Tuesday, January 15, 2008

Fraudulent Borrowing

Tyler Cowen:
There has been plenty of talk about “predatory lending,” but “predatory borrowing” may have been the bigger problem. As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default.

Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers. Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation of income and assets. As long as housing prices kept rising, it didn’t seem to matter.

In other words, many of the people now losing their homes committed fraud. And when a mortgage goes into default in its first year, the chance is high that there was fraud in the initial application, especially because unemployment in general has been low during the last two years.
This is interesting. If the President and Congress are going to look for policy responses to mortgage defaults, then shouldn't this be a big part of the policy discussion? In cases of borrower fraud, it seems to me that the mortgage contracts themselves probably suggest what government's role in the default should be, which is to enforce the contract's provision with respect to default. There wouldn't seem to me very solid normative grounds to have government "bail out" the borrower who had committed fraud in securing the mortgage.


Anonymous said...

Good point, and fraud with respect to borrowers should be treated as you suggest. But there is still the question about enforcing the rules on lending so lenders can't "look the other way" and not get the documentation they should.
Helping individuals and families get into a home of their own is a positive objective; doing it by encouraging unqualified or poorly qualified individuals get a mortgage that is not affordable to them doesn't do either them or the industry any good. And yet the bail out is--in part--doing just that.

Larry Eubanks said...

I don't think I understand the part about using force so lenders can't look the other way. The lenders are taking risk when they loan money. Why would they want to look the other way? Is it because there is a promise, or perhaps just an expectation, that government will use it's power to "bail" them out? If so, then perhaps "looking the other way isn't an accurate description of the situation. Perhaps because of government lenders perceive otherwise risky borrowers as less risky.

Anonymous said...

The government's potential to "bail" them out may be why they looked the other way. Quoting from the article, "Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation of income and assets."
I wasn't suggesting, though, that it was only or exclusively the government using "force" to enforce the rules. Surely there are standards in the lending industry that require certain documentation--the provision of which didn't occur in some cases, leading to issues on both sides of the loan.
Tyler Cowen didn't say what he thought was the reason a lender would look the other way, and your explanation may be correct. Yet, Lenders were taking the chance that their own industry might be unhappy with them, and government wouldn't bail them out, and they still went ahead. Interesting to consider what the incentives to do that were. My suggestion was that perhaps enforcement or adherence to the rules that are/were in place might have prevented some of the loans. Why was there no assurance that such enforcement was forthcoming?

Anonymous said...

Additionally, once the lenders weren't enforcing or using the guidelines, the message that borrowers received was that they could come for loans without the documentation that was needed before. Thus, individual borrowers who might have an interest in predatory borrowing had an opportunity to do so. And others, non-predatory, also got the message that a loan was easier to get than before.