A New Fraud Fad: Illegal Short Sales of Houses

Two Connecticut real estate agents found a way to make money on houses during the bust: buy low, sell fast. Their strategy was profitable. It was also illegal. Sergio Natera and Anna McElaney are scheduled to be sentenced in federal court in Hartford in August after pleading guilty to fraud in February. Their scheme involved persuading lenders to approve short sales—selling homes for less than the balance owed on the mortgage. They did so without disclosing that there were better offers than the ones the banks accepted, which they were legally required to do as licensed real estate agents. The two then flipped the houses for a quick gain.

The FBI, the California Real Estate Dept., and mortgage-finance company Freddie Mac (FRE) have warned that such schemes may be spreading, thanks to a housing bust that has left homeowners owing more than their properties are worth. The scams threaten to deepen losses for lenders that increasingly are agreeing to short sales as an alternative to costlier foreclosures.

"Short sales are an important tool that can help both the bank and the borrower," says Morgan McCarty, executive vice-president for mortgage servicing at Birmingham (Ala.)-based Regions Bank (RF), which lost money in the Connecticut case. "It's just that criminals are always trying to find ways of profiting."

An Obama Administration effort to boost short sales may be unintentionally increasing incentives for fraud, Neil Barofsky, special inspector general for the Troubled Asset Relief Program, wrote in an Apr. 20 report to Congress. Through the Home Affordable Foreclosure Alternatives Program, the government offers 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 common scam involves a practice called "flopping," Barofsky said. Real estate brokers, investors, or home buyers convince a lender to sell a home for less than its loan balance without disclosing the fact that they have lined up someone willing to pay a higher price. They quickly resell the house for a profit, as in the Connecticut case, while the lender takes a loss.

"Flopping" occurs in more than 1 percent of short sales and may cost lenders $50 million this year, according to estimates from CoreLogic, a real estate research company. 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. Regions Bank requires a full appraisal before a resale. It also demands short-sale buyers sign statements affirming the transactions are arm's 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, says he can'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 says. "That's business."

The bottom line: During the boom, the game was to get houses appraised at more than they were worth. Now a low appraisal can aid a fraudulent sale.

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