Finding the Culprits of Mortgage Fraud

Who can we blame for the U.S. mortgage crisis and financial industry meltdown? Mortgage brokers, investors, or corporate executives? Or is it the regulators, who are just now going after the crooks?

"Call them slobs. Call them jerks. Call them gross...Just don't call them when you're in trouble." The tagline about the future men in blue from the 1984 comedy film Police Academy expresses what some taxpayers are currently feeling about mortgage regulators. As the mortgage crisis drags on, many are demanding that regulators root out the troublemakers who started this mess in the first place. Those regulators might finally be listening.

Stalking the mortgage meltdown

The Federal Bureau of Investigation has ramped up efforts to track down mortgage fraud. In a hearing before the Senate Judiciary Committee, the FBI Director said that his agency had already opened up dozens of corporate investigations related to the mortgage meltdown. Subsequent reports indicate that the FBI is already looking specifically at Freddie Mac, Fannie Mae, Lehman Brothers, Countrywide, and AIG.

The SEC is also pursuing several investigations related to subprime mortgage securities and credit default swaps. The latter are contracts in which one party exchanges a series of payments for a guaranteed payoff in the event that a specified credit instrument defaults.  Such swaps can provide protection against defaults, but have also been used for speculation. The collapse of AIG had its roots in credit default swaps-at the end of the second quarter of this year, the company took a whopping $5.6 billion markdown on the swaps it wrote on mortgage-related securities.

Forms of mortgage fraud

Analysts believe that the journey to uncover the crisis culprits will take the FBI and SEC through the entire mortgage food chain, from unscrupulous brokers to highly paid executives. Mortgage fraud can include activities such as:

• Knowingly underwriting mortgages to borrowers who couldn't afford them

• Encouraging borrowers to lie on their loan applications

• Packaging mortgage loans into securities and selling them without adequately describing the risks

• Purchasing excessive amounts of mortgage-related securities and holding them on the books of a publicly held company

According to the Mortgage Asset Research Institute, incidents of lender and broker mortgage fraud ran high in 2007 and continued into the early part of this year. It's widely believed that unchecked fraud greatly contributed to the mortgage crisis. Both the FBI and SEC are also investigating whether illegal stock market manipulation played a role in the financial industry crisis that prompted the feds to propose the recent $700 billion financial bailout.

Taxpayers will foot the bill for this bailout, and they want answers. Regulators have admitted a lack of oversight in the past, citing insufficient resources as the cause. Now that the crisis has spread far beyond initial expectations, mortgage oversight has become a priority. It will be interesting to see how the current investigations proceed, and what types of punishments will be imposed. Regulators can redeem themselves in taxpayers' eyes only by taking swift and fierce action against the guilty parties.