Should the Fox Be Guarding the Henhouse?
by Charlie Elliott, Jr., MAI, SRA

In this era of pressure to meet goals and financial objectives, it behooves each of us to back away and focus on any role in which we may have in the increasing mortgage fraud trend. It tears at the very fabric of our profession and, to the extent that it exists, our livelihood and perhaps freedom is at risk.

In some cases fraud has become so commonplace that many of its participants consider it the standard, rather than the exception in doing mortgage business. The bounds of ethics have been and are often being stretched to the point where variances, which might have been previously considered blatant violations of the law and ethics, are now considered immaterial by some.

What is mortgage fraud? When we were taking business law in college, our text defined fraud simply as “the misrepresentation of a material fact.” Black’s Law Dictionary defines fraud as “an intentional perversion of truth for the purpose of inducing another in reliance upon it to part with some valuable thing belonging to him or to surrender a legal right.” While these two definitions differ somewhat and while neither speak directly to loan fraud, most of us with reasonable intelligence will concur that fraud occurs in our business.

Is it a big problem? Yes. Recently the FBI reported that mortgage fraud complaints more than doubled in 2004, reaching 17,127 as compared to 6,936 the previous year. The mortgage fraud problem is so prevalent that the Mortgage Bankers Association saw fit to devote a new Web site, stopmortgagefraud.com, exclusively to the industry wide problem. The FBI reports that suspicious mortgage activities during 2004 involved $400 million in related losses.

How does mortgage fraud manifest itself? Is it mostly blatant, such as the case where two or more people conspire to take the entire proceeds of a loan without paying off the previous loan? This type of fraud usually requires the cooperation of participants, such as loan officers, attorneys, Realtors and appraisers. Or, is it the more subtle type of fraud, where very little concrete collaboration occurs or is traceable? This is the type of fraud, which occurs when an appraiser appraises a property for more than it is worth, in an attempt to allow the client ordering the appraisal to make a loan, which would otherwise be a rejected, and collect a commission on a property. This may happen with little or no direct discussion between the lender and appraiser for a particular transaction. It is likely based upon understandings from previous transactions that could best be defined as code. No smoking guns here, simply phrases like, “We need $200,000 on this on this one to make it fly,” and “Our previous appraiser just didn’t understand this market.” While most may not, in an attempt to receive a fee, some appraisers will illegally capitulate. The answer to both of the above is yes. Both are occurring right here before our eyes and, yes, we all have a responsibility to do our part as professionals to prevent such activities where we can.

In the past, some of us may have found ourselves an unwitting participant in fraud. This could have occurred when we had no idea that it was going on. Or we may have had our questions, but figured it best to let sleeping dogs lie. Many involved in fraud are willing participants. Some may be in self-denial, some not. Whatever the case, mortgage fraud is an insidious cancer that affects our industry. This cancer is not always easy to detect, and its effects are not always transparent.

What is being done to prevent loan fraud?

• On October 27, 2003, the Office of Comptroller of the Currency along with four other federal regulators sent a statement to all of the 12,000 plus regulated financial institutions, clarifying existing regulations entitled, Independent Appraisal and Evaluation Functions. This statement provided, among other things, that appraisers must be selected by parties not having an interest in the loan transaction, including borrowers. It made exceptions for small institutions and did not cover mortgage brokers.
   

• On March 15, 2005, Bill HR 1295 entitled, The Responsible Lending Act, was introduced to the U .S. House of Representatives. This bill requires, among other things, the physical inspection by appraisers of certain properties that lend themselves to flipping, improves appraiser licensing standards, creates new standards to abate appraiser intimidation, establishes minimum state licensing standards for mortgage brokers and provides for the establishment of a national mortgage lender database.

What else must be done? While the actions stated above are positive steps toward addressing the problem, they do not go far enough. The issue of mortgage fraud is treated by many as a necessary evil of the industry, which we all must accept and that none of us can help prevent.

I beg to differ on this last concept. Mortgage fraud, for the most part cannot exist without the knowledge and permission of those mortgage loan professionals among us, including appraisers, lenders, Realtors and government regulators. As a whole we have an outstanding group of mortgage professionals in all disciplines. There are a few rotten apples, which cause the basket to reek with a very foul smell. The foul fruit must be purged from the container, so as not to spoil the pure. It is an insidious threat to our society in much the same way as are violent gangs and illegal drugs.

Two things must happen before it is to be held in check. Those of us in the profession must hold each other accountable in a supportive and constructive way. While there will be those among us who must be incarcerated as punishment for their actions, the prisons are not large enough to hold all that may break the letter of the law if left unsupervised. We have a responsibility to direct our colleagues and police our own industry in an effort to prevent fraud.

Our government regulators have a responsibility to develop a better playing field, which does not lend itself to the temptation to commit fraud. Our lawmakers and government agencies must develop stronger policies to further separate the functions of appraiser selection and communication from that of those individuals obtaining sales commissions from the successful closing of a mortgage transaction.

Foxes do not make good henhouse guarders.