Stealing home.

How the government and big banks help second-mortgage companies prey on the poor

Just before the credits roll in the movie Tin Men, a couple of 1960s aluminum-siding salesmen commiserate about losing their licenses to hawk home improvements. A city commission has decided to punish the "tin men" who steal the equity in people's homes through shoddy work and overpriced second mortgages.

"You wanna know what our big crime is?" asks tin man Richard Dreyfuss bitterly. "We're nickel-and-dime guys--just small-time hustlers who got caught because we're hustling nickels and dimes."

In real life, three decades later, tin men are still plying their trade in cities across the United States, and home equity rip-offs are no longer nickel-and-dime stuff. Instead, they're well organized, demographically marketed, and nationally franchised. Second-mortgage companies have raked in billions of dollars by fanning out salesmen to slick-talk inner-city homeowners into signing high-interest loans to repair aging rowhouses, pay off medical bills, or stave off foreclosure.

Hundreds of thousands of homeowners have been victimized in the past decade. Tens of thousands have lost their homes; still more have seen their equity sucked out by exorbitant fees and usurious interest rates charged by predatory mortgage companies. Homeowners make ripe targets because they've spent years building up equity in their homes--and because runaway inflation in real estate values has left them sitting on equity gold mines in spite of their modest incomes. Many are targets because they are old or illiterate. Others are vulnerable simply because they are poor and black; they have nowhere to go for credit because mainstream lenders--the banks and savings and loans that have made the American dream of homeownership possible--are reluctant to lend money to residents of working-class black neighborhoods. With mainstream credit cut off, homeowners desperate for cash turn to second-mortgage companies that charge 20, 30, sometimes even 40 percent annual interest.

How does the scam work? Consider 84-year-old Roland Henry. In 1989, real estate entrepreneurs Kevin Merritt and his assistants spotted Henry through a foreclosure listing service. Merritt, then 29, had been working in the Los Angeles real estate market since he was a teenager and claimed to have accumulated a net worth of $10 million. Henry, who got no further than sixth grade, had bought his home three decades earlier with earnings made by selling homemade tamales on street corners in Watts. By the time Merritt got to him, Henry, nearly blind and confined to a wheelchair because of arthritis, was facing foreclosure on two home-equity loans he had taken out when he purchased what he thought was $180 in carpeting.

Merritt offered to help Henry save his home by giving him yet another loan to pay off his debts to the first two lenders. Henry claimed that Merritt fooled him into signing away his two-bedroom house. Merritt claimed Henry knew exactly what he was signing. A civil jury believed Henry. His family was awarded nearly $1.7 million from Merritt's firm this spring. Henry, however, didn't get to hear the verdict. He died last year.

Last May, Merritt was charged with 32 felonies alleging the theft of equity and homes from poor people. He has also been sued at least 175 times. But Merritt, who denies the charges, is still in business--and an increasingly lucrative business it is.

According to Duff and Phelps Credit Rating Co., home equity lending jumped from $1 billion in 1982 to $100 billion in 1988. And while the second-mortgage industry can be a pretty dirty business, to many mainstream banks and S&Ls, the money to be made from it has proved a great temptation--so great that they've helped maintain the home-equity feeding frenzy by bankrolling the tin men: advancing them money for operating expenses and buying up the loans after the ink dries. For example, a subsidiary of the Fleet Financial Group, New England's largest bank, extended a $7.5 million line of credit to one of the region's most notorious lenders, Resource Financial Group. A study last year found that more than three quarters of the Boston families who borrowed money from Resource were facing foreclosure or had already lost their homes.

Fleet is not alone. While most home-equity loans involve middle- to upper-income borrowers, the low-end market and its tantalizingly high interest rates have attracted the attention of financial institutions from Citibank to Security Pacific to the former Bank of New England. (According to surveys by the Consumer Bankers Association, between 1990 and 1991, the proportion of big banks buying home equity loans on the secondary market jumped from 12.5 to 20.9 percent.) In a way, these large institutions had made the second-mortgage business possible by denying mainstream credit to poor and black homeowners. Today, they're profiting from their prejudice.

What do federal regulators say about all this? The usual response is a variation on the theme "It's not our job." Federal bank officials do nothing to regulate second-mortgage companies (which are not depository institutions) and have shown little interest in the banks' role in the problem. In fact, some regulators have suggested that banks could improve their Community Reinvestment Act ratings--which gauge how well banks provide credit to minority and low-income citizens--by purchasing high-rate second mortgages on the secondary market.

This leaves responsibility for cleaning up the mess with the states, many of which have been less than vigilant about policing the industry. In Massachusetts, for example, second-mortgage companies have generally been permitted to charge whatever interest rate they want, as long as they notify the state attorney general in writing if they intend to charge 20 percent or more. It's a little like saying it's OK to rob a liquor store as long as you've dashed off a note to the cops announcing your intent.

The victims of the new tin men aren't all blameless; often their own errors in judgment have allowed the con artists to take advantage. But most are longtime homeowners who give stability and a sense of community to neighborhoods threatened by unemployment, drugs, and gangs. And they are a population in need of legislative protection every bit as much as middle-class S&L depositors whose losses are covered with taxpayer money. Instead of helping out, government, through deregulation, has left these homeowners as legally powerless as they are politically impotent.

Home cheat home

Before the Rodney King riots, the working-class flatlands of South Central Los Angeles had a check-cashing outlet on corner after corner--Gee Gee Liquor on S. Normandie; Cash Now Inc. on S. Figueroa; Nix Check Cashing on Martin Luther King Jr. Boulevard--133 outlets in South Central alone. These are places that don't take deposits or make loans; they simply cash checks for a fee that ranges from 1 to 21 percent of the check's value. Some check-cashing outlets set up mobile offices at public housing projects on the first and fifteenth of each month to cash tenants' government aid checks.

What you won't find in this neighborhood are a lot of banks or S&Ls. There are only 19 in this slice of southern L.A., an area that's home to more than half a million people. The majority of residents are black or hispanic with low or moderate incomes--not the kind of customers banks like to court. With few mainstream banks to turn to, these residents often are without savings accounts and fail to develop the kind of longterm relationship with a bank that is needed to get a loan. Yet many of these residents have at least one valuable asset--one of the thousands of modest, two-bedroom homes built after World War II when veterans poured in to take jobs in factories and nearby shipyards. In the early sixties, a small house with a picket fence cost around $7,000. Today it might be worth $150,000.

The property-rich but credit-starved homeowners are easy targets for second-mortgage companies. Their salespeople use reverse phone directories (which list residents by address) or canvass door-to-door in targeted zip codes. Attorneys say some salesmen cruise these neighborhoods, spot likely houses, and use their car phones to call their offices, which then tap into real estate databases to see whether the owner is a promising mark. The salesman finds out what product a homeowner wants, such as a satellite dish, then sells it to him on credit, securing the loan with a second mortgage on the house. The dizzying paperwork that accompanies mortgage applications makes it easy to mislead someone who's financially unsophisticated. There's a slogan sometimes used in the business: "Cash out the deal before the customer comes out from under the ether."

Some mortgage brokers routinely check foreclosure notices and then lure troubled homeowners with offers to help them save their property. Some will lend a resident money at a high interest rate to get the home temporarily out of default. Others persuade the homeowner to sign over the house until the back debt can be paid off. Unsuspecting homeowners sometimes sign away their homes without knowing it.

It's difficult to put a precise number on how many people across the country have been victimized, because many are too embarrassed or confused to come forward. But it's clear that the number is huge: In 1990, the Better Business Bureau received nearly 130,000 inquiries and 3,100 complaints about consumer finance and loan companies, mortgage and escrow companies, and loan brokers. And a quick sampling of court cases from around the country shows that second-mortgage abuses are anything but uncommon:

* In Chicago, Community Bank of Greater Peoria agreed to pay up to $5 million to settle a class-action lawsuit involving more than 6,275 plaintiffs. The borrowers said they were victimized by deceptive loans from 40 tin men who had working relationships with the bank.

* In New York state, the attorney general has charged a mortgage company, Dartmouth Plan, with defrauding as many as 20,000 borrowers and then siphoning $25 million out of the corporation via a phony employee stock plan. New York has also sued a dozen banks that bought mortgages from the company and plans to sue a dozen more.

* In Connecticut, Dartmouth paid about $4 million to settle a criminal investigation of fraud charges involving 7,000 homeowners. Connecticut officials said the company made mortgage loans in at least 38 states before going out of business in 1990.

* In Alabama, three juries hit Union Mortgage of Dallas with more than $57 million in fraud verdicts. In one case, five families won $45 million after being taken by a tin man who the company had hired despite a record of at least 14 previous lawsuits, liens, and court judgments against him. Attorneys for the victims say Union made 40,000 predatory loans across the country.

* In Virginia, two firms, Landbank Equity and Freedlander Inc., operated giant fraud schemes--stealing from borrowers and investors alike--until the companies' top executives were arrested and sentenced to prison. Landbank made 10,000 loans in five states. Freedlander, once the nation's fourth largest mortgage company, expanded into 33 states and made 37,000 loans totaling $675 million.

Why has such an old scam suddenly become a booming business? Union Mortgage, Landbank, and the rest have thrived thanks to the erosion of regulatory protections for consumers--especially low-income ones--that began in the late seventies and reached a fever pitch during the Reagan era. Throw in economic displacement and recession, and poor people are more vulnerable than they've been in decades.

They're people like James Hogan, 52. Three years ago, he thought it would be simple to do a little work on his seven-room home in Atlanta. At the time, he owed about $7,000 on the house. Today, two equity loans later, he's a squatter in his own home. Fleet Finance, a subsidiary of Fleet Financial Group, is now the owner. Only a class-action lawsuit coordinated by Legal Aid lawyers has prevented Hogan's eviction.

His problems started when he signed up for a home-improvement loan from a local company, Tower Financial Services, which in turn sold the loan to Fleet. A contractor earned $6,200 for work that an appraiser later valued at $3,474. As Hogan struggled to make the payments, a loan broker persuaded him to take out a debt-consolidation loan from Parkway Mortgage. Parkway took nearly $4,000 in prepaid finance fees on the $34,000 mortgage. At 21 percent interest a year over 12 years, the total ran to nearly $85,000. Hogan--who has worked as a truck driver, laborer, and part-time janitor in recent years--wasn't able to keep up with the $581-a-month payments, so Fleet foreclosed and bought the house at the foreclosure sale. "What I so long dreamed about when I was coming up, I said one day I'd like to have me a home," Hogan says. "So I finally got one, and after 20-some years I'm about to lose it just like that. It's more than emotion. It'll almost drive you crazy."

Could New England's largest bank be fleecing James Hogan? Of course not, Fleet officials say: The high-interest lenders that its second-mortgage subsidiary worked with were completely separate businesses. Besides, Hogan's fleecing is perfectly legal. "These people may be poor and illiterate, but no one puts a gun to their head and tells them to sign," Fleet Vice President Robert W. Lougee Jr. told The Boston Globe. "This idea that Fleet should regulate the world is preposterous."

In the face of media criticism and an attorney general's investigation, Fleet has pledged two low-cost loan pools for poor borrowers in Massachusetts. But the bank is still fighting hard against lawsuits in other parts of the country. It's protected by commercial laws that make it tough for borrowers to pin legal responsibility on a bank that has purchased questionable loans unless they can prove the bank knew or should have known that the original lender had been guilty of fraud.

That's a pretty slippery standard. In Atlanta, for instance, an enterprising Boston Globe reporter discovered that Fleet Finance took the homes of 126 borrowers in the first five months of 1991--or one home for every eight mortgage loans it made or bought during that time. Compare that record to a Consumer Bankers Association study that found that, among big banks making home equity loans nationally, just one in 75 mortgages went into default (with only a small portion resulting in foreclosure). Is that exploitation, or simply good business?

Critics of Fleet and other banks that play the second-mortgage market have yet to produce clear proof to back their most serious charge: that some mainstream lenders actually set up second-mortgage and home-repair companies as front operations to insulate themselves from liability if lawsuits emerge. But there is circumstantial evidence in some cases. Court records show that Home Equity Centers--which has been accused of racketeering along with Fleet in a class-action lawsuit in Atlanta--received a business loan from Fleet in 1985. Over the next six years, the company unloaded more than 90 percent of its mortgages in Georgia's DeKalb County to Fleet. Both companies deny any wrongdoing.

Rotten regs

The sequence of events that helped bring companies like Fleet and Home Equity Centers together began in the late seventies, when runaway inflation added urgency to bankers' calls for deregulation of mortgage rates. A 1980 federal banking overhaul signed by Jimmy Carter struck down all state usury laws limiting the interest rates that could be applied to mortgages. The change was meant to affect only first mortgages, but second-mortgage companies found ways to use it to their advantage. If the loan company refinanced a homeowner's original mortgage, it was still generally considered a first mortgage despite the large fees and new, higher interest rate. The states had the choice of rewriting their own usury laws or sticking with the federal exemption. Only 16 states decided to write their own laws, and, taking their cue from the federal government, many also struck down limits on second-mortgage interest or created a long list of loopholes.

The result was a wide-open system that creative lenders could easily exploit. In Pennsylvania, one finance company used the federal first-mortgage loop-hole to avoid interest caps on used-car loans. The company was free to charge whatever rate it wanted by requiring that borrowers secure their loans against their cars and their homes or the homes of co-signers. The company charged annual rates as high as 41 percent. According to testimony in a lawsuit, one down-on-his-luck borrower who tried to return his car was told: "We don't want your car; we want your aunt's house."

Landshark

Thanks in no small part to the poverty of the borrowers, monitoring the second-mortgage industry is not much more politically urgent in most jurisdictions than monitoring pet stores. During the eighties, as many as 17 states didn't require that second-mortgage lenders be licensed. For seven straight years, Massachusetts lawmakers killed legislation aimed at regulating them before exposes in the Boston media shamed the legislature into enacting a licensing law in 1991.

Even when wrongdoing is strongly suspected, the political indifference can be astounding. In 1989, Newsday revealed that the New York state attorney general's office had failed for more than four years to notify 451 borrowers that they were paying a Long Island lender possibly illegal mortgage rates that could have been challenged or renegotiated. At the same time, the attorney general's office did call or send letters to 1,023 investors warning them not to sink any more money into the company because it was under investigation for possible securities fraud. Nearly 200 borrowers had lost their homes by the time Newsday broke the story.

Perhaps no place is more wide open than Virginia, where the state legislature removed its 18 percent cap on second-mortgage interest in 1981. A few months before, Bill Runnells, an eight-grade dropout and former Bible salesman, founded the notorious Landbank Equity in Virginia Beach. Runnells, who shaved his head and liked to hide behind dark glasses like his hero Howard Hughes, had a history of corporate collapses and dodged subpoenas. "I have an IQ of 160," he told one reporter. "I will never commit a crime I can be convicted of." (He spoke too soon: He was eventually slapped with a 40-year prison sentence for defrauding investors.)

Landbank sold itself to unlucky borrowers through the persona of "Miss Cash." "When the banks say 'No,' Miss Cash says 'Yes.'" The company routinely charged up-front fees of 40 percent or more and annual interest rates that reached 30 percent. Runnells' salesmanship was made possible by three dozen banks and S&Ls that cheerfully lent Landbank operating funds and then bought its mortgages. Another Landbank benefactor was Fannie Mae, the quasi-government agency that encourages home ownership by buying mortgages from local lenders. The stamp of approval from Fannie Mae--which bought $20 million in mortgages from Landbank--helped the company expand into other states. In five years, Landbank raked in $200 million.

To keep the Virginia state government friendly, Landbank nurtured its ties to several key legislators or their law firms. One lawyer/legislator, State Senator Peter Babalas, got $66,000 from Landbank through a monthly retainer. In 1984, Babalas used his vote to help kill a bill that would have put a stop to price-gouging by Landbank and other second-mortgage companies. One Landbank record of a $3,000 payment to Babalas included this notation: "This was one we agreed to pay after he stopped legislation in Richmond." The state senate censured Babalas.

After lawsuits piled up--and investors realized that they too were being flimflammed--consumer advocates complained that Virginia authorities were more worried about bailing out S&Ls that had lost money on Landbank loans than about helping borrowers whose homes had been stolen. State officials said consumer laws were so weak that there was little they could do to help borrowers. "There will never be enough law to protect all consumer," the state commissioner of financial institutions remarked. "I object strenuously to being told I have to fasten my seat belt. I'm overprotected these days when I try to get the top off an aspirin bottle."

Tin mend

But clearly, desperate homeowners could use a little protection. Oddly enough, federal and state regulators could learn a thing or two from the reforms that brought down the cinematic tin men--a commitment to license salesmen and lenders and put reasonable limits on their interest rates and fees. Regulators should jerk the licenses of those who take unfair advantage and penalize the banks that support them.

Of course, the tin men thrive because mainstream banks--and federal, state, and local governments--won't invest in poor neighborhoods. The best way to end second-mortgage scams is to eliminate that discrimination. Listening to today's presidential candidates does not inspire hope that the political leadership necessary to make that happen will spring up any time soon. But getting tough with the mortgage industry--through licensing, fee and interest caps, and aggressive state investigations of complaints--could and should happen.

Near the climax of Tin Men, one tin man's boss warns that an investigation is heating up: "Any of those scams you guys are running, if they get wind of it, they're gonna take your license--and it's goodbye to business." It's about time bankers and legislators started sending the same message to scam artists like Kevin Merritt and Bill Runnells.