Arguably, this process involves sales price fraud, a seller concession (in contrast to the claimed "charitable gift"), unlicensed lending, money laundering, and defrauding the Federal government (the FHA has no way of knowing which loans have "real" downpayments and which are being paid by the seller through markups). The FHA, IRS, FBI, GAO, and Congress itself have all ruled against or reported critically on this practice. It’s enough to make you wonder if the Mob is involved. 
Hard hitting Doom friend Aaron, founder of the Implode-O-Meter site, like twist here at Doom, has been a long-time critic of residential real estate Down Payment Assistance (DPA). The other day he took robust exception to a recent Los Angeles Times article  generally supportive of the practice. Doomers are encouraged to examine Aaron’s detailed arguments  and and the further links in his post, and come to their own conclusions. DPA, especially the seller-funded (SFDPA) variety, could well be among the most damaging and insidious institutions at the heart of our present world-wide difficulties. That being said, it’s also a pretty hefty industry in its own right with its own online news/pressure sources, including here and here. One thing you can say about DPA — it’s hardly underground.
The Implode-O-Meter general statement on SFDPA is here (includes a link to their donations page — their opposition to this has not been without cost 🙁 )
————–: "Subtly Misleading LA Times Article Distorts In Favor of Seller-Funded Downpayment Programs", Aaron Krowne, Implode-O-Meter, February 12, 2009. : "Down-payment aid program resurfacing", by Ralph Vartabedian, Los Angeles Times, February 7, 2009.