Posted by Mark Gillispie
(Cleveland Plain Dealer)
The criminal tools were houses and lousy loans. The ringleaders, critics contend, earned seven-figure salaries and hatched their plots from inside well-appointed boardrooms.
The crime was mortgage fraud. The damage it created is still being calculated.
There are estimates that at least $7 billion in fraudulent loans were originated nationally in 2007. Ohio, according to an index that tracks mortgage fraud cases, has one of the worst fraud rates in the country.
Cleveland alone may have seen several hundred million dollars’ worth of mortgage fraud during the subprime lending boom that began in 2002 and ended in 2006.
A Plain Dealer analysis shows that nearly half of the subprime loans written in Cleveland in 2005 by five of the country’s biggest subprime lenders resulted in a foreclosure filing.
This was no victimless crime. Taxpayers will bear much of the cost of Wall Street bailouts and elimination of blight that mortgage fraud created.
If the implosion of the subprime lending market last year and subsequent credit crisis is responsible for the current economic downturn, then mortgage fraud deserves much of the blame.
But the national economy is likely to recover faster than will Cleveland, where fraud-induced foreclosures and their byproduct, vacant and boarded-up homes, have devastated some neighborhoods.
All kinds of people were in on the scam, from buyers and sellers of real estate to the mortgage brokers, appraisers and title officials who facilitated this massive fraud.
But there is a growing belief that the real masterminds behind all this fraudulent activity worked for companies that have called themselves victims – subprime mortgage originators and the banks that provided them with capital.
“This was actual fraud at the highest levels,” said Anthony Accetta, a former federal prosecutor. “It wasn’t an accident. It was not a failure of oversight. It was actual fraud, and we’re not doing anything about it.”
In the 1970s, Accetta prosecuted what was then the largest mortgage fraud case in U.S. history. He later worked as a private attorney for investment banks and then started a private investigative firm that works in the financial sector.
He said the subprime-lending business model worked like a Ponzi scheme. These lenders made loans that they sold to investment banks, which turned them into bonds sold to investors. Banks took their fees and commissions and lent money to mortgage originators so they could write more loans.
The scheme ground to a halt, Accetta said, when investment banks could no longer cover up the billions in losses that bad lending created. Too many people had stopped making their mortgage payments, which meant not enough money was coming in to pay investors.
“This is a national catastrophe, and the perpetrators [on Wall Street] are not being prosecuted,” Accetta said. “It’s one of the easiest cases to prove because there are plenty of witnesses and plenty of evidence out there.”
Eric Forster, a Los Angeles-based consultant for mortgage fraud litigation, said the entire subprime mortgage industry was “fraught with fraud.”
“What makes this crime wave unique is that, in most cases, the banks cooperated with the perpetrators,” Forster said. “Once they discovered they could securitize loans and transfer the risk to some investors in China or Europe, there was no reason to underwrite the loans any longer.”
Bankruptcy no bar to $505,000 loan
Subprime loans were advertised as helping to fulfill the American Dream of homeownership by extending credit to people with poor or incomplete credit histories.
But there is evidence that quantity outstripped quality in the subprime business model. People who might have trouble getting a conventional loan from a bank found themselves able to obtain multiple mortgages from subprime originators.
That’s what happened in the case of Cleveland resident Myra Clarke.
Clarke, 48, had just gotten divorced, had just lost her home at a sheriff’s sale and had just gone through a bankruptcy to shed $38,000 in debt. But that didn’t stop Long Beach Mortgage, a subsidiary of banking giant Washington Mutual, from lending her $505,000 to buy six Cleveland rental properties in 2005.
In conventional mortgage lending, borrowers meet face-to-face with employees of the companies doing the lending. Borrowers provide tax returns along with income and bank statements to prove they can afford a loan. The lenders use trusted appraisers to obtain an honest assessment of a property’s worth.
In the world of subprime lending, the application process and the hiring of appraisers is the responsibility of independent brokers who are paid only when loans are originated.
The proliferation of stated-income loans, known pejoratively in the industry as “liar’s loans,” meant that borrowers did not have to provide much documentation beyond a credit report and a Social Security number to obtain a mortgage.
A study that compared 100 stated-income loans with IRS data showed that 90 percent of the loans overstated actual income by at least 5 percent. Sixty percent of those stated-income loans exaggerated income amounts by at least 50 percent.
Subprime originators were happy to fund these risky loans as a tradeoff for the higher fees and interest rates they could charge. And the more loans these companies sold, the higher the bonuses that everyone from account executives to corporate officers received.
Perhaps this explains why Clarke, who has not been accused of any crimes, got those loans for the six rental properties. Her bankruptcy file showed she was a nurse making less than $40,000 a year. Escrow documents included in the foreclosure lawsuits filed against her show she provided $96,000 to cover down payments and closing costs.
Those foreclosures were filed on Clarke’s six houses within eight months of her buying them, which indicates that she made few, if any, payments on her loans.
Clarke, through a family member, declined to comment. A Washington Mutual spokesman also declined to comment.
All of the properties were sold to Clarke by Amazing Investments, a Warrensville Heights company owned by Timothy Holman. Property records show that Amazing Investments sold 16 houses in Cleveland in 2005 and 2006. All 16 resulted in foreclosures.
The mortgage broker, Buckeye Lending, collected $20,000 in fees on Clarke’s purchases. One of the Buckeye Lending loan officers was Timothy Holman’s brother, Stephen.
Buckeye Lending owner Ted Calkins and Stephen Holman were indicted last year in two different mortgage fraud cases. Calkins received probation in a plea deal. Stephen Holman has pleaded not guilty and has a September trial date.
Attempts to reach the Holmans through their attorney and a family member were unsuccessful.
28 percent of mortgages originated by 5 companies
The Plain Dealer compiled a list of the loans made by the top five subprime lenders in Cleveland during 2005. Records show that 48 percent of those loans to purchase or refinance Cleveland houses have resulted in a foreclosure lawsuit.
The five companies – Argent Mortgage, Long Beach Mortgage, New Century Mortgage, Aegis Funding and People’s Choice Home Loans – originated 28 percent of the 15,000 mortgages sold in the city of Cleveland during 2005. All five lenders have since been absorbed by other companies or have gone out of business.
There is no accurate way to determine what percentage of subprime mortgage loans were fraudulent.
Robert Ruckstuhl is a Newbury Township mortgage broker and appraiser who has become a consultant for attorneys in foreclosure cases. Ruckstuhl did not mention any specific companies, but said that based on the hundreds of files that he has reviewed, he guesses that at least 25 percent of subprime loans written in Cleveland between 2002 and 2006 contained an element of fraud that should have stopped the loan from being funded.
There were about $1.75 billion in subprime loans written in Cleveland during that five-year period. Even if just 10 percent of those loans had fraudulent misrepresentations, the amount of fraud would be substantial.
It’s impossible, Ruckstuhl said, for lenders not to have known they were originating large numbers of fraudulent loans.
“It’s a matter of what they wanted to acknowledge,” he said.
Kathleen Engel, a professor at the Cleveland-Marshall College of Law at Cleveland State University, said assigning criminal liability to executives at mortgage origination companies and investment banks could prove difficult.
A prosecutor would need to prove that executives intentionally participated in the fraud. Part of the genius of subprime lending, Engel said, was how lenders and investment banks insulated themselves from potential liability.
“The reason we saw such huge growth in independent brokers was because they wanted brokers to do the dirty work,” Engel said. “They were able to put a shield between themselves and liability for wrongdoing.”
Prosecutor indicts 171 for fraud
Mortgage fraud has not been ignored locally. The Ohio attorney general has funded a task force here. The Cuyahoga County prosecutor’s office has indicted 171 people for $41.5 million in fraudulent loans since 2007.
The Cleveland FBI field office works with the task force and has its own caseload.
Nationally, the FBI and Securities and Exchange Commission have 19 separate investigations of mortgage lenders, investment banks and rating agencies. Those investigations are focused on accounting fraud and insider trading.
The Ohio attorney general’s office has been using its subpoena powers to gather documents from investment banks and lending companies in anticipation of a lawsuit.
Attorney General Marc Dann said recently that it’s becoming clearer that some corporate executives knew their companies were selling or securitizing large numbers of fraudulent loans.
Industry insiders say lower-echelon employees of companies like Argent actively participated in fraud.
Several former loan officers for local mortgage brokers said account executives for subprime lenders coached them on how to assemble loan packages to ensure their approval.
Ruckstuhl, the Newbury Township mortgage broker, said an account executive tried to show one of his loan officers how to create false income statements.
Jacqulyn Fishwick worked for more than two years at an Argent loan-processing center near Chicago as an underwriter and account manager.
Fishwick said some Argent employees played fast and loose with the rules.
“I personally saw some stuff I didn’t agree with,” she said.
Fishwick said she saw account managers remove documents from files and create documents by cutting and pasting them.
An Argent spokesman declined to comment.
Former Argent Vice President Orson Benn and account executive Constance Golder were indicted in Florida earlier this year on racketeering charges in connection with a mortgage fraud scheme that involved 280 properties and $34 million in loans. Benn and another former Argent employee were indicted for a separate Florida scheme last year.
None of this surprises Accetta, the former federal prosecutor. He says the trail of evidence is clearly marked and ends inside the executive suites of Wall Street’s most powerful investment banks.
Accetta said Wall Street created an environment ripe for fraud. After the high-tech bubble burst in the late 1990s, banks partnered with or founded their own mortgage companies and made billions, Accetta said.
Executives of these banks knew they were selling and securitizing large amounts of fraudulent loans because they had inside information on borrowers and mortgage default rates.
“They were more than happy to absorb hundreds of million in losses that occurred during that process,” Accetta said, “until it became too much and they couldn’t cover it any more and the losses became public.”
Despite the FBI and SEC investigations, Accetta said he doesn’t think the U.S. Justice Department “has the stomach” to prosecute these companies, out of fear it would undermine confidence in those financial institutions and our capital structure.
“So you’re left with prosecuting individuals,” Accetta said. “This was systemic. It had nothing to do with this individual or that individual. There was no individual in any of the investment banks who could have stopped it even if they wanted to.”
Investigator accuses New Century Financial of ignoring the warnings
An investigator hired to examine issues surrounding the bankruptcy of New Century Financial Corp. said senior management ignored ample evidence of rising default and foreclosure rates while allowing the company to write riskier loans.
New Century, one of the largest subprime lenders in the country, was the biggest source of these higher-cost mortgages in Cleveland and Cuyahoga County in 2006.
“The increasingly risky nature of New Century’s loan originations created a ticking time bomb that detonated in 2007,” wrote the Delaware bankruptcy court examiner, attorney Michael Missal, in a report publicly released in March.
California-based New Century filed for Chapter 11 bankruptcy protection in April 2007 after the company revealed that it needed to restate its earnings for the first three quarters of 2006.
The report accuses New Century’s outside auditing firm, KPMG, of allowing or ignoring accounting fraud inside the company. KPMG, which resigned as the company’s auditing firm, has denied wrongdoing in its work for New Century.
The collapse of New Century has been blamed for triggering the implosion of the subprime mortgage market and subsequent credit crisis.
The report said there was plenty of evidence that New Century’s corporate officers were aware of rising default rates in 2004. About 7 percent of the loans originated by New Century in 2004 – or about $1.8 billion – defaulted after borrowers made three or fewer payments. That compares with $312 million in early-payment defaults in 2003.
An internal review of the company’s nine operating centers in 2004 graded the performance of seven centers as unsatisfactory and two as needing improvement.
A senior New Century official afterward questioned whether the auditing teams needed to change their policies rather than have the operating centers “clean up their act.”
Despite the signals of deteriorating loan quality, the percentage of early-payment defaults and kickouts – loans rejected by investors – continued to rise in 2005 and 2006.
Early-payment defaults reached 16 percent by December 2006.
The report said New Century had finally taken substantive steps to improve loan quality in late 2006, but that those measures proved too little too late.
New Century announced on March 8, 2007, that it had stopped accepting mortgage loan applications. The next day, company officials disclosed that New Century was the subject of a criminal investigation.
The New York Stock Exchange soon removed New Century from its listings while the company’s sources of capital demanded immediate payment on loans made to the company.
