June 30 (Bloomberg) -- The first sign of what would ultimately become a $3 billion fraud surfaced Jan. 11, 2000, when Fannie Mae executive Samuel Smith discovered Taylor, Bean & Whitaker Mortgage Corp. sold him a loan owned by someone else.
Fannie Mae, the government-sponsored enterprise which issues almost half of all mortgage-backed securities, determined over the next two years that more than 200 loans acquired from Taylor Bean were bogus, non-performing or lacked critical components such as mortgage insurance.
That might have been the end of Taylor Bean and its chairman and principal owner, Lee Farkas. He was sentenced today in federal court in Alexandria, Virginia, to 30 years in prison for orchestrating what prosecutors call one of the “largest bank fraud schemes in this country’s history.”
Instead, it was just the beginning.
Fannie Mae officials never reported the fraud to law enforcement or anyone outside the company. Internal memos, court papers, and public testimony show it sought only to rid itself of liabilities and cut ties with a mortgage firm selling loans “that had no value,” as Smith, the former vice president of Fannie Mae’s single family operations, said in a 2008 deposition.
The trial of Farkas and his co-defendants resulted in the only major criminal conviction stemming from the financial crisis -- a crisis that followed the September 2008 collapse of Lehman Brothers Holdings Inc. and the U.S. government takeover of Fannie Mae and its rival Freddie Mac that same month.
Neil Barofsky, former special inspector general for the Troubled Asset Relief Program, described the Farkas case in a Feb. 14 letter to President Barack Obama as “the most significant criminal prosecution to date” that arose from the financial crisis.
“If there had been a criminal referral, Farkas would have gone to jail in 2002,” William Black, who served as deputy director of the Federal Savings and Loan Insurance Corp. during the S&L crisis of the 1980s, said in an interview.
Seven more years passed before federal regulators shut down Ocala, Florida-based Taylor Bean and prosecutors charged Farkas with orchestrating the $3 billion scam. He had duped some of the country’s largest financial institutions, sought federal bank bailout funds and contributed to the failures of Montgomery, Alabama-based Colonial Bank and its parent, Colonial BancGroup, once among the nation’s 25 biggest depository banks.
Taylor Bean would have collapsed in 2002 “but for the fraud scheme,” according to prosecutors. It also survived because Freddie Mac began picking up the company’s business within a week of Fannie Mae’s cutoff, Jason Moore, Taylor Bean’s former chief operating officer, said in an interview.
Freddie Mac soon became Taylor Bean’s biggest customer, and the mortgage company grew to be one of its biggest revenue producers, accounting for about 2 percent of single-family home mortgages by volume in 2009, according to a company filing.
Once the 12th-largest U.S. mortgage lender, Taylor Bean’s business was originating, selling and servicing residential mortgage loans that came from a network of small mortgage brokers and banks.
It had about 2,400 employees and was servicing more than 500,000 mortgages, including $51 billion of Freddie Mac loans and $26 billion of Ginnie Mae loans, before it collapsed into bankruptcy in August 2009, according to court papers.
Ginnie Mae, a government-owned insurer of mortgage-backed securities, primarily guarantees loans insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.
Fannie Mae and Freddie Mac, which own or guarantee more than half of all U.S. home loans, were created by the U.S. government to inject capital into the housing market. Fannie Mae was established in 1938, and Freddie Mac in 1970.
Beginning in 2006, the companies began making big investments in subprime loans, many of which eventually defaulted. In the face of their imminent collapse, the U.S. Treasury Department took the government-sponsored entities into conservatorship in September 2008, promising to make good on an implicit government guarantee of the companies’ bonds.
The deal gave the Treasury almost 80 percent of the companies in exchange for a line of credit. Since then, the entities have required more than $160 billion in taxpayer aid.
Freddie Mac, based in McLean, Virginia, filed a claim on Taylor Bean in U.S. bankruptcy court for $1.8 billion. Washington-based Fannie Mae had about $1.7 billion in loans serviced by Taylor Bean when their relationship ended in 2002.
The decision to keep Farkas in business was made by top Fannie Mae officials such as Smith and Zach Oppenheimer, then senior vice president for single family mortgage business, according to Smith’s deposition and a Fannie Mae memorandum.
A confidential agreement between Fannie Mae and Taylor Bean’s Farkas unwinding their relationship was negotiated by lawyers from the general counsel’s office, overseen at the time by Thomas Donilon, now Obama’s national security adviser, according to the documents. Donilon’s spokesman, Tommy Vietor, declined to comment.
Fannie Mae officials feared that seizing the loan portfolio would signal poor loan quality to the mortgage industry, according to deposition testimony and an internal Fannie Mae memo. As a result, the value of the servicing rights to those loans would drop.
Fannie Mae officials were also concerned that an immediate termination of the relationship would have “a devastating effect on TBW’s ability to continue as a viable company,” according to an undated Fannie Mae memo filed as part of a related lawsuit.
The confidential agreement allowed Farkas to seek a buyer for the servicing rights of his Fannie Mae loans. The reasons for the termination by Fannie Mae were to remain a secret, according to court filings.
“We hold people accountable in the judicial system when they don’t report a crime,” said Ken Donohue, former inspector general of the U.S. Department of Housing and Urban Development, who investigated another mortgage fraud matter involving First Beneficial Co. In that case, he said, Fannie Mae “literally knew about a crime” and didn’t report it.
“In my estimation, it happened again,” said Donohue, now a principal at the Reznick Group PC in Bethesda, Maryland.
Amy Bonitatibus, a spokeswoman for Fannie Mae, said in an e-mail that its current practice is to “take action and inform law enforcement” if it discovers “inappropriate activity.” Brad German, a spokesman for Freddie Mac, declined to comment.
Focus of Case
Franklin Raines, who was chairman and CEO at Fannie Mae from 1999 through 2004, said in an interview that he has “no memory” of the Taylor Bean matter.
Fannie Mae either picks up the documents or negotiates an agreement when a termination occurs, Raines said. Fannie Mae’s regional offices manage terminations to get the largest recovery, and such an event wouldn’t be publicly disclosed, he said.
Fannie Mae was owned at the time by its shareholders, and unless there’s a legal obligation to disclose, silence is typical in business arrangements, Raines said.
The termination alone should have been enough warning to Freddie Mac and others businesses to “move with caution,” Raines said.
The government’s case against Farkas and six convicted co-conspirators focused on conduct after Fannie Mae terminated their relationship. Those crimes began because Farkas needed cash to meet operating expenses, such as payroll and loan-servicing payments to Freddie Mac and Ginnie Mae, according to his indictment.
From 2002 through August 2009, he directed the sale of more than $1.5 billion in fake mortgage assets to Colonial Bank and misappropriated more than $1.5 billion from Ocala Funding LLC, a financing vehicle used and controlled by Taylor Bean, prosecutors said in a sentencing document.
Farkas, 58, oversaw the “triple-selling” of $900 million worth of mortgage loans to Colonial, Ocala Funding and Freddie Mac, and led an effort to obtain $553 million from TARP, according to the filing.
At his trial in April, Farkas and three other witnesses were asked about the Fannie Mae termination. The relationship ended, each said, because Fannie Mae discovered that from six to eight delinquent loans it had bought from Taylor Bean were in Farkas’s name. Fannie Mae officials weren’t called to the stand by either the government or the defense.
Documents filed in a 2006 countersuit against Taylor Bean by GMAC Mortgage Corp. showed the number of bogus or bad loans sold to Fannie Mae was much larger.
Fannie Mae, which had worked with Taylor Bean since 1995, first had concerns about possible fraud in January 2000 after the mortgage financier received a telephone call from Catherine Kissick, the manager of Taylor Bean’s accounts at Colonial Bank, according to documents filed in the GMAC litigation. Kissick was sentenced to eight years in prison on June 17 after pleading guilty to conspiracy in the Farkas case.
Kissick called to say the loan in question, which Fannie Mae had paid for, had in fact been sold a few months earlier to Freddie Mac, according to Smith’s deposition.
“The duplicate loan being sold to Fannie Mae could have been an indication of fraud, or it could have had an innocent explanation,” Smith said in the lawsuit deposition. “But, nevertheless, it’s an indication that if they are truly selling duplicate loans to us, they have either got really bad, weak controls, or they’re doing fraud.”
Smith summarized the incident in an internal e-mail, urging colleagues “to be especially cautious in their dealings with” Taylor Bean and “to let me and others know ASAP if you find evidence of such problems.”
Smith, who left Fannie Mae at the end of 2006, declined to comment.
Fannie Mae continued buying loans from Taylor Bean and helped it build a website called Community Banks Online that allowed smaller banks to process mortgage loan applications faster through Taylor Bean. Taylor Bean would then sell those loans to Fannie Mae.
Moore, the former Taylor Bean chief operating officer, ran Community Banks Online. He said in an interview that Fannie Mae was involved in the project and there were plans to market it nationwide with Fannie’s blessing and funding.
The program also afforded Taylor Bean “the ability to go in and manipulate data to a degree it had never been able to do before,” Moore said.
Fannie Mae continued to have concerns about a “lack of attention to underwriting and quality control” at Taylor Bean, and on March 6, 2002, Fannie Mae officials had a face-to-face meeting with Taylor Bean managers, according to an undated Fannie Mae chronology of the termination entitled “Summary of Events” that was filed as part of the lawsuit.
Fifteen days later, Fannie Mae’s loss mitigation team in Atlanta discovered several delinquent Fannie Mae-owned loans in the name of Farkas and other members of Taylor Bean’s senior management. A public records check revealed that the named borrowers didn’t hold title to the real estate and that the mortgages sold to Fannie Mae had never been recorded, according to the Fannie Mae document.
“Our conclusion was that fraud, if I can use that word, had been perpetrated on Fannie Mae, and we considered that to be a very, very serious matter,” Smith said in the 2008 deposition.
On April 1, 2002, Fannie Mae management decided to terminate its contract with Taylor Bean because of “fraudulent loans” and “other serious concerns,” according to the summary document. In addition to the $1.7 billion servicing portfolio, Taylor Bean had an outstanding balance on Fannie Mae’s advance payment line of about $189 million, according to the document.
At that point, the chronology stated, Fannie Mae could have refused to buy any more loans from Taylor Bean, blocked the company’s access to its online loan processing programs, and seized the servicing rights, shifting those contracts to another company without compensating Taylor Bean.
It did none of those things. Fannie Mae wanted to preserve the value of the servicing portfolio, which would plummet if it reported that Taylor Bean was selling bogus loans, according to the summary document and Smith’s deposition.
Smith traveled to Ocala the next day to talk to Farkas about how to end the relationship, according to the deposition. Smith said that he was joined the following day by his boss, Oppenheimer, and Fannie Mae lawyers.
Third Party Move
The negotiation resulted in an agreement that Smith said outlined what Fannie Mae, Farkas and Taylor Bean would do “over the next month or two to get the servicing moved to a third party.” A telephone and e-mail message left for Oppenheimer was returned by Fannie Mae spokeswoman Bonitatibus, who declined to comment.
“Companies that have servicing pulled by Fannie Mae with cause generally do not survive,” said Barry Bier, former executive vice president and chief investment officer at GMAC Mortgage Corp., a unit of Detroit-based Ally Financial Inc., according to a transcript of deposition testimony. “In this case I think Taylor Bean was extremely -- was well benefited by motivated lenders who provided assurances to GMAC to allow them to go forward.”
GMAC bought the Fannie Mae servicing rights from Taylor Bean for $27.6 million on May 31, 2002. While GMAC was vetting the value of the servicing deal, Smith and Oppenheimer declined to say why Fannie Mae cut ties with Taylor Bean, Bier said.
“I tried to get whatever information I could,” he said in the deposition. “Each of those gentlemen would not provide any specifics with respect to the reason for the termination.”
Bier didn’t respond to an e-mail and telephone message seeking comment.
During the termination, Fannie Mae discovered that about 200 loans Taylor Bean sold as insured by the Federal Housing Administration didn’t have valid FHA coverage, according to the “Summary of Events” document.
“Evidence suggests that TBW management knew at the time of sale of these loans to Fannie Mae that the loans were not insured,” according to the document. The loans involved mortgages given to U.S. military veterans, Smith said in his deposition.
“These are high loan-to-value loans without any insurance sold to Fannie Mae as government insured when, in fact, they weren’t,” he said. Taylor Bean was forced to repurchase the loans. The document doesn’t say how much money the loans involved.
GMAC also found that 16 loans in the servicing group it bought from Taylor Bean were delinquent at the time they were sold to Fannie Mae, according to the document. Taylor Bean management knew the loans were bad when they sold them and management falsified a date on the delivery schedule, according to the Fannie Mae document.
Taylor Bean was forced to repurchase those loans as well, according to the filing. By November 2002, all of Fannie Mae’s outstanding claims with Taylor Bean were settled.
The deal with Farkas resembled Fannie Mae’s reaction to an earlier fraud by one of its authorized lenders, said Chris Swecker, who investigated mortgage fraud as head of the Federal Bureau of Investigation’s office in Charlotte, North Carolina.
In 1998, an investigator from North Carolina’s State Banking Commission warned a Fannie Mae employee that Charlotte-based First Beneficial Co. was selling bad loans, according to congressional testimony by Donohue, then HUD’s inspector general. Fannie Mae found many of the First Beneficial loans to be “fictitious,” Donohue said.
Fannie Mae allowed First Beneficial to buy back the fake loans, according to court records. To raise the money, First Beneficial sold some of the loans to Ginnie Mae, which lost about $38 million as a result, according to court documents.
Fannie Mae never notified law enforcement or regulators about the fraud, Swecker said, adding he “pushed hard to indict” Fannie Mae as a corporation for failing to do so. The Justice Department, declining to bring a criminal case, settled a lawsuit in which Fannie Mae agreed to pay the government $7.5 million and admit no wrongdoing, according to court records.
“We felt like we were on the front end of a big problem and the last thing we expected to see was a quasi-government agency sweeping it under the rug,” Swecker said in an interview. In 2004, in a plea for more resources, he testified to Congress that the U.S. was on the brink of a mortgage fraud epidemic.
No Fraud Policy
In a January 2005 letter to lawmakers about the First Beneficial incident, Fannie Mae’s interim CEO Daniel Mudd said the company had no formal policy on reporting possible fraud. Fannie Mae doesn’t usually issue public notice when it suspends or terminates a lender or loan servicer, he said in the letter.
Last year, Mudd, in an interview with the Financial Crisis Inquiry Commission, cited the termination of Taylor Bean as an example of Fannie Mae’s willingness to cut ties with problematic mortgage companies.
A House of Representatives subcommittee held a hearing on First Beneficial in March 2005. As a result, rules were put in place by Fannie Mae’s regulator, the Office of Federal Housing Enterprise Oversight, requiring Fannie Mae, Freddie Mac and other government-sponsored enterprises to report fraud to law enforcement and regulators.
The rule took effect in August 2005, three years after Fannie Mae terminated Taylor Bean.
Fannie Mae’s fraud department looked at $1 billion in suspect loans in 2009 and found $650 million to be fraudulent, according to William H. Brewster, director of Fannie Mae’s mortgage fraud program. Brewster told the Financial Crisis Inquiry Commission that the loans were bought from lenders such as Bank of America Corp., Countrywide Financial Corp., Citigroup Inc. and JPMorgan Chase & Co.
Brewster said his office now reports fraudulent loans to the Federal Housing Finance Agency, or FHFA, which replaced the Office of Federal Housing Enterprise Oversight, or OFHEO, as regulator of Fannie Mae and Freddie Mac in 2008.
A June 21 FHFA inspector general’s report found that FHFA and its predecessor agency ignored or mishandled complaints from consumers about fraud and botched foreclosures because it had no system for dealing with them.
The report said OFHEO failed to pursue a tip from a journalist in June 2008 alleging Taylor Bean was selling loans to Freddie Mac that the company hadn’t yet purchased. The unidentified investigative reporter, in an e-mail, claimed to be in contact with a former Taylor Bean employee who made the allegations, according to the report.
The inspector general found “no standard procedures were in place to assure prompt follow-up” and the matter was never referred to law enforcement for investigation, the report said.
As Fannie Mae broke off its relationship with Taylor Bean in April 2002, Farkas asked Raymond Bowman, then Taylor Bean’s vice president of secondary marketing, to call a friend at Freddie Mac, which at the time was buying from 5 percent to 10 percent of the loans generated by Taylor Bean, Moore said.
In less than a week, Freddie Mac had agreed to purchase any conventional loans originated by Taylor Bean, he said. Within weeks, Bowman was promoted to president.
At Freddie Mac, the decision to boost purchases from Taylor Bean was made by David H. Stevens, then a senior vice president of mortgage sourcing, Donald Bisenius, senior vice president for credit risk management, and Tracy Hagen Mooney, a regional vice president of sales, according to a former Freddie Mac official who spoke on condition of anonymity because he didn’t have permission from his current employer to speak to the media.
Auditors and underwriters were sent to Taylor Bean’s offices in Ocala to look over the loans about a month after the Fannie Mae termination, the ex-official said.
“Freddie Mac came down, we explained what happened, and they decided to keep us,” Bowman said during the Farkas trial.
Bowman, who pleaded guilty to the fraud conspiracy and lying to investigators, was sentenced to 2 1/2 years in prison on June 10.
Farkas told Freddie Mac officials that eight bogus loans sold to Fannie Mae were the result of a clerical mistake and that the company’s termination was due to a personality clash between Farkas and Fannie Mae’s Oppenheimer, the former official said. Farkas, while testifying in his own defense at trial, said the sale of the loans was accidental.
Freddie Mac assumed that because Fannie Mae allowed Taylor Bean to sell the servicing rights, Farkas’s explanation had merit, the former official said.
Bisenius said in an interview he doesn’t remember Freddie Mac’s specific actions regarding Taylor Bean after the Fannie Mae termination, although he said he doesn’t recall anyone alleging fraud within the company before its collapse.
“I don’t think anyone thought that was going on,” Bisenius said.
Bisenius resigned from his last Freddie Mac job, executive vice president for single-family credit guarantee, in April, two months after receiving a so-called Wells notice from the U.S. Securities and Exchange Commission noting he may be the subject of a civil enforcement case.
Hagen Mooney, now senior vice president of single-family servicing and real estate-owned at Freddie Mac, declined to comment.
Stevens, who left Freddie Mac in 2005 for Wells Fargo & Co. and Long & Foster Real Estate, said in an interview that antitrust concerns kept Freddie Mac from asking about the Fannie Mae termination. Their review of the loans showed Taylor Bean was selling “high quality stuff,” he said.
He was named FHA commissioner in 2009 and is now the president and CEO of the Mortgage Bankers Association in Washington.
After Taylor Bean was raided by the FBI, Stevens, in an FHA press release, accused the company of “irresponsible lending practices,” saying Taylor Bean “failed to provide FHA with financial records that help us to protect the integrity of our insurance fund and our ability to continue a 75-year track record of promoting, preserving and protecting the American Dream.”
Fannie Mae fell as much as 1.8 percent to 32.7 cents before closing at 33.1 cents in over the counter trading.
The case is U.S. v. Farkas, 10-cr-00200, U.S. District Court for the Eastern District of Virginia (Alexandria).
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