Banking on unreal estate - the appraisal scam

Washington Monthly, Feb, 1986 by Kenneth Weiss

A key to EPIC's initial success, according to real estate experts, was its ability to buy homes at below-market prices while borrowing money based on full-market appraisals. Generally, EPIC purchased houses that big builders had trouble selling, such as the dregs of large housing projects. Many of EPIC's homes were also in areas with weak housing markets, including Houston, Dallas, Washington state, and Colorado. In return for picking up the unwanted housing, builders gave EPIC discounts of up to 25 percent off the purchase price. Since the loans were based on full market price, EPIC was awash in extra loan money, enabling the company's officials to make money off each home purchase. Yet the EPIC investment deals were structured so they didn't generate enough rent or other income to keep up with the mortgage payments. EPIC officials had to make up the shortfall by constantly bringing in new investors or borrowing money from Community Savings. They knew that if the stream stopped, EPIC would collapse.

That's exactly what happened last August when federal regulators told Community Savings that if it wanted federal insurance, it would have to dump EPIC. This left EPIC officials with no choice but to stop borrowing money from the S&L and quit bringing in new partners. Now the losses are being counted. Community Savings could lose as much as $100 million it sank into EPIC property deals. But ultimately the taxpayers will end up paying a big chunk of the costs. The collapse of Community and several other Maryland S&Ls has bankrupted the states private insurance system. Faced with pressure from angry depositors, Maryland guaranteed the S&Ls deposits. The legislature is now considering a plan to spend $70 million this year and could eventually pay more than $100 million on top of that. Federal officials estimate that at least 5,800 private investors, many of whom bought the homes as tax shelters, will have to absorb $300 million in losses. Maryland officials, who have taken over Community and EPIC and tossed out the former owners, hope the figure is exaggerated. But the ultimate loss will be determined when creditors try to sell the homes for whatever they can get. Congressional investigators looking into fraudulent appraisals say they have collected "numerous examples" of EPIC properties that were appraised 50 percent to 100 percent over their real value.

EPIC's collapse has shaken the entire $20 billion private mortgage securities industry as well as the mortgage insurance industry. At least ten U.S. mortgage insurers and another ten companies in Europe and the U.S. that insure the insurers face claims totaling $400 million. Nearly 100 S&Ls hold EPIC mortgages backed by over-valued properties. In addition, major Wall Street investment houses that buy mortgages from S&Ls and trade them on the securities market are afraid the EPIC collapse will scare away investors. Salomon Brothers, the largest trader in the mortgage-backed securities market, has even tried to put together an industry plan to bail out or buy out EPIC to prevent a crisis of confidence in the secondary mortgage market-once thought to be one of the safest investments around. Fictional golf courses