If you're confused about why banks are being given federal bailouts while homeowners in foreclosure aren't, here's something interesting to consider.

According to an index that tracks active criminal and civil mortgage fraud cases, there's a cause and effect relationship between foreclosure and fraud.

Foreclosure filings rose 57 percent in March from a year ago, says RealtyTrac, and a five percent gain from February. That's more than 234,000 homes in some stage of foreclosure.

In tandem, the Fraudblogger Index for the first quarter of 2008, compiled by MortgageDaily.com, says there's been a jump in mortgage fraud cases filed, from 600 in the fourth quarter 2007 to 713 in the first quarter 2008.

It's a scary trend, as it represents over one billion dollars in active fraud cases tracked.

What's surprising is that the injured parties in the majority of cases aren't consumers, but banks defrauded by homebuyers, mortgage brokers, real estate agents and appraisers.

The good news is that active fraud cases are down nearly $800 million from the first quarter of 2007, but the bad news is that foreclosures largely due to fraud will continue throughout 2009. The number of cases is going up because through the first half of 2007, the industry was still involved in bad underwriting.

Lax underwriting helped encourage homebuyers to use mortgage products like no-doc loans where they didn't have to provide proof of the sources of their incomes.

That's how the fraud is being uncovered. As loans go into default, lenders are investigating the files.

Sam Garcia, founder of Mortgage Daily, estimates that one-fourth to one-third of these buyers committed some sort of serious fraud against the lender by lying about their ability to repay the loan. And that doesn't even count the less serious fraudsters -- like those who borrowed downpayments from friends or family and didn't tell the lender.

Wow! Any way to quantify that? "I get my sense of it from the rating agencies, the source for bad data in the files," says Garcia, "It will take two years to clean itself out."

In 1998 we went through a mini-subprime meltdown, recalls Garcia. But investors' appetite for buying mortgage-backed securities other than those guaranteed by Freddie Mac and Fannie Mae didn't go away.

This time, it's different, says Garcia. "From loan origination to securities, it's annihilated. We won't have the ability to jump back into risky loans for quite a while."

That's a relief.

Published: April 16, 2008

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