Banks Face Short-Sale Fraud as Home `Flopping' Spreads

Two Connecticut real estate agents found a way to profit in the U.S. housing bust: Buy low, sell fast. Their tactic was also illegal.
By: John Gittelsohn: bloomberg.com
Sergio Natera and Anna McElaney are scheduled to be sentenced in Hartford’s federal court in August after pleading guilty to fraud. Their crime involved persuading lenders to approve the sale of homes for less than the balance owed -known as a short sale - without disclosing that there were better offers. They then flipped the houses for a profit.

The Federal Bureau of Investigation, the California Department of Real Estate and mortgage finance company Freddie Mac have warned that such schemes may be spreading after a plunge in values left homeowners owing more than their properties are worth. The scams threaten to deepen losses for lenders that are increasingly agreeing to short sales as an alternative to more costly foreclosures.

“Short sales are an important tool that can help both the bank and the borrower,” said Morgan McCarty, executive vice president for mortgage servicing at Birmingham, Alabama-based Regions Bank, which lost money in the Connecticut case. “It’s just that criminals are always trying to find ways of profiting.”

Barofsky Report

An Obama administration effort to boost short sales may increase incentives for fraud, Neil Barofsky, special inspector general for the Troubled Asset Relief Program, wrote in an April 20 report to Congress. The government, through its Home Affordable Foreclosure Alternatives Program, that month began offering as much as $1,500 to servicers, $2,000 to investors and $3,000 to homeowners who close short sales.

“It appears that the program may lack necessary antifraud protections,” Barofsky wrote.

A prevalent scam involves a practice called “flopping,” Barofsky said. In that scheme, investors or home buyers hire brokers to assess a home for less than its market value and convince banks to accept a sale at that level. The buyer conceals from the lender that he has lined up a higher offer and then quickly resells the property for a profit, as in the Connecticut case.

“Flopping” occurs in more than 1 percent of short sales and may cost lenders $50 million this year, according to estimates from CoreLogic Inc., a real estate data and research company in Santa Ana, California. About 12 percent of existing home sales, or almost 622,000 houses, were short sales in the 12 months through April, data from the National Association of Realtors show.

Quick Profit

“A majority of the short-selling fraud is related to LLCs and investment companies trying to make a quick profit,” said Tim Grace, vice president of fraud analytics at CoreLogic. LLCs refer to limited liability corporations.

The Treasury has “put reasonable protections in place” to prevent short-sale fraud, requiring that the buyer and seller have no hidden relationship and banning most resales within 90 days, said Laurie Maggiano, policy director of the department’s Homeownership Preservation Office in Washington.

Suspected property-valuation fraud almost doubled from the end of 2007 through the first quarter of this year, according to a June 8 report by Interthinx Inc., an Agoura Hills, California- based company that sells mortgage fraud detection software.

In addition to banks losing money, “flopping” may hurt homeowners who complete a short sale and face higher deficiency judgments as lenders seek to recover unpaid mortgage balances, Ann Fulmer, vice president of Interthinx, said in an interview today on Bloomberg Television.

‘On the Hook’

Borrowers are “on the hook for larger deficiencies,” she said. “And there are indications that banks are increasingly turning to collection agencies and to civil lawsuits.”

Investors often use real estate broker opinions, which may rely on drive-by inspections instead of full appraisals, to persuade lenders to sell at a low price, Fulmer said in a separate interview. She suggested an Internet search of “How to influence a broker price opinion,” which yielded 74,800 results.

Near the top of the list is a video hosted by Mark Walters of CashFlowInstitute.com in Glendale, Arizona. It shows Walters feeding carrots to a pot-bellied pig while advising how to influence brokers to reduce their valuation. Among his tips: provide prices of comparable short sales to make the broker’s job easier, and be clear you want a low price.

Swaying Favor

“See if you might be able to sway what they do in your favor,” Walters says on the video.

Walters didn’t respond to e-mails, a fax and phone messages requesting comment. In the video, Walters says he learned about influencing broker price opinions from Dean Edelson, owner of Elysium Investment Group Inc. in Sedona, Arizona.

Edelson said efforts to influence broker price opinions, or BPOs, are needed to counterbalance lender pressure to inflate values. Brokers often form an opinion based on a street view of a home, unaware of hidden flaws, he said. Attempting to influence their opinion is legal as long as there is no pressure or payment to get a desired outcome, according to Edelson, who says he has completed “a few hundred” short sales since 2003.

“How is influencing a BPO fraud?” Edelson, 53, a former producer of promotional trailers for television shows including “Seinfeld” and “Frasier,” said in a telephone interview. “What’s fair market value? It’s determined by what a buyer is willing to pay for the property.”

Investors can help the real estate market by paying cash to lenders, preserving property prices by reducing vacancies and helping homeowners avoid foreclosure, Edelson said.

“Investors move inventory and help prevent market values from declining,” he said.

Taxpayer Losses

By allowing broker price opinions, the Treasury exposes taxpayers to short-sale fraud after $49 billion of government bailouts for housing, Barofsky wrote to Congress.

“As constituted now, the program permits home valuation, the key vulnerability point for a flopping scheme, without a true appraisal,” he wrote. “No program of this type and scale can be considered well designed without robust protections of taxpayer funds against the predation of criminals, particularly given the inconsistent treatment of home valuation.”

Requiring a full appraisal instead of a broker opinion doesn’t guarantee getting the accurate value, the Treasury Department’s Maggiano said.

“It’s all in the integrity of the person doing the valuation,” she said. “Clearly there are poor quality appraisers, licensed or not, and there are poor quality real estate agents, licensed or not.”

Smaller Losses

Lenders usually lose less from short sales than foreclosures, because there’s less property deterioration and repossession cost, Maggiano said. In April, the average loss in principal for prime loans that went into foreclosure was 42 percent, compared with a 33 percent loss for short sales, according to Amherst Securities Group LP, an Austin, Texas-based company that analyzes home-loan assets.

At Bank of America Corp., the largest U.S. mortgage servicer, completed short sales are on pace to more than double this year from 2009, Jumana Bauwens, a spokeswoman for the Charlotte, North Carolina-based bank, wrote in an e-mail. She declined to provide more specific data.

“We have language in our short sale approval letter that prohibits the flipping of a property and after closing we will audit transactions to identify ‘flips’ or ‘flops,’ ” Bauwens wrote. “It’s not in the best interest of our investors or communities at large to encourage or allow flipping.”

Regions Bank, a unit of Regions Financial Corp., completed 498 short sales with $175 million in unpaid principal balances in 2009, double the value of its 2008 transactions, McCarty said. The lender completed 303 short sales worth $93 million this year through May.

Short Sale Requirements

The company requires a full appraisal before a resale, McCarty said. It also demands short-sale buyers sign statements affirming the transactions are arms length, with no hidden buyer-seller relationships, and that there are no agreements to resell the property.

In the Connecticut case, Regions Bank in April 2008 agreed to a short sale of a Bridgeport house for $102,375, unaware that Natera and McElaney had a bidder willing to pay $132,500, according to the plea agreements. Eight weeks after the bank sold for a loss, the pair resold the house for a $30,125 gain.

Natera’s phone has been disconnected and he couldn’t be reached for comment. Arnold Kriss, his defense attorney in New York, declined to discuss the case before sentencing.

McElaney declined to comment when reached by phone. Her New York-based attorney, Mark Bederow, said he couldn’t discuss specifics of the case.

“The mere act of a buyer in a short sale selling again quickly isn’t per se fraudulent,” he said. “That’s business.”