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Make no mistake; as bad as the housing market gets (and it will get worse), it will eventually stabilize and resume its upward trudge.
And when that happens, probably a few years from now, we’ll see a truly once-in-a-lifetime buying opportunity. Perhaps the best housing deals this country’s seen in over a century.
But even then, buyers will be facing an inordinate amount of hidden risk, in the form of massive amounts of real estate fraud.
That’s because incredibly huge bubble-sized profits gave mortgage brokers, bankers, builders, fraudsters and homeowners the incentive to rip people off…the incentive to “game the system” at the cost of honesty and fair play.
You might think this fraud is likely winding down…what with the death of the housing bubble and all. But in reality, the opposite is happening. With the housing bubble burst, go any legitimate bubble-sized profits…leaving just one alternative for fraudsters not wanting to face a rude awakening…
The New Generation of Fraudsters
Back just a few years ago, mortgage fraud felt like a black-tie affair. At least compared to what it’s become today…
Granted, the criminals have definitely changed.
It used to be a non-descript – often ex-convict – seller, and an equally non-descript straw buyer. Seller scoops up the house at an inflated price, turns around and sells it two weeks later, and he makes US$150,000 in fast, easy money. Talk about flipping a house.
Anyway, seller clears his mortgage and takes home the profits. He gives said straw buyer a cut, and the buyer disappears. At the end of the day, the bank has effectively inflated the money supply by a small degree to put money in the hands of a criminal. Just the kind of thing to make your skin crawl.
But today, it’s different.
It’s television ads, builder scams, and call rooms. It’s individuals within organizations, out for personal enrichment at the cost of an already fragile real estate market…and perhaps even your hard-earned savings.
In a sense, it’s to be expected following such a massive housing bubble. As a recent FBI report on mortgage fraud put it, “Industry employees sought to maintain the high standard of living they enjoyed during the boom years of the real estate market and overextended mortgage holders were often desperate to reduce or eliminate their bloated mortgage payments.”
So let’s look at a few of these scams, just to get a sense of what one might look like…
Scam #1 Bailout Money & Foreclosure Assistance ads
It’s a cute young girl (sometimes shaking her upper torso) saying or under her picture with a caption, “the Federal government has set aside special funds to help homeowners in need…” There are also mailers, cards, websites and Internet ads. Through deed transfers, payment of up-front fees, and other means, homeowners can allegedly escape foreclosure.
Naturally, it’s all forged documents and rude awakenings from there on. “In extreme instances,” says the FBI report, “perpetrators may sell the home or secure a second loan without the homeowners’ knowledge, stripping the property’s equity for personal enrichment.” Ice cold.
And it’s a shame too. Because for many of these distressed homeowners, the answer to their troubles is actually bloody simple. Let us explain…
Their gazillion-page mortgage was bundled with hundreds if not thousands of others, then sold to someone – a bank – who didn’t really care. Now I spent a little while in the consumer debt industry, and I can tell you that banks like paperwork about as much as the mafia does. They used to charge about twenty dollars just to bring you an account statement.
And with mortgages it’s an even bigger quagmire.
The Mortgage Electronic Registration System (MERS) scanned all the paperwork, so it’s all on computers somewhere. But most state laws require the original signed document as proof. And it’s your right to ask for it. Generally that can send them bumbling back to the woodshed. They’d rather stall than look through a few million stacks of original mortgage documentation.
So the ads could’ve just told the people to “ask for the original paperwork (proof),” and they wouldn’t even need to respond. But where’s the slimy profit in that?
Scam #2: The Builder Bailout Two-Step
You’re going to have a hard time disagreeing with this one, because it involves the banks getting ripped off.
And that’s not just because you probably hate the banks. But you think that by this point, they’d actually be focused on getting the job done. We’ve pumped trillions of dollars into some of these companies so they could do precisely that. But it still seems that if one really wants to rip a bank off, it’s not that hard…
Usually this one happens when developer’s having trouble unloading a property, don’t mind getting their hands dirty to do it. Using shifty tricks in the paperwork, they’ll confuse lenders on the terms of the deal. To quote the FBI, “In a common scenario, the builder has difficulty selling property and offers an incentive of a mortgage with no down payment. For example, a builder wishes to sell a property for $200,000. He inflates the value of the property to $240,000 and finds a buyer. The lender funds a mortgage loan of $200,000 believing that $40,000 was paid to the builder, thus creating home equity.”
Unfortunately, there’s no equity involved. And the bank gets caught giving a sizable loan on terms they never agreed to. Should the mortgage-holder default, the bank is stuck with all the expenses.
But one of the only ways this could affect you personally – assuming you’re not a banker – is if you find yourself in possession of mortgage-backed paper with these kinds of “equity included” deals underlying your investment.
Scam #3: The Outright Ponzi
It sounds brazen, yes, but for a bold few…like the guys at AFG Financial Group, it worked. For a while at least.
AFG, a ring of 25 lawyers, mortgage brokers, appraisers and bankers was recently charged with $100 million in outright mortgage fraud. Back in the heat of the bubble, these guys used inflated appraisals, forged documentation and fake deals to bilk some major players out of huge amounts of cash.
New Century Financial, Countrywide, and Washington Mutual can be counted among their victims. Add in a heap of straw buyers who often weren’t aware they were straw buyers, and you have the makings of a great crime novel. Good thing they’ll have plenty of time to write.
But as much as you may think these ponzi-style schemes of outright fraud are a thing of the past – a relic of the real estate bubble – think again. As investors start to sift through the depths of paperwork behind the U.S. mortgage market, these scams will likely keep coming to light. So keep them in mind if you ever find yourself bottom-fishing real estate debt (an extremely profitable enterprise if timed and carried out correctly).
Scam #4: Short-Sale Fraud
And with this, the last of our scams up for review, we come full circle. Or at least close to it.
This kind of scam is favorable for our “old school” fraudster, the kind who works with straw buyers. Except he can double up; by purchasing a short-sale property from another straw buyer.
Essentially, the first buyer goes into default. And because our fraudster’s in touch with him, he knows all about the timing. So before the foreclosure sale, he approaches the bank and makes an offer. If he makes the right offer, the bank accepts, and he gets a discount – without having to compete at auction – and no one even suspects fraud.
He can then turn around and flip the house – as in the example above – and make fraudulent profits two times around!
I know what you’re thinking. The banks loaning him the money…aren’t these the guys we’re currently bailing out? And weren’t these mortgages averaging over US$200,000…and much higher in some places? So it’s possible we’re bailing out over a million in toxic mortgage debt; just because of a single incident of fraud?
The answer on all accounts is – of course – yes.
Caveat Emptor
Warren Buffet is famously quoted as saying, “Only when the tide runs out do you see who’s been swimming naked.” And Bernie Madoff’s arrest and sentencing over the last few months seem to suggest Warren’s right.
But as you can see from the examples above, naked swimming is alive and well even as we approach low tide. At the turn of every corner, the fraudsters still have a leg up on bankers, homeowners and investors. By comparison, the feds and the banks look like dopey, lumbering buffoons. Sure they might “crack down” on one kind of fraud, but that just drives the criminals elsewhere.
So make no mistake; apparently the “real estate fraud” bubble is lagging housing. Because even though the real estate market has already peaked out, fraud still seems to be growing.
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