The Secondary Market Overview: From bonds to production ... Fraud and the secondary markets
Today’s issue is fraud. Fraud affects the secondary markets in two very important ways: The existence of fraud is a valid reason to require a seller to repurchase a mortgage. This is commonly known as a “buyback.” The higher the prevalence of fraud within mortgages originated, the higher the risk of default of these mortgages, and thus, the lower the value of the commodities created and sold in the secondary markets. In other words, the more fraud in our industry, the higher rates will go.
The decline of the housing market was precipitated by many factors. Certainly one was the tightening of loose underwriting guidelines, which shut out many who wanted to qualify for loans. This continues today with Fannie Mae the latest to raise minimum scores and lower maximum debt-to-income (DTI) ratios.
High default rates, due to declining property values and poor credit quality of borrowers, also contributed to wider spreads between Treasury rates and mortgage rates. The “spread” is the difference between the rate on the 10-year Treasury and a par mortgage rate. This wider spread was entirely due to the increased risk of default for mortgages as opposed to Treasuries. As I mentioned in a previous article, the government has combated this increase by purchasing mortgages, which has created artificial demand. But the government purchase program must end sometime—most likely in the first quarter of next year. If default rates have not improved by the time the Fed exits the market, the spreads will return in the form of higher rates.
I, for one, expected fraud levels to decline as underwriting standards tightened. During the real estate boom, the most prevalent forms of fraud included falsifying 1003s with regard to the income on stated loans (we even called them “liar loans”) and claiming that investment properties were going to be occupied by the purchasers. But with tighter standards and with stated loans going away, shouldn’t the incidence of fraud decline greatly?
That is logical. But there are several factors working against this logic right now:
►Increased enforcement efforts by the government is causing more fraud to be uncovered than ever. This does not mean that fraud is increasing, but our knowledge of this fraud is increasing. Thus we see stats of increased fraud being released by the Federal Bureau of Investigations (FBI). These stats influence those who are looking to purchase mortgages as an investment.
►People are more desperate right now. If you are about to lose your home, you will do just about anything to save it—including lying, cheating or stealing to get a loan.
►There are opportunities to make money. Just as people saw opportunities to flip houses during the heyday, today, foreclosures are attracting investors who see the opportunity to make a quick buck. And any time there is that “get rich quick” mentality attached to real estate, it represents a bad combination.
Here is the problem, if we don’t all band together to fight this fraud, we will be paying a long term price in terms of tighter guidelines and higher rates in the secondary markets. For decades through my books, such as The Book of Home Finance, I have been teaching concepts such as the long-term value of owning real estate instead of over-leveraging and getting rich quick. And I have been teaching ethics in lending. Our Certified Mortgage Advisor course has always had a segment on ethics and our CMA’s are all provided with an ethics policy to which they must adhere (www.webinars.originationpro.com). This is one reason that our partner RateLink has started offering the program to their subscribers. As the secondary marketing experts, they understand the connection between doing things right and the long-term benefit to all of us.
But this is not enough. We must become proactive. It is time we stopped looking the other way. For every individual who benefits from a fraudulent action, the populace as a whole must pay a price. Think of the industry as all living on a river and make our living off the river. If one person throws their garbage into the river, no big deal. But if a bunch of people do it—our living goes away. It is incumbent upon all of use to make sure that this does not happen.
Dave Hershman is a leading author for the mortgage industry with eight books and several hundred articles to his credit. He is also head of OriginationPro Mortgage School and a top industry speaker. Dave’s Certified Mortgage Advisor Program can be found at www.webinars.originationpro.com. If you would like to stay ahead of what is happening in the markets, visit ratelink.originationpro.com for a free trial or e-mail email@example.com.
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