OIG Report Says TBW Fraud Scheme Could Have Been Avoided

The elaborate mortgage fraud scheme perpetrated by lender Taylor, Bean and Whitaker (TBW) and its warehouse lender, Colonial Bank, which resulted in billions of dollars in losses for Freddie Mac and Ginnie Mae, could have been avoided had Fannie Mae alerted Freddie and Ginnie that it had terminated its contract with TBW over discrepancies in 2000. Further, the scheme could have been stopped before it snowballed over the next eight years, had Freddie and Ginnie noticed the ‘red flags,’ a report from the Office of Inspector General (OIG) of the Federal Housing Finance Agency (FHFA) states.

The fraud scheme – in which TBW and Colonial basically ‘cooked the books’ to cover up losses and sold bogus paper to investors (there were no assets to back up the loans) – resulted in Freddie Mac losing nearly $2 billion and Ginnie Mae almost $1 billion. Private banks that conducted business with TBW also lost billions – for example, Deutsche Bank and BNP Paribas together lost more than $1.5 billion.

TBW filed for bankruptcy in 2009. Two years later, the company's CEO, Lee Bentley Farkas, was imprisoned for his role in the scheme.

One of the main failings was on the part of Fannie Mae, which didn't notify Freddie Mac and Ginnie Mae of the fraud after an executive discovered in 2000 that TBW had pledged to a third party the same loans that had purportedly been sold to Fannie Mae.

‘After studying the issue for nearly two years – including discovering that Farkas personally had taken out $2 million worth of mortgage loans that were not backed by homes or other eligible collateral to finance the repurchase of non-compliant loans that TBW had sold to Fannie Mae – Fannie Mae terminated TBW's right to sell loans to the enterprise [note: Fannie Mae was not yet in conservatorship], but it did not formally advise Freddie Mac or its regulator about TBW's termination,’ the OIG report states.

As a result, Freddie Mac, a competitor to Fannie Mae, saw the cessation of business as an ‘opportunity’ and ‘with very little in the way of due diligence’ proceeded to pick up more business from TBW.

Not only did Fannie fail to notify Freddie and Ginnie as to what was going on, Freddie and Ginnie failed to perform adequate ‘counterparty monitoring’ – in other words, they failed to investigate why Fannie broke off its relationship with TBW. This could have been avoided, the report from Acting Inspector General (AIG) Michael P. Stephens states, had Freddie and Ginnie rotated the independent public accountants charged with conducting audits to ensure compliance with the companies' seller/servicer guides – and had those accountants focused more on counterparty activities ‘that reflect abnormal or unusual characteristics.’Â

Ginnie Mae, in particular, ignored warning signs and financial discrepancies that would have made it aware of the scam, the AIG report states.

‘Various red flags should have alerted counterparties, investors and regulators to the fraud scheme, but they were not adequately addressed,’ Stephens writes in the report. ‘The failure to adequately address the red flags cost various parties losses of billions of dollars.’

The fraud was uncovered when the market crashed in 2008 – however, by then it was too late, TBW was on its way to bankruptcy and, therefore, was no longer able to buy the loans back from Freddie and Ginnie.

To prevent similar fraud schemes from occurring in the future, the OIG recommends that the companies not only open up their lines of communication when something smells fishy, but also routinely ‘share negative performance and compliance data, and evidence of illegal activities of counterparties.’

To read the full report, click here.


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