"The system is completely broken. It's amazing that the system ever worked at all." - Marc L. Weinberg, Acting Executive Director and General Counsel, Appraisal Subcommittee>
Last night, we discussed various kinds of real estate related fraud; Appraisal fraud was front and center.
This morning, I stumbled across an interesting Associated Press article on the governing rules on Appraisals: Weak rules cripple appraiser oversight. It is rather fascinating:
As soaring home prices set the stage for America's great housing meltdown, a critical step in making sure those home sales were a fair deal -- the real estate appraisal -- was undermined from within. After the nation's last major banking disaster, Congress set up a system to catch rogue appraisers. Their game: inflating the value of homes at the direction of equally unscrupulous real estate agents and mortgage brokers, whose commissions are determined by the size of the deals.
But a six-month Associated Press investigation found that the system is crippled by both the bumbling of its policemen and their inability to effectively punish those caught committing fraud. And despite ample evidence appraisers are pressured into inflating home values -- sometimes to prices in support of loans that are more than buyers can afford -- the federal regulators charged with protecting consumers have thus far made a conscious choice not to act. (emphasis mine)
This has been a very consistent element of the entire housing boom and collapse, as well as the very related credit crunch: an abdication of responsibility from the very entities assigned to supervise and regulate various aspects of our financial system.
It's as if the referees were on the field, but made the ideological decision against making any calls so as not to sully the purity of the game.
This wasn't mere Incompetence (doing a job poorly) or Malfeasance (commission of an unlawful act) -- this was Nonfeasance: the Failure to perform an act that is either an official duty or a legal requirement.
If I had to select a single word to describe the Greenspan era of the Federal Reserve (and to a lesser degree, the Bush White House), Nonfeasance is the word I would choose.
How bad was the Nonfeasance this last housing cycle? An Associated Press investigation, including "dozens of interviews" and the review of "thousands of state and federal documents" found that:
• Since 2005, at the height of the housing boom, more than two dozen states and U.S. territories have violated federal rules by failing to investigate and resolve complaints about appraisers within a year. Some complaints sat uninvestigated for as long as four years. As a result, hundreds of appraisers accused of wrongdoing remained in business.
• The only tool federal regulators have to force states into compliance is so draconian -- it would effectively halt all mortgage lending in a state -- that it has never been used.
• Both state appraisal boards and the federal agency tasked with their oversight are chronically understaffed, many with only one full-time investigator to handle the hundreds of complaints that arrive each year. Some don't even have an investigator.
Note that as far back in 2005, appraiser organizations were testifying in Congress that appraisers were under increasing pressure from lenders, mortgage bankers and real estate agents to "hit their number" when appraising property (Appraisal fraud: your home at risk). The pressure from mortgage brokers, lenders and RE agents had become so widespread that "more than 8,000 appraisers – roughly 10 percent of the industry – have signed a petition asking the federal government to take action."
The response was yet more Nonfeasance.
Why is this so significant? Consider what appraisers are supposed to do: Come up with a true value of a home's worth free of any outside pressure. As the AP article noted, more than three dozen appraisers nationwide interviewed "said they often felt pushed by a real estate agent or mortgage broker to fraudulently inflate a property's value. They supplied the AP with documents from lenders asking them to "hit a number."
Back when that petition in 2005 went to Congress, here is what CNN/Money wrote:
A puffed up appraisal can have serious consequences for a homeowner down the road.
There are a lot of people who have refinanced for more than their homes are actually worth and they're effectively already upside down even without a real estate bubble bursting," said Callahan. Down the road if they have to sell or decide to refinance, a more accurate appraisal might show that they owe more than the house is worth.
"The real issue is on the refinance side where people are cashing out of their equity on the basis of higher and higher values," said Zielinski, who before accepting a job e-mails lenders and brokers to remind them that he is obligated to appraise property based on market conditions, not a predetermined value. "Conservatively, I'd say that 10 percent of the houses I appraise are worth less than the mortgage on them."
One overvalued appraisal can skew home prices throughout a neighborhood, according to the Appraisal Institute's Kelly. "If a house is appraised for 10 percent or 15 percent more than it's actually worth and the sale closes, it may be used by another appraiser as a comparable sale the very next day," he said. "It has a ripple effect."
That could have even greater implications, said Martin. "The cumulative effect of appraisal fraud is you may have investors holding mortgage debt that's backed by real estate worth less than they think it is," said Martin. "It's a train wreck waiting to happen."
Your train wreck has arrived on Track 1 . . .
Fraud in Real Estate, Mortgages & Homebuilders (August 2008)
Weak rules cripple appraiser oversight
Associated Press August 17, 2:12 pm ET
Also, Washington Post
Appraisal fraud: your home at risk
Appraisers say they're being pressured by lenders to inflate their estimates of home values.
CNN/Money June 2, 2005: 9:56 AM EDT
Arizona bans Zillow from offering real estate estimates