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Lending Fraud’s Role in the 2008 Financial Crisis

A new study compiled by a financial researcher at The University of Texas at Austin has determined that mortgage fraud was far more prevalent than previously known during the 2007-2009 financial crisis.

The study by John Griffin, a finance professor in the McCombs School of Business at UT Austin, will appear in the next edition of the Journal of Economic Literature. Griffin explained that the fraud which played a major role in the last financial crisis was predicated by four stakeholder groups in the residential mortgage-backed securities sector:

  • Mortgage originators that emphasized profit-fueled quantity over loan quality, which resulted in the misreporting of key financial information in 48% of loans securitized by nongovernment agencies;
  • Appraisers who worked in conjunction with originators, resulting 45% of securitized loans where the appraisal and loans exactly matched;
  • Investment bank underwriters who earned more by securitizing low-quality loans with high interest rates and falsely presenting them to investors as high-quality securities; and
  • Credit rating agencies that frequently inflated ratings of mortgage-backed securities by adjusting their standard rating models.

Griffin’s study concluded that fraud deepened the depth and scope of the financial crisis, noting that home prices in California plummeted by 45% in the ZIP codes where more than 15% of home loans involved fraud, but only fell by 5% where fraud was involved in just 3% of home loans.

“Fraud led to massive distortions in the prices of houses,” Griffin said. “The bubble was very regionalized to those areas where fraudulent loan originations were common.”

Griffin’s research was synthesized from more than 80 papers, along with legal settlements by 11 banks with the U.S. Department of Justice. He noted that despite the massive scale of fraud, only a single investment banker went to prison as a result of the mortgage meltdown – in comparison, 1,700 bankers were convicted in the savings and loan crisis of the late 1980s.

Today, Griffin warns that the greatest threat for fraud is not in residential mortgages, but in other securitized assets such as commercial mortgages and collateralized loan obligations.

"The coronavirus is a different cause, but it may have the same effect, revealing the same forces that were at work in the pre-financial-crisis period," Griffin said. “Market corrections have a way of revealing fraud and structural problems.”

And while the 2007-2009 crisis may seem like history today, Griffin warned that history can repeat itself.

"A lot of academics think that conflicts of interest and fraud are things the media like to talk about, but they’re not of major economic importance,” he said. “This paper and all the research that it summarizes says the opposite. That they did play a major role in the financial crisis. Checks and balances are supposed to be in place, but a lot of them don’t work."

About Author: Phil Hall

Phil Hall is a former United Nations-based reporter for Fairchild Broadcast News, the author of nine books, the host of the award-winning SoundCloud podcast "The Online Movie Show," co-host of the award-winning WAPJ-FM talk show "Nutmeg Chatter" and a writer with credits in The New York Times, New York Daily News, Hartford Courant, Wired, The Hill's Congress Blog and Profit Confidential. His real estate finance writing has been published in the ABA Banking Journal, Secondary Marketing Executive, Servicing Management, MortgageOrb, Progress in Lending, National Mortgage Professional, Mortgage Professional America, Canadian Mortgage Professional, Mortgage Professional News, Mortgage Broker News and HousingWire.

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