Monday, April 26th, 2010 at 3:05am

TARP Inspector “Flopping” Fraud Warning

Posted by Ron Ballard

The latest “emergency news” flashing across the Internet is about the TARP (Troubled Asset Relief Program) SIG (Special Inspector General) Report to Congress warning about Property “Flopping” Fraud.

“Flopping” is not a misspelling, so add it to your spell checker.

Before more people start blogging (and offering new training programs designed to “solve” the new “problem”), I suggest reading the actual TARP Inspector General Report to Congress April 2010, which is why I have it linked for intelligent review and discussion. The relevant portions are on pages 138-140 of the report (pages 140-142 of the PDF file).

Warning: This is a long post because it involves thinking and analysis, not hype and sales of the next greatest thing.
The setting being discussed in the report relates to “revisions to the Home Affordable Foreclosure Alternatives (“HAFA”) program [which may] present an increased prospect of potential fraud.” Note: the report is talking about HAFA procedures, not necessarily non-HAFA short sales which likely are not under the purview of the TARP SIG.
The report defines “flopping” as a short sale “scheme” centering on “home values that are fraudulently deflated for the purpose of decreasing the cost of the short sale to a ‘straw purchaser.’ The property is then quickly resold for its true market value, leaving the difference in the crook’s pocket. Historically, these schemes often involve the participation of corrupt brokers and servicers.” (Report p. 139) As will be discussed below, the issue centers around the use of broker’s price opinions (BPO’s) instead of  full appraisals.

I admit it. I advise investors who want to comply with the law and reasonable standards of commerce. Hence, I’m not sure how the “crooks” commit property flopping, especially in concert with corrupt loan servicers who are supposed to be either: (a) getting the best price to minimize the loss on the loan; or, (b) running the file out as long as possible to increase servicing fees. Neither of these jive with the concept of unloading the loan to the crook for the lowest price, unless the SIG is implying that individual loss mitigators are somehow getting kickbacks or bribes.

My clients who want to buy and rapidly resell short sale properties definitely have problems with BPO agents. Most often the problem is the opposite of the SIG Report: the BPO agent hired by the bank issues an artificially high BPO so the property will go to foreclosure (since it will not receive offers for the value the bank thinks it should) and then the BPO’s agent’s brokerage gets the (or other similarly overvalued) REO listings. Due to this problem, I and many other advisors encourage investors to have their own BPO performed and submitted to the short sale lender/servicer for competitive analysis. The data included in the investor’s BPO must be true, accurate factual statements about the local market. So long as it is true, there is no “fraud.” Every kind of commercial negotiations involves competing views of value. This is a normal, every day, regular legitimate part of business.

The bank hires THEIR BPO agent, not the investor. If the property is in a small enough market in which the BPO agent and “crook” know each other, then maybe there is a chance that they will conspire to produce a low BPO. In most urban and suburban markets (at least in California) there are so many BPO agents that it is unlikely and rare that either a legitimate investor or a “crook” would know the BPO agent and be able to collude with them.

So the first step to the “flopping” problem is an intentionally low BPO prepared by the BPO agent hired by and for the bank.

Where did this idea come from? According to American Banker, “The inspector general came down on the side of the Appraisal Institute, a trade group for appraisers, which sent a letter to Treasury Secretary Tim Geithner in March urging ‘independence in the valuation process’ and the use of full appraisals.” The article goes on to state, “BPOs are cheaper at about $40 per property, compared with the $350 to $500 for the cost a full appraisal.”

Could it be that the appraisers are trying to get a cut on the business they are missing? Could this obscure part of a long report be more the outcome of effective lobbying than a legitimate concern?

Frankly, I expect that appraisers understand the difference between a “distress property value” or “liquidation value” versus a “fair market value” – the importance of which will be discussed below. Other than the additional costs it will inject into the process (and who will pay for them), I don’t have a problem with the impact of using appraisals instead of BPO’s on legitimate short sale flip transactions. But let’s return to the SIG report.

The second step of “flopping” is the undervalued sale to a “straw purchaser.”  

The term “straw purchaser” is not defined and a search of the Internet finds a lot of opinions, but I didn’t come across anything very authoritative. The closest could be the Encarta/MSN definition of a “straw buyer” as “somebody who purchases property for another person in order to conceal the identity of the real purchaser.”

In the SIG report, I’m guessing the intermediate buyer is called a “straw purchaser” because it hides the identity of the end buyer. However, a true “straw purchaser” is engaged by the end buyer. In this case, the end buyer would not have a motivation to engage a straw buyer and then buy for a higher price.

The use of “straw purchaser” further does not really fit, because the idea of a straw purchaser is that the identify of the “real purchaser” is usually not revealed. The most common Internet discussions of “straw buyers” in “fraudulent” situations revolve around a good credit buyer obtaining a loan on behalf of a poor credit buyer, hence deceiving the lender of the true identity of the actual beneficial owner of the property. In those cases, I don’t believe the true identity of the beneficial owner is revealed at any time near the closing.

In a “flopping” transaction, the property is rapidly sold to a third party (as in legitimate “flipping”), presumably with record title transferring to the end buyer. If record title is not transferred to the end buyer, then I can understand the use of the term “straw purchaser.” Otherwise, I think the term is poorly chosen and inaccurately used.

The third step of “flopping” is the property is quickly resold for its true market value.

I have a Bachelor’s degree in Economics and have studied valuation from a legal perspective to advise clients. To my studied understanding (and I don’t have time or space to fill this overly long post with citations), “market value,” especially “true market value” is a theoretical concept, not a valuation standard. Often, one deals with a concept of “fair market value,” which can be defined as “the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arms-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion.”

Too many officials, regulators, investigators, pundits, commentators and bloggers exhibit abject ignorance of valuation differences and natural variations in market circumstances. Attachment A to Freddie Mac Bulletin 2009-24 is the most cogent “official” statement validly acknowledging the difference between distress property value and fair market value. None of the active discussions of “fraud” reflect any understanding of these differences. By accepting a 20% spread between the purchase and resale of distress properties in the Waiver of 90 Day “No Flip” Rule, FHA is essentially acknowledging this as a typical difference between distress/liquidation value and market value.

A homeowner who needs a short sale due to a legitimate hardship (I do not advise “strategic defaults”), and who likely is in default and probably in foreclosure, is not a fair market seller, but a distress seller. The foreclosure process is generally becomes public record and the market then forces a steep discount. Commencing a foreclosure transforms a typical short sale from potentially close to a “fair market value” to a “liquidation value” in which appraisers speak of “a seller who is compelled to sell after an exposure period which is less than the market-normal timeframe.” It’s the bank’s decision to publicly foreclose that triggers the precipitace decline of the property value.

A legitimate investor will likely have no problem with the SIG recommendation to use appraisers because appraisers should understand that a short sale is a “liquidation value” sale in their parlance and not a “fair market value” sale (which is probably what the SIG report calls “true market value”).

HAFA will not solve the liquidation value market discount because it places an initial 120 day deadline for the homeowner to sell their house at the bank-dictated price. This is usually “less than the market-normal timeframe” and will require banks to dictate liquidation value prices rather than seeking “true market values.” Even “retail” buyers will likely wait for the foreclosure auction or the REO marketing of HAFA short sale properties when they know the seller effectively has a gun to their head and the bank has over-priced the house.

I find the lack of understanding of actual real estate market dynamics among those responsible for regulating it nothing short of remarkable. I guess if one is not “in the trenches” there is a chasm of lack of knowledge.

The ironic differences between “the sky is falling” warnings to investors and the “use appraisals to reduce losses on short sales” is that neither of them have a strong basis for legitimacy in the predicted likely market outcomes, as follows:

1.   The use of appraisals should curb the more common practice of over-valued BPO’s than the less common practice of conspired under-valued BPO’s. The SIG Report does not express any knowledge of this practice, which to my impression is more prevalent. Legitimate appraisers are professionally obligated to provide banks with “liquidation value” appraisals rather than some kind of “fair market value” report which overstates the price which retail end buyers (much less investors) are willing to pay.

2.   By reducing the more common practice of over-valued BPO’s, the use of appraisals could create a better environment for legitimate investors by guiding banks to more realistic pricing of traditional (non-HAFA short sales). The primary difficulty with reports like this and with the Freddie Mac “short payoff fraud” news article, is that they create an entirely false illusion that it is not possible to engage in legitimate investor-based flip transactions. Unfortunately, this could discourage honest investors from this market segment and prolong the housing crisis.

3.   The SIG Report unwittingly overlooks two key elements of the HAFA program which appraisers will ultimately need to consider in their valuation (which BPO agents likely don’t consider at this point). First, is that the 120 day deadline to complete a HAFA short sale will encourage buyers to avoid HAFA purchases and let the properties go to a deed in lieu of foreclosure to get the property at a subsequently lower REO price. And, secondly, that the HAFA anti-flip provision effectively excludes investors from purchasing properties which have been the most natural ones for investors to buy. These factors will further depress housing prices and further increase loan losses. (Which FHA has apparently determined is the case in it’s decision to waive the 90 day “no-flip” rule.)

And all the government’s regulators, and all the government bailed-out bankers (who are shorting mortgage pools) will say: “we never saw this coming.”

All they had to do was read this article.

5 Responses to “TARP Inspector “Flopping” Fraud Warning”

  1. Steve Pawera says:

    Hi Ron,

    This is fascinating: And useful too.
    “Legitimate appraisers are professionally obligated to provide banks with “liquidation value” appraisals rather than some kind of “fair market value””.
    It makes perfect senes. Is it also a published appraisal standards?

    Separately, you’ve made it clear you are not a fan of ‘strategic default’.
    Wouldn’t the act of not paying while one has the means to do so, wouldn’t that be more like a breach of a contract than a ‘fraud’? It wasn’t the intent to not pay when you borrowed the money.

    Would you have a different opinion of people doing strategic defaults if they are done straight up? ‘Mr. Lender, I am done paying on this loan. Yes I have the means but I’m not going to pay. If you’d like to accept the short sale offer I’m presenting, you can stem your losses’.


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  3. Ron Ballard says:


    I’ll see what I can find for links about appraisal standards. Plus, I should clarify that the appraiser must respond to the order for the appraisal. If the bank requests a “fair market value,” then that is what they will get — which not the circumstances of the sale. If it asks for the estimated selling price, then the appraiser should be providing a liquidation value based on the foreclosure status.

    With respect to strategic defaults, the bottom line of all my legal advice is: tell the truth. If a borrower simply says they don’t want to pay, then that is not fraud. Just as you said, it is then a standard breach of contract. The bank can evaluate the loss or it can deny based on lack of hardship or that it doesn’t want to grant the short sale in order to discourage others.


  4. paul motley says:

    Hi Ron,

    I’m just trying to gain a bit more clarity with regards to HAFA As it pertains to investor protocol. A HAFA Disclosure Form declares that the borrower is not enrolled and will not be enrolled in the program. However, I read on the NAR website that mortgage servicers participating in HAMP are required to comply with HAFA. They also provide a list of mortgage participants ( Does this mean that mortgages that are HAMP affiliated should be disregarded as prospective deals?

    Best Wishes,


  5. Ron Ballard says:

    Hi Paul,

    As I understand this, it means the servicers who are in HAMP must offer and administer HAFA. It does not require the borrower to pursue a HAFA short sale vs. a traditional short sale. HAFA remains opt-in for the borrower. It’s just not opt-in for the servicer if it is already in HAMP.

    Ron Ballard

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