The lead story in a recent Wall Street Journal says that borrower fraud “goes a long way toward explaining why mortgage defaults and foreclosures are rocking financial institutions, Wall Street and the economy.”

In other words, some significant share for the blame mortgage crisis rests not just on borrowers, but on dishonest, even criminal borrowers.

If the premise of this story is true, we need to seriously rethink the mortgage dilemma and tighten safeguards to protect lenders, Wall Street securities dealers and institutional investors against hordes of unscrupulous borrowers. And yet, the Federal Reserve has neglected to do anything of the kind in proposing new lending rules. Instead, these deal entirely with unscrupulous lending practices.

But, of course, the premise of the story is not true. I don’t know anyone who thinks that. Even Bear Stearns, an alleged victim in the story, if you can believe it, isn’t saying that.

And even if you think it is true, there is a journalistic problem here: The assertion is unsupported. The evidence cited in the story does not make, or come close to making, the case for the idea that borrower fraud is an important driver of the mortgage crisis. To see that, frankly, does not even require a particularly close reading.

For its main evidence—potential dollar losses from criminal fraud—the story relies solely on the word of a consultant who has a direct interest inflating the extent of the problem.

In 2006, losses from fraud could total a record $4.5 billion, a 100% increase from the previous year, says Arthur Prieston, chairman of the Prieston Group, which provides lenders with mortgage-fraud insurance and training.

How Prieston came up with that figure is not disclosed. That’s another journalistic problem.

But even if this conflicted, previously unknown, and soon-to-be-forgotten source is to be believed and his maximum estimate is taken at face value—“losses on fraud could total a record $4.5 billion in 2006”—that still is a tiny fraction of total losses that will result from the mortgage crisis. The total is not known but is believed to be in the hundreds of billions of dollars. A commonly cited figure is $400 billion.

Multiplying Prieston’s worst case by all six and a half years of the housing bubble gets you to $30 billion. Now, you’re officially in fantasyland, and still under 8 percent.

The full support for the premise is here:

Fraud goes a long way toward explaining why mortgage defaults and foreclosures are rocking financial institutions, Wall Street and the economy. The Federal Bureau of Investigation says the share of its white-collar agents and analysts devoted to prosecuting mortgage fraud has risen to 28%, up from 7% in 2003. Suspicious Activity Reports, which many lenders are required to file with the Treasury Department’s Financial Crimes Enforcement Network when they suspect fraud, shot up nearly 700% between 2000 and 2006.

In 2006, losses from fraud could total a record $4.5 billion, a 100% increase from the previous year, says Arthur Prieston, chairman of the Prieston Group, which provides lenders with mortgage-fraud insurance and training. The surge ranges from one-off cases of fudging and fibbing to organized criminal rings. The FBI says its active mortgage-fraud cases have increased to 1,210 this year from 436 in 2003. In some regions, fraud may account for half of all foreclosures. ‘We’ve created a culture where a great many people know how to take advantage of the system,’ says Mr. Prieston.

Yes, it is useful to know that banks are reporting suspicious incidents at a rate that is 700 percent greater than before, and that the FBI has stepped up fraud investigations. But those facts support only the unsurprising proposition that criminal fraud increased rapidly as mortgage volume grew. Neither fact demonstrates that the mortgage crisis can be explained to any significant degree by borrower fraud.

As for the assertion that half of foreclosures come from fraud in “some regions,” the sole source is a verbal estimate from an Atlanta real estate agent judging from sixty cases he’s seen.
That’s not “some regions.” That’s not even a single region.

These are issues of basic journalism standards. Readers have a right to feel tricked here.

Constance Mitchell Ford, the editor of the Journal’s real estate group, says the story was extensively reported and that sources across the board support the story’s premise. She also says the story takes into account not just criminally prosecuted fraud, but all forms of behavior that could be described as fraud—lying about income, about whether the owner will occupy a house, etc.—and that by doing so, the story shows fraud is a significant driver of the mortgage crisis.

Also, it should be said, the story does say that lenders collaborated in the fraud, if that’s what you want to call it.

Yet the system itself bears blame. The evolution of mortgages into a securities instrument turned loan origination into a competition. Caution gave way to a push for speed and volume. Embroiled in an all-out war for market share, issuers reduced barriers to credit, for example, by offering so-called ‘stated-income’ loans, which require no proof of income. ‘The stated-income loan deserves the nickname used by many in the industry, the “liar’s loan,” ‘ says the Mortgage Asset Research Institute, which works with lenders to prevent fraud. A recent review of a sampling of about 100 stated-income loans revealed that almost 60% of the stated amounts were exaggerated by more than 50%, MARI says.

But even this ignores the fact that it is lenders—not borrowers—that have already settled cases of widespread, systematic, and not especially sophisticated fraud against borrowers—fraud as a core business strategy.

In early 2006, Ameriquest Mortgage Co., once the leading subprime lender (now closed), settled allegations with forty-nine states that it had engaged in deceptive lending practices, including bait-and-switch sales tactics, arranging inflated appraisals, and hiding and giving inaccurate information about basic financial terms, including interest rates.

Audit readers, the Journal says the FBI has 1,200 cases open. Wow. This settlement alone covers 725,000 borrowers. This is no estimate by some flunky consultant or Atlanta real estate broker. It’s a settled case brought by the government, and it followed similarly sweeping cases against Household Finance, Associates (now a Citigroup unit) and others.

(The states couldn’t pursue affiliates of nationally chartered banks, like Citigroup, because the comptroller of the currency, upheld by the Supreme Court and the WSJ editorial page, successfully blocked such efforts.)

Evidence in the public record is abundant that lender fraud “goes a long way” toward explaining the mortgage crisis. Parallel evidence does not exist to support the same assertion about borrower fraud; the Journal should not pretend that it does.

And a word about “liars loans,” in which borrowers knowingly overstated their income. A major claim of the states against Ameriquest, according to Iowa Attorney General Tom Miller: “Encouraging borrowers to give inaccurate income or employment information to obtain loans.” If the Journal’s point were only that many borrowers went along with the game, I’m sure that’s true. But to conflate this encouraged practice with hard-core criminal fraud schemes, as the Journal story does, is regrettable.

The very idea that the mortgage crisis is about lenders being victimized on a large scale is preposterous and is in any event unproved.

The New York Times recently got the borrower fraud story right: Officials can’t keep up with the growing number of cases. (1) The difference is the Times doesn’t try to pin the mortgage crisis on the phenomenon.

The author of the story under review, Michael Corkery, is a skilled and experienced reporter who has done much fine work in the past, will do good work in the future, and in fact even in this case, uncovered and reported compelling and entertaining stories that deserved to be in the paper. The Marketplace cover page seems like the better home for this one.

The reason is simple: if borrower fraud does not go a long way toward explaining the mortgage crisis, but instead only explains it to some unknown degree, then the story’s findings do not justify page-one play. That’s the case here.

I think the Journal, institutionally, took good reporting and pushed it too far on this one.

Unfortunately, the issue is not a trivial one. The question of who is to blame for the mortgage crisis is at the center of a public debate that will shape the financial system and its regulatory regime for years to come. No one should believe that the financial-services industry, in order to evade its own, overwhelming responsibility, will shrink from attempting to portray borrowers as irresponsible or even criminal. It happened to insurance policyholders after Hurricane Katrina. It will happen here.


1. “Officials Say They Are Falling Behind on Mortgage Fraud Cases,”
The New York Times
25 December 2007

Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014).

Follow Dean on Twitter: @deanstarkman.