Bankruptcy

Mortgage Fraud Prosecutions

By Adam Levitin

Joe Nocera's Talking Business column today relates a very disturbing government prosecution of mortgage fraud. Read it. It's a very troubling story.

I have not looked at any of the documents from the case and am forming my opinions solely from Nocera's reporting.  As described, however, the convicted Mr. Engle is hardly a saint, whatever one believes about the disputed facts--he clearly knew that he was benefiting from a liar loan, whether or not he actually lied. But the entrapment by the IRS that Nocera describes is deeply disturbing, especially given the lack of prosecutions of financial executives and when paired with this other NYT article about GE not paying any taxes. Then again we've got a Treasury Secretary who wasn't paying his taxes. Hmmm. No prosecution there. I continue to be puzzled why the National Mall isn't turning into Tahrir Square and why there aren't riots in Phoenix and Las Vegas and other foreclosure hotbeds. 

I'm also puzzled how what Nocera describes could have been fraud, even assuming that Mr. Engle did state his income at $32,500/month. Common law fraud requires not just the intentional making of a material misrepresentation with the aim that the other party rely on it, but reasonable reliance by the other party. (Maybe the prosecution was under some special mortgage fraud statute with different elements.)

Did Countrywide actually rely on the stated income? Weren't they just lending against his FICO and property value? Do we really think that Countrywide wouldn't have made Mr. Engle a loan if he had lower income? Given that he could have lost his job the next day, etc. I think there's a good chance they would have done so regardless. Certainly during the housing bubble everybody knew what was going on and no one was really relying on stated income. Countrywide was as much part of the fraud as any of the borrowers--the patsies were the MBS investors.

Even if Countrywide did rely on the stated income, was such reliance reasonable? Is it ever reasonable for a lender to rely on a stated income loan? Congress doesn't think so. The Credit CARD Act seemed to require verification of ability to repay. The Fed gutted this requirement in its rulemaking by permitting lenders to underwrite via models, among other things. And section 1411 the Dodd-Frank Act requires income verification for mortgage loans (with an important safe-harbor in section 1412 for still-to-be-defined "qualified mortgages"--we'll see what magic the Fed works there...). I remained perplexed by this prosecution, but there might be more to this case than we know. 

Full post as published by Credit Slips on March 25, 2011 (boomark / email).