I was less persuaded by the court’s reasoning that this was essentially an “asset based” loan. Mrs. Hill (who is not related to me) “was self-employed … distributing free periodicals for various companies.” According to the court “[h]er income also fluctuated, depending on how many companies were employing her for this purpose.” She seems like exactly the type of candidate that a stated income loan was designed to accommodate. It would have been difficult to verify her income, yet she did have income. Did the bank care about her income? You bet it did. If Mrs. Hill had provided her real income, the bank would have denied the loan. Mrs. Hill knew that. That is why she lied.

But was it reasonable for the bank to rely on Mrs. Hill’s lies? The bank verified that Mrs. Hill had income by getting a letter from her CPA stating that she had her own business. In this case, the letter came on a CPA’s letterhead, but was not signed by the CPA. The court suggests this was unreasonable. After all ‘’[t]he person signing the letter did not identify himself as a CPA and may not even have been an employee of the CPA on whose letterhead the letter was written.” This seems like a small technical point especially when the court had already concluded Mrs. Hill lied on the loan application (and did not testify credibly in court). The court also says the bank should have been suspicious because, according to loan applications, Mrs. Hill’s income increased significantly over only six-months. Perhaps, but the whole point of these stated income loans is that banks do not attempt to get independent verification of the borrowers' income because it would be too difficult. The court suggests that the whole procedure for these stated income loans is suspect. Really what the court is saying is that banks should verify income. I am afraid this would cut off credit to self-employed people (non-liars) who would have difficulty verifying their income. If lenders must always verify, what is the point in having § 523(a)(2)(B)? Shouldn’t lenders be able to detect any fraud?

The questionable CPA letter is not "a small technical point." Lots of fraud gets committed on false or forged attestations by CPAs. And the CPA whose letterhead apparently was misappropriated here could suffer repercussions with the California agency that regulates CPAs.

That aside, this bankruptcy judge's decision strikes me as a short-lived footnote in the law. It won't hold up on appeal.

The IRS needs to go after those liars! Hey...you must be lieing on your 1040...give us more money.

Julie, on the issue of the CPA letter versus Mrs. Hill's lying, the debtors were no doubt undeserving. But section 523(a)(2)(B) is not a balancing test. The reliance requirement applies regardless. In this regard, the "red flag" argument seems plausible to me: the borrowers' stated income jumped 30% between April and October, with the same lender on both loans. Also the big jump in valuation. As a policy matter, reasonable minds might differ as to who should win between the undeserving debtor and the undeserving lender. But 523(a)(2)(B) seems to answer that question for now.

You may be right that Judge T's skepticism of the Guidelines means that lenders ought to verify income, but I'm not sure that means self-employed people can't get loans. Schedule Cs and other income tax filings, for example, are an easy and low-cost device to verify self-employed income. Self-employed income fluctuates, no doubt, and though past performance is no guaranty of future performance, that's still better information than what the Guidelines require. It's hard to see how proof of the mere existence of the borrower's business gives much comfort that she will be able to pay the debt.

My point on the CPA letter was only that they court said that the person who signed the letter MAY not have been employed by the CPA. It is unclear whether the court had evidence (in addition to the CPA letter itself) as to whether the letterhead was misappropriated. If the bank had actually verified the signature and the outcome would have been no different (if the signer was employed in the CPA's office) then I don't think the court should use it to suggest that the bank acted unreasonably in not verifying the signature.

Fred makes the broader point that the CPA letter is nothing that should be relied on anyway, because it just verifies employment, not income. It is a fair point, but one on which I think reasonable minds could differ. To me it is not unreasonable for a bank to rely on the signed stated income of the debtor after verifying employment if there is no evidence that the bank (or broker) encouraged the borrower to lie. Perhaps we can no longer rely on a handshake, but we should be able to rely on a signature.

"I am afraid this would cut off credit to self-employed people (non-liars) who would have difficulty verifying their income."

Hmm, I am self employed for many years and have no problems getting full doc loans. My tax returns are unambiguous. I keep seeing this comment over and over and do not understand it. Would somebody please explain in itty bitty words and teensy weensy sentences why self employed people cannot verify income.

It can be very difficult to untangle someone's financial situation from a tax return. What lenders care most about is money coming in each month (provided the loan has monthly payments). Tax returns don't show this. Not all income is necessarily included. In addition, some expenses, for example, depreciation on equipment, is not necessarily an expense that should reduce income for lending purposes. Sometimes, lenders can sift through the information on a tax return to get a fairly accurate picture and sometimes they can't. Those whose businesses are new, are growing, or have income that varies from year to year will have the hardest time verifying income. (Those whose income consists primarily of dividends from a closely held corporation also sometimes have difficulty verifying their income.) Finally, I think most lenders who look at tax returns prefer the whole return instead of just the Schedule C. The whole return sometimes contains sensitive information that the borrower would rather not share with the lender (dependants, donations, medical expenses, etc.).

Certainly any bank that would rely on a supposed "CPA letter" like this is a very sloppy bank indeed.

Sometimes, it is true, getting the whole picture from a prospective borrower's tax return can be a challenge. In such cases, the prospective lender can, and should, request bank statements that will reflect cash inflows and outflows. (But what of the offshore bank account that no one is supposed to know about?)

Tax returns are a useful anchor in the credit approval process, because the prospective borrower must sign them under penalty of perjury. If the ancillary financial records don't square with the tax returns, a savvy lender can figure out what steps to take.

As a practical matter, there arguably is an inverse relationship between a prospective borrower's reluctance to disclose his/her "sensitive" financial information, and the interest rate that the prospective lender will charge, not to mention the collateral, reps and warranties the lender may demand.

This debate, as well as the outcries in the media about the many subprime borrowers who are "victims" of "predatory" lenders, may underscore how innumerate the American citizenry has become. TANSTAAFL.

The IRS go after the little people. Go after Clinton for letting wall street securitize and package these loans. Get rid of that ridiculous No tax on capital gains when sold within two years. People did what was legally available to them. Same as any politician.
Look at the big boys who let it pass.

Does a borrower have to provide a copy of his take returns with the BK filing ?