As was widely rumored last week, hundreds of people have been arrested for fraud related to mortgage schemes. The numbers are staggering. Authorities have charged 1,215 people, with 485 arrests coming in just the past four months. The FBI is reportedly pursuing over 3,000 cases. Losses related to this criminal activity exceed $2 billion. This kind of widespread fraud poses two questions: what went wrong, and how do we fix it?
Before getting into that, it's important to note a few things. First, although these numbers are pretty incredible, it's clearly absurd to say that fraud was the main cause of the housing bubble. It certainly played a part, but $2 billion is insignificant compared to the amount of bad subprime mortgages originated or overall losses that have resulted since the peak of the market.
With that said, there are also some cases that will slip through the cracks. Some criminals simply won't be caught or convicted. Other unethical mortgage brokers may not have technically broken the law, but knowingly originated doomed loans. So as bad as it sounds, it's not even the whole story.
If there was a mechanism in place to prevent bad mortgages from being knowingly originated, then we would have been a lot better off. This suggests that the first problem was mortgage market regulation being too lax. Not just anyone should be able to call themselves a mortgage broker. Licensing, which would include background checks, might have helped.
But that wouldn't have been enough if consumers didn't know how to verify whether the person they were getting their mortgage from was legit. This raises another problem: consumers had no way of knowing which loan providers were trustworthy. A database of mortgage originators might be a good solution. Then, you could check on the references and background of whoever is providing your mortgage.
If these mortgage brokers never got any financing, however, then their fraud wouldn't have succeeded. This speaks to another problem: banks and mortgage companies didn't pay enough attention to the people they were doing business with. These firms should have taken more time to investigate these individuals and the loans they submitted for funding. Due diligence was likely shoddy or non-existent.
In short, consumers need better resources for identifying legitimate loan providers, and financing providers need to perform better due diligence. With those two changes, a fair portion of this fraud would likely have been avoided. This reflects one of the problems with bubbles: when people are rushing to cash in on the latest business fad, there will always be unscrupulous people looking to take advantage of their carelessness.