Are you invested in a hard money mortgage fund with one of our competitors? Is that fund off “paying” you eight percent? Nine percent? (If some hard money mortgage fund is paying you ten percent or more, you may already be screwed. Your sponsor sounds more Ponzi-like than simply unwise.) If your hard money mortgage fund is paying you more than seven percent, you need to get out this fund immediately. Today. Not next week, but today. Why?

"Born in 1882 in Parma, Italy, Charles Ponzi was the infamous swindler who paid out returns with other investors' money. The "Ponzi scheme" is named after him. After running a highly profitable and expansive investment scheme, Ponzi was arrested on August 12, 1920, and charged with 86 counts of mail fraud. Owing an estimated $7 million, he pleaded guilty to mail fraud, and subsequently spent 14 years in prison. 

Around 1919, Ponzi received a letter in the mail from a company in Spain that contained in it an international reply coupon (a coupon that can be exchanged for a number of priority airmail postage stamps from another country). Ponzi realized that he could turn a profit by buying IRCs in one country, and exchanging them for more expensive stamps in another country. 

Ponzi's perfectly legal system of arbitrage worked like this: He would send money to agents working for him in other countries, who would buy IRCs and send them back to the United States. Ponzi would then exchange the IRC for stamps worth more than he paid for them, and then he would sell the stamps. Ponzi reportedly made more than 400 percent on some of these sales.

Not satisfied with running the profitable scheme on his own, Ponzi began to seek investors to turn even higher profits. He promised investors outrageous returns of 50 percent in 45 days, or 100 percent in 90 days. Ponzi paid these investors using money from other investors, rather than with actual profit…

Ponzi's manipulation made him very rich—he bought a mansion in Lexington, Massachusetts, with air conditioning and a heated swimming pool. He reportedly made $250,000 a day. Ponzi's scheme began to unravel in August 1920, when The Boston Post began to investigate his returns. The investigation set off a run on Ponzi's company, with investors trying to pull their money out of it.

Ponzi’s wife, Rose, divorced him in 1937, and Ponzi died penniless in Rio de Janeiro, Brazil, on January 18, 1949."

A therapist has a theory that the more often couples make love, the happier they are. So he tests it at a seminar by asking those assembled, "How many people here make love two tot three times a week?" Half the people raise their hands, each of them grinning widely. "How about once a week?" A third of the audience members raise their hands, their grins a bit less vibrant. "Once a month?" A few hands tepidly go up. Then he asks, "OK, how about once a year?"

One man in the back jumps up and down, jubilantly waving his hands. The therapist is shocked as this lone aberration disproves his theory. "If you make love only once a year," he asks, "what are you so happy about?” The man, grinning from ear to ear, yells back, "Tonight’s the night!"

Before I go any further, I want to make clear that I am not suggesting that all of these hard money mortgage funds are being run by fraudsters. No-no-no. These newbie hard money brokers probably mean well, but VERY few of them were in business before the start of the Great Recession. These newbies probably genuinely believe that all is well. What they fail to appreciate is that… careful here, I am just pulling rough numbers out of thin air… at least 190 out of the 200 of the hard money mortgage funds in existence before the Great Recession collapsed. The investors in these funds got crushed.

I’ll explain further below why these funds collapsed, but for now you need to appreciate that when the sponsor of these funds went bankrupt, the funds got looted. They (in most cases) did NOT get looted by the old sponsors. In other words, the old hard money broker usually did not dip into the trust account to fund a lavish lifestyle - complete with [gasp] air conditioning like Charles Ponzi.

The problem for the investors was that when the sponsor went bankrupt, no one was left to watch the shop. When borrowers were late, no one called to nag on them, so many of them stopped paying altogether. The real estate taxes, on many loans, went unpaid. Hopefully none of the properties burned to the ground after the borrower stopped paying his fire insurance premiums.

Finally the bankruptcy court appoints a trustee (cha-ching) to marshal the assets of the fund and a bankruptcy attorney (cha-ching) to represent the rights of the investors. The first thing the Trustee does is to appoint a CPA firm (cha-ching) to audit the books and conduct an accounting (cha-ching) of every loan in the fund’s portfolio. 

In the meantime, no one is winterizing the buildings that have come back in foreclosure. Pipes are breaking, and the insurance doesn’t cover the losses (cha-ching) because the buildings were not kept heated. Vandals are breaking into the properties and stealing the appliances and copper pipes (cha-ching) because no one has installed fencing and/or security alarms monitored by an alarm company.

The Court then appoints a Receiver (cha-ching) to protect the assets of the fund, and the bleeding slows from a gusher to just a steady bleed of gallons. The Receiver hires a property management company (cha-ching) to manage the foreclosed properties. But the Receiver only has so much give-a-darn, so he is not going to renovate the foreclosed properties before he sells them, choosing instead to sell the REO’s (foreclosed properties) at fire sale prices. Cha-ching, cha-ching. The fund’s assets are relentless whittled down, and by the end, the investors feel blessed to walk away with 20% to 35% of their original investment.

If you take nothing else away from this long letter, please remember this one thing: The single most important feature in a good hard money mortgage fund is NOT the yield but rather the likelihood that the sponsor will survive the next recession.  

It is crucial to you that your sponsor survive. You don’t want the leeches - the bankruptcy Trustee, the bankruptcy attorney, the CPA firm, the Receiver, the property manager, the leasing agents, and selling realtors - feeding on your corpus for years.

I think the pilot on my last trip was pretty new to his job. I base that on his pre-flight announcement, which was: "We're going to be taking off in a few ... Whoa, here we go!”

If these newbie hard money brokers, with their new mortgage funds, are generally honest men and mean well, why did I re-tell the story of Charles Ponzi? If some hard money mortgage fund is paying you 8% or 9%, they are clearly not taking a loan servicing fee or fund management fee large enough to survive the next recession.

How can I know this? The market for good hard money loans is incredibly competitive right now. There are no barriers to entry anymore to getting into the hard money business. Any fool can offer a high rate of interest, and investors will flock to his doors. The banks today are still paying less than 2% on deposits, and investors are desperate for yield. And since there are hundreds of new hard money shops sprouting up, there is far more money chasing loans than there are good hard money loans available. So what happens in capitalism? The rates that hard money borrowers have to pay have plummeted. Just four years ago Blackburne & Sons could charge 13.9% on many deals. Today we even have trouble attracting deals at 7.9% in California!

So how could a fund charge borrowers just 7.9% to 9.9% interest and still pay out 8% to 9% to their investors? The only way they can do this is to cut their loan servicing fees / fund management fees to just 50 basis points. That’s not nearly enough. My own hard money shop, Blackburne & Sons, operates in Sacramento, where housing costs are a small fraction of those closer to the ocean. Even still, our monthly nut is about $120,000 with just 10 employees. Remember, I’ve been paring costs and finding efficiencies in my hard money shop for 38 years, and this is the best that I can do.

How is the sponsor of your hard money mortgage fund going to come up with $120,000 per month (assuming he has only 10 employees) when the next recession hits and all of his investor line up to withdraw their money from his fund? In the next recession, these newbie mortgage fund sponsors will have no funds with which to make new loans and earn new loan fees.  This is the Ponzi-like feature of these funds. They cannot survive without new loan fees. If they are not constantly bringing in new money, with which to make new loans and earn new loan fees, they will drown. Remember, the proceeds of any pay-off’s went to withdrawing investors. 

The Ponzi Scheme: More than 90% of all existing hard money mortgage funds are unsustainable in a recession. Remember, what I have described today is not science fiction. It is exactly what happened to 190 out of 200 hard money mortgage funds just ten years ago.

The sponsors will throw up their hands in surrender - like the pilot in the funny pic above - and the bankruptcy trustees start to salivate. The bankruptcy attorneys start to salivate, as will the CPA firms, the Receivers, and the property managers. They will gorge themselves on the corpus of these failed funds, until they fall off like leeches.

Get out. Like right now. Run!

Cletus is passing by Billy Bob's hay barn one day when, through a gap in the door, he sees Billy Bob doing a striptease in front of an old John Deere tractor. Butt clenched, he performs a slow pirouette, and gently slides off the right strap of his overalls, followed by the left. He then hunches his shoulders forward and in a classic striptease move, lets his overalls fall down to his hips, revealing a torn and frayed plaid shirt.

Then, grabbing both sides of his shirt, he rips it apart to reveal his stained T-shirt underneath. With a final flourish, he tears the T-shirt from his body, and hurls his baseball cap onto a pile of hay. Having seen enough, Cletus rushes in and says, "What the world're ya doing, Billy Bob?"

"Good grief, Cletus, ya scared the bejeebers out of me," says an obviously embarrassed Billy Bob. "But me 'n the wife been havin' trouble lately in the bedroom d'partment, and the therapist suggested I do something sexy to a tractor.”

I know what you are thinking. You are thinking that I am only writing this today because I want you to get out of those funds and invest with Blackburne & Sons. You’re absolutely right. You busted me. But what happened to those 190 hard money mortgage funds that were in business before the Great Recession??? Hmmm.

I am not a big supporter of the fund concept.In theory, investing in a diversified portfolio of hard money loans sounds great; but in practice real estate recessions, where real estate values fall 20% to 45%, are simply too common. Time and time again the sponsors of these funds fail, and funds in general do very poorly in bankruptcy. 

But let’s say that you invest in a fractionalized loan from Blackburne & Sons, and a meteor destroys the office during working hours. The Blackburne’s and our staff are smushed. You and your fellow investors can simply hire a loan servicing company to take over the servicing of the loan. After all, the loan is in your name, as to your fractionalized percentage of ownership. You’re the boss.

So yes, I want you to get out of any competing hard money mortgage fund immediately so that you can invest with Blackburne & Sons, but that doesn’t explain what happened to those 190 hard money funds. Is there any hurry? Yesterday I told my broker to sell every penny of stocks in the company’s pension plan, as well as in my personal IRA.

Warm Regards,

George Blackburne III, Esq.

www.BlackburneAndSons.com

4811 Chippendale Drive, Suite 101

Sacramento, CA 95841

P: (916) 338-3232 // F: (916)338-2328

CA DRE #829677 // NMLS #103430