As the government ramps up to spend trillions of dollars to revive the economy, loopholes in federal law and a shortage of FBI agents assigned to investigate white-collar crime could lead to a big payday for perpetrators of mortgage fraud and other schemes.
That's the view of lawmakers who want to extend federal fraud laws to private mortgage companies that aren't regulated at the federal level, and provide $155 million a year to the U.S. Justice Department to triple the number of active mortgage-fraud task forces and help the FBI rebuild its white-collar investigation program.
Senate Bill 386, The Fraud Enforcement and Recovery Act, is aimed at deterring fraud among not only mortgage originators, but the Wall Street financiers who securitized and sold mortgages to investors, said the bill's sponsor, Sen. Patrick Leahy, D-Vt. The bill is also intended to protect the $700 billion Troubled Asset Relief Program (TARP) from fraudulent schemes.
In the wake of the savings-and-loan crisis of the 1980s, the FBI assigned 1,000 agents to strike forces in 27 cities to work with forensic experts and federal prosecutors to root out fraud, FBI Deputy Director John Pistole told members of Leahy's Senate Judiciary Committee at a hearing last week. The effort led to more than 600 convictions, and judicial orders for $130 million in restitution, Pistole said.
The current financial crisis "dwarfs" the savings-and-loan crisis, Pistole testified, with losses at financial institutions surpassing $1 trillion. Yet the FBI has fewer than 250 agents working on financial fraud cases, Leahy said, and loopholes in the law make it difficult or impossible to bring federal fraud charges against unregulated mortgage originators and options and futures traders who may have contributed to the financial collapse.
Neil Barofsky, the special inspector general overseeing TARP, warned the committee that as the government stands poised to spend trillions of dollars to revive the economy, "We stand on the precipice of the largest infusion of government funds over the shortest period of time in our nation's history."
Unfortunately, Barofsky said, "history teaches us that an outlay of so much money in such a short period of time will inevitably draw those seeking to profit criminally."
Barofsky cited hurricane relief, Iraq reconstruction, and the Resolution Trust Corp. as "important lessons." The RTC was the government-owned company that, according to the FDIC, liquidated neary $400 billion in real estate and mortgages of insolvent savings-and-loans from 1989-95.
The FBI has acknowledged that it has been spread thin in some areas, including white-collar criminal investigations, since shifting about 2,000 agents into counterterrorism after the Sept. 11, 2001, attacks.
Barofsky, who prosecuted securities and mortgage fraud cases in New York as a Justice Department lawyer from 2000-08, said he saw the effects of the shift firsthand. Areas of coverage for white-collar crime shrank, he said, and the threshold for prosecuting cases rose. But now, the Justice Department's renewed focus on mortgage fraud has left other areas of white-collar crime underfunded and underprosecuted, Barofsky said.
Enforcement stepped up
Pistole said the FBI increased the number of special agents investigating mortgage fraud from 120 in 2007 to 180 last year, adding that the bureau currently has 16 mortgage-fraud task forces operating in the U.S. The number of open FBI mortgage-fraud investigations has grown from 881 in 2006 to more than 1,600 through the end of September 2008, he said.
Last summer, 46 of the FBI's 56 field offices took part in "Operation Malicious Mortgage," a roundup of more than 400 mortgage-fraud suspects that has so far led to 164 convictions, Pistole said.
But there's little doubt those cases represent only the tip of a much larger iceberg. In the last six years, suspicious activity reports alleging mortgage fraud filed with the Treasury Department have increased more than tenfold, from about 5,400 in 2002 to more than 60,000 in 2008, Leahy said in introducing S 386 into the Congressional Record.
At current staffing levels, the FBI "cannot even begin to investigate" the more than 5,000 mortgage-fraud allegations received from the Treasury Department each month, Leahy said.
Mortgage-fraud statistics can trend up during housing downturns because falling home prices expose house-flipping schemes that rely on inflated home valuations and falsified borrower information. But the Mortgage Asset Research Institute reported in December that incidents of mortgage fraud increased by 45 percent in the second quarter of 2008, despite a drop in loan applications.
MARI's quarterly report found most fraud occurs at the beginning of the loan process, with more than 65 percent of suspected fraud incidents involving application misrepresentations such as an incorrect name, occupancy or asset. Income misrepresentations were suspected on 36 percent of applications, and employment on 20 percent.
Pistole said the FBI is focusing its enforcement efforts on industry insiders who are part of organized rings engaged in mortgage "fraud for profit," as opposed to "fraud for housing" -- instances where individual borrowers make misrepresentations in order to acquire a house to live in.
"Industry insiders are of priority concern as they are, in many instances, the facilitators that permit the fraud to occur," Pistole said.
As foreclosures continue to rise, so have foreclosure rescue scams, Pistole said, and the FBI is out to "target, disrupt and dismantle" individuals and companies engaged in such fraud schemes.
The default servicing arena "appears to be the new frontier for fraud perpetrators," the Mortgage Bankers Association says in a brochure promotin
g its upcoming National Fraud Issues Conference in Las Vegas. The conference, which takes place March 16-18, will include a panel discussion of national fraud trends and problem areas with representatives of the FBI, U.S. Attorney, and the Department of Housing and Urban Development's Office of the Inspector General.
The Fraud Enforcement and Recovery Act would provide $65 million a year in 2010 and 2011 to allow the FBI to hire 190 additional special agents and more than 200 additional staff and forensic analysts to rebuild its white-collar investigation program and staff 50 mortgage-fraud task forces in the hardest-hit metro areas.
The bill would also provide $50 million annually for additional U.S. Attorneys to prosecute mortgage-fraud cases the task forces uncover, and $40 million for the criminal, civil, and tax divisions at the Justice Department to provide special litigation and investigative support.
Another $60 million a year is earmarked for investigators and analysts at the U.S. Postal Inspection Service and the Office of Inspector General for the Housing and Urban Development Department, whose partnerships with the FBI in mortgage-fraud cases Pistole called a "force multiplier."
The bill would also close loopholes that make it difficult to win money-laundering convictions or bring federal fraud charges against unregulated mortgage originators and options and futures traders.
S 386 would amend the definition of "financial institution" in the criminal code, extending federal fraud laws to private, non-bank mortgage lenders who are not directly regulated or insured by the federal government, such as Countrywide Home Loans (before it was acquired by Bank of America) and GMAC Mortgage.
Institutions that aren't subject to the current bank fraud criminal statute accounted for more than 50 percent of subprime mortgages in 2005, said Rita Glavin, acting assistant attorney general in the Justice Department's criminal division.
Changing the definition of "financial institution” to include non-bank lenders "will enhance our ability to prosecute criminals under the bank fraud statute," Glavin testified.
The financial crisis "has demonstrated how bad mortgages can affect the health of the banking system and the overall economy," Glavin said. Non-bank lenders "should be held accountable in the same way as traditional financial institutions, given the impact of their businesses on federally insured and federally regulated institutions."
Leahy's bill would also amend the federal securities statute to cover fraud schemes involving commodities futures and options, including some of the financial products and derivatives involving mortgage-backed securities that were part of the financial collapse, Glavin said.