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Thursday, June 10, 2010

Flip a Short-Sale Home, Go Directly to Jail?

A seemingly innocuous residential real estate transaction -- the flip -- may now be viewed by the federal authorities as potentially criminal in nature.  A new twist on bank fraud. Read this report at
http://www.bloomberg.com/apps/news?pid=20601109&sid=avevHVg0VvHs&pos=10.

The gravamen of this crime is the illicit influencing of the appraiser to come up with an artificially low price so as to induce the bank holding the mortgage to take a loss, which later results in an illicit gain when the buyer sells. Actually, I don't see how the resale is an element of the crime -- it isn't -- but it helps prove intent.

The risk to the innocent: How does one distinguish between a valid flip on serendipitious circumstances and terms, and a criminal low-appraisal to defraud the bank?

Here, innocent homebuyers seeking to get a great deal may run some risk of law enforcement scrutiny and possibly the presumption of illegality.   To make matters worse, this virtually criminalizes the use of leverage and negotiating power in a business transaction, elements which have been used in commerce since the beginning of recorded human history. 

So what is really criminal here?   Could we have a new, unspoken, intended rule -- that any profits from a quick resale of a house first bought from a bank in a short sale belong to the bank?  If that is true, then the  bank gets to "cut its losses" (but also realize, or "book" them) by doing the short sale, thus ending its downside exposure while thereafter keeping the upside potential.   The subsequent buyer has a far different deal -- he risks criminal investigation and prosecution if he sells the house too quickly, and he faces having to surrender any gains on the house to the bank, but has no downside protection -- he has all the liabilities of a property owner and can lose all his equity.

Maybe the lesson here is that while banks get taxpayer bailouts to compensate them for their losses -- while the banks continue to hand out million-dollar executive bonuses and advertise and sponsor sports stadia -- individual homeowners (especially those who can afford their mortgage) can absorb the full risk of loss.   Moreover, criminal prosecution awaits anyone who tries to take advantage of a bank's financial distress to score a good deal.   
Unless these prosecutions and investigations are brought in the narrowest, most egregious of cases, local U.S. Attorney's Offices run a risk of seriously discouraging knowledgeable, prospective purchasers by implementing a de facto policy of pursuing such cases.  (There are even constitutional issues here, with the executive branch Justice Department creating and enforcing a de facto law of its own creation -- but that's a different story for another time.)  Banks will have more difficulty finding buyers at certain price points -- even the reviled speculators and flippers will be dissuaded from the market.   This will seriously hurt the residential real estate market. 
Eric Dixon is a New York lawyer who regularly comments on legal and economic issues. He is available for comment at 917-696-2442.

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