May 4th, 2011
in Op Ed
Guest Author: Frank McKenna, Vice President of Fraud Strategy and Analytics for CoreLogic. Frank writes periodic articles about fraud. This is the 16th in the series "Fighting Fraud with Frank." Bio at end of article.
As fictional character Gordon Gekko once said, “Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures, the essence of the evolutionary spirit.” While I do not agree with this statement or his perspective that greed drives mankind’s progress, I do think it provides a glimpse into what drives some people or companies to try to cheat the system. The cheating road is paved with bricks of greed. In the case of the mortgage and real estate industries, I believe if you follow the trail of greed you will find it leads to cases of fraud, and nowhere is fraud more apparent in today’s market than in so-called house flipping, i.e. when a home is purchased at an under-market value and resold in a short period of time for a significantly greater price. Follow up:
Welcome to the 16th edition of Fighting Fraud with Frank. The mortgage market is dealing with unprecedented levels of distressed real estate in markets where home valuations might fluctuate wildly. There are bargains to be had amidst the turmoil. This is great news for investors that want to find properties at rock bottom prices, but not such good news for lenders that need to foreclose, short sell or finance borrowers on those properties. Flipping is a natural by-product of a distressed real estate market. Real estate agents and savvy investors that know the local market are experts at identifying those bargains. They can quickly flip properties that have been undervalued and usually this is a good thing for the mortgage market. Flipping becomes problematic when agents or investors get a little too greedy and begin withholding, fabricating or disguising pertinent information. In this issue, I want to shed some light on a type of flipping that is particularly damaging to the mortgage industry - short sale flipping fraud. It’s important that I state this clearly – most short sale flips are not fraud. CoreLogic believes only a small minority, less than two percent of all short sales, appear to be suspicious. However, the impact on the industry is large – more than $300 million a year in net losses to lenders in 2010. Lender losses are not the only problem with short sale fraud; there are many.
Impacts of Short Sale Fraud:
Short Sale Fraud Hurts the Entire Mortgage Industry.
According to CoreLogic research, just two years ago suspicious short sale flips were averaging approximately $90 million per quarter. In 2010 this more than tripled to approximately $260 million in short sale flips per quarter, which equates to an alarming $1 billion in suspicious short sale flips for the year. The net loss on these transactions (the amount lenders left on the table) was about $300 million last year. That is a big loss to lenders which ultimately will impact consumers and homebuyers in higher loan costs in the future.
Short Sale Fraud hurts buyers, neighbors and tax payers.
During our analysis CoreLogic noted that some short sale flips have an interesting dynamic in terms of valuation of the property. Properties involved in certain short sales have a significant undervaluation during the short sale itself, and then subsequently have an inflated value during the flip of the property to another buyer. In many of these cases the short sale seller is perpetrating fraud upon both the lender and the eventual buyer of the property. The short sale fraudster is taking as much money as he can with little thought about the long-term consequences. To make matters worse, the trend toward using straw borrowers that qualify for FHA loans to buy those short sale properties at inflated prices appears to be on the rise according to lenders in the CoreLogic Mortgage Fraud Consortium. Lenders reported that loans made to straw borrowers default at a much higher rate, sending the property into another vicious cycle of distress.
So, who eventually pays the price for short sale fraud? In the case I mention above there are several parties:
1. The lender who lost money on the original transaction
2. The new lender and the FHA who will lose money on the subsequent transaction, if it defaults
3. The neighbors around the property who will watch their property values decline, and
4. The tax payers who will bear the cost of losses on FHA loans
Everyone else loses while a single short sale fraudster wins.
Short Sale Fraud Hurts Legitimate Short Sellers and Investors.
Short sales have become so prevalent that lenders now monitor them more closely for fraud and are putting in place more checks and balances to ensure that they do not fall victim to fraud in the short sale process. Lenders are, for example, starting to implement more stringent anti-flipping requirements which prohibit the resale of a short sale property for a certain period of time, such as 90 days. Given the current level of short sale fraud, this is a completely rational policy but this does impact legitimate investors that buy and quickly improve short sale properties. Investors want to hold properties for the shortest amount of time possible in order to reduce overhead expenses and this new requirement may slow them down. Short sale fraudsters are hurting legitimate investors from managing their investment efficiently.
Short Sale Fraud Creates More Short Sale Fraud.
A small leak in a pipe, left unchecked, will eventually turn into a large leak and then a big flood. The same is true with short sale fraud. As short sale fraudsters become successful and make lots of money more people, motivated by greed and the urge to make a quick buck, will follow in their footsteps thus compounding the problem. A good example of this can be seen in the increasing rate of short sale fraud in 2010. In 2008, the rate of short sale fraud was one in every 62 transactions. In 2010, the rate of short sale fraud was one in every 52 and the rate is dropping lower each quarter. Short sale fraud is increasing at an alarming rate. This leaky pipe is ready to burst if left unchecked.
What We are Doing about It – Short Sale Monitoring
At CoreLogic we have created a new solution to help lenders find short sale fraudsters before the short sale transaction is approved. It’s called Short Sale Monitoring and it is changing the way lenders look at short sales. CoreLogic provides alerts to lenders if there appears to be a second prospective sale brewing on a property during the short sale process. If it appears there is another sale in the works, this is an instant clue to a lender that there might be a flip brewing. Lenders can then inquire about the other transaction to see if it can be explained. In addition to alerts furnished before a short sale closes, participating lenders can receive a notification if the property was flipped after they short sold the property. If the flip was contrary to any agreements signed during the short sale, the lender may have recourse.
Just as lenders do, CoreLogic takes short sale fraud seriously and we are devoting our time to research the problem and find new ways to solve it. We’re hoping that by this time next year we will see a significant reduction in the level of short sales and short sale fraud.
Disclaimer: The views expressed by the author are his and not necessarily the views of CoreLogic.
ForeclosureGate Deal is a Cover Up by Michael Collins
Strategic Defaults: A Bad Situation that Could Get Worse by Keith Jurow
CoreLogic: Home Prices Down 7 Straight Months by Steven Hansen
Daniel Tarullo - Problems in Mortgage Servicing by John Lounsbury
Servicer-Driven Foreclosures: The Perfect Crime? by Yves Smith
The Mortgage Mess by Yves Smith
Frank McKenna is the vice president of Fraud Strategy & Analytics for CoreLogic. He is responsible for developing highly effective fraud solutions and service methodologies, and identifying unique and effective tools to manage lender risk through pattern analysis and evaluate other parties in the transaction.
The co-founder of BasePoint Analytics, McKenna is widely recognized for his extensive fraud consulting expertise in the financial services and mortgage industries. He helped develop and introduce advanced predictive technology to detect mortgage fraud and also pioneered the development of internal fraud solutions and methodologies for proactive detection of employee data theft.
Prior to establishing BasePoint, Frank served as director of Fraud Consulting for HNC Software/Fair Isaac Corporation where he helped define successful fraud reduction strategies for more than 30 companies. In this position, he oversaw eight large-scale fraud reduction projects with major issuers worldwide, helping those companies achieve hundreds of millions of dollars in combined fraud savings. Frank also spent ten years working in various aspects of fraud management within Providian Bancorp and Wells Fargo Bank.
Frank holds a Masters Degree in Business Administration from California State.
For more information about CoreLogic, go to www.corelogic.com.