Blowing Bubbles

Regulators call it fraud for profit. Real estate insiders refer to it as scamming for cash. Lehman Brothers isn't calling it anything at all--or saying anything about being swindled out of upward of $50 million.

The U.S. Attorney in Los Angeles says the scam was masterminded by developers Charles Elliot Fitzgerald and Mark Alan Abrams, with help from Joseph Aram Babajian, real estate broker to such stars as Warren Beatty, Ryan Seacrest and Harrison Ford. Five people have been indicted on multiple charges of fraud and conspiracy. Between 2000 and 2003 the defendants allegedly stole tens of millions of dollars by inflating the values of homes. According to the criminal complaint, they bought real estate at fair prices, had the properties appraised at far higher amounts, borrowed those greater sums from Lehman and pocketed the difference, using the money to fund extravagant lifestyles. Five people, developer Abrams among them, have pleaded guilty to multiple felonies and await sentencing after they testify against other defendants. Babajian (pronounced Baba-zhan) and Fitzgerald have entered not guilty pleas.

As the mortgage cyclone lurches from subprime loans and shaky securities to blue-chip customers and creditors, it is exposing scams that were hidden for years behind rising real estate prices. Fraud reports by banks jumped sixfold between 2000 and 2006, to 21,279, though the real number is probably far greater since only federally insured banks are required to report suspected foul play. The FBI says it is chasing mainly big-dollar investigations, but its load exceeded 1,200 cases last year. No one knows the size of this con game. The Mortgage Bankers Association, which represents some of the very folks under investigation, puts the value of mortgage fraud in 2007 at $3 billion to $4 billion. "It's an extremely conservative estimate, and that's just direct losses to banks," says Ann Fulmer, a vice president at Interthinx, an Agoura Hills, Calif. fraud prevention consultancy. In such cases, she says, creditors typically lose 45% to 100% of the loan amounts.

Could lenders really have been so blind--and dumb? The Securities & Exchange Commission is looking into whether Washington Mutual, the nation's largest thrift, knowingly made loans based on inflated appraisals. (WaMu says it did no such thing and is cooperating with the SEC.) Bear Stearns, stung by a $7 million flimflam in Atlanta, claims it is trying to smoke out fraud. "Lenders are not interested in knowing," says Gary Crabtree, a Bakersfield, Calif. appraiser who has identified 207 home sales in the last year he claims are almost certainly fraudulent. The loans, he says, involved a total $111 million from the likes of WaMu, SunTrust Bank, Countrywide and others. Crabtree called them and mentioned his suspicions. "GreenPoint Mortgage told me it was none of my business," he recalls. "SunTrust was another I reported numerous frauds to. They just want to write them down and get out of town." The banks declined comment.

Lehman did file a civil complaint against Fitzgerald and Abrams and appraisers in April 2003, alleging breach of contract and fraud. But that occurred after a call from Christian Stevens, a broker in the Beverly Hills office of Keller Williams Realty. Stevens says he was impressed with the prices Abrams and Fitzgerald were paying for "properties that were languishing on the market. They all needed work." In one case a Beverly Hills home that had gone unsold for months at $800,000 suddenly sold for $3 million. Stevens phoned Lehman, which had made that and many other loans, and expressed his concerns about possible fraud. A lending executive, he says, told him, "They're all current with their mortgage payments, so I don't understand what your problem is." Finally, in January 2003, according to an affidavit in the civil suit, a Lehman account executive told Abrams over the phone that some of his loans contained false information about the borrowers. "What's the worst that can happen to us?" Abrams replied. Lehman revoked its agreement with Abrams and Fitzgerald and later filed suit.

According to the indictment, the pair borrowed $137 million from Lehman for 80 homes, which they purchased for $87 million. To persuade Lehman to lend the money, they recruited straw borrowers with good credit. Two appraisers allegedly inflated home values in exchange for hundreds of thousands of dollars. Abrams and Fitzgerald also paid off Richard Maize, a mortgage banker with RBC Mortgage, which made loans on behalf of Lehman, prosecutors allege. Babajian and his partner Kyle Grasso, say the feds, supplied fresh listings for the scam and controlled a title company, which allowed Fitzgerald and Abrams to supply Lehman with false documents.

To keep the bank at bay, the pair allegedly rented many of the homes, using the cash flow to make mortgage payments--or to buy new properties. In order to portray straw borrowers as reliable credit risks, says the criminal complaint, Abrams and Fitzgerald faked mortgage payments and rents, and used shell companies to funnel proceeds to various bank accounts or to pay millions of dollars in kickbacks.

The rest of the money, says a court-appointed receiver, went for art, jewelry, fine wines and other luxuries, like the renting of a 26-seat Gulfstream jet. Abrams leased himself a Ferrari and a Mercedes, and bought a vacation home at a California desert golf community, say court documents. He acquired prints by Chagall and Miró, a rare map of California from 1777 and first editions of such children's favorites as Charlotte's Web and Stuart Little. In early 2003 he and his family spent $173,000 during a single month on restaurants, designer clothing, plane tickets and so on. Fitzgerald and his wife, Meya, say the documents, spent tens of thousands of dollars staying in hotels like the Beverly Wilshire and shopping at Macy's West.

In April 2003, as Lehman rushed to uncover the extent of the fraud, Fitzgerald and Abrams tried to cover their tracks. With help from employees, the duo wiped business records from their computer hard drives and shifted money among bank accounts, court documents say. The day after a judge ordered their assets frozen, Abrams and Fitzgerald loaded two pickup trucks with photocopiers, computers, boxes and framed pictures, finishing long after midnight, according to building security. Fitzgerald allegedly smashed the hard drives with a sledgehammer in his back yard.

With authorities closing in, there was time for one last spree--in Las Vegas. Along for the jaunt was Shawna Fitzgerald, who later explained to the court that she, too, was married to Charles Fitzgerald and that the couple have a young son. Shawna claimed that she lived with Charles during the week in Hesperia, Calif. and that Meya was his "weekend wife."

In June 2003 Fitzgerald loaded up a U-Haul truck and moving van and sent everything to Salt Lake City, say court documents. He and his family hightailed it out of the country, according to the feds, taking $6,000 in cash and valuable coins. They called Meya's parents after they touched down to tell them they were on a South Pacific island. Abrams, meanwhile, tried to outmaneuver the court, shredding thousands of documents and moving personal belongings out of his Beverly Hills home to a condo across town. He hid his vintage wines and champagnes, worth $240,000, in his secretary's dining room and bought her an air conditioner to keep the collection chilled. When U.S. marshals raided his condo, they found $172,000 in cash hidden in shoes and socks. The marshals told the judge they feared a violent confrontation: They could account for only four of his six guns, and Abrams had told his wife he was going to kill himself.

The feds caught up with Fitzgerald in Samoa in December 2006 and brought him back to face charges of conspiracy, bank fraud and money laundering. Babajian continued doing megadeals, including the sale of a $22 million Beverly Hills home to soccer star David Beckham, until he was indicted, along with Grasso (who has pleaded not guilty), in August on charges of conspiracy and fraud.

The lenders are in a sorry spot. Lehman securitized the loans, sold them to investors--and agreed to buy back the properties in the event of fraud. Out nearly $50 million, it recouped $20 million-plus from RBC Mortgage, which was forced to repurchase some of the loans.

The case is, in the scheme of real estate cycles, ancient history, coming to light now only with the prosecutions. What else lurks out there that hasn't been uncovered by investigators?