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HUD's House of Pancakes
June 22, 2006: Holy housing bubble! The U.S. Department of Housing and Urban Development (HUD) is finally cracking down on fraudulent mortgage flippers. Flipping is the quick (within a few months, weeks, days or even hours) turnover of property, with the resale price far exceeding the purchase amount. Not all flipping is illegal. The crooked kind involves a variety of fraudulent practices, most typically perped in repeated instances by industry professionals acting in collusion. Though illegal flipping occurs in upscale urban and suburban areas, it hits inner city neighborhoods the hardest. Leaving behind swaths of foreclosed properties ripe for drug crime, slumlords, and further mortgage frauds. And while facilitated by policies and programs aimed at expanding homeownership opportunity, flipping helps turn affordable borderline neighborhoods into inflated unaffordable slums.

The classic urban flip goes like this: corporate or non-profit entities, at times working with local governments, obtain properties for peanuts in low income neighborhoods. Sometimes they rehab, sometimes not. Rehabs are typically cosmetic. (There have been cases where houses were painted, but sewer lines left unconnected.) Appraisers inflate property values. Realtors, closing attorneys, et al, grease the process. Straw buyers are paid to pose as qualified purchasers, using phony proof of income, assets, etc. After an inflated loan is obtained, they decamp. The property slides into default. Some buyers recruited by flippers are merely naive. They sincerely want homes-- even if they fudge qualifications or take kickbacks. These buyers get stuck with a king size mortgage on a poor condition property and spiral into debt. On the way down, they can be tapped for a few rounds of refinance fraud or a foreclosure rescue scam.

Among other possible players in flipper fraud rings are mortgage brokers who set buyers up with lenders. And lenders themselves.

Once upon a time, lenders were less likely to be involved in mortgage fraud. Since defaults based on inflated appraisals would bounce back on banks. But a lot has changed since ye old days. Now mortgages are bundled into securities and sold to investors. By the time bad loans sour, they've been balanced by the larger percentage of good ones. Freedom from blowback allows banks to grant more mortgages, with higher levels of risk. Thereby expanding homeownership opportunity. The largest marketeers of mortgage backed securities are the government sponsored entities (GSE) Fannie Mae and Freddie Mac. Though lately their clout has been diminishing.

A GSE is a strange bird. Neither government agency, nor free market enterprise. But as "government sponsored" suggests, resting on an implicit promise of taxpayer back-up. By 2002, Fannie & Freddie were moving roughly two thirds of the residential mortgage market. But beneath no-fail facades, both were having problems.(As example, in 2003, Fannie Mae was found to be juggling earnings from year to year to present a more even picture of profits.) GSE reform has become a perpetual topic in Washington. Legislative action re tighter control of the GSEs is bobbling around in the Senate.

Over the years, some reformers advocated ending the GSEs' privileged, government sponsored status. Others thought oversight of the GSEs should be shifted to the U.S. Treasury Department. Away from their current watchdog-- the Office of Federal Housing Enterprise Oversight (OFHEO). OFHEO is an agency within HUD. When problems at Fannie and Freddie first surfaced, OFHEO was characterized as asleep at the wheel. Faced with the threat of losing its GSE connection, OFHEO started spitting out scathing reports about GSE malfeasance. The most recent being a June 15th report castigating Fannie Mae's "arrogant and unethical corporate culture". OFHEO's recommended reforms include expanding OFHEO control over GSE policy.

Also under HUD's umbrella is the Federal Housing Administration (FHA). FHA backed mortgages, which are intended to help low income buyers, require small down payments and have less stringent income standards. When an FHA mortgage defaults, the FHA insurance fund reimburses the bank. But in this age of exotic mortgages that require no down payment or proof of income, FHA mortgages have become less attractive. Due to various fees (sometimes called predatory) exotic mortgages are very profitable for lenders. However, there's a move to restore FHA loans to their former prominence in the affordable market. The National Realtors Association, among other groups, is pushing for the FHA to reform by dropping its last few lending standards.

The Long Green Years

In March, 2001, former HUD Inspector General Susan Gaffney warned the House Subcommittee on Housing and Community Opportunity, that illegal flipping was becoming a major problem in inner city neighborhoods, and criticized the mission creep which she believed made HUD unable to sufficiently police its core programs. She also expressed concern for the future of the FHA insurance fund. Gaffney's concern for the fund may have been misplaced. As realtors apparently realize, taxpayers can't default. But Gaffney's take on the destructive impact of flipping in inner city neighborhoods was right on target.

Later in 2001, Senator Susan M. Collins, Chairman of the United States Senate Permanent Subcommittee on Investigations, characterized the federal government as having "essentially subsidized" much of the mortgage fraud in the nation's cities. Her observation is included in the 09/25/01 Committee on Governmental Affairs document "Property Flipping: HUD's Failure to Curb Mortgage Fraud.

By December, 2005, the FBI was declaring that an epidemic of mortgage fraud was sweeping the country and that they, in concert with the IRS, the Department of Justice, the U.S. Postal Inspection Service, and HUD's Office of Inspector General had launched "Operation Quick Flip".

In July of this year HUD's new anti-flipping rules, which have been in the pipeline for several years, will go into effect. The FHA will no longer finance loans on homes sold within 90 days of purchase. If a seller moves a property between 91 and 180 days following acquisition, and the sales price is 100 percent or more than the original purchase, a second appraisal must be obtained. Other tuff measures are included in the rules; most worded so as to make enforcement a matter of HUD discretion. There are also some notable exceptions as regards the actual restrictions.

Among the roster of the exempted, are non-profit community housing development organizations (CHDOs) approved by HUD to buy HUD homes. However, only CHDOs (pronounced Chee-doughs) acting under HUD scrutiny will be allowed to beat the resale clock. While HUD acknowledges that many CHDOs have furthered home ownership opportunities, not all CHDOs "receive the level of oversight HUD believes is necessary to exempt this category of housing provider."

Also on the restriction-free list are non-profit organizations marketing HUD homes in HUD's Single Family Property Disposition (SFPD) program. Plus non-profit entities approved to utilize HUD's Discount Program to provide affordable housing to low income people. The list goes on and on to include local or state housing agencies, state licensed and federally chartered lenders, FHA approved lenders, HUD itself and oh yes-- the GSEs. Despite OFHEO's critiques, Fannie and Freddie won't be voted off the quik resale island. HUD believes that "state and federally chartered financial institutions, and the GSEs, are highly regulated or supervised by state and federal agencies and do not engage in predatory practices".

Let's see. Who does that leave at the helm of the flipper ship, cringing beneath HUD's onerous restrictions? Merely the handful of sleazy, free-lance real estate professionals responsible for the nation's mortgage fraud epidemic. Never have so few done so much! Stay tuned. As the housing bubble deflates, their villainy will become more apparent. As will the impact of their actions on federal taxpayers, the last buyers into the pool of inflated affordable housing, and dwellers in low income neighborhoods deep in the heart of Flip City.

Carola Von Hoffmannstahl-Solomonoff

Sources include but are not limited to:

Statement of the Honorable James B. Lockhart III, Acting Director, Office of Federal Housing Enterprise Oversight On OFHEO's Report Of The Special Examination of Fannie Mae Before The Committee On Banking, Housing, And Urban Affairs, U. S. Senate, O6/15/06

Mortgagee Letter 2006-14, "Property Flipping Prohibition Amendment," U. S. Department of Housing and Urban Development, 06/08/06

Prohibition of Property Flipping in HUD's Single Family Mortgage Insurance Programs; Additional Exceptions to Time Restrictions On Sales, U. S. Department of Housing and Urban Development, 05/26/06

Mortgage Fraud Operation "Quick Flip", Federal Bureau of Investigation Press Release, 12/14/05

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Copyright (c) 2006 by Carola Von Hoffmannstahl-Solomonoff. This material may be freely distributed subject to the terms and conditions set forth in the Open Publication License. This license relieves the author of any liability or implication of warranty, grants others permission to use the Content in whole or in part, and insures that the original author will be properly credited when Content is used. It also grants others permission to modify and redistribute the Content if they clearly mark what changes have been made, when they were made, and who made them. Finally, the license insures that if someone else bases a work on this Content, that the resultant work will be made available under the Open Publication License as well.

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