After considering the developments of the past year, I am admittedly concerned about the real estate and mortgage fraud outlook for 2007. Real estate and mortgage fraud is a complicated issue, one that presents a spectrum of societal challenges in the form of costs and consequences.

• Industry leaders express concern without revealing a concise and cohesive strategy to combat the epidemic.
• The U.S. Justice Department continues a misguided agenda of prosecuting mostly notorious fraudsters in metropolitan areas.
• State and local authorities often recognize the existence of a problem, but lack the resources to confront this sophisticated form of theft.
• As a matter of public policy, the causation factors that result in a breakdown of protocol in real estate transactions are either misunderstood or conveniently ignored.

We are told that real estate and mortgage fraud is properly managed by tagging individuals and properties as high risk factors based on information contained in databases. Transparency is the sound-byte of the day and ostensibly a contributing factor to loan quality enhancement and loss mitigation. Sadly, though, technology is the only publicly disclosed solution proposed by lenders and title insurers at this time. The two industries that stand to lose the most have inexplicably shown little initiative in solving, i.e., studying the problem. A dependence on technology has blinded them from a simple truth: The consequences of real estate fraud are a human reality, not a virtual reality. Why would a cybernetic approach to fraud prevention work in 2007 if it did not work in 2006?

The unrealistic expectations placed on automation by the real estate industry begin at the advent of every transaction. Homes are listed and sold locally, yet lenders and title companies now embrace a business model that espouses the virtues of mass production. The variables leading to homeownership are not linear and quantifiable as suggested by the “factory mentality” that is loan and title processing in today’s world. Escalating real estate and mortgage fraud statistics correlate directly to the application of new technology. The real estate industry has lost site of the fact that advances in technology are meant only for the advancement of the human condition. The incidence of real estate fraud was statistically insignificant in the past when lending and title services were personalized and community-based.

Far too often, fraudsters target communities and individuals that can least afford the abuse. A boarded up home is visible evidence of real estate fraud; despair is the human cost that’s publicized so rarely. Consumers are sensationalized as villains by professional associations and the media when, in reality, all schemes require the orchestrated efforts and coaching of industry insiders. Legitimate studies conclude that predatory lending practices are biased towards minority and lower income groups. Deceitful Realtors enlist the cooperation of title agents and appraisers to exploit unsophisticated or otherwise vulnerable borrowers. A study released earlier this month by the Consumer Federation of America indicates that woman with above average income and credit scores were more likely to obtain sub-prime financing than men with similar profiles. Households headed by woman, particularly women of color, are unable to realize financial security through the traditional path of homeownership. The “yield spread premium,” an advanced banking concept designed to bundle disparate loans in commodity markets, is often used abusively by mortgage brokers to over-sell unsustainable payments to trusting customers. The deceitful mortgage brokers are then paid undisclosed fees by wholesale lenders. I strongly oppose the use of the yield-spread premium in retail markets without disclosure requirements that are much stricter than those currently employed.

In some ways, 2006 marked the beginning of a period of accountability for industry insiders who commit or facilitate real estate and mortgage fraud. A dramatic spike in default rates occasioned by rising interest rates has unearthed a generation of loans originated by internally falsified documentation and over inflated appraisals. It is now impossible for lenders to use hyper-appreciated REO values to understate actual losses caused by foreclosures. The crimes of the past decade are finally coming to light. The media suspects that the real estate industry has had its collective hand in the ill gotten profits of fraud. Future articles appearing in respected publications will provide the basis for criminal investigations, regulatory inquiries, and class action litigation.

Reform will take a very long time and will offer no relief for those already victimized by fraudsters. In his book, “An Inconvenient Truth,” former Vice President Al Gore wrote: “We have everything we need to begin solving the crises, with the possible exception of the will to act.” An informed and concerned community of consumers is the fraudster’s worst enemy! A community-based approach to fraud prevention presents opportunities for consumers to avoid exploitation, especially when initiated by industry insiders. FlippingFrenzy.com is a perfect example of a learning opportunity for consumers and industry insiders alike. I predict that fraud statistics in 2007 will escalate to startling heights. For reasons I cannot comprehend, legislators and industry leaders will continue to approach the problem with stone hearts and closed minds.

Real estate and mortgage fraud is a human issue that can only be solved through a shift in public policy and public perspective. Once society recognizes that human suffering is the primary cost associated with fraudulent activity in the housing market, things will change. The system is broken and needs fixing, and while 2006 saw some progress, sadly, it was not nearly enough.

On November 26, 2006, the Orlando Sentinel published an article by noted syndicated columnist Robert Bruss entitled “Hear this loud and clear: A “silent mortgage” is fraud.” The term “silent mortgage,” synonymous with “silent second,” is one that I hadn’t heard for nearly a decade. Feeling admittedly startled, the observation of a lending industry veteran shared long ago came to mind: Fraudulent schemes from the past have a way of resurfacing when the housing market slows.

The term “silent second” was used often among industry insiders to describe a popular scheme to defraud lenders during the 1990’s. With this being said, consumers need to know enough about “silent seconds” to avoid them and the accompanying criminal consequences. The FBI’s website offers this definition of the silent second:

Silent Second: The buyer of a property who borrows the down payment from the seller through the issuance of a non-disclosed second mortgage. The primary lender believes the borrower has invested his own money in the down payment, when in fact, it is borrowed. The second mortgage may not be recorded to further conceal its status from the primary lender.

It is important to note that the buyer actually intends to repay the debt to the seller. As harmless as this scenario might appear, it’s riddled with deeper underpinnings of fraudulent activity including the misrepresentation of the borrower’s financial profile to the lender. A common fallacy to avoid at all costs is one dependent on the right of buyers and sellers to have side agreements that are not disclosed to lenders.

There is another scheme involving second mortgages and multiple layers of criminal planning that is also worth mentioning. The scheme, known as the “throw away second,” works like this:

Once a selling price for a home is agreed upon, a second contract is fraudulently drafted for a higher (predetermined) amount. The primary lender is deceived into relying on the existence of a second mortgage between buyer and seller for the difference between the actual selling price and the overstated selling price. Why? Some conventional loan programs allow a buyer to borrow a percentage of the selling price from the seller as a substitute for a deposit. The “throw away second” is typically recorded, but sellers are asked to sign a release at the closing table. Payments are never made or expected. In addition to the two (2) different contracts of sale, this particular scheme is evidenced by two (2) different settlements sheets and a commission paid on the lower selling price.

Quite obviously, the crimes described above could not exist without the assistance of Realtors, title agents, loan brokers and appraisers. Once a scheme to defraud a lender is revealed, buyers and sellers face a distinct risk of prosecution in spite of a contradictory misconception held by many. The following federal case illustrates an example of a consumer being implicated along with an industry insider:

On May 9, 2006, a 31-year-old mortgage broker from Centerville, Ohio, pled guilty in federal court to one count of money laundering as part of a mortgage fraud scheme. The scheme involved the mortgage broker and the seller of a home that the mortgage broker was purchasing as a personal residence. The two conspired to deceive a lender by misrepresenting seller’s monies as the buyer’s down payment. Both individuals were indicted by a federal grand jury. The settlement sheet signed by buyers and sellers at every residential transaction contains the following warning:

It is a crime to knowingly make false statements to the United States on this or any other similar form. Penalties upon conviction can include a fine and imprisonment.

The vast majority of home loans have a nexus to federally insured funds. It’s as simple as that! My advice to consumers and industry insiders alike:

1. Avoid any aspect of a real estate transaction that’s described by the word “silent”
2. Avoid any transaction where an “actual” second mortgage is not disclosed to a lender
3. Avoid any transaction where a “fabricated” second mortgage is disclosed to a lender
4. Avoid any transaction that requires two (2) differing settlement sheet and/or contracts of sale
5. Reject any notion that real estate fraud is not actively prosecuted by authorities

The recent implosion of the housing market has created a difficult situation for many people trying to sell a home. Rumors abound of innovative and creative inducements being offered to prospective buyers. While the temptation to participate in seemingly benign schemes that make a house more affordable to buyers may be overwhelming, keep one thought in mind though: Any time the success of Real Estate deal requires less than total and honest disclosure to a lender…it is illegal.

Recently, an investigative reporter for Seattle, Washington’s King 5 News broke a story that illustrates a concept and a phrase that may be unfamiliar to many, Affinity Fraud. Affinity Fraud refers to a situation where a trusted member of a shared group or organization preys upon a victim. In the recently reported story, reporter Susannah Frame found that a mortgage broker affiliated with a Filipino Christian congregation devised a fraudulent scheme to procure home loans for church members with damaged credit. The mortgage broker deceived homebuyers and lenders by substituting the identities and credit histories of past customers who were also church members. These unsuspecting and misdirected individuals thought they were purchasing homes when, in fact, ownership was vested in the names of others. It should come as no surprise that forged documents can be traced to a single title company and a number of its employees who are notaries. The mortgage broker took the scheme to new depths by collecting monthly payments from borrowers and allowing the loans to default.

Susannah Frame was correct to question the practices of the title company identified in her report; notary abuse is just one visible symptom of a greater disregard for accepted practices. Real estate fraud requires a great deal of planning and coordination among numerous insiders; it takes a team. The fraudster has no choice but to enlist the cooperation of a title agent who is uniquely positioned as the “last line of defense” in any transaction. The transparency of this particular scheme and the brazenness of the fraudsters should shock everyone. Clearly, they felt they would not be caught, or that nothing would happen to them if they did. Boy, were they were sorely misinformed! The number of real estate-related crimes reported each year has become a primary focus of federal investigators and prosecutors. State and local authorities are equally as concerned and only slightly less so prepared to take a serious stance (budgets permitting). Still, a title community comprised of properly trained professionals should have proven a formidable barrier to the criminal aspirations of the mortgage broker described in the King 5 News report. So, what exactly is the problem?

The title industry faces an enormously complex set of challenges as it evolves from something that it was in the past to something that it’s expected to be in the present. I often ask audiences of title agents to define their work product in 10 words or less. The answer is not quite as simple as it seems. The traditional sources of business for the title industry now have an affinity of their own for sharing profits in return for directed title orders. The title industry once possessed a moral high ground that has eroded in the face of anti-competitive forces. Today’s title agent lacks the ability to confront partners in joint ventures or to replace lost sources of business. Is the title company in the King 5 News report guilty of greed in a traditional sense, or is it guilty of a newly spawned category of real estate fraud, “complacency on demand?” Only a thorough investigation by authorities will reveal the real motive… both are criminal offenses.

It is my opinion that the land title industry exists for the following reasons:

1. To expertly examine titles and provide curative remedies for title issues
2. To disclose all material facts (in writing) to interested parties
3. To actively promote fraud prevention in real estate transactions

Many title agents lack the professional skills needed to fulfill the legal duty to act in the best interest of consumers and lenders. Licensing standards are determined by individual states, as are continuing education requirements. For the most part, it requires very little experience or practical knowledge to become a title agent. Continuing education is geared towards the novice and has little to offer seasoned practitioners. Additionally, title insurers are far too zealous in their efforts to expand market share by signing new agencies. The overall effect has been disastrous for the public as evidenced by current fraud statistics and the endless barrage of news reports illuminating the activities of fraudsters.

Back to King 5 News reporter Susannah Frame…she has a blog that adds valuable insight into the human side of Seattle’s real estate-related affinity fraud. Honest and well-intended members of Seattle’s real estate community are properly concerned that the reputation of their industry has been tarnished by the unscrupulous behavior of one single mortgage broker and a single title company. Members of Christian groups worry as well that the public will be unforgiving in its assessment of their religious beliefs. The actions of real estate professionals profoundly influence the lives of many.

At the end of the day, after contemplating the motives of a title company that lacks the courage to say “no” and the actions of a dishonest woman hiding behind a veil of religious values, one question remains: What has happened to human decency?

Recently, Forbes Magazine ran an article which could only be taken as a negative indictment of the title industry. Referring at different times to research, interviews and the findings of an 18-month investigation conducted by the state of Washington’s insurance commissioner, the article’s author, Scott Woolley, contends that the title industry has enriched itself for decades and “bilked home buyers out of billions of dollars.” Additionally, Woolley asserts that automated land records will eliminate the need for title insurance and the title profession. (If you haven’t read “Inside America’s Richest Insurance Racket,” do so before reading any further. The article itself is followed by several pages of spirited, sometimes heated, comments, including a rebuttal by the American Land Title Association.)

While I do not agree with everything in the article, it is clear that the title industry needs a major overhaul. It’s no coincidence that Woolley’s article is just one of many that have surfaced as the media, legislators, investigators and consumers question the practices of a decidedly misunderstood industry. The title industry is being attacked nationally for employing illegal tactics to generate orders from realtors and lenders. Just as disturbing is a dramatic increase in the incidence of class action lawsuits alleging anti-competitive practices (pricing) and failure to disclose material facts to consumers. Only a handful of title insurers now dominate this very important and lucrative market following an aggressive stream of acquisitions. The public understands little about the scope of a title policy and the role of the title agent because the industry has chosen to conduct its day to day business “in silence.”

The concept of “bundled services” has added an entirely new dimension to the evolution of the title industry by giving many of it’s participants an “identity crises” that may be difficult to overcome. It’s now common practice for title professionals to join forces with realtors and lenders by sharing the ownership of a new company that enjoys the benefits of captive title orders. The joint venture, assuming that its RESPA compliant, must conform to federally mandated guidelines that control its initial capitalization, its “core title” practices and the way dividends are paid. In theory, the joint venture benefits from “economies of scale” and accordingly rewards the consumer with a reduced fee structure. Additionally, we’re told that the interests of the consumer are best served by the convenience of a “one stop” shop. One by-product of the joint venture when paired with technology is the ability to process regional, or national, title orders (and loan applications) from a single location.

The marriage of title company with source of business should raise a number of concerns for anyone interested in fraud prevention. The removal of processing activities to distant points is the first of these concerns. In the past realtors, title agents and mortgage brokers conducted business in the same communities in which they lived. There was a relationship between the real estate professional and the consumer. There was a real-world familiarity with the condition and value of the homes being sold. The success of the realtor, title agent and mortgage broker was in large part decided by referrals from friends and neighbors. I realize that I’m oversimplifying this scenario and that real estate fraud has always existed, but we cannot ignore the fact that the fraudster benefits by doing business with a “voice on the phone.” Technology is a potent detector, and deterrent, of fraud. Still, many of the “tell-tale” signs of real estate fraud are extremely subtle and require direct observation. There is no substitute for the human element in matters of homeownership.

A second downside of the joint venture has to do with the reduced ability of the title professional to make independent decisions. A title agent has a very serious duty to act in the best interest of the source of funds. Keep in mind, the mortgage broker (loan officer) is not the source of funds. During a criminal investigation the title agent is held accountable for all of his professional decisions and is unable to make excuses by saying that he” didn’t know”, he “didn’t understand” or that he “can’t recall.” Consider an example where the title agent in a joint venture is asked by his business partner to “discretely” use seller proceeds to pay buyer closing costs. A title agent facing a situation such as this is in a real dilemma. The request itself is a solid indicator that falsified documentation was used to approve the loan. Also, the closing instructions would specifically prohibit the seller from contributing any amount without the actual knowledge of the source of funds. Yet, how does the title agent say “no” to his business partner and only source of business?

While I cannot quite agree with Mr. Woolley’s analysis that the title industry is no longer needed, I do have some advice for the title industry: Learn from prescription drug manufacturers and sell yourself and your services to the consumer. You’re being attacked, in part, because the public doesn’t know you!

Prior to his conviction, Baltimore, Maryland’s, Ed Rybczynski was a licensed title agent and the owner of a successful title company. Nowadays, during his presentations, Ed speaks candidly about his role in a well publicized flipping scheme that resulted in his imprisonment in a federal prison camp. Ed’s message is a simple one: That real estate fraud prevention can only be accomplished through personal accountability and responsible corporate citizenship.

In his own words, from a comment Ed left here on FlippingFrenzy.com just a few days ago (in case anyone missed it):

Ralph:

I would like to comment on the newly released statistics for mortgage related fraud. I’m not sure if the statistics apply only to instances where a lender is victimized during the loan application process or if they include predatory lending practices and other types of fraud where a consumer is targeted by a lender. It’s probably safe to assume that the report encompassed any and all suspicious activity reports (SARs). An often cited FBI report states that 80 percent of all mortgage fraud involves the tacit participation of a real estate professional. I personally believe that the percentage is much closer to 100 percent. A real estate professional who fails to ask questions or exercise due diligence is in fact an active participant in the fraud. I feel uniquely qualified to comment on these matters. I was a title industry insider for 20 years and also did time in a federal prison camp for my role in a fraudulent scheme involving property flipping and loan fraud.

It comes as no surprise to me that the incidence of fraud has climbed so dramatically. In fact, I believe the numbers are understated as a substantial amount of mortgage fraud remains undetected and/or unreported. Most people, industry insiders included, have no idea of how to properly report complex schemes of this type. Along the same lines, very few people are able to recognize the warning signs of fraud which are often subtle. It’s my opinion that real estate related crime will continue as an accelerating epidemic in this country. I do not believe that changes in interest rates or the economy will have any diminishing effects on the two broad categories of fraud identified by the FBI – fraud for housing and fraud for profit. The lending industry and title industry have decided to look to technology as a solution to an overwhelmingly complicated situation with human nature at its core. A data base - search engine is no match for many white collar criminals.

The problem worsens as the technology used to process a loan or title file reduces the consumer to a faceless and ambiguous name on a computer screen. It’s time for the real estate industry to address fraud in a realistic manner by taking an honest look at its hideous effects on real people. A study released on 5/31/06 by the Center for Responsible Lending entitled “Unfair Lending: The Effect of Race and Ethnicity on the Price of Subprime Mortgages” finds that predatory lending activities are most often targeted at minority groups with an ethnic bias. Real estate related crime is still perceived as being benign and victim-less. It’s not true; every aspect of our society suffers when a home is foreclosed and a family displaced. We’ve all heard the cache phrases that tell us much. No one will know! Everybody gets paid! What difference does it make! The buyer gets the house!

The statistics concerning the licensing of mortgage brokers are alarming. A similar situation exists within the title industry. Keep in mind that federal prosecutors view the role of a title agent as having the social importance of a doctor or a lawyer. Title agents not only examine title, they are also responsible for managing enormous escrow accounts and for guarantying the secured interest of the source of funds. It’s a technical and serious job that’s accompanied by a great deal of risk. In the context of fraud prevention, the title agent is the final stop in a transaction with a serious obligation to detect and report fraud. Yet, 3 states plus the District of Columbia do not require that title agents be licensed; 18 states and the District of Columbia do not require a title agent to pass a test to become licensed; only 20 states have an educational requirement as a pre-requisite to licensing. My source for the above information was a report released on 4/26/2006 by the Government Accountability Office entitled “Title Insurance: Preliminary Views and Issues for Further Study”.

I agree with you that mortgage brokers should be subject to national standards for licensing and oversight. I also feel that national standards must be established for title agents. The professional development of title agents and mortgage brokers is the critical first step to fraud prevention. Continuing education as it exists today for the title agent is simply ineffective. Professional education should be substantive and emphasize best practices. I’m particularly alarmed by the recent findings of an 18 month investigation conducted by the Insurance Commissioner of the state of Washington. A number of national title insurers and title companies were caught in the act of paying illegal inducements and incentives in return for title orders. All title agents look to their underwriters to set the highest possible standard for proper and ethical behavior. Where do we go from here?

The use of technology is just one vital aspect of mortgage fraud prevention. Uniform licensing standards for professionals and background checks are equally as important. But, when dealing with a topic matter as important as a home we cannot ignore the power of the human condition. Awareness is the key. Through training, title agents and mortgage brokers must be exposed to the possible consequences of their professional decisions. They must learn that an over inflated appraisal or falsified bank verification can cause real harm (and pain) to children, families, communities, etc. Additionally, real estate professionals must be exposed to the personal consequences of improper behavior including the payment of restitution, incarceration, the loss of a career and the loss of professional legitimacy. Then, and only then, will title agents and loan brokers fully recognize the need to develop a decision making model based on core values. Then, and only then, will mortgage fraud statistics begin to decline. Remember, mortgage fraud cannot exist without the participation of real estate professionals.

Regards,

Ed Rybczynski