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The Tragic Dance of Mortgage Lenders and Borrowers

Richard Warren
2 min read

 

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Hoisted by their own petard!
  This 16th century expression is an apt description of what happened to both lenders and borrowers in the recent mortgage meltdown and burst real estate bubble.  A petard was a crude explosive device used in medeival times to breach castle walls and doors.  These bombs would frequently blow up prematurely resulting in the maiming or killing of the individuals attempting to use them.  The expression, to be hoisted by one’s own petard, came to mean that you were done in by a scheme of your own creation.

The Borrowers

Investors, in trying to out-smart the system, took advantage of liar loans, interest-only mortgages, Pay Option ARMs, and other creative funding devices to acquire property that they couldn’t afford.   They assumed, incorrectly it turns out, that real estate prices would escalate for a long time to come.  They would acquire investment properties and wait for the inevitable appreciation.  When appreciation occurred they would refinance the property for the maximum amount possible in order to buy additional properties.  Lather, rinse, repeat.  Some investors were able to acquire a large amount of property in this manner.

Using 20-20 hindsight, we know that this couldn’t continue forever.  Eventually the music stopped and investors were collectively stuck with large amounts of property, yet had little or no equity.  The greed that was driving them had blinded them to the enormous risk that they were taking.  Now we have a rash of foreclosures and a real estate market that will never be the same.

The Lenders

While the borrowers are certainly responsible for their own actions, they could not have done it without the lenders.  Lenders large and small were looking to cash in on the real estate craze.  With an eye on short-term profits, rather than long-term implications, they relaxed lending standards, created a host of new products, and essentially focused on making loans to anyone.  They were looking for ways to give away money without regard to a borrower’s ability to repay.

It had become a feeding frenzy of easy money.  Inexperienced loan officers were handing money to novice investors.  It was a case of the blind leading the blind and the inmates running the asylum.  The level of insanity had reached epic proportions, yet there was no call to end the madness.  There was so much money being made and no one wanted to party to end.

The Cleanup Begins

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On June 19, 2008 the FBI announced that it had made more than 400 arrests since March 2008 for mortgage related fraud.  There were big names related to the Bear Sterns debacle as well as smaller players in various schemes.  Some cases were pretty obvious scams involving straw buyers and inflated appraisals to defraud lenders, the FBI called these instances “fraud for profit.”  However there is an interesting twist that should be making a lot of people nervous.  They will also be targeting those who committed “fraud for housing.”  This latter class would include those who misstated the facts on mortgage loan applications as well as loan officers, real estate agents, and appraisers who helped unqualified buyers obtain mortgages to purchase homes.

The FBI has stated that this is just the beginning.  They are currently investigating at least 19 companies for crimes related to mortgage fraud.  As of May 31st they have more than 1400 possible cases of mortgage fraud under investigation.  With mortgage related losses estimated to be in excess of $1 trillion worldwide, this is not something that can just be swept under the rug.

This is a quote from FBI Director Robert Mueller: “To Persons who are involved in such schemes, we will find you.  You will be investigated, and you will be prosecuted… engaging in such schemes, you will spend time in jail.  That is the message we’re sending out.”

That is one huge petard!

Things gained through unjust fraud are never secure. – Sophocles

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.