A large body of empirical research has now convincingly documented how mortgage fraud contaminated all portions of this supply chain (Griffin and Maturana, 2016; Piskorski, Seru and Witkin, 2015; Garmaise, 2015; Jiang, Nelson and Vytlacil, 2014; Black, 2013; Ben-David, 2011). This research has shown how these mortgages were originated with fraudulent and negligent practices, and how these abusive practices were then concealed from and misrepresented to investors who purchased securities based on these mortgages.The private label originate-to-distribute supply chain consisted of institutions which originated mortgages and then sold these loans to investment banks for distribution. Investment banks then packaged mortgages into securities, obtained ratings from ratings agencies, and sold the securities to investors. Finally, a servicer would process loan payments and manage defaults on behalf of the investors. Often a single large institution, such as Wells Fargo, would be responsible for all parts of this supply chain, but it was more common for these functions to be handled by separate institutions.
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What sellers of MBS concealed from investors was a wholesale breakdown in underwriting standards at origination, which included outright falsification of borrower financial information. However, the sale of loans that were originated with fraudulent practices, or simply negligent underwriting, typically violated market regulations and contractual obligations. These rules require the accurate disclosure of loan quality. Of course, if these practices were disclosed, the securities would obviously not have been marketable. Loan officers and underwriters who originated loans for private securitization used a variety of techniques to falsify borrower financial information such as inflation of appraisal values, failure to report second liens, income overstatement, and misreported owner occupancy status. This was done to qualify borrowers for larger loans than they would otherwise be able to obtain and had the effect of making loans more risky by increasing borrower leverage.
The direct falsification of borrower financial information was largely committed by loan officers and underwriters within the industry, who coached borrowers on the specific ways to falsify their information, rather than by borrowers who defrauded otherwise honest lenders. For example, based on investigations and fraud reports, the FBI found that 80% of fraud cases involved collusion or collaboration with industry insiders (FBI, 2007). For example, a loan officer from Ameriquest explicitly described deceiving borrowers who were not comfortable with falsifying their information. He stated that, “Every closing was a bait and switch, because you could never get them to the table if you were honest,” and further elaborated, “There were instances where the borrower felt uncomfortable about signing the stated income letter, because they didn’t want to lie, and the stated income letter would be filled out later on by the processing staff.”[2] Perhaps most infamously, workers at another Ameriquest branch dubbed their break room the “Art Department” because it contained all the tools needed to falsify documents (Hudson, 2010).
