September 6, 2009

Does Liar Loan = Tax Evader?

The Liar’s Loan? study by economists Wei Jiang, Ashlyn Aiko Nelson, and Edward Vytlacil of over 700,000 mortgages issued during the Housing Bubble by an unnamed financial institution focusing on the "low documentation" mortgages brought in by independent brokers (now that's a trustworthy-sounding combination) raises questions about exactly what kind of borrower wants to pay higher interest rates in return for hiding facts about themselves.

Although this mortgage bank handed out fewer subprime loans than the national average, it still rode the Housing Bubble hard:
First, the bank experienced a rapid increase in loan production during the mortgage boom, followed by a sharp decline during the housing bust; new loan originations increased from about 20,000 in the first half of 2004 to a peak of over 154,000 in the second half of 2006, followed by precipitous decline starting in the second half of 2007.

It's specialty was low-doc loans:
Finally, the low-documentation loans represent just 20% of loans in the McDash database, but represent 70% of our sample. The difference is due to the lender’s specialization in low-documentation loans.

Like the lab rat that keeps hitting the button that dispenses more cocaine, the financial institution kept hitting the Low Doc / Broker channel harder and harder:
Figure 2 also shows that the rapid expansion in loan production was driven almost exclusively by increased loan originations through the broker channel, and expansion of low-documentation loans through the broker channel in particular. Broker-originated loans represented 73% of all loan originations in the first half of 2004, increasing to 94% by the second half of 2006; while broker low-doc loans accounted for 39% of originations in early 2004, they comprised 75% of loan originations by late 2006.

The creditworthiness of the four different channels is exactly what you'd expect:
The median duration times (in months) reported at the bottom of Table 3 reveal that a loan originated with full documentation by the bank has a median life of 25 years (300 months) before delinquency; the same median lifetime drops steeply to 8.4 years for Bank/Low-Doc loans, and to 7.9 years for Broker/Full-Doc loans. Finally, the median life is a mere 4.6 years for Broker/Low-Doc loans.

Not surprisingly, by 2009 the cumulative delinquency rates for 2007 loans were about 2.5X higher than for early 2004 loans.

So, what exactly was the business strategy behind pursuing the low documenation Don't-Ask-Don't-Tell borrower?

A 2006 MSN tried to put a good spin low-doc mortgages, it but it still comes out sounding sleazy:
No-doc mortgages let you pay for privacy

If your income doesn't come from a paycheck or you don't want to reveal all to some lender, you can still get a home loan, but you'll pay more. Here's how.


Most homebuyers work for a steady paycheck and are willing to divulge details of their finances in exchange for the best available mortgage loan.

But a lot of buyers don't draw a steady paycheck from a boss. They own businesses, make commissions, live off investments, get their income in cash or live a life of crime. Others don't want to give up their financial privacy. Limited-documentation mortgages are available for these people. ...

Ethical mortgage brokers and lenders generally try to talk customers out of getting low-doc and no-doc loans because they cost more.

Hmmhmmm ...
There are three main types of low-doc/no-doc mortgages.
  • Stated-income mortgages tend to be for people who work but don't draw regular wages or salary from an employer. That includes self-employed people or those who make a living off commissions or tips.

  • No-ratio loans are often the right call for wealthy people with complex financial lives, retirees who live off investments and people whose lives are in flux because of divorce, recent death of a spouse, or career change.

  • No-doc or NINA (no income/no asset verification) mortgages are for creditworthy people who want maximum privacy and can afford to pay for it.
Stated-income mortgages

Someone who gets a stated-income mortgage must disclose annual earnings, usually for the last two years and sometimes more. Instead of backing up the income statement with pay stubs and W2 forms, the borrower might have to show tax returns, bank statements and even profit-and-loss statements.

The borrower must list assets and debts. That's why the term "low documentation" isn't always accurate.

Stated-income mortgages are for people who make the money they say they make, but that amount doesn't show up on the bottom line of their income taxes, says Hugh McLaughlin, president and CEO of KMC Mortgage Services Inc., a lender and broker in Naples, Fla.

"They work for cash. They might be cleaning people or people who work in restaurants," McLaughlin says. "It is also good for self-employed borrowers who actually make gross sufficient amounts of income, but write off a lot on their taxes. They have the capacity to pay the loan back, but what they file with the IRS doesn't reflect their real income." ...
No-ratio mortgages

With these mortgages, the borrower doesn't declare income. No pay stubs, no W2s, no tax returns. Think of it as the "don't ask, don't tell" mortgage: The lender doesn't ask how much the borrower earns, and the borrower doesn't tell. ...

But the borrower does list assets -- money in the bank, stocks and bonds, real estate, ownership stakes in businesses.

"The purpose of the no-ratio program is to provide expedited processing for creditworthy borrowers," Pawsat says. "It's not intended as a means to qualify marginal borrowers."

Someone who owns 10 car dealerships might apply for a no-ratio mortgage because a conventional loan could require submitting personal and corporate tax returns and a year-to-date profit-and-loss statement for all the dealerships. ...

He says these loans also are for people "who say, 'I don't want to tell my whole life story to someone, so I want to pay a premium rate not to do that.'" ...

No-income/no-asset verification mortgages

These loans, sometimes known as NINAs, need the least documentation. In some cases the borrower provides his or her name, Social Security number, the amount of the down payment and the address of the property being bought. That's it. The lender gets a credit report and a property appraisal.

The line gets fuzzy between no-ratio and NINA mortgages, McLaughlin says. A lot depends upon the borrower's credit score. The better the score, the less documentation the lender will demand. In many cases, the lender will want to know what the buyer does for a living, and for how long. Lenders feel more comfortable with a borrower who has been doing the same job for at least two years.

In any case, an excellent credit score is required. These mortgages are for people who never, ever fail to pay bills on time. Actually, they're for people who employ assistants to pay the bills on time.

They're meant for people who zealously guard their privacy -- the movie star who doesn't want someone in the loan office selling copies of her tax return to The National Enquirer, the mobster who doesn't want to leave a paper trail.

In summary, these loans were invented for well-to-do tax evaders.

Yet, classy criminals, the kind who will lie to the IRS but not to the bank, the honor-among-thieves crowd, are fairly thin on the ground. If you go looking for liars to lend money to, you're likely to find ones who will lie to you, too.

One thing that would be worth exploring is how the interaction of illegal immigration and the Housing Bubble helped make liar loans so plausible sounding. Lots of who employed illegal immigrants, such as building contractors, were making lots of money during the Bubble, but doing much of it on a cash basis. Their employees wanted to be paid in cash, so that gave them an excuse to demand cash, too. Moreover, they tended to be speculators in housing, so if, like most of the financial community, you assume that we need ever more housing for our ever growing population which leads to ever increasing land prices, then they were good bets.

Of course, lots of people who implied they were making a lot in the untaxed market weren't.

You know, it's just hard to tell.

My published articles are archived at -- Steve Sailer


rightsaidfred said...

or live a life of crime.

??? Someone at MSN wrote this with a straight face? Monty Python could not be funny today with daily life so beyond parody.

Anonymous said...

"Someone who gets a stated-income mortgage must disclose annual earnings, usually for the last two years and sometimes more. Instead of backing up the income statement with pay stubs and W2 forms, the borrower might have to show tax returns, bank statements and even profit-and-loss statements." If we had bank statements and tax returns that showed they made the money, this was just another full doc loan.

It has been over 15 years since I worked in lending (including the early subprime which we called "A- through D" at the time), but what you are describing as a "Stated Income" loan was something we would have processed as standard Freddy/Fannie/FHA. I even took a class on how to go through someone's tax returns, P&L, etc to allow an underwriter to see someone's real cash flow (back out depreciation, non recurring expenses, subtracting the non deductible portion of entertainment expenses, etc).

Andrew Ryan said...

"Does Liar Loan = Tax Evader?"

Yes. My brother-in-law has a no-doc loan b/c he is a self-employed contractor who gets paid in cash and reports minimal income to the IRS.

The amount of tax evasion that occurs is astounding. I have family in catering that will openly give their clients a discount for cash payment b/c they won't report the income. When I had work done on the AC in my house they quoted me a reduced price for cash over the phone.

The other interesting aspect of cash businesses is how often they are involved in laundering drug money. I delivered pizza for a place that later became a major drug distribution center.

When I tell people these stories they are shocked. I often think you average college-educated American is painfully ignorant of how seedy and criminal much of our society is.

Bill said...

I can see divorced men who hide much of their income from their ex-wives using these.

CS/alimony laws are punitive enough to drive a good portion of this, I'd guess. For example, if a guy has a variable income and his ex manages to fix a monthly CS payment on the high end, he's screwed. If he can cut his reported income as much as possible to avoid that, he might enjoy a somewhat better lifestyle, but he's going to be forced to hide anything extra so as to keep her from taking him back to court and increasing his obligations.

Probably most contractors who buy and renovate houses get divorced. Every single one of these guys I've known who was foolish enough to get married ended up divorced (the wife has an incentive due to the property).

John Seiler said...

One of the things that needs to be studied is the shift in lending from your local bank or S&L, folks who knew your rep in the community or could find out, to a nationalized, faceless system -- typically somebody who knows you only by phone; somebody who, if you're a foreigner, likely speaks your language as a native.

John Seiler said...

Another consideration is how bad this housing disaster -- and the deepening Depression - would be if we had been on the gold standard, with gold pegged at the 1981-2001 average of $350/ounce begun by Reagan and Volcker. Since 2001, under the Greenspan-Bush-Bernanke-Obama inflation, gold's price has nearly tripled, to $992 on Sept. 6. I suspect the housing and other economic problems would be much less and we would be in the recovery stage right now.

Instead, nobody knows what the value of the dollar will be a year or 5 years from now, so economic planning, for families or businesses or governments, is made much more difficult. There will be no recovery until the Fed indicates it will no longer inflate. (Better yet, as Ron Paul titles his new book, "End the Fed." Since the Fed was undemocratically and unconstitutionally imposed on us in 1913 -- when gold was $22/ounce -- it has been mainly an engine of inflation. From $22/ounce in 1913 to $992 in 2009 is a vast robbery of wealth from Main Street folks to Wall Street speculators.)

Roger Chaillet said...

I worked in the mortgage industry just a few years ago. Steve and others would be amazed at the obscenely high credit scores of immigrants, specifically Hispanics. Many would have really high scores. It wasn't because they had much credit; it was mostly because they would have a car or truck loan. They would always, always, always make payments on their vehicles. I would compare the vehicle note payments to housing costs, and discover the note payment was as much or more than monthly rent on an apartment or house!

So, a self-employed Hispanic contractor with a good credit score could easily obtain a stated income loan even though his income was grossly understated.

But this only worked as long as the credit bubble fueled the housing market here in Texas and elsewhere.

I remember one Mexican couple from a small town near Corpus Christi. Adjusted gross income per their tax returns was just over $3,000 per month. The note they wanted to re-finance was around $2,000 per month! The couple "earned" so little money that they received earned income credits for their two daughters. The husband spoke so little English that I almost always spoke with his wife. He was a self-employed general contractor. I could not get the loan done. Once a borrower disclosed income a loan could only be done as full documentation loan and not a stated income one.

Bill said...

unnamed financial institution focusing on the "low documentation" mortgages

I wonder if there are any financial institutions which focused on low doc loans and which are also listed in boldface on this webpage?

Anonymous said...

>how seedy and criminal much of our society is.<

It's the high-tax government that's seedy and criminal. Blaming evaders often means blaming victims. (No advocacy of tax evasion or black market activity implied. Hail Obama!)

Anonymous said...

> There will be no recovery until the Fed indicates it will no longer inflate. (Better yet, as Ron Paul titles his new book, "End the Fed." <

How will we defend Ohio from Iranian A-bombs if we don't have ever-larger appropriations for the military, to invade and bomb ever-larger areas of the earth? Ruling the world isn't cheap, y'know. Don't forget that the source of wealth is the destruction of people and capital goods.

realtor in Vancouver said...

Hello and thank you for your post. The biggest problem is that people do not realize that if they continue taking loans and borrowing money, the situation never will be better. The more loans they get, the more in debt the country is and the more "housing bubbles" will appear.

Take care,