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Most people are already well aware of the fraud committed at the two largest mortgage operations in the world, Fannie Mae and Freddie Mac. The two companies effectively “cooked the books” to the tune of about $12 billion. That this hasn’t drawn more outrage and calls for intervention is simply amazing. What most people are less aware of, however, is the fraud that pervades the entire real estate industry.

Conflicts of interest in real estate are at least as great as they were between Enron and their complicit auditor Arthur Andersen or between Wall Street research analysts and their subjects/clients. Real estate agents have a duty to protect their clients. Mortgage loan originators and home appraisers have a duty to protect the bank’s investment. The problem is that their independence is compromised by the fact that they all have one common goal: generate as many property deals as humanly possible. Why? Because they thrive on commissions and fees. The more deals get done the more money they make. Period.

Recently, honest home appraisers have raised a red flag in railing against these incestuous relationships. Complaining that the real estate agents and mortgage brokers who control the transaction process have been coercing appraisers to commit appraisal fraud, over 8,000 appraisers have lobbied Washington to provide federal regulation to these highly unregulated businesses. The fact is more that half of all home appraisers admit that they have been pressured to inflate property valuations.

Legally inflating appraisals actually shouldn’t be too hard to do. Anyone who has bought or sold a home knows that appraisals are based on comparable home sales or “comps.” A home is effectively worth x because a similar home down the street sold for x. This is akin to saying Google is selling for 113-times-earnings so Yahoo!, at only 58-times-earnings, is undervalued by half! This is also the process by which real estate prices go up simply because they’re going up. So for appraisers to be even having difficulty justifying prices there must be some really aggressive realtors and mortgage brokers out there.

Indeed, so aggressive that the Mortgage Asset Research Institute, MARI, reports that California and Florida, perhaps the two hottest real estate markets in the country, are leading the growing epidemic of mortgage fraud. One would think that with so many appraisers pressured to commit appraisal fraud it would lead the way in overall mortgage fraud. But even considering its prevalence in today’s market, it trails, by a large margin, the greatest type of mortgage fraud: application fraud.

Application fraud is simply falsifying information on a mortgage loan application, presumably information that may be detrimental to obtaining the loan. If mortgage brokers and real estate agents are already coercing appraisers to commit fraud who could put appraisal fraud past them? William Matthews, vice president of MARI, calls this, “fraud for commission, where a professional such as the mortgage broker, banker, realty agent or appraiser changes documents in order to get a commission.” This type of fraud makes up at least 60% of the growing instances of mortgage fraud.

From top to bottom, from Fannie Mae to the initial mortgage application, fraud is helping inflate the real estate bubble. David Callahan, research director for the nonpartisan think tank Davos and author of the report, “Home Insecurity, How Widespread Appraisal Fraud Puts Homeowners at Risk,” puts the unsettling trend of mortgage fraud into perspective in saying, “This is just another area in American life where a boom, with all its money to be made, brought out the worst in us.” Sounds kind of familiar. Anybody remember Enron?

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