Worst Still To Come In Lending Crisis

From the bloggernewsnet:

The FBI just released an interesting report showing fraud trends that contributed to the current financial crisis the housing boom has caused. It’s key findings were that mortgage fraud is on the rise, subprime loans contributed to mortgage fraud, the downward trend in housing will continue and that the current financial crisis is creating a new wave of fraud targeting the people, who have already lost their shirts, as as result of this crisis.

From the press release on this subject:

The latest mortgage scams run the gamut: from “builder-bailout” schemes where developers unload excess inventory through financial trickery…to foreclosure rescue frauds that trick homeowners into signing over the deed to their house; from seller-assistance scams that use false appraisals to sell homes…to identity theft that leads to home equity credit lines being opened and drained. See the report for more details.

The report lists the two main categories of mortgage fraud:

Mortgage loan fraud is divided into two categories: fraud for property and fraud for profit.

Fraud for property/housing entails misrepresentations by the applicant for the purpose of purchasing a property for a primary residence. This scheme usually involves a single loan. Although applicants may embellish income and conceal debt, their intent is to repay the loan.

Fraud for profit, however, often involves multiple loans and elaborate schemes perpetrated to gain illicit proceeds from property sales. It is this second category that is of most concern to law enforcement and the mortgage industry. Gross misrepresentations concerning appraisals and loan documents are common in fraud for profit schemes and participants are frequently paid for their participation.

The full report, which goes into a lot of detail on current trends can be seen, here.

Besides the latest report, the FBI has a page on their website dedicated to educating the average person how they might be taken to the cleaners as a result of mortgage fraud.

The page has information on a lot of the recently discovered schemes. Included is a well-written story about a pretty scary phenomenon called, “house stealing.”

House stealing is where mortgage fraud meets identity theft.

… The con artists start by picking out a house to steal—say, YOURS. … Next, they assume your identity—getting a hold of your name and personal information (easy enough to do off the Internet) and using that to create fake IDs, social security cards, etc. … Then, they go to an office supply store and purchase forms that transfer property. … After forging your signature and using the fake IDs, they file these deeds with the proper authorities, and lo and behold, your house is now THEIRS.*

Although not considered common, there was a recent case in Southern California involving a variation of this scheme and it involved over 100 homeowners. More recently, the Boston Globe reported that 11 individuals were indicted in a $10.6 million loan fraud scam. Straw buyers and identity theft are part of the formula in this case, also.

And it doesn’t only happen in the United States, I’ve read of this occurring in Canada, also.

The FBI has allocated 200 agents and 33 task forces to investigate mortgage fraud, according to an article in Reuters that quoted FBI Director Robert Mueller. The article mentioned that 19 major corporations are under investigation and Mueller referred to the FBI’s involvement in investigating the Saving and Loan crisis, Enron and World.com, while delivering his speech.

If you happen to get approached with an offer that seems a little too good to be true (or are suspicious of a past scheme) you can report the matter to the FBI. The people behind these schemes have caused a lot of pain and suffering for a lot of people and besides that, if you pay taxes, you are probably paying for this problem.

From moneymorning.com:

Oppenheimer & Co. (OPY) analyst Meredith Whitney’s reputation has soared like a skyrocket since she made her bearish – but highly prescient – call on the banking sector, including Citigroup Inc. (C), as Money Morning reported last fall.

Now she’s back. And her outlook for the financial sector is actually worse. Whitney is now predicting that the banking-sector’s financial crisis will extend well into next year. If not beyond.

And that’s not even the bad news.

Whitney now says the worst may be yet to come. The banking-sector financial crisis will last at least until the end of next year, and may actually stretch well past that. And that could lead to a major U.S. downturn.

"We believe the credit crisis is far from over," Whitney wrote in a research report last week. "In fact, we believe what lies ahead will be worse than what is behind us."

The so-called "first wave" of the credit crisis hit banks’ trading books. But the second lightning strike will hit lenders where it hurts the most – right in their lending businesses. If she’s right, the impact on the economy will be devastating.

Here’s why. The banking system’s "originate-to-distribute" model changed the rules of the game. No longer did banks make loans that were based on very careful risk-of-loss analyses. Under the new system, banks make loans – such as subprime mortgages – which are then "securitized," or packaged together, into debt instruments that the trading operations of banks, investment banks or institutional investors might then purchase, believing it was a way of achieving higher returns.

Initially, this led to higher profits. Which induced banks to boost lending so that they could boost securitizations. But here’s the problem. First, since the banks were no longer going to keep the loans, they relaxed lending standards. In fact, they actually had to since, second, they wanted to boost those volumes.

When the underlying loans unraveled as the subprime-mortgage crisis spiraled deeper and deeper out of control, companies such as The Bear Stearns Cos. Inc. (BSC) took losses that just kept growing. Bear Stearns is now being taken over by JPMorgan Chase & Co. (JPM), with the help of the U.S. Federal Reserve.

The sins weren’t limited to banks, however. Consumers stoked this credit inferno – and, in doing so, unknowingly created their own funeral pyre.
Consumers grew accustomed to the "rolling loan gathers no loss" mindset, Whitney says. Housing values were soaring, and as long as those values continued to rise, homeowners could continue to roll over their loans into new borrowings – often packing in a lot of ancillary consumer debt from credit cards or car payments long the way.

When the housing market collapsed, however, homes were no longer a real-estate-version of an automated teller machine (ATM) that consumers could turn to each time they needed to eradicate debt from car loans, home loans or even credit-card debt.

When banks stopped lending, consumers had nowhere to turn to roll over their loans. Making matters worse were two other factors:

• First, many of their loans had so-called "re-set" provisions that permitted the loans to reset at much higher interest rates – a fact that caused the overall monthly mortgage payments to increase, sometimes by as much as 40% or more. And since their incomes weren’t rising in kind, many consumers could no longer make these payments, and defaulted on their mortgages.
• Second, the downturn in the housing market sent home prices into a severe tailspin, in some cases leaving homeowners with mortgage balances that were much larger than the new (lower) market value of their home. And if the mortgage loan also reset, that homeowner was hit with a double-whammy blow – a boosted mortgage payment on a house whose value had plunged.

Those resets have caused foreclosures to soar, the news is going to get lots worse, real estate data firm RealtyTrac Inc. said last month. Indeed, U.S. home foreclosures likely won’t peak until the fourth quarter, Money Morning reported last month.

"What we’re really looking at is ongoing fallout from people overextending themselves to buy homes they couldn’t afford and using highly toxic loan products to get into the houses in the first place," Rick Sharga, RealtyTrac’s vice president of marketing, told The Associated Press. "We’re going to see quite possibly a record amount of foreclosure activity in the third or fourth quarter," reflecting the spike in monthly payments because of the re-sets on adjustable-rate subprime mortgages that will take place in May and June.

And that brings us back to Whitney.

The banking sector’s lending pullback will fuel these losses and foreclosures, for many of the reasons we’ve detailed here. Already, banks will likely have to set aside an additional $170 billion in reserves through the end of 2008 – just to keep up with mounting loan losses.

To do that, banks will have to further rein in lending – to the tune of about $2 trillion worth of available credit lines, BusinessWeek.com reported.
For some context, the annual gross domestic product (GDP) of the entire U.S. economy is approaching $14 trillion. Two-thirds of that is driven by consumer spending.

That’s why the lending pullback is going to have a massive contractionary effect on the U.S. economy.

"New and unforeseen strains on consumer liquidity will push more consumers into precarious credit positions and cause consumer credit losses to be far worse than what is currently estimated, even by the most-draconian of investors," Whitney wrote.