Suddenly, occupancy fraud is national news
Recent allegations of mortgage loan occupancy fraud[1] on second homes and investor properties against Federal Reserve Governor, Lisa Cook, and other federal and state officials have put mortgage industry practices and legal issues into the national spotlight. This occupancy fraud issue has gotten bound up with other national news about the constitutionality of independent agencies and the rule of law generally. It all seems ripe for one of my Mortgage Musings.
Finding “intent”
Legally, to prove fraud, you generally need to prove there was “intent to decieve”. So, to illustrate the occupancy fraud issue to people outside the mortgage industry, I offer below a realistic example of how this might play out for second home buyer[2] using a fictional person in the public light of policy and politics (a “PPPP” for short). PPPPs are generally expected to be morally upstanding and abide by the law.[3] A PPPP is definitely not normally the kind of person who would intentionally or even recklessly commit fraud.[4] So, just to pick a few “totally random” [5] examples, maybe this PPPP is a US Senator, State Attorney General, Federal Reserve Governor, or a member of the President’s cabinet.[6]
The Occupancy “Fraud” Dialogues
What follows is the exact (as I imagined it) conversation between an actual PPPP and a mortgage originator named “Bob” where (I guess) FHFA Director Bill Pulte would say they conspired to commit occupancy fraud.[7] Some version of this conversation with varied facts probably happens thousands of times a year.
PPPP: Hey, Bob since you just helped me refinance my home last week can you also help me get a loan to buy a condo in DC?
Bob: 100% for sure, but I thought you said you’ll be renting in DC. Anyway, buying makes sense if you’re going to be there a few years. I would be honored to help you again with that purchase.
PPPP: Thanks. By the way, have rates changed[8] since last week when we closed the refi?
Bob: Uh, yes, but you are in luck, because they just went down.
PPPP: Great, because I heard that second homes can be charged higher rates.[9]
Bob: Well, I was assuming this condo would be your primary home going forward since you are going to be in DC.
PPPP: Yeah, I’m going to live there when I’m in DC, but my wife is going to stay back in Kansas most of the time.
Bob: Sounds good. I’ll resend the link to our application portal and you can get started filling out the application. You can count on me to take good care of you again.
Aha! Fraudsters caught red-handed! Wait, you don’t see what Bill Pulte sees? Neither would a court, because as Daylight AML’s antifraud expert Bob Simpson[10] explained to me, “Getting to actual fraud is a high bar - it requires that you find intent and that you understand the bumps in your borrower’s road.”
My readers should know by now that it’s always complicated if you really dig into the facts and law. Rarely does fraud leap off the page with intent manifest in the four corners of a document. But if you are a good, experienced mortgage originator, you know what this is going to look like to your underwriter if you submit the loan as a primary residence a week after refinancing another primary residence. So, Bob the originator will be prepared with a solid compliant “changed circumstance” narrative to address occupancy questions. Meanwhile, the issue of the meaning of “primary home” can remain largely uncertain.[11] Besides, (before this current events episode) loan purchasers almost never looked at occupancy unless there was a delinquency.
The dialogue that never happened
Now here’s a significantly more satisfying (from a clarity of intent and fully transparent ethical perspective) continuation to the same imagined conversation. I can assure you this part of the conversation, however, never happened.
Bob: Ok, here’s the thing, in order to give you that low rate I quoted you’re going to have to say pretty much under oath that this new place is your “primary” residence even though you just said that about your other place last week.
PPPP: Yeah, so what? I decided to buy another place in DC.
Bob (demonstrating unbelievable foresight, integrity, and legal knowledge for a mortgage originator): Right, changed circumstances, so you’ve got a decent legal argument that you didn’t intend to defraud anyone. Although someone, maybe a political enemy, could say you intended to buy the condo all along. Remember you are in the public light and even an allegation of fraud would tarnish your reputation and potentially be cause for termination by a powerful unitary executive. Also, you should be aware that back in the days following the mortgage meltdown, loan investors wanted to find an error in a loan file they could put your loan under a microscope to find any discrepancy so they could pass a loss back to an originator. This kind of thing could come back to haunt you and me in many ways. Are you sure you want to take that risk just to get a lower rate?
PPPP: I don’t understand what you are saying. Sorry Bob, your competitor is offering an even lower rate than you. I’m just going to go with her.
Actually, the last statement above can happen frequently, which is why this continuation conversation never happens.
Rate competition
According to real estate lawyer Doug Miller as quoted by ProPublica in connection with the widening occupancy fraud allegations among DC insiders, “Loan officers who are competing for business will often quote lower rates in order to get a customer’s business.” Well, I am shocked. Shocked! In the “grass is green, the sky is blue” category, to put it mildly, Mr. Miller is on to something. But, last time I checked, lower prices due to competition was a good thing,[12] and helping consumers to design a truthful and compliant narrative to qualify for lower rate financing is exactly what a mortgage originator should do.
Any mortgage company owner would agree that helping a borrower to commit fraud (or engaging in deception without the borrower’s knowledge) is unacceptable. So, Miller adds, “Few consumers understand this issue, and if there is someone at fault here, it is likely the loan officer who likely advised them to sign up for this loan that obviously wasn’t for their primary residence.”
Whoa. Wait a minute. “Obviously wasn’t their primary residence?” Let’s explore that a bit. So, I go back to Bob Simpson who has built a career tracking down fraudsters and reporting on their activities. According to Simpson,
“Technically, fraud does not exist without the intent to deceive. My question for any loan officer doing any of these loans that have made the news is, "Did you get tricked? Did you not know where the borrower worked or how many properties they owned? There are just two options: Either the LO got tricked by the borrower, or they blessed the terms of the transaction and got their borrower an owner-occupied rate. Borrower trickery does happen. But wink-wink does happen with occupancy more frequently than we might hope.”
Simpson added that if the LO claims “they had no idea”, it usually only demonstrates incompetence.
Who Gets Blamed
When the mortgage industry got blamed[13] for the near collapse of the economy in 2008 that became known as the Great Recession, it was largely because the industry had allowed and encouraged borrowers to qualify for loans they couldn’t afford by lying about their income.[14] When the real estate market tanked, foreclosures and job losses resulted in huge losses to consumers and mortgage investors alike including the GSEs (Fannie and Freddie). In the end, however, the mortgage industry’s reputation as a whole was seriously tarnished for mistreating consumers and that resulted in numerous regulations on lending activity[15] and character requirements for the people engaged in the industry. Consumers and policymakers weren’t so much upset about enabling alot of lying as the damage it did to people and the economy.
The industry’s actions taken during the COVID era should have gone a long way towards restoring mortgage lenders’ reputations with consumers and policymakers, but, while unlikely to bring down the economy, this occupancy fraud thing is about to give originators another kick in the pants about ethics and professionalism. Lawyers and people interested in semantics can debate whether someone can have more than one “principal” or “primary” residence, but as Mr. Simpson’s comments confirm, mortgage industry folks should know occupancy “fraud”[16] when they see it. You can be sure, however, that whoever originated the loans for Federal Reserve Board Governor Lisa Cook did not see this level of scrutiny coming. I’m not saying anyone is guilty of occupancy fraud, but if Governor Cook or any other PPPP is found to have misrepresented residency, you can be sure that they will all blame their LO for putting them up to it. Unfortunately, given the reality of price competition, there could be a lot of blame to go around.
The Fed and the unitary executive
The whole reason this issue is coming up is tied to the exercise of strong unitary executive powers by President Trump posing challenges to the nation’s constitutional order and specifically the Federal Reserve’s independence. Many people I greatly respect look at things like: immigration decisions without due process, national guard troop deployments to cities, and even the CFPB staffing decimation,[17] among others, and ask if these are lawless actions by a President who thinks he and his office are above the law. While acknowledging that some of these actions are lawless (which many courts also have concluded), and the President’s rhetoric can be disturbing, I have yet to see a defining “Jacksonian” defiance of the rule of law[18] to conclude President Trump will ignore the rule of law. Still, even though this isn’t the first time a President has tried to unduly pressure the Fed, nearly 600 economists are concerned about the implications of his actions vis Fed Governor Cook.
The Rule of Law
The fact that Trump and Pulte are pointing to occupancy fraud as the reason for firing Ms. Cook is significant because it seems to reflect a recognition that the President can only remove a Fed Governor “for cause”. While the whole thing smacks of the administration’s theme of retribution,[19] the pretense of having a basis for alleging a “for cause” firing of Ms. Cook should also be seen as a concession to the Fed’s independence.[20] As I have noted previously, even SCOTUS Justice Samuel Alito says (in a footnote to his 2024 CFPB funding case dissent) that the Federal Reserve is “a special arrangement sanctioned by history”, so even the most powerful unitary executive isn’t going to be permitted unfettered control over the Fed from this Supreme Court. The desire to find “cause”, even if pretextual, is reassuring from the perspective that the Rule of Law is still paramount.
I don’t know how this ends for Ms. Cook or the others personally, and I still have faith in the Constitutional order, but I think it’s another black eye for the home finance industry.
Speaking Engagements
Coming up, I have RESPRO in Philly on September 15-16 and the MBA's Compliance and Risk Management Conference in Washington DC September 28-30.
[1] “Fraud” requires specific intent. Mortgage investors like to throw around the word “fraud” when they want a reason for a loan seller to buy back a loan that has a loss, but what is called “occupancy fraud” in the mortgage business rarely passes the test for the kind of “fraud” that lawyers talk about in court.
[2] Investor occupancy fraud is a much greater issue than second home occupancy concerns. Lumping them together mislabels and misstates the risks. See generally, this 2023 Philadelphia Fed research paper.
[3] In terms of these kinds of expectations, this could also be the CEO of a public company, a bank director, church leader, or many other positions of trust and power. By contrast, this person is not a used car dealer, rock or rap music artist, or teenage movie star.
[4] Again, to be clear, you cannot legally be convicted of fraud without specific intent, so my saying “intentionally commit fraud” is redundant but that was done for clarity.
[5] For those of you keeping score, I can assure you this is not going to be a partisan discussion.
[6] Admittedly, those kinds of expectations for this particular President’s staff may not be particularly high.
[7] I want my reader to come to their own conclusions.
[8] I’m going to say here that this PPPP was definitely not a Fed Governor asking about rate movement.
[9] Unlike this PPPP, most borrowers wouldn’t even be aware that higher rates apply to second homes (investors are probably more aware). But, it is hard to imagine a significant risk basis for having a higher rate on second homes. Whether the home is “primary” or “secondary” in terms of occupancy percentages should not matter to default risk. The question of whether second homes or investor purchases, however, should even be eligible for federally subsidized financing is a separate issue entirely.
[10] Although Simpson is both a former mortgage originator and lawyer, it is totally coincidental that I used the name “Bob” for the originator in this Musing’s dialogues.
[11] Can PPPP have a different “primary” residence from his wife? Does it matter what percentage of time is spent at each residence? What if you claim to have 3 residences-which would be the primary and how would you decide?
[12] Time to cue one of my Musings about the LO Comp Rule here.
[13] I’m not saying that the mortgage industry was entirely to blame for the Great Recession, but we sure were the poster child.
[14] And structuring loan products that mostly relied on eternally rising real estate values to sustain payments.
[15] The fact Congress needed to pass a law (ATR) to make sure no mortgage loan is made to a person who can’t reasonably be expected to pay it back is shameful.
[16] Again, I’m putting “fraud” in quotes because it rarely is something where specific intent to defraud can be found, especially with second homes. Still it does often result in repurchase claims.
[17] Roughly speaking, this is accurate since CFPB went from around 3,000 employees to around 300. “Decimate” literally means to eliminate (kill) 9 out of 10.
[18] President Andrew Jackson reportedly responded to an 1832 Supreme Court decision that went against him: "John Marshall has made his decision; now let him enforce it!”
[19] Trump’s felony convictions in New York for whatever illegal things he supposedly did, was prosecuted only because they wanted to “get Trump”.
[20] The Federal Reserve is a creature of Congressional statute. It does not appear in the Constitution, so if Humprey’s Executor is overturned, the independence of the Fed from the executive branch (and thus the President’s authority) needs another source. SCOTUS seems to have landed on precedent and history for the Fed (at least in footnotes and in emergency docket rulings) whereas other agencies such as CFPB, FHFA, and FTC may not be given the same treatment.