Garbage in, garbage out

The best credit risk analysis system in the world will not help you if your employees just fill in the blanks with random crap. Barry Ritholtz:

3 "handy steps" for getting a questionable loan approved by JPM Chase's automatic system:

1. Lump all of an applicant's compensation as the applicant's base income, rather than breaking out commissions, bonuses and tips.

2. Do not disclose use of gifts for down payments.

3. If all else fails, simply inflate the applicant's income. "Inch it up $500 to see if you can get the findings you want. Do the same for assets.

Thus reads an internal memo from Chase obtained that accidentally found its way into the hands of journalist Jeff Manning of The Oregonian. It was the basis for an article titled, Chase mortgage memo pushes 'Cheats & Tricks'.

This, mind you, from one of the banks who is weathering the subprime crisis rather well. One wonders where they were getting the numbers at the other banks.

No, don't answer that. This is a family blog.

Comments

I can't wait for the memos and emails about the appraisers to come out. Then the...oh sorry, family blog.

Posted by freddiemac | March 28, 2008 1:34 PM

I think we'll see *much* more of this kind of thing coming out.

I live in the SF Bay area (ie, obscene home prices), and a couple of years ago I was considering buying and went to see several mortgage brokers.

Almost all the brokers were looking for a way to get me a loan, truth be damned. Several of them recommended that I do a "stated income", no documentation loan, and they told me the income I'd have to state to get the loan. They explicitly knew my real income, and explicitly told me in what ways and amounts to lie on the application.

Thankfully I had the good sense not to get into something I couldn't really afford (I still rent). But my experience showed me that many of these mortgage brokers knowingly were gaming the system (polite way of saying "flat out lieing"), and it wasn't hidden under the table. It was an open and encouraged practice.

I'll think we'll see many more of these types of documents. Homebuyers certainly bear much responsibility for the current mortgage crisis, but it isn't as if the lenders are blameless - they got into this with their eyes wide open.

Posted by Quint | March 28, 2008 1:46 PM

I live in McLean VA (I rent) and I wonder: Is there anyone in the NoVa/MoCo/DC area who doesn't know someone who's in more house than they can afford?

Posted by wiredog | March 28, 2008 2:24 PM

yep, way more than 'old-fashioned' over-leveraging...sadly, we've got a long way to the bottom of this.

Worse, this has been known for years, while the MSM was chanting from the *deleted* playbook.

Posted by MEH | March 28, 2008 3:13 PM

This, mind you, from one of the banks who is weathering the subprime crisis rather well.

That's a lie, Megan.

It's not "from one of the banks". It is from an employee of the bank. There's no evidence that the bank itself authorized this kind of fraud.

It is typical left-wing pablum that that fraud was normal and accepted in the mortgage industry. Uh, where's the data? Anecdote != data. It's no different than when the left-wing was indicting all of corporate America as a result of Enron.

Posted by Al | March 28, 2008 3:19 PM

Megan, you didn't mention anything about the beauty and wonders of industry self-regulation. As for me at least, I got to come right out and say it: "Thank God! Where would we be without it!!"

Posted by JYK | March 28, 2008 3:37 PM

"While fielding questions from an overflowing crowd at the AMEX Base and Precious Metals conference, it became clear to me that for the first time in my life, I am scared.

Not for me, not for those of you prepared, but for those stuck by inertia and the average hardworking family man.

Monty is right in that criticism of actions taken carries no contribution. It is our job here to focus on consequences, to be prepared for all consequences, but to hope for the best.

Two new figures can be seen on the horizon. One is a political review of OTC derivatives and the other is OTC derivative litigation. Both these specters are capable of pulling the blanket of secrecy back to expose the reality of why the Fed had no other choice but to finance and broker the “bury the bankruptcy” deal of Bear Stearns into JP Morgan.

The Fed has now established a precedent for being the lender of last resort to any entity that has the capacity of calling into view the credit ability of US Treasury instruments and the net work of obligations thereupon.

The revelation that politics and litigation has is to reveal the character of the defunct so called asset being accepted as collateral for permanent 28 to 30 day loans and outright purchases that are sure to be rolled over repeatedly.

Another revelation is that these are not mortgage buys but specific performance contracts and items derived from mortgages called SIVs. These now defunct former assets are now working their evil on the balance sheet of the central bank of the USA.

Central Banks cannot go broke as they have a mechanism that results in a blank check for themselves or others. What can happen as the virus of OTC derivatives infects the balance sheet of the Fed is to further pressure the US dollar lower.

The threat that the army of attorneys poses in the descent upon the directors and officers of defunct companies is a killer blow to an already reeling dollar.

The political thrust is against the Fed’s use of public money to sustain just those who have vented this awful situation on mankind. The Fed did what it had to do as doing nothing would have been a bigger mistake than doing something with vast long term economic consequences.

All the machinations of Fed activity can only hide the reality of the worthlessness of derived entities from real assets.

This is not a mortgage crisis. It is a crisis of the light of reality being shined on the lack of reality in OTC derived items as assets with value and fundability.

The definition of a derivative meltdown is not visible smoke and fire, but the inability of one side (the loser) of a special performance contract to perform as obligated.

Inability to perform is an inability to pay, hence the bankruptcy and no comeback in value ever.

We are in the midst of a meltdown with the effort being to prevent the domino effect."
http://www.jsmineset.com/

Posted by MEH | March 28, 2008 3:38 PM

Typical agency problem.

Life insurance companies have this problem too--- no reason for the agent not to go find people on their deathbeds and sell them policies. They get their commission, and they don't really care if the life insurance company (which they usually don't directly work for anyway) has to pay out a bunch of money a few months down the road. Of course the companies have policies to discourage this sort of thing, but absent those policies there is no incentive for the agent to worry about the mother companies liabilities.

Mortgage brokers who work on commission don't necessarily give a damn if the people getting the mortgage end up going tits up. They got their piece.

If anything this shows that at least some mortgage companies had policies against doing this sort of thing but failed at policing their agents to prevent fraud.

Which is half-heartening at least.

Posted by Toxic | March 28, 2008 4:28 PM

I don't know, but I get the feeling that the collapse of several mortgage brokers, the lawsuit against a major accounting firm (for ignoring certain irregularities), and the writedowns of several billions of dollars of mortgage related assets will probably yield more than anecdotal evidence that fraud was widespread.

Institutions themselves never usually say, "Go do bad stuff." What usually happens is that those who should be paying attention, and monitoring compliance, don't, either due to willful ignorance or incompetence.

And it's not left wing to suggest that the mortgage industry was full of fraud. You can be quite conservative and assert the same fact, and when millions of people are being thrown out of their homes on mortgages that should result in them not being thrown out of their homes, something is probably wrong.

If one employee of a particularly good bank was found to be gaming the system, one can rightly assume that he was not a "loan" evil genious, and totally out of the mental context that might exist with other similarly positioned people at firms up and down the home finance spectrum.

Posted by Finn | March 28, 2008 4:39 PM

My comment above was in response to Al@ 3:19

Posted by Finn | March 28, 2008 4:46 PM

It is typical left-wing pablum that that fraud was normal and accepted in the mortgage industry.

My sister worked for one of the banks that failed (and she's worked in the industry for the last 20 years). While fraud might be a strong word for it, she tells me that brokers push the envelope all the time, in good times and bad. Is it policy to do that? No. But guess who gets the president's club sales award at the end of the year?

Posted by Anonymous | March 28, 2008 6:41 PM

Anony.-

"My sister worked for one of the banks that failed (and she's worked in the industry for the last 20 years). While fraud might be a strong word for it..."

You should ask your Sister what, if anything, is 'lent' to the 'borrower'...

Posted by MEH | March 28, 2008 6:58 PM

Toxic has it right, I think. One additional point: If many or all of your competitors are cutting corners in some way, and you aren't, then you will be pushed out of the market. If the fraud became widespread enough (I don't know if it did), then it may be that in places with seriously inflated housing prices, there was a lot of it going on, just because the market selected for mortgage salesfolk that were willing to lie.

Posted by albatross | March 28, 2008 8:44 PM

I guess it's sort of like fudging hits at a blog site by mentionning Ron Paul.

Posted by Sidney | March 28, 2008 10:23 PM

Albatross: What market is that? If I'm looking for a mortgage that I can actually pay, I'm not going to be hunting for banks that cut corners so they can sell me a mortgage that I can't afford.

Your point applies to many other markets (e.g., if you're raising beef for supermarkets and your competitors are selling beef with weight added by injecting salt water, increasing the growth rate of their cows by giving them antibiotics, and feeding them reprocessed garbage, you might have to match their corner-cutting to be able to match their prices), but I don't see how it applies to the mortgage market - unless "people looking for a mortgage they will default on" is a market anyone wants to get into. If it is, it is because somewhere there are idiots buying up mortgages from the issuers on contracts that don't leave at least part of the responsibility for losses due to default on the originating company.

I'll note that, in regards to Toxic's post, insurance companies do have policies in place that prevent this sort of agency problem. I don't know the details, but my grandfather was an independent insurance agent for forty years or more, and he was highly motivated to uncover risks applicants wanted to hide. If I gave him a chance, he'd go on for hours about the things people would do to conceal their fatal diseases to get life insurance, drunk driving habit to get car insurance, fire hazards of their businesses, etc. If some companies were buying up mortgages without similarly protecting themselves, they deserve to lose their money...

But the people who bought McMansions they couldn't afford by any reasonable measure don't deserve anything more than an empty packing crate, either.

Posted by markm | March 30, 2008 11:18 AM

A lot of this was driven by the fact that investors barely cared if loans were SISA - Stated Income, Stated Assets. To me, this is the most insane part of the mortgage bubble. You're engaging in what might be the biggest financial transaction of your life and you can't be bothered to find some pay stubs?! And the investor doesn't find this suspicious!?

Posted by Kyle | March 30, 2008 11:22 PM