The summer of 2012 has brought with it a new round of real estate-related fraud convictions. It shouldn’t surprise those who watch enforcement carefully over time: The Federal Bureau of Investigation doubled its prosecutorial efforts between 2009 and 2010, reaching over 3,000 pending cases that year. Those cases are winding their way through the justice system, and some of them are resulting in convictions now.
For example: A federal jury in Brooklyn, New York, convicted attorneys Matthew Bernstein and Aaron Rabinowitz, both 40 years of age, at the end of July. The two lawyers were found to have been running a “straw buyer” scheme that ripped off some $25 million from mortgage lenders Countrywide, Countrywide Financial, Fremont Investment and Loan, IndyMac, Sun Trust., Wells Fargo, and New Century Mortgage Corporation.
Specifically, the two attorneys worked at the center of a ring of corrupt real estate professionals – agents, appraisers, and even corrupt lending officers themselves – to help buyers get mortgages. The buyers, it turns out, were frequently straw buyers who would take the loan proceeds but almost immediately default, walking away and letting the homes go into foreclosure.
They face up to 30 years in prison, plus restitutions. They will be sentenced in November.
A Lender Betrayed From Within
The populist point of view blames the mortgage crisis on big lenders. But the lenders themselves are sometimes victimized by their own trusted employees. Case in point: Victoria Allen, a 57-year-old branch manager and loan originator with First Horizon Home Loan Corporation, Chesapeake, Virginia. Ms. Allen worked on the inside to help her co-conspirators, Ephrain Harris, an accounting firm principal, Shavonda York, a mortgage broker, Tamiko Alston, a title company manager, and a local business owner named Darrell Booker.
According to the FBI, these crooks got together to submit fraudulent mortgage documents to Allen at First Horizon. They would then use the loan proceeds to buy cashier’s checks for themselves, which they then used to fund their down payments, concealing the fact that they were not putting up their own down payment money.
They would also use their fraudulently-obtained loan proceeds to pay transaction costs on the property – another no-no, unless you disclose that to the lender.
Ms. Allen would then create two HUD-1 Settlement Statements.
The mechanics: In a statement of fact provided to prosecutors as part of her plea arrangement, Allen either produced or knowingly forwarded fake W-2 forms or pay stubs on at least 13 conventional loans. First Horizon then sold those loans upstream to investors or to Fannie Mae and Freddie Mac. When these loans started to default, they attracted attention.
Here’s how the scam got broken up:
The Federal Housing Authority keeps statistics by originator on all the FHA-insured loans it originates. When the default rates on loans coming out of Allen’s branch hit an absurd 30.30 percent – the highest in the state – it attracted the attention of both company executives and the FBI.
They Will Rat You Out
The thing about crooks – they roll on each other with astonishing ease once investigators get their hooks on them. Ms. Allen was no different, rolling on her companions. The FBI got their factual information above from a plea deal that Allen and her lawyers themselves wrote out. The Feds, having secured Allen’s cooperation, rolled up the others. Shavonda York plead guilty in May 2009 and got a 25-month sentence. Tamiko Alston was next, pleading guilty in July 2010 and getting 25 months. Darrell Booker plead guilty in October 2010 and received a 21-month sentence. Ms. Allen plead guilty in December of 2010. She received her sentence in March: 48 months in prison, and an order to pay over $1.9 million in restitution to the victims of her fraud.
When investigators break up conspiracies, they set the conspirators against each other, so whoever turns first gets a break.
Forty-eight months may not seem like a break, but remember – federal bank fraud can get you 30 years, so Allen received only a fraction of the sentence the judge could have dealt.
States are Getting In on the Act
While the Feds have the legal nuke at their disposal – a potential 30-year sentence in federal prison for bank fraud – fraudsters are also coming under increasing scrutiny and pressure from state and local governments. For example, Wayne County, Michigan, formed a deed fraud unit in 2005. Originally formed because of a rash of cases in which crooks had forged or fraudulently transferred deeds to themselves – often from the recently deceased or from people in nursing homes, the Wayne County prosecutors have expanded their scope, securing a conviction against Samer Zahr, 37, of Dearborn, Michigan on August 14.
Zahr would have his wife and mother act as straw buyers and help them obtain fraudulent loans. But instead of buying the home, his mother and wife would just spend the money and default on the loan. Curiously, Zahr’s wife and mother were acquitted on all counts. Zahr took the heat, getting a fine of $200,000, though no jail time.
When the Tide Went Out …
Warren Buffett, one of history’s greatest investors, is fond of saying, “It’s only when the tide goes out that you learn who’s been swimming naked.”
The analogy holds up well in real estate. The Zahr’s actually bought their houses in 2004 and 2005, but didn’t default on them until 2007 when property values started to fall.
In a rising market, the lenders are able to paper over a lot of fraud because they can eventually foreclose on a property that’s worth more than the loan. No blood, no foul, as the saying goes. Mortgage originators and salespeople were happy to take the commissions on bad business they originated, and the proceeds from auctions could be turned around to lend again, and to generate more commission income for the originators.
When the market reverses, though, the tide goes out – and everyone with negative equity is swimming naked.
The Effect on Flippers
Flippers are the amphibians of the real estate world. They can function when the tide is coming in and markets are rising. And they can still function when the tide is going out, and other investors are left high and dry. This is because the short holding period doesn’t allow much time for market forces to work against them.
But obeying the law is paramount. A casual landlord who buys and holds one or two properties can plead ignorance to some extent. And there aren’t that many transactions to generate fraud issues.
If you’re flipping multiple properties a year, though, and you’re playing fast and loose with the law, you can easily generate four, five, six, 20 counts against you: each count with a well-documented paper trail. Sooner or later, your world is going to come crashing down on you.
The Bottom Line
Mortgage, deed and other forms of real estate fraud aren’t just wrong – though that should be enough. And they aren’t just illegal, though that should be enough to deter those unfazed by it being wrong. The fact is it’s also stupid.
Read enough of these releases and court dockets, and it’s clear that none of those convicted gets away with the fraud for very long. They have a few years’ run, and then they’re facing long prison sentences and steep fines that will destroy whatever prosperity their family thought they had obtained.
If it were realistic to get away with it much longer, we would see a much wider distribution of time lags between fraudulent transaction and prosecution. But two to six years seems to be the norm.
A good flipper doesn’t need fraud. The flippin’ insider doesn’t make money from inflating values. He doesn’t make money by over-borrowing and stiffing lenders. He doesn’t need kickbacks, straw buyers, or other nonsense. The flippin’ insider makes money in two ways: Buying property at a reasonable discount from motivated sellers, and adding value through repairs and improvements.
Focus on the basics.
Keep it simple, and find good properties.
Jason Van Steenwyk is a veteran financial industry journalist who has been fighting to make the world safe for the retail investor since 1999. He lives at Ground Zero of the real estate bubble in Fort Lauderdale, Florida.