Tuesday, January 23, 2007

Bamboozling the Bubble

Mortgage fraud has steadily been growing as a hot topic over the last year but with the recently reported (hat tip to HousingPanic) “Cash-Back” sham occurring in Arizona (as well as many other markets in the nation), the deception has taken on a decidedly different course.

As has been previously reported, scams involving a coordinated effort by sellers, brokers and appraisers are widespread and fairly commonplace occurring in just about every market in the country.

The scams vary slightly, but in most cases the “investor” buys a property (usually cheap and in rough shape) with the intent of quickly “flipping” it to an unsuspecting and inexperienced buyer that has been brought in by a rigged real estate broker.

The real estate broker proceeds to engage a rigged mortgage broker and appraiser who work together to both dramatically inflate the value of the property as well as falsify loan application documents to provide the evidence needed to justify the loan (i.e. buyers income, down payment etc.).

When the deal closes, the investor, the brokers and the appraiser all get a cut of the “winnings” and the buyer and lender get stuck in a pretty rough situation that usually results in a quick foreclosure.

The buyers credit is ruined, the lender is out most if not all their money and the scammers move on to the next payday.

Clearly, in the above scenario the buyer is most directly damaged as they now have a serious incident on their credit history as well as having lost their home and any deposit and payments that they may have made on the property.

To a lesser extent, the neighborhood is also damaged as foreclosures typically result in vacant properties that in many areas become run down and cost both the town/city valuable administrative resources as well as contributing to increases in violent crime as the Federal Reserve Bank of Chicago demonstrated in an interesting study last year.

The lender on the other hand is certainly damaged but after reading reports from both the GSE lenders (Fannie and Freddie) as well as private lenders, their take is fairly dispassionate as they have already accounted on a certain percentage of “bad loans”.

For many of the largest lenders, any single incident foreclosure generally results in a minor statistical blip in an otherwise stable loan portfolio.

But now it appears that times are really changing.

In the last few months there have been numerous examples of smaller, riskier lenders going bust because of a high percentage of bad loans. (Check out the Mortgage Lender Impolde-O-Meter for daily list of lenders going belly up!)

More startling even is that the nature of mortgage scams are now transforming to include deals that would otherwise appear to be on the level.

Many of the “Cash-Back” at closing scenarios are now showing themselves to be subtle (and sometimes not so subtle in the case of the recent wave of real estate investment clubs and “get rich quick” schemes) forms of mortgage fraud that are executed with the full and willing knowledge of the buyer.

In one scenario, a seller offers the buyer an incentive of a significant sum of money (sometimes hundreds of thousands of dollars) back at the closing table.

The buyer apparently is drawn in because not only do they get the property but out of the shoot they get a huge “equity” withdrawal that they can either sit on as a buffer or simply plunder on typical consumer items.

At first one might question why a buyer would want to purposefully overpay (i.e. have a much larger mortgage) for a property only to receive a significant chunk of money back from the seller at the closing.

But given the nature of our housing culture at the moment (“toxic” ARM loans, cash out refis, HELOCs), this scenario looks to be in-line with many of the other ridiculous activity that has recently occurred.

To the typical overly optimistic buyer, it appears to be simply a way of withdrawing equity that the property doesn’t have yet but is sure to in the near future.

Why not have fun now rather than having to wait for the equity it to build over time in order to get that HELOC or “Cash-Out” refinance?

In some sense, it’s hard to understand where the scam comes in with happy sellers moving property and happy buyers living easy.

Apparently though, many of these deals are coming with some of the same rigged mortgage broker and appraiser activity of the prior scam so that the property really appears to the buyer to be valuable and the buyer is helped in any way to qualify for such a great deal.

In addition, the overall effect on the nations housing market is sever as home prices are artificially inflated with a nearly certain outcome of price instability, especially for such illogical bubble markets such as Phoenix and Las Vegas.

Only time will tell what the total impact of these scenarios will be on an already stressed housing market but the one thing that seems fairly certain is that the varied and widespread mortgage fraud is currently hitting the wall with the resultant financial crisis bankrupting lenders on an almost daily basis.

Posted by at