How We Got Here


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Appraisers dependent on lender referrals led to escalating property values without basis.

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  • A vast chasm developed between the loan originator (the mortgage broker) and the final owner of a mortgage (hedge funds via CDOs). And it’s precisely this disconnect between the originator and the investor that created the current problems in the market. Why should a mortgage broker care if a borrower defaults? That’s the investor’s problem. He earns his commission either way. In fact, the more exotic the loan, the bigger his paycheck so his incentive is to find buyers that are likely to default.
  • How We Got Here

    1. 1. Economic Recovery Reforms Senator Christopher Dodd Chairman of the Senate Banking Committee Congressman Barney Frank Chairman of the House Financial Services Committee Proposed Guidance for Legislation Submitted to the offices of : January 24, 2009 Prepared by: Sam Chughtai, Risk Management Microsoft Corporation, [email_address] Chris Dufault, Fraud, Credit & Risk Management Consultant, [email_address] Mark Gabel, Risk Management Microsoft Corporation, [email_address] Senator Tim Johnson Ranking Member Senate Banking Committee
    2. 2. Table of Contents/Agenda <ul><li>How We Got Here </li></ul><ul><ul><li>Substandard Mortgage Qualification </li></ul></ul><ul><ul><li>Lack of independent Oversight </li></ul></ul><ul><ul><li>Inadequate Check and Balance Control </li></ul></ul><ul><ul><li>Irrational Home Affordability Model </li></ul></ul><ul><ul><li>Mortgage Crash </li></ul></ul><ul><ul><li>Crisis Spreads </li></ul></ul><ul><ul><li>Frozen Credit Market </li></ul></ul><ul><li>Solution: Solve Mortgage First </li></ul><ul><ul><li>Better Mortgage First </li></ul></ul><ul><ul><li>Proposed Guidance for Legislation </li></ul></ul><ul><ul><li>Timothy Geithner Senate Testimony </li></ul></ul><ul><ul><li>Early Fraud Detection Risk Management Framework </li></ul></ul><ul><ul><li>New Mortgage Regulation </li></ul></ul><ul><ul><li>Improve Credit Transparency </li></ul></ul><ul><ul><li>Objective Real Property Valuation </li></ul></ul><ul><ul><li>Averting Fraud – a Watchful Eye </li></ul></ul><ul><ul><li>Proposed Changes Impact Analysis </li></ul></ul><ul><ul><li>Who We Are </li></ul></ul>
    3. 3. How We Got Here <ul><li>Irrational escalation of property value to income </li></ul>
    4. 4. Substandard Mortgage Qualification <ul><ul><li>Lowest qualified applicants with inadequate credit scores incur highest costs and become first to default </li></ul></ul><ul><ul><li>Lax income verification, ARMs, stepped interest programs </li></ul></ul>
    5. 5. Lack of Independent Oversight <ul><ul><li>Homebuyers mortgage loans based on inflated appraisals derived under pressure from lending and real estate agents </li></ul></ul><ul><ul><li>This artificially boosted rapid run-up in home prices between 2001 and 2006, and put the local housing market at a higher risk of falling. </li></ul></ul><ul><ul><li>A 2006 study by Richfield, Ohio-based mortgage and real estate research firm October Research Corp. found that 90 percent of 1,200 appraisers nationwide said they had been pressured to raise valuations, up from 55 percent in a smaller 2003 survey </li></ul></ul><ul><ul><li>The problem is underreported because of appraisers' fears that they will be blacklisted by real estate lending or sales agent </li></ul></ul>
    6. 6. Inadequate Checks And Balances Control Mechanisms <ul><ul><li>Loan brokers separated from credit grantors and servicing </li></ul></ul><ul><ul><li>Brokers don’t care if borrower defaults </li></ul></ul><ul><ul><li>The more exotic the loan the higher the commission - providing incentives for brokers to seek out non-creditworthy buyers. </li></ul></ul>
    7. 7. Irrational Home Affordability Model <ul><ul><li>Expectation was that property value would always increase. </li></ul></ul><ul><ul><li>Equity tapped to make mortgage payments. </li></ul></ul><ul><ul><li>Equity provided false sense of consumer confidence </li></ul></ul><ul><ul><li>Equity ‘feels-like-income’ and is used to finance lifestyle. </li></ul></ul><ul><ul><ul><li>Equity provided purchasing ability to drive economy. </li></ul></ul></ul><ul><ul><ul><li>Economy & stock market became over dependent on credit </li></ul></ul></ul><ul><ul><ul><li>Less than 0% savings rate. </li></ul></ul></ul>
    8. 8. Mortgage Crash <ul><li>Home prices beyond affordability </li></ul><ul><ul><li>Despite step up and negative amortization loan programs </li></ul></ul><ul><ul><li>Median home values grossly exceed affordability for median income </li></ul></ul><ul><li>ARM interest rate resets causing initial delinquencies </li></ul><ul><ul><li>Delinquencies turn into defaults, then to foreclosures dragging down home prices </li></ul></ul><ul><ul><li>Median home prices begin to fall towards median income affordability </li></ul></ul><ul><li>Resale and new construction inventory surplus depresses home prices further </li></ul><ul><li>Default rate increases </li></ul><ul><li>Upside down mortgages will continue to fuel consumer discontent which will plague markets until confidence is restored. </li></ul>
    9. 9. Crisis Spreads <ul><li>Mortgage portfolios begin to underperform </li></ul><ul><ul><li>Falling home values reduce securitization of mortgage portfolios make them less attractive to secondary markets </li></ul></ul><ul><ul><li>Impedes ability for banks to lend in other in non-mortgage areas (i.e. consumer and commercial loans.) </li></ul></ul><ul><li>Fannie Mae and Freddie Mac are taken over by fed. </li></ul><ul><li>Mortgage performance insurance programs are unable to meet potential payout demands </li></ul><ul><ul><li>AIG is bailed out </li></ul></ul><ul><ul><li>Exposure to credit derivative contracts start to bring down investment banks. </li></ul></ul>“ Some theorize that money from real property speculation quickly moved into food and oil commodities speculation exacerbating domestic economic crisis by further eroding consumer ability to pay mortgages.”
    10. 10. Frozen Credit Market <ul><li>Banks conserve cash to meet liquidity requirements and stop lending to one another. </li></ul><ul><li>Banks tighten consumer and commercial lending requirements. </li></ul><ul><li>Businesses are unable to access credit for working capital needs and business expansion. </li></ul><ul><li>Home equity lines of credit are reduced. </li></ul><ul><li>Consumer auto finance is severely curtailed </li></ul><ul><ul><li>Auto manufacturers begin to fail </li></ul></ul><ul><li>Consumer and commercial purchasing slows . </li></ul>
    11. 11. Stock Market Crash <ul><li>Slowing consumer and businesses purchasing reduces business revenue </li></ul><ul><li>Global stock markets dramatically lose value. </li></ul><ul><li>Consumer stock investments decline further restricting purchases and causing stock sell panic. </li></ul><ul><li>Job losses in financial sectors spread to many sectors causing further erosion of consumer confidence and restrictions in spending. </li></ul><ul><li>More banks fail </li></ul><ul><li>Businesses dependent on credit begin to fail </li></ul>
    12. 12. Solution: Solve Mortgages First <ul><li>Remediating distressed mortgages will restore consumer confidence and commercial credit availability. </li></ul><ul><li>Current workout practice </li></ul><ul><ul><li>Get housing debt to income to 38% </li></ul></ul><ul><ul><li>Convert ARM to fixed, reduce rate to approx 6.5% (FM Survey) </li></ul></ul><ul><ul><li>Add past due payments to principal </li></ul></ul><ul><ul><li>Step up interest over 5 years starting at 3% - re-amortize each year </li></ul></ul><ul><ul><li>Reschedule loan to 40 years </li></ul></ul><ul><ul><li>In most dire circumstances reschedule portion of principal to a balloon payment </li></ul></ul><ul><li>Current loan modification workout strategies have failed – 60% of loan modifications result in default </li></ul>
    13. 13. Better Mortgage Workouts <ul><li>Develop a workout strategy that permanently reduces principal </li></ul><ul><ul><li>Modification must be part of a BK to revise all household debt </li></ul></ul><ul><ul><ul><li>Provide BK judges with authority to reduce principal to market value </li></ul></ul></ul><ul><ul><ul><li>BK credit penalty offsets ‘fairness’ issue for non-adjusting homeowners </li></ul></ul></ul><ul><ul><ul><li>Determine ’30-day quick sale’ home value with a Broker Price Opinion and AVM crosscheck </li></ul></ul></ul><ul><li>Worked out loans are transferred to FDIC as TARP </li></ul><ul><ul><li>Loan is purchased for discount between actual remaining principal and modified principal amount. </li></ul></ul><ul><li>Loan repayment is administered/serviced by BK trustee </li></ul><ul><ul><li>Mortgage reverts to private servicer after other consumer debt paid </li></ul></ul>
    14. 14. Proposed Guidance for Legislation <ul><li>As President Obama said on Inauguration Day, “this crisis has reminded us that without a Watchful Eye, the market can spin out of control” </li></ul><ul><li>We propose a Third Party Independent Risk Rating Value based Financial transaction Valuation and Audit model to ensure objective decision making for Individual (small) and Portfolio based (large) Financial / Mortgage transactions with built in criminal penalties. </li></ul><ul><li>Mandate Third Party Intrusive Oversight with criminal penalties to prevent the future catastrophe in financial and mortgage industry. </li></ul>
    15. 15. Timothy Geithner Senate Testimony <ul><li>More intrusive oversight </li></ul><ul><li>Most prudent course is most forceful course to avoid financial catastrophe </li></ul><ul><li>Independent transparent oversight is must </li></ul><ul><li>Serious concern about independence and accountability and requires necessary transparency </li></ul><ul><li>This recovery depends upon reforms we initiate now </li></ul><ul><li>System was unfair and unjust even individual and business they were responsible was hurt </li></ul><ul><li>Need much stronger tools to respond to a future crisis </li></ul><ul><li>The scale of damage we have never seen before </li></ul>
    16. 16. Early Fraud Detection Risk Mgmt. Framework <ul><li>Develop and Mandate Risk Rating / Early Fraud Detection Framework compliance for all financial services organization, SEC Brokers and Audit Firms. </li></ul><ul><li>Introduce a Third Party Audit firm attestation requirement for Risk Management / Fraud Detection Valuation for all individual small / portfolio based large transactions. </li></ul><ul><li>An independent Risk Management Value ensure a common taxonomy across all transaction partners and prevent misleading High, Medium and Low subjective ratings based frauds by transaction beneficiaries and participant. </li></ul><ul><li>Mandate All individual Financial Transaction and secondary mortgage market Portfolio be assigned an independent Risk Rating value by a third party for quarterly disclosure reporting. </li></ul><ul><li>Mandate Criminal Penalties from Board of Directors to Senior Management for avoiding / tempering red flags reporting for High Risk Rating transaction execution. </li></ul>
    17. 17. New Mortgage Regulation <ul><li>Improve property valuation objectivity </li></ul><ul><ul><li>Develop and Mandate Risk Rating / Early Fraud Detection Framework compliance for all financial services organization, SEC Brokers and Audit Firms </li></ul></ul><ul><ul><li>Introduce a Third Party Audit firm attestation requirement for Risk Management / Fraud Detection Valuation for all individual small / portfolio based large transactions </li></ul></ul><ul><ul><li>Strengthen civil and criminal penalties for inaccurate appraisals </li></ul></ul><ul><ul><li>Consolidate national license repository to prevent interstate abuse (similar to Commercial Driver’s License Information System (CDLIS) </li></ul></ul><ul><ul><li>Cross-check appraisals with broker price opinions (BPO) and automated valuation models (AVM) </li></ul></ul><ul><li>Improve loan underwriting standards. </li></ul><ul><ul><li>Strengthen civil and criminal penalties for abusive lending practices </li></ul></ul><ul><ul><li>Monitor loans for two years, audit defaults for unethical loan approval. </li></ul></ul>
    18. 18. Improve Credit Transparency <ul><li>Transparency in financial transactions is critical to rebuilding trust in the financial sector. </li></ul><ul><li>Commercial credit and fraud detection tools provide transparency. </li></ul><ul><li>These commercial information tools are dependent on a comprehensive and complete accounts receivable trade information provided by credit providers. </li></ul><ul><li>However, there is a problem of opaqueness in commercial lending. </li></ul><ul><li>Bank reporting of commercial A/R data falls short of consumer credit reporting. </li></ul><ul><ul><li>Lack of commercial trade data hampers development of commercial credit analytics and fraud deterrence solutions. </li></ul></ul><ul><ul><li>Government should compel banks to report commercial trade lines with same detail as they report consumer trade data. </li></ul></ul>
    19. 19. Objective Real Property Valuation <ul><li>Mandate independent third party property valuation cross-checks </li></ul><ul><ul><li>AVM </li></ul></ul><ul><ul><li>Broker Price Opinion </li></ul></ul><ul><li>Mandate independent verification of data on appraisal reports </li></ul><ul><ul><li>Use third party confidence scores to validate appraisals </li></ul></ul>
    20. 20. Averting Fraud - a Watchful Eye <ul><li>Civil & criminal penalties for non-compliance to regulations </li></ul><ul><li>Authenticate and report all parties to a loan transaction including guarantors, borrowers, sellers, mortgage broker, real estate broker, appraiser etc. </li></ul><ul><ul><li>Mandate banks to contribute all commercial and consumer trades to credit bureaus with Risk Rating Framework Value </li></ul></ul><ul><li>National appraiser registry to track and report infractions </li></ul><ul><li>Mandate third party income validation to assure adequate debt to income </li></ul><ul><li>Mandate insurance companies to report property claims history to help prevent insurance fraud. </li></ul>
    21. 21. Proposed Changes & Impact Analysis Mortgage Finance Transaction Processes Current Lending Practice Proposed Model Impact Third party property valuation crosscheck ( AVM/BPO) No Yes Improve transparency / reduces fraud Independent income verification / enforce debt to income qualification No Yes Improve transparency / reduces fraud Mortgage broker / appraiser collusion potential (it was the trigger for the current crisis) Yes No Improve transparency / eliminates frauds Assign every transaction an independent formula driven CRV (calculated risk value) No Yes Improve objectivity / eliminates frauds Attestation requirement for all transactions risk values ( CRV) audit and validation No Yes Improve objectivity / eliminates frauds Mandate civil/criminal penalties for misrepresentation and fraud for all levels from appraiser to board of director No Yes Improve transparency / reduce frauds Mandate third party transaction validation and risk mitigation assessment with quarterly reporting for all transactions No Yes Improve objectivity / eliminates frauds Establish national registry for appraisers, mortgage brokers , and other financial services key players / authenticate all parties to a transaction No Yes Improve objectivity / reduce frauds Mandate commercial trade lines reporting No Yes Improve transparency Mandate banks to submit all transaction details to credit bureau with assigned risk value (CRV) No Yes Improve transparency / eliminates frauds All parties to a mortgage transaction remain responsible for loan performance (i.e. brokers who sell loans are not ‘off the hook’ for poorly qualified loans..) No Yes Improve accountability for loan qualification Mandate insurance companies to report claims histories and frauds to insurance claims reporting companies No Yes Improve transparency / eliminates frauds
    22. 22. Who We Are <ul><li>We are an independent group of senior leaders in Risk Management / Fraud Detection domain with over 60 years combined experience with fortune 100 companies and public sector clients. </li></ul><ul><li>We offer our Subject Matter Expertise in Risk Management Framework Development, Fraud Detection, Credit Reporting and Real Estate Valuation to assist and strengthen the forthcoming financial risk management / compliance legislation. </li></ul><ul><li>While we’re versed in private sector risk aversion solutions, we have no current association with financial services, information services or other entities that would create conflicts of interest and can assure our complete independence during legislation guidance. We are available for more detail discussion and guidance development if requested. </li></ul>INTEGRITY
    23. 23. Who We Are <ul><li>Sam Chughtai </li></ul><ul><ul><li>An industry leader in risk management and fraud detection with over 20 years of professional consulting experience with Price Waterhouse Coopers, KPMG, Microsoft, Choicepoint and public sector clients. </li></ul></ul><ul><ul><li>[email_address] 425-704-0414 / (425) -614-8414 Cell </li></ul></ul><ul><li>Chris Dufault </li></ul><ul><ul><li>An industry leader in consumer and commercial business credit fraud detection, risk management and electronic real estate valuation experience with over 22 years of experience consulting fortune 100 companies, Experian, Equifax, and Choicepoint. </li></ul></ul><ul><ul><li> [email_address] (949) 273-2002 / 949-679-1056 cell </li></ul></ul><ul><li>Mark Gabel </li></ul><ul><ul><li>A Senior Leader at Microsoft in risk management group managing global risk management practice with over 18 years of industry experience providing risk management and fraud detection guidance to Roche, Eli Lilly and many Fortune 100 companies. </li></ul></ul><ul><ul><li>[email_address] (425) 421-9092 / (206) 617-5665 cell </li></ul></ul>CITIZEN PARTICIPANTS