Wall Street's Sneaky New Way to Make Bank from Struggling Homeowners
When Florida retiree Gladys Walker fell behind in paying taxes on her modest Pompano Beach home, she had no idea one of America's biggest banks and a major Wall Street hedge fund engaged in frenzied bidding for the right to collect her debt--all $768.25 of it.
"I just couldn't come up with the money," said Walker, 67, a former hotel worker who makes do on a monthly Social Security check.
Barely more than a year after a taxpayer bailout of major financial institutions, Bank of America and the hedge fund, Fortress Investment Group, spotted a fresh money-making opportunity - collecting the tax debts of tens of thousands of people like Walker. The bank and hedge fund can add interest charges and fees, and they bundled the debts as securities for investors.
In late May and early June, proxies for the two institutions quietly bought hundreds of millions of dollars in homeowners' property tax debts in Florida by bidding at a series of online auctions held by county tax collectors. They didn't use their names but donned multiple other identities, dominating the auctions and repeatedly bidding on the same parcels - in the case of Walker's small home, more than 8,000 times.
Then, in September, Bank of America's securities division packaged $301 million worth of the tax liens it and Fortress had acquired into bonds pitched privately to major investors. The anticipated return - estimated at between 7 to 10 percent - is possible because buyers of tax debts can assess a panoply of interest charges and other fees. When the debt goes unpaid long enough, the liens buyer can seize properties through foreclosure.
Because the bonds were sold privately, there's no public record indicating who purchased them, the prices paid, or the anticipated return. Moody Investment Services spokesman Tom Lemmon said the type of offering, known as a tax lien securitization trust, is fairly uncommon. Bank of America, he added, may make additional offerings in future years.
A Bank of America spokesman, while otherwise declining comment, said that the bank and Fortress had not acted together in bidding in the auctions.
Bank of America spokesman William Halldin said by email: "Our bids were made independent of any other organization. Any suggestion that they weren't independent is simply incorrect."
Fortress, which is headed by former Fannie Mae chief Daniel Mudd, had no comment.
The Florida securities deal illustrates how financial institutions, including some beneficiaries of federal bailout dollars, are actively creating new ways to profit from the financial distress of homeowners. Acting as surrogate tax collectors, they can help local governments quickly and efficiently bolster their budgets by tens of millions of dollars and in some cases find new owners for dilapidated property. Miami-Dade County, for instance, took in more than $374 million in June 2009 from the sale of about 60,000 property tax liens.
Yet no one is looking out for property owners who suddenly find themselves in debt to the new Wall Street taxman. The growing $5 billion tax lien market goes largely unwatched and unregulated because rules haven't kept pace with the industry's flourishing growth in economic hard times, the Huffington Post Investigative Fund has found in a review of the industry.
While federal officials have recently tightened regulations to protect consumers from a variety of debt collection tactics, private tax collectors aren't on their radar. Meanwhile, many county tax officials say they simply lack the manpower to police the sales and collection process more closely.
"There's an opportunity for sophisticated investors to come in and make a lot of money until the law is able to catch up. That's the reality of what's been happening," said Robert Lawless, a law professor at the University of Illinois and expert on consumer credit issues.
Government officials often don't even know who their new tax collection partners are. Many buyers of liens hop from state to state participating in fast-paced, online auctions without revealing their connections to Wall Street or registering their operations, even though the process grants them special foreclosure rights. In some instances, tax lien buyers have used drop boxes and empty offices as their addresses.
Officials routinely conduct millions of dollars in tax-sale business with limited liability companies that give little clue to their owners' identities. All that's required to get in is cash--in recent years a very big pile of it--and a tax identification number, which a buyer can apply for online.
"The regulations probably have not kept up with the technology as much as they should," said W. Dale Summerford, Gadsden County (Fla.) tax collector. "There's always something new you can't keep up with."
In Florida and other states in previous years, authorities occasionally have alleged other bidders in tax sale auctions may have colluded. In one such scheme in Florida eight years ago, more than a dozen firms paid more than $604,000 to settle civil allegations they fixed bids by acting together to keep interest rates high. Some collectors argue that online auctions, in which thousands of bidders sign on, are less likely to be tainted, however.
Many laws governing tax lien sales were written decades ago in hopes that they would encourage investors whose restoration of delinquent buildings would return them to the tax rolls. But some urban planners and legal experts question whether those laws now make sense, given today's distressed property values and economic hard times. After all, buyers of homes that have greatly declined in value have less incentive to fix them up.
Communities might be worse off. John Pottow, a commercial law expert at the University of Michigan, predicts growth in private sales of tax liens will "result in a lot more foreclosures." County tax collectors traditionally might have been more forgiving of citizens, and willing to work out debt repayment terms rather than see people forced out of their homes. "Banks won't care about that," said Pottow.
Some consumer advocates react more viscerally. They said they were dismayed to hear that institutions such as Bank of America, rescued by taxpayers, have rushed to cash in on homeowners in tax trouble. The bank accepted and later repaid more than $45 billion in taxpayer bailout money.
Even so, "if they are profiting off people in distress, it certainly isn't consistent with what large banks say they do," said John Rao, an attorney with the National Consumer Law Center in Boston.
In Florida, where tax-lien sales are the nation's busiest, several tax collectors said they were unaware until a reporter called that Bank of America and Fortress had snared such a large cache of property liens using corporate aliases, or that the bank and hedge fund later pooled the debts to create a new investment opportunity for Wall Street.
Homeowners like Walker have no idea, either. Rather than risk losing their homes, most debtors eventually pay, along with penalties and interest, to the usual county tax collectors, who then forward the money to investors who own the lien. Walker said she took out a new mortgage to secure a roof over her head.
A THRIVING TRADE
While sales data and corporate filings show that banks and hedge funds often capture the lion's share of the market, many other players are being drawn to tax lien investing. The allure includes the potential in some states to charge property owners as much as 18 percent interest and a slew of other fees. Tax lien holders can foreclose in as little as six months in some states, though others give homeowners more time to climb out of debt.
Some entrepreneurs, promising healthy returns and low risk, are reselling government-issued tax lien "certificates" on the Internet, adding another wrinkle to the nation's ongoing property foreclosure debacle. Some websites suggest they are selling the home itself rather than the legal authority to collect a debt on it. People often don't understand the difference, said Sam McClelland, deputy tax collector in Florida's Pinellas County. "The Internet has opened all this up," he said.
In other investment pitches, late night television and web-based promoters promise everyday folks quick riches through courses in how to build wealth off the tax lien trade--sometimes by misrepresenting the prospects, according to federal regulators.
The Federal Trade Commission, which has no direct oversight of the tax lien industry, has taken action under general consumer fraud statutes. The agency is suing tax sale promoter John Beck Amazing Profits, LLC, a fixture on late-night television. More than 600,000 consumers have purchased Beck's lessons, according to the lawsuit. The agency alleges that customers initially pay $39.95 a month, but those fees can escalate to $4,000 on average--some three times that much--for more course material and other advice in how to purchase homes for what Beck says are "pennies on the dollar."
"Despite their best efforts, consumers have been unable to buy homes for a few hundred dollars at tax sales or to quickly and easily earn substantial amounts of money," FTC lawyers wrote in court filings. The suit is set for trial in California at the end of 2011.
Beck's attorney, Larry C. Russ, said his client disputes the FTC's allegations. He called Beck a "guru" of the tax lien business who is selling a "how to" book and courses to help other investors.
Veterans of the tax-lien trade acknowledge some abuses occur. But they argue that the sales of liens routinely help cash-strapped cities and counties efficiently collect millions of dollars in overdue taxes and other municipal bills. Homeowners can stay out of trouble by paying their taxes on time, they note, and for those who can't, they offer what amounts to a loan, albeit one that can pile on high interest charges and fees.
Holding annual tax sales gets delinquent bills paid and "really makes a big impact" by generating new revenues that help pay for schools, said Mark L. Manoil, an Arizona lawyer and expert on the industry. By early next year, Maricopa County is likely to collect close to $100 million in property debts. "That's pretty astonishing," he said.
Revenue collectors add that some people would simply ignore their obligation to pay taxes without the threat of losing their homes, or paying steep interest to keep them. They say that publishing a list of delinquent properties in the local newspaper prior to the tax sale prompts a rush of last-minute payments.
Buying liens in the kind of volume traced to Bank of America and Fortress would once have been difficult. For years, small groups of local real estate investors typically bid on debt-laden parcels by holding up paddles. Auctions at county courthouses could take days.
These days many "tax sale" auctions flourish in cyberspace and attract sophisticated, anonymous buyers from anywhere in the world. In a matter of minutes, millions of dollars change hands through transactions that leave homeowners little more than unwitting pawns in a deal that, in effect, raises the prospect of losing their property over debts as small as a few hundred dollars.
In Florida, auctions in late May or early June stunned veterans with the ferocity of the bidding. In total, 67 counties sold off more than $1 billion in tax debt through auctions, about half of them online.
In Pinellas County, the St. Petersburg area, the tax sale used to draw 60 to 70 people. This year, the county processed 340 million electronic bids from tens of thousands of online bidders. Deputy tax collector McClelland said employees in his office were "shocked" to see 50,000 bids or more fly in on a property. At one point, the computers crashed under the strain and the auction had to be shut down temporarily, he said.
Yet for all the frenzy, there were not as many bidders as it appeared because a handful of deep-pocketed bidders--mostly tied to banks and hedge funds-- dominated, a computer-assisted analysis of sales data by the Huffington Post Investigative Fund has found. Most of the liens were awarded to a small group of interests.
County auctioneers start the bidding at 18 percent interest, the highest rate homeowners can be charged on their debts under state law. Bidders compete by agreeing to accept a smaller interest rate, which for desirable properties in many counties often ends up falling all the way to .25 percent. Tax collectors argue that this competition helps homeowners because lower interest rates reduce the amount homeowners must pay to satisfy the debt.
Florida law also guarantees a minimum 5 percent penalty, even if investors have agreed to accept a smaller interest rate. In past years, many homeowners or their mortgage holders have paid off the debt within a few months. That means investors often wind up with a quick 5 percent over a short term, which many find attractive in a flat economy.
Big investors gain an edge in the auctions by creating multiple corporate identities, in some cases thousands of variations of the same name, which bid on the same parcel over and over. Computer software randomly assigns ties among the bidders, so those able to place the greatest numbers of bids at the lowest rate stand the best chance of winning a tie. In some counties, ties decide who gets most of the liens sold.
County officials contacted by the Investigative Fund said it was generally acceptable and legal under current rules for a single underlying investor to create multiple corporate entities to make thousands of bids on the same property.
BANKS DENY COORDINATION
Bank of America and the Fortress hedge fund dominated this year's auctions in Florida's three most populous counties, Miami-Dade, Broward and Palm Beach using colorful aliases and similar bidding strategies, the Investigative Fund's data analysis shows.
Bank of America bid mainly through thousands of variations of Bennu, LLC, named for a mythical Egyptian bird, and Ecru LLC., named for the French word for a brownish-white color. Both Bennu and Ecru typically bid .25 percent multiple times on the same parcels, auction records show. So did Fortress, which had 17 identities with names like Citrus Capital, LLC, which used thousands of bid numbers. Such bidding had the effect of driving the interest rate down to the bare minimum; in Florida, that meant the winning bidders immediately can assess a 5 percent penalty.
On May 25, just after 10 a.m., the debt on Walker's $62,000 Pompano Beach home came up for sale. It promptly drew 8,031 electronic bids, auction records show, all but two dozen from Bank of America or Fortress entities.
The bidding for Walker's $768.25 lien ended in a tie, with "Bennu, LLC JA13B" winning collection rights, county records show. Like the thousands of other Bennu variations, it lists a post office box in Atlanta as its address. The Fortress companies listed the firm's midtown Manhattan headquarters.
Two other bank operations, a subsidiary of JP Morgan Chase & Co. and BankAtlantic, a longtime tax sale investor based in Fort Lauderdale, and some other big investors also bid using multiple identities. But Bank of America and Fortress overwhelmed competitors with the volume of bids it lodged, so much so that some bidders who had planned to spend millions of dollars buying liens came away with little to show for it.
James Cox, a Duke University School of Law professor who specializes in corporate and securities law, said the domination of auctions by a few underlying entities using multiple names and bids "always raises questions" about whether all bidders competed on a level playing field.
About half the 78,698 liens in the bond deal are on property in the state's three most populous counties. The liens average just under $5,000 each, but many debts were no larger than a few hundred dollars. They range from debt on mansions fronting Biscayne Bay in Miami Beach to modest condominiums and commercial buildings. Most are far below the property's assessed value, county records and sales data show.
Because the bonds were offered privately, there's little public record of how much they are expected to earn. Issuers of securities typically collect fees and can profit from a rise in the prices of the bonds. New York City, which has issued bonds backed by tax liens since 1996, is one of the few jurisdictions to do so.
The consequences for property owners are yet to play out. Under Florida law, the tax lien holder can foreclose if the homeowner doesn't pay the bill with interest and fees within two years, but aren't allowed to contact them about the matter until then. Most people will eventually pay off the debt rather than risk losing their homes.
NO FEDERAL POLICING
Federal consumer regulators don't record complaints about tax lien sales, so little is known about the impact on investors or homeowners. "That's not an area we've been particularly active in," said Monica Vaca, assistant director of the Federal Trade Commission's division of marketing practices.
That leaves jurisdiction over collection practices for these debts to local authorities, some of whom are starting to complain about the consequences for citizens and neighborhoods. Tax lien investing has proven contentious in cities such as Cleveland, which canceled this year's sale amid concerns that previous ones had contributed to an upsurge in foreclosures. That, in turn, caused further decay in marginal neighborhoods, housing advocates say. Cleveland has relied on a subsidiary of JP Morgan to handle these duties.
In Maryland, three Baltimore area men were sentenced earlier this year after pleading guilty to criminal charges of bid rigging in a U.S. Justice Department antitrust case. A federal grand jury in New Jersey also is investigating tax lien investing, though no charges have been filed.
Many firms were subpoenaed in the New Jersey probe, which does not appear to involve Bank of America. One firm subpoenaed was Mooring Tax Asset Group, a Virginia company that has helped service Bank of America's tax liens, including those pledged in the investment package. Mooring denies any wrongdoing and said it is cooperating fully with the investigation.
Officials in Maryland and the District of Columbia have struggled for years to rein in tax certificate investors who pile fees--sometimes thousands of dollars worth--on homeowners, who can lose their property as a result. DC officials are facing off in court with one investment group to try and find out the owners' identities and halt what they consider excessive legal fees charged to homeowners.
Two Baltimore area men convicted in the Maryland bid rigging investigation, for instance, made at least $10 million threatening homeowners with foreclosure unless they paid them fees that often amounted to ten times the taxes owed, according to federal prosecutors.
In another example, the Huffington Post Investigative Fund reported in May on the case of Vicki Valentine, an unemployed mother of four who lost her Baltimore home over what began as an unpaid city water bill of $362. She was unable to pay the thousands of dollars in legal fees and other charges due to investors and keep the mortgage free property, which her family had owned for nearly three decades.
Collection policies vary widely among the 29 states that conduct lien auctions, compounding the uncertainty and confusion. In addition, it's far from sure if growing concerns over the legality of paperwork used to support property foreclosures nationwide will have an impact on the tax-lien market, officials said.
In most states, the owner of a property tax lien--even if it's just a few hundred dollars on real estate worth many times that much--is given the highest priority under the law. A tax lien can wipe out a mortgage, for instance, and courts generally won't challenge that supremacy, meaning that in some cases investors can walk away with homes for little more than the taxes due on them.
Some tax collectors worry that banks or others might turn to tax lien purchases as a way to guarantee a less messy path to foreclosure. In some areas, it might be much easier and quicker to foreclose by securing a tax lien on a property on which the bank holds a mortgage. That's possible in Florida, though it is not permitted in New Jersey, which considers it a conflict of interest.
Nobody knows how many banks are bidding on property they hold mortgages on because tax collectors aren't equipped to collect the data. That leaves Florida collectors unsure who will be presenting certificates of ownership two years from now when homeowners whose liens were sold this year might be faced with a foreclosure action.
Other collectors, though they are pleased at how efficiently online auctions can generate tens of millions of dollars in newfound revenue, acknowledge bidding rules are lax and that they lack the expertise to police the sales.
Walker, the Florida retiree, said she realizes she had an obligation to pay her debt. But she said she feels it's wrong for faraway investors on Wall Street to be taking advantage of her shaky finances. "I don't think it's fair," she said.