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While no industry is immune to fraud, few have as many vulnerabilities for fraudsters to exploit as the mortgage lending industry. In addition to the inherent risk associated with lending large sums of money, the mortgage industry involves numerous individuals (e.g., brokers, lenders, appraisers, underwriters, accountants, real estate agents, loan originators, settlement attorneys, land developers, real estate investors, etc.) who have a high level of access to financial documents, software and systems, confidential data and licensure information. These various access points are vulnerable to wrongdoers bent on committing fraud. Time and again, perpetrators have demonstrated their aptitude for eluding legislation and regulations by modifying existing schemes or devising new schemes to exploit loopholes. As the Great Recession showed us, much rides on the health and stability of the mortgage industry; it is therefore imperative that the industry takes the measures necessary to protect itself—and the consumers it serves—against fraud.
My personal experience with mortgage fraud began in 1990 when I joined the newly created Resolution Trust Corporation, Office of Investigations, an off-shoot of the Federal Deposit Insurance Corporation (FDIC), which was created to address the savings and loan (S&L) crisis. Criminal and civil fraud cases were brought against such fraudsters as Charles Keating, Lincoln Savings and Loan, Phoenix, Ariz.; David Paul of Centrust S&L, Miami, Fla.; and Michael Milken, the junk bond king, New York, N.Y.
Like many others, I thought we had learned our lesson and that a crisis such as the S&L debacle could not—or would not—occur again because the federal regulatory agencies could not—and would not—allow it to happen.
Fast-forward to the 2000s, the inflation of the housing bubble, and the subsequent bursting of that bubble. The 2008 bailout added fuel to the fire by angering taxpayers, who, in turn, demanded stricter oversight of the financial services industry. The government responded with legislation such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, which aims, in part, to stem fraudulent behavior by enhancing the transparency and accountability of the financial services sector.
From 2001 to 2010, I served as the Inspector General for the U.S. Department of Housing & Urban Development (HUD). This position included oversight of the Federal Housing Administration (FHA) and Office of Federal Housing Enforcement and Oversight (OFHEO). OFHEO had oversight of the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. During my tenure, we identified, investigated and prosecuted appraisers, settlement agents, mortgage brokers, and any other actors who perpetrated mortgage fraud. From my vantage point, a number of trends emerged that created an environment in which fraud schemes flourished:
►Lenders with high rates of defaults lacked strong quality-control platforms. Such lenders focused more on loan volume than on evaluating the risk of those loans defaulting due to the financial instability and other risk factors of the parties involved in the transactions.
►Some lenders lacked adequate processes for performing due diligence and ongoing monitoring of third parties.
►Policy-makers and regulatory agencies approved and encouraged no-documentation and low-documentation loan programs, which compromised loan-quality assurance.
The S&L crisis of the 1990s and the mortgage crisis of the 2000s serve as cautionary tales that fraud schemes are resilient and easily adapt to fluctuations in the economy and changes in lending policies. The continued sluggish housing market is proving to be an attractive environment for mortgage fraud perpetrators who are devising new schemes to exploit gaps in the mortgage lending market. According to the CoreLogic Mortgage Fraud Report, mortgage fraud has risen 3.2 percent in the last year. For the 12 months ending the second quarter of 2014, the report estimates the total value of applications with fraud or serious misrepresentations at $19.8 billion1. The cycle of fraud needs to be stemmed for the sake of the industry, the consumers it serves, and the economy as a whole.
Over the past few years, I have spoken at several mortgage lending industry events. Each time, I have emphasized the need for lenders to continue to enhance their risk management practices, including performing due diligence before contracting with third-party service providers and carrying out ongoing monitoring of the vendors thereafter. Service providers who are unknowledgeable regarding consumer financial protection laws or have weak internal controls pose a threat to consumers—and therefore, the lenders, as they are accountable for managing vendor relationships. Whether it is appraisers, settlement agents, mortgage brokers, firms that conduct loan-level quality control reviews, or anyone else, lenders must take action to monitor the integrity of vendors and act so that they can demonstrate that they have adequate policies and procedures in place.
Reinforcing the call for more robust fraud mitigation, the Consumer Financial Protection Bureau (CFPB) released Bulletin 2012-03 in April 2013. The Bulletin articulates the Bureau’s expectation that CFPB-supervised institutions (i.e., large banks, mortgage lenders or servicers, student lenders, payday lenders, large debt collectors, or debt buyers) have an effective process for managing the risks of service provider relationships and may be held responsible for the actions of companies with which they contract. The bulletin makes it clear that the CFPB would take a close look at service providers’ interactions with consumers, and would hold all appropriate companies accountable when legal violations occur. In the Bulletin, the Bureau recommends that supervised financial institutions take steps to ensure that business arrangements with service providers do not present unwarranted risks to consumers. Steps include:
1. Conducting thorough due diligence
2. Requesting and reviewing policies, procedures, internal controls and training materials
3. Making sure contracts with service providers include clear expectations about compliance and appropriate and enforceable consequences for violations
4. Establishing internal controls and ongoing monitoring
5. Taking prompt action to address any problem identified through the monitoring process
Another consideration for lenders is the protection of confidential data. The recent well-publicized cybersecurity breaches experienced in other industries, most notably retail (i.e., Home Depot and Target), serve as stark reminders of the need to be ever-vigilant with regard to data protection. In this light, performing thorough due diligence and ongoing monitoring are of paramount importance given the fact that mortgage banking employees and vendors have access to enormous amounts of privileged information of their applicants. These professionals have the ability to cause significant harm to a borrower; therefore, consumers deserve an expectation that whatever information they provide is handled safely and securely. In the mortgage process, the consumer is at a great disadvantage dealing with a complex transaction involving many moving parts, voluminous documentation, and many different parties managing the transaction for them. Consequently, lenders and vendors must place the rights and expectations of consumers first. Lenders must be in the position to pull the plug on relationships and even stop loans from closing if they suspect wrongdoing. The CFPB has made it clear that lenders are responsible for ensuring that their relationships with service providers do not pose unwarranted risk to consumers and will be held accountable for mismanaging vendor relationships.
Finally, I do not propose that fraud management and third-party monitoring are the sole challenges for this industry to once again gain its critical footprint. I do, however, believe that lenders need to address these issues, be sensitive to consumer expectations, and manage their relationships with vendors accordingly.
The Honorable Kenneth M. Donohue is a director and senior advisor with CohnReznick Advisory Group–Government Services. He can be reached by phone at (301) 280-6460 or e-mail [email protected].