Mortgage Fraud: New Schemes Emerge

Certain U.S. markets are expected throughout 2010 to continue to see incidents of mortgage fraud grow. In fact, LexisNexis Risk Solutions has identified five markets in Florida as being the weakest and most vulnerable.

Despite continual increases in foreclosure rates, criminals and con artists are taking advantage of those markets' conditions by focusing on new types of scams such as rescue schemes, which often involve the purchase of a home that's about to go into foreclosure.

In this interview, Jennifer Butts, an author of the MARI Annual Case Report on Mortgage Fraud, which is published by LexisNexis' Mortgage Asset Research Institute, shares insights from her research regarding:

  • New fraud schemes hitting the market, as well as traditional schemes that continue to plague lenders;
  • The transparency and standardization benefits that collaboration between Fannie Mae and Freddie Mac are expected to bring to lending and appraisal practices;
  • How financial institutions can do a better lending job when they identify risks and verify transaction participants.

Butts manages the research, processing and presentation of all data maintained by the Mortgage Asset Research Institute, a group within LexisNexis Risk Solutions that is devoted to the use of information for mortgage fraud detection and prevention. She is an author of the MARI Annual Case Report on Mortgage Fraud, as well as other periodic fraud trend analyses. Butts is a frequent industry speaker and contributor on issues facing the mortgage industry. She has been quoted by industry and mainstream press, such as such as the Associated Press, USA Today, CNN Money, The Washington Post and the Los Angeles Times. She is a member of the Mortgage Bankers Association Fraud and Ethics Committee and the Quality Assurance Subcommittee, for whom she frequently presents mortgage fraud trends.

Butts has been with the Mortgage Asset Research Institute for 11 years. She holds two graduate degrees in English Literature from The University of Alabama and The George Washington University.

TRACY KITTEN: Jennifer, could you please tell the audience a little bit about your role within the LexisNexis Mortgage Asset Research Institute, as well as some of the primary functions of the institute?

JENNIFER BUTTS: My role within LexisNexis' Mortgage Asset Research Institute pertains specifically to data, so everything that involves the processing of data that we bring in, the presentation of data in report format, and the research behind all of the data that we collect and present to the industry fall under my purview. As far as the primary functions of the Institute, historically, our role has always been to help the industry defend itself against entities that perpetrate fraud and serious misrepresentation; the way that we accomplish that is by the responsible sharing of information.

What we do is we pull in information from a variety of sources, from state regulators, for example, federal regulators, and we also pull in information from our bank of customers, our subscribers out there in the industry, mortgage lenders, appraisers, investors, insurers; and all of this information that is pulled in, negative in nature, a derogatory sanction, for example, from a regulator, an investigation, for example, from the lender, add a background component picture to entities in the industry. And our customers then use the product -- use the data that we collected to create a picture, if you will, of an entity's professional background.

KITTEN: And you have answered part of my next question, which is how, is information for the annual report that the Institute puts out, how is that information collected?

BUTTS: The information that we use in our annual report, which is basically a report about fraud trends nationally for a specific year, is collected from our subscribers, so this information is restricted to the investigations that we pull in from people out of the industry. Anybody who has a financial stake in a transaction and does a QA investigation, either pre- or post-funding, sends that investigation to us. Now the investigation has to meet some criteria; there has to be material misrepresentation, which means it can't be $5 on a pay stub. It has to be verified misrepresentation, meaning the submitter has to have actually verified that there was serious misconduct or misrepresentation; it can't be just suspicious activity. And, finally, we don't accept information that is strictly borrower or consumer fraud. So all of the information that we pull in involves the professional, and this information, the investigations that meet that criteria, are then put into a database and we mine that data to present statistics for mortgage fraud trends every year.

So where our annual report is concerned, what we do to generate a national ranking for a given year is we take the data that we pull in from those investigations and we weigh them against origination data so that we have a more fair picture of any given state's fraud and misrepresentation rate. We all know that Florida, for example, has far more loan originations than a state like Vermont; so when we take the origination data and we weigh those percentages against the percentages of fraud reports in our database, we come out with what we call the Mortgage Asset Research Institute Fraud Index, or an MFI, which is basically a number that essentially ranks those states in terms of fraud incidents in any given year.

KITTEN: Now the Institute in its most recent report has identified five Florida markets as being the most weakened by the mortgage fraud crisis. Markets in New Jersey, Arizona, and Virginia also have recently been added. What is contributing to some of these weaknesses in some of these markets?

BUTTS: We can't tell why markets are performing the way that they are, and we can't tell why certain states are trending higher than others. Anecdotally, though, we see what the rest of the country sees. We see that in Florida, and even in a state like California, for example, the proliferation of investment properties or beach condos certainly makes fraud in those states very easy, and the sheer volume of those properties coupled with value inflation has always been a red flag for Florida, specifically. Now, as far as the other states, New Jersey, Arizona, Virginia, those that you mentioned, those states are red flag states as far as value declining in those markets. If you look at property values in those three states, what you will see is that property values are falling dramatically there, and that information actually trends pretty closely to mortgage fraud reports in those states.

KITTEN: From 2008 to 2009, the total number of mortgage fraud suspicious activity reports increased by 5 percent, but that increase was significantly lower than the reports that were provided from 2007 to 2008, for instance. So does that mean that mortgage fraud is decreasing, or is that just that the industry might not be doing a good job of identifying the new types of frauds?

BUTTS: Actually, I don't think either of those is really the case; what I think is that there is still a 5 percent increase. Keep in mind that the 5 percent increase is on top of the record-high previous year increases; a 5 percent increase over the two-year highs for the previous two years is still a pretty sizeable increase. The increase, as you pointed out, isn't growing as exponentially as it has been; that's a good thing, because it tells us, No. 1, that as loan volumes decrease, so decrease fraud volumes. It also tells us that the industry has taken up the mantle of reporting this information; so one of the reasons that these fraud numbers here put out by FinCEN (Financial Crimes Enforcement Network) and the FBI and in our reports as well, increase and have increased for the past three to five years, is that people in the industry are actually reporting more. So they are investigating more thoroughly, and they are reporting that information, and there is no real way to separate, you know, "mortgage fraud is up 7 percent this year." Is it really that there is a 7 percent greater incidence of mortgage fraud, or is part of that, definitely part of that is, that the industry is reporting more information on there as well?

KITTEN: So what are some of the new schemes hitting the market?

BUTTS: Well, I think if you take a look at what is happening in the industry right now, foreclosures, short sales, what we learn, if anything, is that people out there who perpetrate fraud do so by paying attention to what's happening. Right now, what we will see is there is a proliferation of foreclosures and short sales in the industry. In short sale fraud, for example, fraudsters will essentially flip a property. Once they know that a property is going to be sold for a short sale, perfectly legal, for a price less than what the balance of what is owed to the bank, they convince the bank or the lender to take less than half its worth, while secretly they have made a deal with somebody, either the buyer or somebody else, to sell the property to someone else for a higher rate. So essentially that is flipping that property very quickly after putting a smaller amount to the lender, so the lender is the one who is being stuck here with and they are losing, say, $50,000 or $100,000 on a property, because they are not aware of that backhand deal, so to speak. The other type of fraud that I mentioned, the foreclosure prevention and rescue schemes, each usually involves folks posing as knowledgeable foreclosure specialists, if you will. They will put fliers on your car; they will knock on your door; they will say, "Hey, we know you are about to be foreclosed on, we can help you. Let us buy your house and we will pay your bills. You can live there and you can rent from us and you can pay your rent, and then we will sell it back to you, because we are just trying to help."

What actually happens is, of course, is that these folks sell the house out from under the previous owners who were being foreclosed on and then run off with the money and evict the folks. What you see here are typical, traditional con artists. They are going after people who are in desperate situations financially.

KITTEN: So you expect application fraud to once again top the list in 2010?

BUTTS: Yeah, I mean, there is no way for us to really predict that, but I definitely think we are going to see an increase in these other practices because the industry itself has changed. One of the things that we found in 2009 was that appraisal fraud has risen from a relatively average kind of fraud type to actually second in the fraud type list for 2009, so we expect to see potentially more appraisal fraud out there. We also expect to see, you know, application fraud to trend highly, fraud on the application, because there is so much information on the application -- there is income, there is employment, there is asset, there is occupancy, and there is identity. So with any of those types of things, basically anything that is part of the borrower's profile, is misrepresented or fraudulent on the application, that is going to make that entire package a problem.

KITTEN: I wanted you to also speak to some of the fraud opportunities that the institute has identified, as well as explain how Fannie Mae's Collateral Data Delivery initiative is expected to combat fraud.

BUTTS: Well, as far as what was identified, I think that the short sale fraud, fraud foreclosure, rescue fraud and those kinds of things fall into that arena. What we are looking at now, and what we are looking at as a result of our report that came out this spring, is that increase in appraisal fraud; and as you point out here, Fannie Mae's CDD, or Collateral Data Delivery, system has been put in place to address some of those issues with the appraisals. Now, since we have written this report, Fannie Mae's CDDs will actually be soon phased out, because they have a new program in conjunction with Freddie Mac. These two guys have been working together and they are putting out the new Uniform Mortgage Data Program, UMDP. What this program essentially does is it supersedes the CDD. OK. That's a lot of acronyms; but essentially what is happening is that instead of Fannie Mae putting out a system wherein they would take in electronic appraisal data, now Fannie Mae and Freddie Mac are working together to put in place a very similar system.

So the system that goes into place, I believe, January 1, 2011, is called, again, the UMDP. What the UMDP does is it requires more electronic uniform consistent data from appraisers, specifically, obviously, on the appraisals. What that is going to do for the industry is that it is going to standardize -- it is going to get everybody on the same page as far as requirement language, acceptable and non-acceptable ambiguities, and, what is actually a really good thing, using a shared framework -- using a shared platform. What we will have as a result is a more transparent appraisal process; an appraisal process wherein appraisers across the country who are going to produce loans with Fannie and Freddie have to be in the same guidelines. And Fannie and Freddie are going to have a full day, at the very least, to look at the information and verify it.

KITTEN: So, how can lenders do a better job of forecasting poorly performing real estate markets, which will help them better access risk in their valuations and tailor lending strategies?

BUTTS: Tracy, a nice thing about common sense, and I hate to be the common-sensical sort of speaker here, but data like economic data, like foreclosure and employment rates, actually really closely correlate to areas that are the hardest hit in the mortgage industry. So paying attention to high foreclosure rates, they are actually going to tell you about future property valuation issues. Obviously, they are going to talk about borrowers' ability to pay loans. As the last couple of years have shown us, certainly the national economy, houses, jobs, mortgages, income, all of these things are pretty tightly wound up. Paying attention to all kinds of markers in the economy, like I was saying, foreclosure, job numbers, property values, that is going to help us find those areas where there are going to be problems in the future. In addition, paying attention to fraud-trending areas, like the states and metropolitan areas we talk about and some of the competitors talk about it as well, are actually going to help lenders put big red flags over areas so they can pay special attention to that as well.

KITTEN: What can financial institutions do now to reduce their risk of mortgage fraud?

BUTTS: The message now is verify all information in a loan transaction. We can break that down into three things. No. 1: Verify the professional's credentials. Are they who they say they are? Are they licensed? Do they have any past disciplinary actions? No. 2: Verify the borrower's credentials -- the employment, the income, the assets, the debt, their address history, even their identity. Verify everything associated with that person or those persons. And No. 3: Verify the property's credentials. Is the value right? Are the comps appropriate? What about the amenities?

After all of the information has been verified, what we need to do as an industry, what financial institutions should do, is then report unscrupulous activity that they discovery during the verification process to the appropriate agencies or law enforcement, state regulators, federal regulators, and also to information providers like us, because we wouldn't be able to trend information, to give information out to the industry, without the industry's participation and sharing of information together for a common purpose.

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