WASHINGTON STATEDEPARTMENT OF

FINANCIALINSTITUTIONS

OVERVIEW OFPREDATORY LENDING

James R. BrusselbackEnforcement Chief

Division of Consumer Services

AARMR October 2005

DISCLAIMERS

The comments and opinions expressed today are solely my comments and opinions and do not necessarily reflect those of the Department of Financial Institutions, its management, or anyone associated with the Department of Financial Institutions.

DFI cannot give legal or financial advice, and we do not endorse or recommend any person, product or institution.

DISCLAIMERSThe comments and opinions expressed today are solely my

comments and opinions and do not necessarily reflect those of the Department of Financial Institutions, its management, or

anyone associated with the Department of Financial Institutions.

The Department cannot give legal or financial advice, and we do not endorse or recommend any person, product or

institution.

OUTLINE

1. Predatory LendingWhat is it? Where is it? Who’s involved?

How does it happen? How is it done?

2. Combating Predatory LendingEnforcement – Administrative & Criminal

Research, Education and Outreach

Lender Accountability? Impose agency?

WHAT IS PREDATORY LENDING?

Mortgage Fraud Practiced Against Consumers

The words “mortgage” and “fraud” may be too narrow.

Lending and mortgage origination practices become “predatory” when

the borrower is led into a transaction that is not what they

expected.

Predatory Home Lending – Moving Toward Legal & Policy Decisions

“Transactions specifically crafted to result in net-losses for the

borrower.”

Susan M. WachterSeptember 10, 2005 Chicago, Illinois

Chuck’s Definition

Surreptitiously employing an artifice or subterfuge in a financial

transaction such that the chicanery has the result of bamboozling the

consumer into accepting a spurious deal.

GENERAL BELIEFS:

• Products themselves are not predatory.• However, certain products or volume of products may indicate bad practices.• Certain types of lenders are more likely to employ predatory lending practices.• Certain types of consumers are more likely to

become victims of predatory lending practices.

WE ARE ALSO UNDERSTANDING THAT . . .

• Predatory servicing may be as big a harm as predatory lending.

• Enforcement is still the best deterrent.• Prison sentences may be the silver bullet.• Education must be targeted to be effective.

WHERE IS IT TAKING PLACE?

THE MAJORITY OF PREDATORY LENDING TAKES PLACE WITHIN

THE SUBPRIME MORTGAGE REFINANCE MARKET

WHY REFINANCES?

•More equity to convert from the borrower.

•Less transaction overhead.

•Larger market of debt ridden borrowers.

•Fewer eyes on the deal.

WHO’S INVOLVED?

Predatory lending practices may involve:

Lenders, Mortgage Brokers, Real Estate Professionals, Appraisers, Attorneys, Escrow Agents, and Home Improvement Contractors.

Schemes commonly target:

People who have small incomes - but substantial equities in their homes and minority communities.

HOW DOES THIS HAPPEN?

Consumers can be lured into dealing with predatory lenders by: aggressive mail,

telephone, TV and door-to-door sales tactics.

Advertisements promise lower monthly payments as a way out of debt, but don't tell potential borrowers that they will be paying

more and longer.

HOW IS IT DONE?1. Equity Stripping

2. Bait and Switch

3. Loan Flipping

4. Property Flipping & Appraisal Fraud

5. Packing

6. Hidden Loan Terms

7. Discrimination

8. Home Improvement Scams

9. Discount Point Deception

10. Predatory Servicing

EQUITY STRIPPING

BAIT AND SWITCH

BAIT AND SWITCH EXAMPLES

•Loan Type

•Loan Amount

•Loan Fees

•Payment Amount

LOAN FLIPPING

PROPERTY FLIPPING AND APPRAISAL FRAUD

PACKING

HIDING LOAN TERMS

DISCRIMINATION

HOME IMPROVEMENT SCAMS

DISCOUNT POINT DECEPTION

MORTGAGE BROKERS

Should never charge discount points or a discount fee that is payable to

themselves.

Discount Point Deception

HOUSEHOLD FINANCE

Disclosed ranges of discount points. For example: GFE disclosure of

$0 to $10,000 with the HUD1

always charging the maximum.

Discount Point Deception

EXAMPLE #2: “ABC” MORTGAGE COMPANY

No par rate so that a borrower never knows the starting point the rate is bought down from. Also, discount

points hold very different results for like borrowers.

Discount Point Deception

EXAMPLE #3: Another “ABC” FINANCIAL COMPANY

Disclosure of loan origination fees as discount points, thereby giving

impression that rate has been bought down when it has not been bought

down.

Discount Point Deception

PREDATORY SERVICING

SOME HARMFUL SERVICING PRACTICES

1. Accounting Practices

2. Force Placed Insurance

3. Junk Fees

4. Loan Transfers

5. Customer Service Accountability

6. Customer Service Locations

ENFORCEMENT

• FBI’s caseload for mortgage fraud is up 500% over 3 years ago• “ ..loan frauds account for almost 40 percent of all financial institution losses.”•“Mortgage fraud is becoming epidemic”•As of Sept 2004 – 12,100 instances of suspicious activity have been reported to the FBI.

(Chris Swecker, FBI assistant director for criminal investigations)(2004 – Associated Press)

IS ENFORCEMENT NEEDED?

Sept, 17 2004 Department of Justice

• “Operation Continued Action” - The largest operation in FBI history, directed against financial fraud

• 5,000 cases targeting financial institution fraud• Action against 205 individuals

• 2000 – 2004:– 11,466 indictments– 11,362 convictions– $ 8.1 Billion in restitution orders

• In 45 days during August/September:– Identified 245 subjects– 158 investigations– 151 indictments– 144 arrests– Potential loss of $3 Billion dollars

5 Bloomberg News – 12\2004

•FNMA required First Beneficial Mortgage to buy back Millions in fraudulent loans from the Charlotte area•FNMA - Fails to notify the “Feds”•Later, GNMA “unknowingly” buys the loans from First Beneficial Mortgage•Loans go into default

•$38 Million loss to date

ENFORCEMENT TOOLS

•Administrative authorities.

•Civil actions.

•Criminal prosecution.

It’s possible that more than 1,000 fraudulent appraisals were created between 1997 - 2000

Spokane Population - 195,62998 Foreclosures in a single month

Same foreclosure rate for multiple monthsAll from the same mortgage company and three

appraisersOriginal sales: 1997 – 2001

Foreclosures: 2002 -- today

Same ratio in Seattle would result in 300 foreclosures a month from a single mortgage company

On July 29, 2004:

Owner Dale Gibbons was found guilty of 15 separate counts of conspiracy and wire fraud.

Gibbons testifies that: “[He] didn’t intentionally break the law,

but was only doing what he was told by the lenders.”

Ronald BurgerBanned from working in the mortgage industry for 25 yearsFine: $17,685.00Restitution to victims: $14,589.66

Dale Sage GibbonsBanned from working in the mortgage industry for 25 yearsFine: $17,685.00Restitution to victims: $14,589.66

ADMINISTRATIVE ACTION

Agent - Sally Gibson

Defended herself in the state licensing action, she blamed [lender] WMC for promoting predatory lending

practices.

Agent Sally Gibson, trying to act as her own attorney, was found guilty of 11 separate counts of conspiracy and

wire fraud.

Sentencing - 2005

Profession Name Prison Restitution

Agent Sally Gibson 3 Years $264,406

Appraiser John T Hanson 18 mo. $287,796

Broker Dale Gibbons 5 Years $449,953

Broker Ron Burger 3 Years $423,011

Escrow C. Patrick 2 months $148,340

• In court documents and interviews, 32 former employees…witnessed or participated in improper practices, mostly in 2003 and 2004. This behavior was said to have included:• deceiving borrowers about the terms of their loans, • forging documents, • falsifying appraisals,• fabricating borrowers' income to qualify them for loans they couldn't afford •(LA Times Feb 2005)

•“Iowa Attorney General Tom Miller . . . is leading the investigation into Ameriquest. [H]e said the group would either settle with Ameriquest ‘soon’ or sue it.”

•“Chuck Cross, a division director at Washington’s Department of Financial Insitutions, said the allegations in the Times article . . . were consistent with what he and other regulators have seen across the country.”

The Allegations

1. Deceptive and aggressive sales practices.

2. Discount points that aren’t.

3. Belittling the significance of GFEs.

4. Fraudulent appraisals.

5. Fraudulent employment and income.

MORTGAGE LENDING FRAUD PROSECUTION

ACCOUNT

2003 WASHINGTON LEGISLATURE

WHAT THE LAW DOES

• Provides funding to prosecutors

• Allows DFI to determine which cases will be prosecuted by putting us in control of the funds

HOW DOES IT DO THIS?

• Every real estate recording in WA is assessed a $1 surcharge

• The county auditor forwards these funds to DFI

• DFI “retains” prosecutorial agencies

• DFI approves case applications for funding

WHAT CAN BE ACHIEVED

• Develop criminal experts in the area of mortgage fraud

• Target mortgage fraud specifically

• Prosecute cases, such as misdemeanors that never got prosecuted before

• A more direct link between DFI and prosecutors

CONVICTIONS• Craig Warberg – guilty 2 counts of theft (Trust Account)

• Micki Green – guilty 10 felonies identity theft and theft

• Elizabeth Coan- guilty 10 Felonies identity theft

• Damien Sims – guilty Attempted Theft

• Devon Hughes – guilty Theft, Money Laundering, Identity Theft.

REFERRED CASESAs of July 2005

10 cases pending – Big and Small

CASES UNDER DEVELOPMENT

About 20 cases involving flipping, mortgage rescue, mortgage elimination, loan application fraud

Mortgage Rescue Scam

Principal(s) of Shell Company

All money passes through them via HUD-1 (“Devlopement” fee, “remodeling” fee, “Consulting” fee)

Recruits investors

Locates victims

Refers victims to mortgage broker

Refers victims to escrow company

Handles all aspects of investors and victims transactions

Often religious affiliation with victim and investor (sales pitch)

Victim Property Owner 1

Elderly

Low/fixed income

High equity in property/flip potential

Financial need (rising property taxes, medical issues, etc.)

Church affiliation

Told lease payments would be set aside

Victim Property Owner 3

Close to retirement

Looking to invest equity – told some of the equity going somewhere productive

Unsophisticated

Victim Property Owner 2

Middle aged

Some equity/property has potential for a flip (hot neighborhood, rehab, land value)

High Mortgage

Financial set back

Religious affiliation

Escrow Company

Close relationship with Principals

Knows something is up

May or may not be directly involved

Mortgage Broker

Knows Principals

Knows something is up

Loan application fraud (owner occupancy issues)

Typically high fees and ysp referrals

Investor(s)

Essentially a straw buyer

Lease and repurchase agreement with the victim

Compassionate investment (sales pitch from Principals)

May be ignorant of the scam

Lease/repurchase designed to fail and result in eviction

ESCROW OFFICER

Escrow Officer's Shell Company

• Used to Acquire Properties

• Used to Sell Properties

• “Assigns” = steps in last minute

• Very short sales

Bank

• Short Term Loans

• Suspect Commercial Accts.

• IOLTA Accts.

• Suspect Personal Accts.

Mortgage Broker 2

• Loan Officer A– straw buyer– straw buyer– straw buyer

• Loan Officer B– straw buyer– straw buyer– straw buyer

• "Partner"– scouting– recruiting– managing

• High fees, high ysp’s

Real Estate Agent

May have knowledge (buyers agent/front end)

Paid through fees, referrals or possible kick backs

May be scouting properties

May be recruiting straw buyers

Almost never used on second half of the flip

Lender's Account Exec.

May have knowledge

Paid through fees (esp. due to high ysp’s)and possible kick backs

Appraiser

Has knowledgePaid in fees (“rush jobs” & referrals) and kick backsLook at P&S used = knowledgeLook at rep. as to who holds title/History of prior sales = knowledge

Mortgage Broker 1• Loan Officer A

– straw buyer is a friend– straw buyer is a relative– straw buyer is a customer

• Loan Officer B– straw buyer is a friend– straw buyer is a relative– straw buyer is a customer

• "Partner"– Scouting for properties, tying them with P&S– Recruiting straw buyers– Managing flipped properties

• Loan Fraud– VOE– VOD– VOI– Stated, partial doc, full doc (W-2’s, paystubs, 1040’s, etc.)– Exam issues – look single consumers with multiple loans (sudden acquisition of properties)

Escrow CompanyLenders Conditions =Need to forged and are evidence of intentStraw buyer’s earnest money deposits forgedStraw buyer’s closing costs (deposit slips or cashier’s checks) forgedStraw buyers signatures forged ten notarizedIOLTA funds for purchase moneyManipulated closing dates (pre-funding or pass throughs)Closing instructions ignored (preferential payoffs) Flat out theft of funds (liens not paid off)

Attorney

• IOLTA Account– Source of Shell Company $– Back filled by proceeds of flips

Notaries

Straw buyers not present at closing

Forged signatures

WHY WILL PRISON TIME FOR LENDING CRIME WORK?

RESEARCH

EDUCATION

OUTREACH

WASHINGTON STATE UNIVERSITY

SOCIAL AND ECONOMICSRESEARCH CENTER

SURVEY OF FINANCIAL LITERACY IN WA STATE:

Knowledge, Behavior, Attitudes and Experiences

FINDINGS OF THE STUDY

1. Higher degrees of education are a factor.

2. Victims of predatory lending had been repeatedly turned down for financing.

3. The general population is more likely to invest and save for the future.

4. The victim pool exhibited certain “risky” financial behaviors.

RISKY BEHAVIORS

•Home refinancings were primarily to pay off credit card debt.

•Being behind in debt payments.

•Multiple liens on their home.

•Cash advances on credit cards.

•Much less likely to pay off credit cards each month.

•Significant use of payday lenders (24%).

CONCLUSIONS•No understanding or concept of compound interest.

•Scarce access to credit creates desperation.

•Desperate borrowers fall for bait and switch and other predatory practices.

•The degree to which victims pursue risky behaviors indicates that they are not responding to the consequences of their actions.

•Primarily reactionary rather than planning.

“This means that they may not be aware of their own personal vulnerabilities and lack the

knowledge needed to keep from being susceptible to loans with

disadvantageous terms.”

Guide To Home Loans CD ROM

Includes such topics as:

• What consumers need to know about home loans

• Questions to ask a lender

• Examples of disclosure forms

• Tips to avoid predatory loans

• A glossary of terms

• Worksheets

1-877-RING-DFI

www.DFI.WA.GOV

WASHINGTON STATE DEPARTMENT OF

FINANCIALINSTITUTIONS

LENDER ACCOUNTABILITY?

IF THE LENDER HOLDS DETAILED INFORMATION ABOUT THE CONSUMER’S

CREDIT AND PAYMENT HISTORY . . .

IF THEY KNOW THAT CERTAIN CONSUMERS

LACK THE KNOWLEDGE TO FULLY UNDERSTAND THE

TRANSACTION . . .

AND THEY HAVE DIRECT ACCESS TO THIS TYPE OF

CONSUMER . . .

AND THEY UNDERSTAND THE MARKETING VALUE OF

DESPERATION . . .

WHAT EXACTLY IS THEIR RESPONSIBILITY?

WHAT ABOUT CREATING AN AGENCY RELATIONSHIP BETWEEN THE BORROWER

AND THE MORTGAGE BROKER?