“Under the Loan Warrantee Program offered by DFF International, you pay a fee of 17 percent of your mortgage loan upfront, and in 60 months they cut you a check for the original loan amount. If you pay a fee of 25 percent of the loan, they cut you a check for the loan amount in 36 months. Can this be on the level?”

No possible way!

They tell you that if you take out a new mortgage loan for $200,000 and pay them $34,000, they will pay you $200,000 in five years. That’s a return of 42.5 percent a year. If you pay them $50,000, they will pay you $200,000 in three years. That’s a return of 58.7 percent a year.

How can they earn returns this large? Indeed, they have to be even larger if they are going to make a profit. On their Web site, they associate themselves with hedge funds, insurance companies and other sophisticated investors who can earn large returns. But none of those entities consistently earns anything like the returns promised by the Loan Warrantee Program (LWP).

“…Is this a Ponzi scheme?”

Promoters of Ponzi schemes collect your money upfront by promising you a mega-return in the future. They pay the promised return to very early entrants, thereby attracting new investors who provide the funds needed to pay the old ones. But when the money coming in from new investors no longer exceeds the money going out to old ones, the promoters shut their doors and flee with what they have.

Whether the LWP is a Ponzi or not depends on the intentions of the promoters, which I don’t know. But I do know that the promises of 42.5 percent and 58.7 percent returns are ridiculous and not to be believed.

I called DFF International to ask, among other things, whether they were able to refer me to any participants who had been paid off the full amount promised. The person who responded to my call said “no,” but that they would have some soon. Even if this were true, it would prove nothing, since paying off a few investors in order to stimulate more to participate is a standard feature of all Ponzi schemes.

I also asked how they could be sure of being able to pay the promised returns. The rep said that the returns were not guaranteed, and referred me to some fine print on their Web site. It says, “No one can guarantee the outcome of the Loan Warrantee Program, but the principle amount is guaranteed so you risk nothing.” The rep referred to this as a “worst-case scenario”.

Strange, my dictionary says that warranty and guarantee mean much the same thing. Given the risk of losing it all if this is a Ponzi scheme, I would say that getting back your original investment is a best-case scenario.

Another question I asked was whether they could refer me to one or two of the 300 lenders that they claim to broker loans for, who I could talk to about the LWP. The rep said that the lenders have nothing to do with the program and knew nothing about it. That is not surprising, for reasons explained below.

The LWP is offered in connection with home loans so it can be presented as a warranty, like the warranty you buy on an automobile or vacuum cleaner. Indeed, the rep I spoke to used the analogy of an automobile warranty to explain the program to me. A warranty does not fall under the jurisdiction of the Securities and Exchange Commission.

In fact, there is no resemblance between the two. An automobile warranty is tied to the automobile and couldn’t exist without it. The LWP, in contrast, has no connection to the mortgage loan with which it is associated except in the minds of the participants. The LWP is an investment masquerading as a warranty, but it is not an investment I would consider.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.  Comments and questions can be left at www.mtgprofessor.com.

***

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