Last fall, we reported about a high-stakes real estate scheme that turned run-down Harlem brownstones into big bucks, courtesy of underwriting from a federal housing loan program designed to encourage rehabilitation in poor neighborhoods. At the time, the threat seemed clear: Dilapidated properties in this vulnerable neighborhood were being saddled with wildly inflated mortgages, handed out to nonprofits that knew little or nothing about housing development.

Now, a year later, more than 150 of these buildings are tumbling into default. The original mortgage lender has gone out of business, the two banks that hold these mortgages are owed more than $50 million, and the responsibility of paying back the bad loans has fallen on the federal Department of Housing and Urban Development. The spectacular wreckage of the scheme is visible on the streets of Harlem, where dozens of buildings have been left gutted or half-renovated and abandoned.

Under the 203(k) program, nonprofits can get federally backed loans to purchase and repair buildings for rehab. But in Harlem, this program was exploited in a scenario in which nonprofits bought high-priced buildings from realty companies that had bought them very cheaply only days or weeks beforehand. For example, Cazzo Realty purchased the building at 336 West 145th Street in April 1998 for $20,000, and sold it seven days later to nonprofit Word of Life Ministries for ten times as much. The nonprofit made the purchase with a $316,000 federally insured 203(k) loan from a private lender called Mortgage Lenders of America, which in turn quickly sold the loan to a bank.

Full transaction records on 31 of these buildings shed light on the extent of the gains. The realty companies that initially purchased the properties spent about $4 million total in 1998 and 1999, but the nonprofits who bought the buildings immediately afterward took out $10.7 million in federally-backed loans to pay for them. In most cases, repair work was never finished, and only a few mortgage payments were made.

Over last summer, as the loans started to go south, the banks began trying to sell these decrepit properties–but rather than take a loss, they were offering them at prices far beyond what the market will bear, up to $525,000. “We’re flooding the market with overpriced buildings that can’t be sold,” said one Harlem realtor. Now, HUD has agreed to allow the banks to revalue the properties and sell them more cheaply, and it will make up the difference from the Federal Housing Administration insurance pool, which is funded through small annual charges to mortgage borrowers.

Another possible scenario might enlist more experienced local community development groups to take over and rehab the buildings, said Lisa Daglian, a spokesperson for Manhattan Borough President C. Virginia Fields. Other experienced developers said the plan would probably require a substantial influx of money and major financial restructuring. “We’ll see if out of all of this bad, we can’t get some good,” Daglian added.