A few years ago, a small-town editor in Kansas had the feeling that criminals were actually getting ideas from the crimes he reported in the newspaper. He decided to stop reporting on burglaries--and was suprised to find that, according to the policies records, burglaries actually increased. This phenomenon showed that as the burglary reporting ceased, the citizens of the town became more complacent and left their doors and windows unlocked more often. The town became ripe for burglaries. This example also describes the dangers of a false sense of security in the mortgage lending industry regarding insider fraud.
With all the media attention thrust on the role of fraud in the downfall of some of the nation's mightiest thrifts, mortgage bankers may also be tempted to slip into a state of complacency. After all, mortgage bankers are not backed by the full faith and credit of the United States taxpayer, nor are they necessarily subject to the same regulatory scrutiny as federally supervised financial institutions. In a climate of declining production and revenues, the temptation may be to overlook or even failt to see fraud that is happening in our own institutions. This state of affairs has come to be known by leading professionals as "NIMBO" (Not In My Branch Office).
Who is an insider? Virtually anyone in a position of trust with direct or indirect influence over the loan-decision process. Because of this, malfeasance on the part of trusted associates is the form of fraud most likely to escape detection, yet it also accounts for the largest losses. There is no internal control system developed that can protect lenders from victimization with a 100 percent level of assurance. This is partly because the control function itself may be manipulated by the same individuals who are entrusted to maintain it.
Conflicts of interest
To understand how inside employees may allow themselves to be compromised, it is important to consider how conflicts of interest may arise out of a company's compensation plan. At each phase of loan origination, copensation is typically contingent upon the occurrence of a specific event. This contingency creates a series of "borrower advocates" who share a common self-interest in seeing the ultimate goal of the borrower--loan approval--be fulfilled. In the case of fraudulent or even marginal loans, this may be directly at odds with the best interest of the employer.
A conflict of interest can be implicit in many stages throughout the origination process. Because the loan officer will not be paid a commission unless the loan is approved and his or her employer will not book any fees until the loan funds, and the borrower will not obtain the loan unless all the lender's requirements are met, there is a strong financial incentive to approve, rather than deny, many loan applications.
Other affiliated relationships also want to achieve more loan approvals, and the implicit benefit they receive can create conflict of interest. Appraisers may not get any further business from the lender if they consistently fail to arrive at the desired value. Real estate brokers will not collect a commission until the sale closes. Title companies will not receive any fees for the title policy until the transaction records. Also, the escrow holder may lose business if it does not perform according to its client's expectations or demands. Mortgage insurers will not collect premiums unless the policy is issued. Thus, the fall of each new domino is contingent upon the fall of the previous one.
Even sellers can be caught up in a conflict, because they will not realize a profit (or in some circumstances, avoid a loss) until the lender approves the loan.
A conflict of interest may also arise from management's desire to produce loans in...