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Discretion in the Criminal Justice System

      Discretion is arguably the most important tool in a criminal justice professional’s arsenal. Without it, we would be robots. Even the ...

The Housing Collapse of 2008, Was it Criminal?


    The housing market collapse of 2008 had very far-reaching consequences, both in the homeland and in the global economy. It came at a time between presidential elections when the political climate was instable at best, and completely war stricken at its worst. At the best of the recession, people stopped spending money in the market. At the worst of it, people could not afford their mortgages and faced potential homelessness. Because of rampant derivatives trading with little to no checks and balances on its design, people across the globe felt the implications.

    “Reaganomics” brought a massive shift in wealth between the classes in the United States of America. Eventually the rich would discover that they could play around in the housing market where there was a seemingly untapped potential for money. The reason that the risk was thought to be completely mitigated was because the house is seen as a home, not a toy, meaning that it was not seen as something that the common person would default on.[1] Because of many factors, including including income distribution as the rich got richer and the poor became poorer, the housing market should have slowed as less families could afford a house. This is the opposite of what happened, as proven by how house purchasing was at an all-time high.[1]

    Subprime mortgages are those that are riskier for the bank because the borrower may have a lower credit score or inconsistent work history. These mortgages only constituted a small percent of the mortgage market, roughly six to eight percent throughout the 1990’s and early 2000’s. By 2006, that number had tripled or even quadrupled to around a quarter of all mortgages. [1] This is primarily because of the increasingly lax standards that the housing market began to employ. Due to a plethora of reasons a lot of these risky subprime mortgage benefactors could not afford their mortgage. When they couldn’t pay, the bank foreclosed on their homes. Americans lost their houses, their savings, and ultimately their trust in the market. If this was rampant capitalism, a lot of young adults would be hesitant to believe in it.

    Because the housing market was in a bubble, they could be bought and sold as if they were stocks, even on the same day. This makes the market liquid and, “through a process called securitization, a bundle of real estate properties can be packaged and resold as a piece of paper; houses are converted not to homes, but to derivatives.” [1] This means that the average person’s mortgage could be tied up with multiple mortgages and sold on a piece of paper, called a security, completely behind the scenes.

    The market that sprung up around these securities was known as “hedge funds,” and the banks were making so much money from these securities, that they decided not to put the transactions on their balance sheets, effectively leaving them unregulated and unchecked.1 This made their capital reserves seem safer than they actually were and with the amount of money in these hedge funds, a catastrophe seemed imminent.

    The multiple mortgages on one piece of paper is where the market became tricky. Higher quality loans were misrepresented as being the majority of these securities, with some riskier loans stuffed in. Because of so much repackaging, however, the securities kept being cut with higher amounts of riskier loans. Eventually, where these securities should have been a vast majority of triple-A mortgages, they became overwhelmingly the opposite.

    This widespread, rampant corruption led to catastrophic delinquencies in our global economy. The recession began with the decline of Bear Stearns after they had to be bailed out by both the Federal Reserve and JP Morgan following the sub-prime mortgage conundrum. Bear Stearns, the fifth largest investment bank in the United States, collapsed entirely when a deal could not be brokered, and the Federal Reserve would not back the loan penned by JP Morgan. [1]

    The common theme behind the reasoning for the global crash following the United States’ is interconnectedness.[2] Because all European banks have vested interest in the Dublin bank, the collapse of the Irish bank on September 29th, 2008 would set the stage for the global ramifications that the United States market crash would have. In 2008, David Bartlett of Finance Director Europe predicted that, “European financial entities stand to incur $123bn in mortgage-related losses. Within the latter group, British institutions face $40bn in asset write offs, nearly matching the combined losses of the euro area ($45bn)” [2] These numbers are substantial, especially when these are just early predictions.

    Man Financial Group was a global investing firm that had its eyes on the scope of Goldman Sachs or J.P. Morgan. When it failed during the housing collapse, it would take a large number of smaller clients out with it. These clients were mainly individual investors and small business clients such as ranchers and farmers. [3] From the same article Ross states that, “In an effort to meet its obligations, MF Global admitted to accessing what should have been separate client funds. This latter action would appear to constitute fraud, though no one has been charged, as yet, with any criminal wrongdoing.” [3]

    On April 24th, 2012, Chairman Tim Johnson would hold a meeting by the Banking, Housing, and Urban Affairs Committee in the U.S. Senate. This meeting was with James W. Giddens, a trustee of MF Global, and Louis J. Freech, another trustee of MF Global among others and took place to, “examine the lessons learned from the collapse of MF Global.”[4] Chairman Johnson also says in his opening statement that over $1.6 Billion has not been recovered by hundreds of South Dakotans out of what should have been protected accounts following MF Global’s bankruptcy. [4]

    This means that ultimately, consumers and small businesses did have to foot the bill for large parts of this recession. This is especially unnerving when considering that what happened in the higher echelons of MF Global could possibly be constituted as fraud that the average citizen is being punished for. Upon testimony, Jon Corzine, the Chief Executive Officer and Head Trustee of MF Global stated that, “I simply do not know where the money is, or why the accounts have not been reconciled to date. I do not know which accounts are unreconciled or whether the unreconciled accounts were or were not subject to the segregation rules."[4] This quote was taken from testimony at one of the highest offices of land, and the best that Corzine could say is that he simply doesn’t know where $1.6 Billion dollars in his clients’ money is.
    There are two types of mortgage fraud according to the F.B.I.[5] There is fraud-for-housing, which is where someone misrepresents themselves on paperwork for the purpose of qualifying on a loan, and there is fraud-for-profit, in which individuals fictitiously inflate the value of the home in order to reap a profit, or they trade in properties that are non-existent.[5] An alarming statistic from around the time of the housing collapse is the forty percent rise in the number of Suspicious Activity Reports that were reported from 2007 to 2008. This directly coincides with the number of defaults on mortgages in the same year.[5]

    The study by Paul E. Carillo to test for fraud in the mortgage crisis produced a very specific result. “Specifically, it is found that homeowners who bought their homes during 2006 and defaulted on their loan payments shortly after the sale (within 1 year) paid an average premium of at least 1.8% of the home value.”[5] This is important because in a fraud-for-profit model of business, why would the pseudo homeowners pay any value of the house down? The 1.8%, although not a large number by any means, shows that the people buying homes in 2006 did intend on keeping them, whether they committed fraud on the initial applications or not. And with nobody checking the income sources, which has been extensively documented, could we really hold people accountable from trying to own a home?

    If there was a large amount of fraud to take place, it was by the higher-ups in the mortgage industry or at least perpetrated by them using normal citizens. This widespread fraud cannot be narrowed down to one or two people, but rather a trove of people that each had their own part in undermining the mortgage industry. One brokerage firm that seemingly had their hands inside of everything was AFG Financial.[6] AFG Financial was indicted in July 2009 by Manhattan D.A. Robert Morganthau in what he described as their business model being solely focused on defrauding the lending banks of millions of dollars. [6]

    The scheme was simple, recruiters would find both suitable houses and suitable people with high credit scores. They would then have these “straw buyers” stand in for the real buyers and would be compensated for it. They would then forge documents, including W-2’s and bank statements to inflate the chances of the buyer receiving the mortgage. They forged these records in an already easy-to-qualify system, showing that not only did they not only take advantage of the housing bubble, but that they took illegal steps to financially gain from the crisis. Corrupt appraisers and bank employees were also complicit in the scam.5 The article goes on to state that, “The conspirators were so brazen that in one transaction, they created a sham appraisal with a stated value of over $500,000 for a 2-family home which was, in reality, only a vacant lot.” [6]

    When all was said and done with the scheme, the houses would go into default. The straw buyers had ruined credit and the banks had worthless mortgages. AFG Financial would walk away with over $12 Million in profit that was supposed to go to the sellers and defrauded the bank for over $100 Million. [6] This was not an isolated case as this sort of behavior may have led to the crisis in the first place.

    In an August 2006 Federal Reserve Hearing, the President of The Mortgage Broker Association for Responsible Lending, had made a statement regarding the alarmingly high rate of incomes being fraudulently reported on mortgage applications. 5 His declaration came with the review of one-hundred stated income loans by the Mortgage Asset Research Institute that used tax returns to compare against the borrower’s stated income. “The analysis found that 90% of all the applicants had exaggerated their income and more than half of these borrowers had inflated their actual incomes by more than 50%.”[6] 

    Can individual people at the initial borrower level be considered responsible for the entire collapse of the system? While they have to have some small association with the crisis, it was the banks at the top that were approving these people. If someone’s family member told them about a great opportunity to buy a house, who wouldn’t want to take advantage of it. A home is the American dream, and such, should not be tampered with by the large investment groups at the top. A lot of people in these firms lost their jobs, but many more Americans lost their entire homes. This is what our market system looks like when left to the morality of bankers and institutions.

[1] Canterbery, E. R. (2011). The Global Recession. Singapore: World Scientific.

[2] PBS Newshour. (2018, September 18). How the 2008 financial crisis crashed the economy and changed the worldRetrieved from YouTube

[3] Ross, M. L. (2019, June 25). What Happened at MF GlobalRetrieved fromInvestopedia

[4] U.S. Senate Comittee on Banking, Housing, Urban Affairs. (2012). Hearing Before the Committee on Banking, Housing, Urban Affairs. Washington D.C.: U.S. Government Printing Office.

[5] Carrillo, P. E. (2013). Testing for Fraud in the Residential                     Mortgage Market: How Much Did Early-Payment-Defaults              Overpay for Housing? Journal of Real Estate Finan Econ, 36-64.

[6] Jurow, K. (2010, April 27). SPECIAL REPORT: How Widespread       Mortgage Fraud Toppled the U.S. Housing Market. Retrieved          from World Property Journal