One of the causes of the Real Estate meltdown - but not the only cause - was widespread and rampant Mortgage Fraud. How does Mortgage Fraud work?
NOTE: The following information I received from a CLE seminar last year on Amelia Island. It was, to say the least, a fascinating eye-opener!
During the go-go era of the 2000's, home prices appreciated by 10%, 20%, even 30% annually in some States and neighborhoods. At the same time, it became easier and easier to buy a home with nothing down and no documentation. And as a result, some criminals got involved in Mortgage Fraud, and made millions of dollars and walked away, scot-free.
What is Mortgage Fraud and how does it work? Let's look at an example.
Mortgage Fraud is organized crime. And Johhny is an organized crime boss. Johnny has a number of schemes going on, from loan-sharking to prostitution to gambling, to drugs. And all of them are profitable. But he also has a lot of other things going on as well, and Mortgage Fraud is his latest gag - or it was, in the 2000's.
A lot of people owe Johnny money and owe Johnny favors, so he has a lot of minions he can use to advance his scheme. And of course, he has the members of his organized crime "family" to rely on. And he can bribe others to get involved as well. And he'll need a few actors to help him, too.
Here's how his scheme works:
Fred and Thelma have their house for sale in Happy Acres Estates, for a price that is a little over market value, early on in the Real Estate boom. They are pleasantly surprised to get an offer from Jimmy, for the asking price of the house. Jimmy is a straw man in this transaction. He is a gambler who owed Johnny some money and is getting involved in this scam to help pay down that debt. Jimmy will be buying a lot of houses in the next few years! Jimmy has good credit, which is why Johnny is using him.
Jimmy applies for a mortgage for the house, using a no-doc "liar's loan". They have Sammy appraise the house for the bank, and the appraisal comes in fine. Sammy is also in debt to Johnny, and he will end up losing his job over this (and more) when it is all said and done. The Bank approves the loan and the house closes. Of course, it helps to have one of Johnny's "friends" at the Bank, or as a Mortgage Broker, but in many cases that might not be necessary, as Banks are eager to close loans and make loan origination fees.
They go to close on the house. Johnny has approached a local Attorney, Jason, to become a closing agent for Johnny. Jason is a Criminal Law Attorney whose practice has fallen on hard times. Johnny says he can send dozens of closings to Jason - and provide paralegal help, too! "All you have to do, is sign some documents, and you'll make a ton of dough!" Johnny says. Foolishly, Jason goes along with this, even though he has no prior Real Estate Law experience - which is why Johnny picked him in the first place. He will end up being disbarred.
Again, many of these actors in this scheme might not have any choice in the matter. They may own money to Johnny in gambling debts or in loan-sharking deals, or Johnny may be blackmailing them with photos he took when the victims visited one of his prostitutes. Or Johnny may have simply offered them a "taste" of the action - which was more money than they could walk away from. Johnny is a very persuasive guy!
Within a few weeks or months, of closing, Johnny directs Jimmy to sell the house. This time, it will be sold to another straw buyer, Joseph, who is heavily in debt to Johnny. But this time, the house is sold for $100,000 more than the purchase price that Jimmy paid just weeks earlier. Again, Sammy does the appraisal, and Joseph, who has (or had) a good credit rating, is approved for the loan by the Bank.
Most of the $100,000 in profit from the sale of the home goes to Johnny - he gives a pittance to Jason, Jimmy, Joseph, and Sammy. By having his minions sign a few pieces of paper and shuffle nominal ownership of a home around, Johnny has netted a cool hundred grand within a few weeks.
But of course, it doesn't end there. Johnny expands the operation rapidly - buying other homes in the Happy Acres Estates neighborhood and doing the same thing - flipping them multiple times, each time for $100,000 more than the time previous. His first sale to Joseph is now a "comparable" and Sammy has an easier time selling the appraisal to skeptical Banks. And let's face it, the Banks aren't looking too closely, anyway. Loan officers are more interested in their lucrative fees than in looking closely at loan docs.
Jason's law practice is booming - but he does little more than sit in his office and get nervous. There are a lot of odd strangers in his office, and Johnny has taken up permanent residence in a back room. Every day, there is a Real Estate Closing. Sometimes, there are "back to back" closings of the same property on the same day! And the prices for the homes are escalating wildly.
By now, that original home that Johnny started with has been flipped several times between straw buyers - with Johnny taking the profits from each sale for himself every time. The other players in this scheme get a small "taste" of the profits - but Johnny keeps most for himself. And some of the players may actually live in some of the homes - enjoying granite countertops and luxury living - at least for a time. Or they may rent out the homes, pocketing the rent in cash for a little extra dough, or as their "taste" of the action.
The loans are payment-optional ARMS and other "toxic" type funny-money loans. Some of the buyers make some mortgage payments - others never do. Either the homes are sold before they go to foreclosure (for even staggeringly higher prices) or if they have been "tapped out" they are allowed to go to foreclosure and the nominal owner walks away with a ruined credit rating, but intact kneecaps.
Meanwhile, Johnny has amassed millions of dollars in tax-free profits from these deals. Hundreds of houses have changed hands by now - many several times. The neighborhoods have skyrocketed in value, but once the market crashes, home sales plummet and prices drop as well. The few legitimate homeowners who actually bought homes in these neighborhoods, end up destitute.
Jimmy and Joesph, of course, never quite get their debt to Johnny paid off using this scheme - but their credit ratings have basically been destroyed.
Sammy's appraisal business is in the tank, of course, and he is under investigation by the FBI. He offers to testify against Johnny, but weeks later, his body (or what is left of it, after the gators were done with him) is found floating in the Everglades.
Jason is under investigation by the State Bar for fraud. He will likely lose his law license, and his career. It all seemed like easy money at the time, but the pit in his stomach should have been telling him something - when money is "too easy" something isn't right.
As for the Banks? Well the loan officers all got their tidy bonuses. Many lost their jobs, but many more are still working at those same banks - and those same banks were bailed out with TARP funds. Business, it seems, is as usual, even if it is not as lucrative as the heyday.
Of course, you and I, as taxpayers and as investors, all took this on the chin. Our tax dollars bailed out the banks in the TARP bailout, and our investments suffered, along with the rest of the nation, as the Dow dropped by nearly 50%.
As for Johnny? Well, he's still living in South Florida, and doing quite well, thank you. Most of his money is safely in cash or in offshore accounts. He's done with Mortgage Fraud - for the time being. Johnny is a creature of opportunity, and he strikes when the pickings are good, and then fades into the background before it all blows up. He's smart. And he's on to some other scam, these days, no doubt. Some scam that we'll read about in the papers, years from now.
And we all like to idolize Johnny - after all, he's just like that lovable Tony Soprano, right? But if you look at what he did to entire neighborhoods, and to people's careers, lives, credit ratings, and of course, Sammy, well, you realize that Johnny isn't very funny at all - and in fact he's very evil.
But, that's Mortgage Fraud, in a nutshell. Or it was, anyway.....
Note that Johnny, Jimmy, Joseph, Jason, Sammy, Fred, and Thelma are just composites of hundreds and hundreds of people who got into these schemes - in Florida, Georgia (Atlanta), Las Vegas, California, and other areas of the Country where home prices skyrocketed in recent years. They do not represent particular individuals, and any similarities in names is purely coincidental.