Sunday, December 9, 2007

The mortgage crisis, part 2 - Fraud

I already talked about how the Fed is thinking about lowering interest rates Tuesday to help the markets out during this credit crunch brought on by the mortgage lenders. GMB over at I can't believe it's not a democracy! pointed me to this article in the San Fransisco Chronicle about possible reasons for the new "freeze" being proposed. In it the author proposes that the agreement was agreed on to give the mortgage industry time to hide the fraud that is one of the root causes of this problem. I can only speak anecdotally about the subject, but I don't believe the fraud was as rampant as the reporter is claiming.

Don't get me wrong. There was a large amount of fraud happening. Everything from appraisers being paid to give good assessments to websites offering to sell you a paycheck stub (halfway down the page) to inflate your income. There was also the slightly more creative fraud in how these mortgages were presented to the borrowers - "Oh, don't worry about the balloon rate, by the time that kicks in you could sell your house and move in to one twice as big." (never mind the fact that the rate jumps just six months after you sign the paperwork...) However I don't believe, as the article's author said "I assure you it was a minority of borrowers whose loans didn't involve fraud."

Nothing was ever presented to us that would lead me to believe there was any fraud in our house purchase twelve months ago. Our income was just enough to afford this house (although we were told we could technically, according to their math, afford one 10% more expensive, which is shifty salesmanship and probably where a lot of borrowers were mislead), but we never caught wind that there might be a way to "boost" our income. It also just happened that the year after we bought our house it was due for a county re-assessment, and while our lender's assessment was higher than the county assessment (by about 5%) it was not significant and the county assessment was almost exactly what we paid.

Like I said though, this is all anecdotal and just one family's experience in the relatively stable mid-west. Your mileage may vary. I don't think though, that this rate freeze would work as a panacea to escape the fraud issue. There are a few issues that the article brought up, but didn't point out all the implications. First, and this was not brought up, much of the sub-prime lending was done through mortgage brokers and other third party institutions, which is where most of this fraud would have taken place. These people find the borrowers (often through agreements with real-estate agents), sucker them in with promises like what I described above, and then within days of closing on the mortgage sell it to a bank or other large institution, and never worry about it again. These people, currently, are getting off scott free, except for the fact that their business is drying up. Don't get me wrong, not all of them were bad. In fact, the one we finally went through was very helpful and upfront with us, and not pushy about how much to borrow.

The other problem is that these mortgages are only having their rates frozen, and just for five years. I don't know for sure about most of you, but my wages haven't increased significantly (outside of getting a new job) in the last five years, and according to the government, average wages for working class Americans has barely kept pace with inflation. This means that the five year freeze is just a gamble that the same thing won't happen again then, or maybe not a gamble, maybe Bush just doesn't want this to be as easy to stick to him...

Related to that is the fact that house values aren't likely, as of now, to appreciate significantly over this time frame either. Houses still aren't getting sold now, and people are still finding it harder to get financing to buy houses. It's so bad for one seller near me that they are advertising the price on the for sale sign. And like I said before, a drop in rates won't help most buyers because the banks are still more wary about lending.

He also, in the article, mentions that the FHA is being brought in to help some borrowers (the ones that won't get the freeze) to refinance. He says this is so that "[t]hey could say, 'Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!'" The problem though is that these borrowers would need to get approved for this new financing. This just won't happen in most of these cases as their houses clearly aren't worth as much now as when they bought it, even six months previously, and many won't be able to afford a standard FHA rate, which is why they got the ARM in the first place.

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