Banking on unreal estate - the appraisal scam

Washington Monthly, Feb, 1986 by Kenneth Weiss

Other banks and S&Ls around the country have encountered massive real estate over-appraisals. Federal banking examiners found 411 instances of faulty or fraudulent property appraisals when they examined the records of the failed Empire Savings and Loan in Mesquite, Texas. The case is a classic example of "land flips," a lucrative scam in which a group of collaborators sell land among themselves, each time artificially raising the property's value with new, bloated appraisals. In some cases the property's value triples in a day or two. Independent auditors discovered that Empire's $59.3 million in real estate collateral was actually worth $7.9 million.

Federal regulators last July seized Sunrise Savings & Loan in Boynton Beach, Florida. The troubled S&L may sustain as much as $200 million in losses, mostly from over-appraised real estate. In one instance, an appraiser valued undeveloped land at $29,000 an acre even though nearby property went for no more than $5,000 an acre. The appraiser based his assessment on what the land would be worth if surrounded by a luxurious country club and golf course--neither of which was in the works.

Lest you think the appraisal racket is stinging only smaller S&Ls, Bank of America of San Francisco lost $95 million in 1984 because property loans it handled were based on fraudulent appraisals. And over-appraisals played a role in the biggest blowout of all, the near-collapse of Continental Illinois Bank and Trust Company. The Federal Deposit Insurance Corporation (FDIC) has testified that it will have to absorb at least a $200-million loss from overvalued real estate in the bailout of Continental. After purchasing real estate appraised at $400 million on Continental's books, the FDIC discovered the land was worth only half that amount.

Failures to notice

Despite the growing number of government bailouts and mounting losses, most bank regulators treat the over-appraisal problem as if it were little more than a bounced check to the corner grocery. Take, for example, the Federal Deposit Insurance Corporation, which insures all U.S. commercial banks and regulates state-chartered banks that are not members of the Federal Reserve system. Even though the FDIC will have to pay $200 million just to cover overvalued real estate holdings of Continental Illinois, the agency insists that it need not pursue tighter restrictions on appraisals. "We feel that the ones we have in place now are adequate," says George J. Masa, assistant director of the FDIC's division of bank supervision.

The Office of the Comptroller of the Currency, which regulates the country's 5,000 national banks, including Continental, didn't seem to mind Continental's inflated appraisals either In a letter to Rep. Doug Barnard, chairman of the monetary affairs subcommittee, a representative of the Comptroller's office said that its examiners, in viewing Continental's records, "did not disclose any real estate appraisal abuses warranting disciplinary action or criminal referral."