Trust, But Verify.

 

 

It was either just after 3 a.m. count or just after, I don’t remember. In the federal prison camp where I lived in 2005, it was unusual but not uncommon for the officers to allow some of us to read quietly or work in the unit’s library after bedtime, provided we stayed quiet, didn’t wander, and stayed put for the midnight and 3 a.m. counts. I was in the library with Jack, a lawyer from Michigan, and Lex, who was trained and licensed as a lawyer but had decided on architecture instead, and we were trying to help Jamie. Jamie had misrepresented his earnings and received a mortgage on a beautiful piece of property from a prominent family. And every time Jamie needed more money after that, he did a cash-out refinance on the home. You can do that… in a prolonged, booming market.

Jamie had a court date the following day (actually it was later that day). He’d been convicted of five counts of bank fraud for the original mortgage and four subsequent refinances. Since in the aggregate the total was over $1 million, he was facing a sentencing enhancement – more time – on the bank fraud charges. His legal reasoning was that because the bank was no longer on the hook for the original mortgage and the first three refinances, he shouldn’t have to face the additional charges or the sentencing enhancement. It was a stretch, I know. In general, you don’t get to claim you didn’t fraudulently obtain money just because you paid it back before you were discovered. I have some experience with that one.

My clear impression had been that on his applications, Jamie had simply filled in an amount of income he thought was appropriate for the loans and that the bank had simply approved them. It’s still bank fraud of course, but hey, people do it – right? But at one point I asked Jamie to confirm a dollar amount and he said, “Well, my wife’s W-2 said $200,000.” (I could be off by a few thousand on that)

He now had my full attention. I asked him, “W-2?”

“Sure,” he said. “My corporation recognized a liability to her for the salary they couldn’t pay at the time, and that’s the number on the W-2.” (I’m fairly sure that the amount they couldn’t pay “at the time” was probably $199,900.)

“Did you file a tax return and recognize a tax liability on that $200,000 in gross income?” I asked.

“Of course, not. She didn’t get the money. Why should we pay tax on money we don’t have yet?”

I realized at that point that my buddy hadn’t done anything that could be explained away as a misunderstanding or a question of interpretation or even a question about the definition of “income.” He had fabricated a document and presented it as proof of his wife’s income.

Patiently I explained to him that a W-2 is a cash-basis reporting return. It’s a record of actual money paid by an actual company to an actual person. It says real assets have been transferred from one entity to another. An executive with a successful company might be able to show a bank an IOU from his employer as collateral for a loan, but then the bank has the right to investigate the employer’s background and creditworthiness. In this case, had the bank looked into the employer’s finances, they would have seen, well, tumbleweeds.

I went to bed shortly after that, realizing that there was little I could do to help Jamie’s case.

 

The Moral (Besides the whole “Don’t defraud banks” idea) is that maybe it isn’t enough to see a W-2, or even a few paystubs. As a lender, with a customer’s paystubs in hand, I’d be interested in seeing his bank statement to locate the direct deposits from those paystubs. If he gives me a W-2, I want to see the tax return; I might even have him bring in a statement from the local  IRS office showing his account information (they can print on the spot, and they’re free). Our mortgage lender asked for our tax returns and verification directly from IRS when my wife and I bought this house. But Jamie’s bank hadn’t.

Trust, but verify. доверяй, но проверяй. Your customer’s loan packet is composed of documents he or she can produce, and some documents he or she can’t (or shouldn’t) produce. For the same reason our kid’s college wanted his high school transcripts directly from the high school, you should gather information produced by third parties. And things might get interesting if you compare it to the information your customer gives you.