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Madoff Has Met His Match: Mortgage Fraud Crime of the Century

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U.S. Subprime lending expanded dramatically 2004-2006 (Photo credit: Wikipedia)

With less than 88 years left in this century, it's awful tough to say what the crime of this century will be.

Will it be the $60 billion Madoff Ponzi scam? The Dot-Com bubble? My candidate is a slam dunk so far: Mortgage fraud.

Mortgage fraud took place on so many levels for so many years that it eclipses Madoff by a factor of 100. That's my humble estimate because nobody really knows how pervasive it was. Prosecutors are still issuing indictments more than six years after the real estate market peaked.

The recent $1 billion suit against Bank of America/Countrywide alleging that the bank sold defective loans to Fannie Mae and Freddie Mac is but a small piece of this unraveling series of financial flim-flams, which rival most scams because of its pervasive nature and involvement of thousands of financial institutions and intermediaries. The bank says the government's claims are "simply false."

Why is mortgage fraud such a Tyrannosaurus Rex in the world of scamdom? Because it combined easy money, greed and securitizing that avarice all over the world. It was based on the myth that home prices don't decline and quick profits could be had by nearly anyone. You, too, could become an investment banker! More importantly, it may prove to be the mother of all swindles because it nearly took down the world's largest financial system.  And we're not out of the woods yet.

We have some idea of how many mortgage crimes were out there thanks to the suspicious activity reports supplied to the FBI by banks, starting in the first quarter of 2006. These weren't necessarily fraud cases that resulted in prosecution. In fact, very few ended up as court cases in which people went to jail, which has been a widespread problem in mortgage fraud.

Starting in 2006, the FBI got wind of some 7,500 suspicious mortgage activities. By 2008, that figure doubled and peaked in the second quarter of last year at nearly 30,000, according to the Financial Crimes Enforcement Network or FinCen. The number of fraud filings dropped 41 percent from the second quarter of last year through this year's second quarter.

What do these numbers mean? That bankers suspected foul play in the origination or refinancing of mortgages. And these reports were the proverbial tip of the iceberg, because they only looked at the problem from one step in the process. Here's what else was going on, although we don't have any hard numbers:

  • Mortgage Foreclosure "Rescues." Companies would set up shop to promise defaulting homeowners that they could halt the foreclosure process. They'd fleece the hapless homeowner for a steep fee, then move on.
  • Appraisal Scams. Individuals would hire crooked appraisers to under-appraise a home, obtain a mortgage, then sell it at a much-higher price.
  • Securitization Swindles. This may be the biggest scam of all. Junk mortgages were bundled, given the highest credit ratings, then sold to investors in vehicles like collateralized mortgage obligations. These "sub-prime loans" are still on the books of some of our largest banks, Fannie Mae and Freddie Mac.
  • Robo-Signing. Banks eager to sell loans to Wall Street hurried the process along by creating automated, illegitimate pipelines. State attorneys general settled with the banks on this issue, although no one seems to have been prosecuted for these crimes and it's done little to stem the foreclosure wave.
  • Predatory Lending. Low-income areas were targeted by rapacious brokers and bankers to sell mortgages and home-equity loans with high rates and fees to people who couldn't afford them.

How much did all of this cost Americans? Again, there's no reliable estimate, but when this massive house of cards came tumbling down at the end of 2008, trillions were lost. Wall Street and AIG insurance got a $700-billion-plus bailout and American homeowners are still down some $7 trillion in terms of lost equity, according to Robert Reich, an economist and former labor secretary.

While a handful of hedge fund gurus and contrarian investors won big on betting against this mammoth mortgage swindle, "Wall Street's excesses almost ruined the economy," Reich said. If the Federal Reserve, U.S. Treasury, Congress, George W. Bush and President Obama hadn't teamed up to bail out the banks, this year would've been worse than 1932, instead of a sluggish 2012.

And the beat goes on as prosecutors dig through layers of the mortgage fraud. Here's just a typical sampling of some recent activity from the FBI and federal prosecutors:

"A federal indictment charged 17 defendants in Charlotte, North Carolina, and elsewhere with racketeering, investment fraud, mortgage fraud, bank bribery, and money laundering. The government alleges a criminal enterprise engaged in an extensive pattern of racketeering activities, consisting of investment fraud, mortgage fraud, bank fraud, money laundering, and distribution of illegal drugs. Members of the enterprise also bribed bank officials and committed perjury before the grand jury. The co-conspirators stole more than $27 million from more than 50 investor victims. Rather than investing victims’ money as promised, the enterprise diverted victims’ money to finance its mortgage fraud operations and to support its members’ lifestyles."

I wouldn't be exaggerating if I predicted that there are hundreds more mortgage frauds yet to be discovered and prosecuted. The states are finding them all the time, some four years after the collapse of Lehman Brothers.

The larger problem is that the perpetrators are still at large and the system that allowed huge derivative gambles on mortgages is still in place. The mega-banks behind this devilish casino got larger, and still need to be broken up. Fannie Mae and Freddie Mac, the two quasi-public mortgage insurers that bought warehouses of bad mortgages, are still wards of the state. And foreclosures continue to ravage communities from California to Florida.

After what will certainly be one of the closest and contentious elections in decades, Congress needs to get to work to bust up hobbled giants like Bank and America and Citigroup. Then it needs to institute the Volcker rule to isolate speculation from federally insured banking activities or bring back Glass-Steagall, which completely separated trading from regulated lending as part of New Deal reforms.

A tax on speculative trading would also reduce systemic risk. I don't care if banks gamble on their trading desks, but they shouldn't do it expecting a big bailout on the taxpayers' backs.

What can you do? You can report suspicious activity to your state attorney general or the Department of Justice, through its financial crimes site stopfraud.gov. You may not help the government land a big crook -- they all seem to be enjoying their fat compensation packages in the Hamptons -- but you could give prosecutors a leg up on shutting down an ongoing scam.