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A Road Not Taken by Lenders
Gretchen Morgenson
April 6, 2008

WE’VE all heard a great deal in recent months about the greedy borrowers who caused the subprime mortgage calamity. Hordes of them duped unsuspecting lenders, don’t you know, by falsifying their incomes on loan documents. Now those loans are in default and the rapacious borrowers have moved on with their riches.

People who make these claims, with a straight face no less, overlook a crucial fact. Almost all mortgage applicants had to sign a document allowing lenders to verify their incomes with the Internal Revenue Service. At least 90 percent of borrowers had to sign, seal and deliver this form, known as a 4506T, industry experts say. This includes the so-called stated income mortgages, affectionately known as “liar loans.”

So while borrowers may have misrepresented their incomes, either on their own or at the urging of their mortgage brokers, lenders had the tools to identify these fibs before making the loans. All they had to do was ask the I.R.S. The fact that in most cases they apparently didn’t do so puts the lie to the idea that cagey borrowers duped unsuspecting lenders to secure on loans that are now — surprise! — failing.

Instead, lenders appear to be complicit in the rampant fibbery that is one of the root causes of our continuing mortgage nightmare.

Mike Summers, vice president for sales and marketing at Veri-tax Inc., in Tustin, Calif., knows plenty about this. His company handles the filing of these verification forms with the I.R.S. on behalf of lenders and loan originators. He began selling the service to lenders in 1999 and said he was surprised at the reaction he received — like that of a skunk at a garden party.

“In 2001, I was going around the subprime world trying to get them to sign up,” Mr. Summers recalled. “Ameriquest, and others I don’t want to name, just didn’t want to know because it would kill the deals. The attitude was don’t ask, don’t tell.”

Ameriquest, just to jog your memory, is now defunct.

Mr. Summers said Ameriquest and other prospective clients used lame reasons for turning him down. Submitting the forms was too costly, they said ($20 per loan, on average), or too time-consuming (the information came back to the lender in about one business day).

“It was greed on a few different levels,” Mr. Summers said. “I don’t think $20 to protect your interest in a $500,000 loan and weed out things that aren’t going to work is that big an investment.”

In 2006, the I.R.S. made it even easier for lenders to verify borrowers’ incomes by automating its systems, Mr. Summers said. The turnaround time under the new system fell significantly.

Still, the tool remained unused. When a customer signed up for Veri-tax’s service, it was typically to spot-check the quality of loans after they were made, Mr. Summers said.

“My estimate was between 3 and 5 percent of all the loans that were funded in 2006 were executed with a 4506,” Mr. Summers said. “They just turned a blind eye, saying, ‘Everything is going to be fine.’ ”

We know how well that turned out. Lenders still do not routinely check borrowers’ incomes with the I.R.S., Mr. Summers said. This seems odd, given how easy it is to hop onto the Internet and create documents that look like authentic W-2s or Form 1040s.

Indeed, according to a report on mortgage fraud released Thursday by the Financial Crimes Enforcement Network, a unit of the Treasury Department, only 31 percent of suspected fraud was detected before loan disbursements in the 12 months ended March 31, 2007. On stated income loans, only 19 percent of the cases of suspected fraud were detected before the loans were financed, versus 33.5 percent on more fully documented loans.

Yet 43 percent of the cases sampled in the study involved misrepresentation of income, assets or debts. The next-largest category was forged documents, totaling 28 percent of the sampled loans.

Mortgage brokers initiated the loans on 64 percent of the reports involving misrepresentation of income, assets or debt, the study said.

The study’s findings on the institutions that file suspicious-activity reports related to mortgages are also revealing. Banks, of course, file a vast majority of these reports. Securities firms, which packaged and sold billions of dollars in mortgage loans to investors and were certainly in a position to identify problems in them, filed almost none. They seemed to have little appetite for the job.

During the 12 months ended March 31, 2007, banks filed 41,000 reports on suspected mortgage fraud. By comparison, during the more than four years that ended May 1 of last year, 18 securities firms filed just 36 reports of suspicious activity.

THE degree to which mortgage lenders and Wall Street looked the other way on borrowers’ incomes, a sin of commission given the ease with which they could have been checked, raises an intriguing question.

Can investors stuck with losses on these loans sue to recover their investments based on this due-diligence failure? After all, mortgage originators made representations and warranties to investors that the quality of these loans was good when it clearly was not. And they made these representations knowing that they had not bothered to conduct quick and easy borrower-income checks.

“Investors hoping to put back the loans for deficient underwriting under reps and warranties would end up going back to the originators,” said Josh Rosner, an analyst at Graham Fisher & Company and an authority on mortgage-backed securities. “Given that many of these lenders are out of business, ultimately this could come back to the bank or investment bank.”

“The general view is this should not be talked about out loud,” Mr. Rosner added.

Wall Street will certainly battle forcefully against such lawsuits, if investors bring them. But its role as one of the great enablers in this mortgage debacle is something that even Wall Street can’t deny.

http://www.nytimes.com/2008/04/06/business/06gret.html?_r=1&ref=business&oref=slogin