By William K. Black
Bloomington, MN: February 13, 2015
The website “538” has one claim to fame – interpreting data. In the mortgage fraud context it got this horribly wrong in a way that should be an object lesson to the dangers of implicit assumptions that implicitly exclude alternative theories of causation. This typically happens because of an unrecognized bias. Ben Casselman and Andrew Flowers provided the object lesson in their discussion of a new study (behind a pay wall) by Atif Mian and Amir Sufi entitled “Fraudulent Income Overstatement on Mortgage Applications during the Credit Expansion of 2002 to 2005”
“What they found: Mortgage lending surged in low-income, less creditworthy areas of the U.S. between 2002 and 2005. But systemic differences between incomes reported on mortgage applications and incomes reported to the IRS indicate that much of this “subprime” lending was reliant on borrowers fraudulently overstating their income.
Why it matters: Between 2002 and 2005, there was a tsunami of money for prospective U.S. homebuyers. This surge of mortgage credit was strongest in less creditworthy, low-income areas. But some economists have argued that incomes of homebuyers were increasing in these areas. After all, by looking at income as reported on mortgage applications, the areas with lower credit scores seem to have robust growth of homebuyers’ income. But new research from Sufi and Mian — the authors of “House of Debt” who have written for FiveThirtyEight — confirms that, no, economic improvement wasn’t behind these improving income numbers. It was fraud. Specifically, the fraud of homebuyers overstating income.”
Casselman then tweeted Sufi and reiterated the claim that the study shows that the homebuyers commit the fraud. He plainly wanted to emphasize the point. The difficulties which regular readers will have already spotted, are (1) the study could not determine whether the borrower, the lender, or the lender’s agents sought to overstate the borrower’s income, (2) the study did not conclude that the borrowers were the source of overstatement, and (3) logic and findings from those have actually investigated the issue demonstrate that it is overwhelmingly the lenders and their agents who put the lies in “liar’s” loans.
Casselman and Flowers have, obviously, never looked at the criminology literature explaining the three mortgage fraud epidemics that drove the most recent crisis. Had they read the experts on fraud they would have avoided this particular mistake. Of course, criminologists are not so naïve as to expect journalists who write about fraud to read the experts on fraud. Why would a journalist discussing fraudulent liar’s loans read the work of a former financial regulator who led the enforcement actions that drove liar’s loans out of the S&L industry beginning into 1991?
The real question is: why were Casselman and Flowers so eager to misread the study and solely blame homebuyers for mortgage fraud when there was literally nothing in the study that purported to make the homebuyers the primary, much less exclusive, movants in mortgage fraud? Casselman and Flowers had an overwhelming, unacknowledged desire to attack the borrowers and valorize the lenders as victims. They bought into one of the most facially absurd memes in history – the claim that the crisis was caused by the extraordinarily clever hairdressers who defrauded the oh-so-trusting and unsophisticated investment bankers with starting salaries of $300,000. The poor naifs were helpless – they could not (1) stop making liar’s loans, (2) verify the borrower’s income by checking with the employer, or (3) require the borrower to sign a 4506-T. Ah, that’s right, they could have done each of these things and they typically did require a signed 4506-T – which they virtually never used to get the borrower’s tax “transcript.” The tax return information allows the easy verification of the income of even self-employed entrepreneurs.
We also know that the probability of Casselman and Flowers being familiar with the “fraud recipe” for a lender (or loan purchaser) is zero. If they were familiar with the recipe they would know why the officers that control the lenders create and maintain the perverse incentives that lead to endemic fraudulent lending. This means that Casselman and Flowers are unfamiliar not only with the criminology literature but also George Akerlof and Paul Romer’s classic 1993 article “Looting: The Economic Underworld of Bankruptcy for Profit.” They would understand why lenders and their agents overwhelmingly encouraged and ensured the endemic lies in liar’s loans if he were familiar with either literature.