets are in my company’s equity.

  12. Jim D

    Dan -
    As already stated, the “form” that the self employed need is a tax form, submitted every year by law to the Federal gov’t. Or were you thinking of a different form? If they don’t have their tax forms available, they’re also in violation of federal law.
    Again, there’s no plausible non-fraudulent reason for a no doc loan. I’d love to hear one, but for the last 2 years of making this statement, I’ve yet to hear one – in fact, the only thing I’ve ever heard was Dan’s comment, which is pretty easily seen as incorrect. If your income is larger than claimed on your taxes, then that’s fraud too – a very serious kind of fraud, no less.
    Please note that this doesn’t free the originator from responsibility – even in no doc loans, the lender was supposed to check your income via a form they send the Feds. Since most of them didn’t, they willingly participated in the fraud.

  13. Ethan

    BK at 05:47
    I hope you were being sarcastic. Their jobs are to shovel money out the door. Their jobs are to make loans that have a reasonable expectancy of being repaid and at interest rates which reflect the risk that the loans will not be repaid.

  14. Ethan

    Sorry for the double post. It didn’t seem to be taking the first time.
    Plus I agree with all the comments about using form 1040 to justify your allegations of income. I ran a solo professional business for a few years, and whenever I asked for credit I ALWAYS gave them my last two years’ 1040s. But then mine were honest so I didn’t have to worry about them being too low for the credit I was requesting.

  15. Ken

    Ethan wrote: “Their jobs are to make loans that have a reasonable expectancy of being repaid and at interest rates which reflect the risk that the loans will not be repaid.”
    Actually, their jobs are to maximize the profit of their company. If they can do that by scribbling crayon on butcher paper and selling that paper to an investor for $10,000 more than it cost to buy the paper and crayons, then it is perfectly reasonable – strictly from an economic point of view – for them to do that. You may of course substitute any other method of generating objectively worthless paper that can be sold at an immediate profit with no future risk.
    This is a point that I like to keep in mind whenever anyone claims that a market will solve some problem. The claim is (possibly) true, but only if the market is structured so that maximization of profit, also produces the desired outcome. As the Enron situation showed, if a company that trades electricity can increase profits by reducing the amount of electricity available, that’s what you’ll get.
    As an exercise for the reader, try to design a for-profit health insurance system that maximizes profits by providing health care – as opposed to refusing it.

  16. Ethan

    BK at 05:47
    I hope you were being sarcastic. Their jobs are NOT to shovel money out the door. Their jobs are to make loans that have a reasonable expectancy of being repaid and at interest rates which reflect the risk that the loans will not be repaid.

  17. randymiller

    There was also an article in Time or Newsweek about some of the mortgage fraud in Cleveland, complete with appraiser fraud, etc.
    With the passage of the rescue bill, I am very curious about a couple of things.
    First, I can understand why institutions like Fannie Mae, Freddie Mac, and Bear Stearns are too big to fail, but what about the people who ran them? Are they suffering financial stress, or are they being left in charge. Can we not enforce moral hazard for management, and stockholders?
    Second, are fraudulent appraisers being prosecuted?

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