How Did the Banks Get Away With Pledging Mortgages to Multiple Buyers?
a mortgage sold to two different entities, wouldn't the income
from the mortgage be shown on the books of both entities?
the interest/principal payments that were made by the homeowner
before they stopped being divided between both entities? If so,
wouldn't this have rung alarm bells immediately?
- If only one was getting it, why didn't the other entity immediately try to foreclose?
there was one servicer involved, was the servicer covering the
difference between what was collected and the payments actually
made? If so, how did the servicer do this and still remain in
- If two servicers were involved, why didn't this come out sooner or were both servicers hiding this fraud?
I wrote to some of the leading experts on mortgage fraud - L. Randall
Wray (economics professor), Christopher Whalen (banking expert with
Institutional Risk Analytics), and William K. Black (professor of
economics and law, and the senior regulator during the S & L crisis)
- to seek their insight.
Chris Whalen told me:
good points, but the short answer is that nobody may have noticed until
now. The issue of substitution and other games played by servicers
makes exact tracking of loans problematic. It should show up in the
servicers reports and should be caught, but there are a lot of things
that go on in loan servicing that nobody talks about. Until about 2006,
the GSEs and banks would advance cash and would substitute, but not
now. The noble practitioners you heard from are all sincere and want to
believe in intelligent design.
to FAS [i.e. Financial Accounting Standards] 166/167, a defaulted loan
might sit in a FNM/FRE pool for up to a year before the default was
removed from the trust. The issuer would then place a new loan into the
pool or “substitute” for the old loan. No purchase event was booked.
The investor would never know. In fact, the issuer would keep paying
interest on the original principal amount in those days. Now under FAS
166/167, the issuer must immediately repurchase the defaulted loan and
take the loss less estimated recovery. That is why the pace picked up
this year when it comes to repurchase demands.
You should refer
your dubious and very naive friends to the case of National Bank of
Keystone, WV. One of the worst failures per $ of assets in FDIC
history. The management hid a Ponzi scheme in the loan servicing area
for five years. Paid interest to investors with their own principal.
Two auditors missed the fraud and later were sued by the FDIC acting as
receiver for the dead bank. And this was a small operation. The big
five are an even worse mess. Remember, when the seller of a loan and
the servicer are the same, anything can happen. And it usually does.
Professor Black told me:
pledges (as they're typically called, though one could pledge multiple
times) are a well known fraud device. It is correct that one of the key
purposes of adopting Article 9 of the Uniform Commercial Code (UCC) was
to reduce the risk and frequency of this form of fraud. So, double
pledges in the modern era require both (A) fraud (on the part of the
borrower or purchaser) and incompetence, indifference, or corruption on
the part of the original secured lender or their agents if the borrower
is the fraudster or the purchasers if they are the fraudsters.
two potential sources of fraud: A fraudulent borrower could pledge the
same home as security for multiple mortgage loans. Title checks, by
the lender/title insurer are so easy to conduct and so vital to protect
the lender that this form of fraud is vanishingly rare. Alternatively,
and far more likely, the lender could sell the mortgage to multiple
buyers. Those buyers could have far lower incentives to check on prior
pledges and less ability to check for prior pledges. The entity selling
a loan to multiple parties (A) has a compelling incentive to hide the
prior pledge(s), (B) is financially sophisticated, and
capable of deception than a homeowner, and (C) can pick who to make the
multiple sales to -- allowing them to select the most vulnerable
targets for fraud.
Subpart (C) provides the logical transition to
the second requisite for multiple pledge frauds -- vulnerable victims.
The characteristics they would exhibit include (A) growing massively,
(B) purchasing nonprime loans without fully underwriting the quality of
the loans (and quality in this context inherently requires superb
"paperwork"), (C) poor internal and external controls, and (D) opaque
systems that make it extremely difficult to determine the beneficial
owner and locate key mortgage documents that would reveal multiple
sales. Unfortunately, these four characteristics were characteristic
of many purchasers of nonprime mortgages. That is why I have long
stated that the process was dominated by the financial sector equivalent
of "don't ask; don't tell."
Bottom line: the elite bankers and the anti-regulators have been so unwilling to
find the truth that no one knows how bad these frauds became. Finding the facts
is essential and can and should be done by reviewing samples of the loans pledged or sold to Fannie and Freddie and the Fed.
And professor Wray told me that record-keeping by servicers was terrible, and pointed me to the following article from the Tampa Tribune:
Bakowski, a 58-year-old former Tampa mortgage broker, has admitted
orchestrating a Ponzi scheme that involved more than 30 investors and
institutions and more than 150 deals, documents show.
Bakowski sold the mortgage assignments to multiple investors, promising high rates of return and using all the money he generated to "keep the scheme afloat," according to his plea agreement.