Enacting rules to curb abuses arising
during a housing bubble, which don’t take effect until the succeeding
financial crisis, can easily do more harm than good. This is the case
with new rules requiring that property appraisals be insulated from
pressures exerted by any of the parties with a financial interest in an
appraised value: primarily lenders, mortgage brokers and Realtors.
Appraisals are informed judgments
regarding the value of specific properties. They are not perfect because
appraisers must work with incomplete information. Further, appraisers
are subject to bias, the more so the less complete the information
available to them,
During periods of rising house prices,
such as 2000-2006, many appraisers erred on the upside, because they
were part of a community that expected further price increases. This
tendency was sometimes reinforced by pressures exerted by lenders,
Realtors and mortgage brokers. None of them wanted to see deals
torpedoed by appraisals below the prices buyers had agreed to pay.
In late 2007, attorney general of NY
State Andrew Cuomo sued the appraisal subsidiary of title insurer First
American for allegedly conspiring with WAMU, a major mortgage lender at
the time, to inflate appraisals. Because WAMU sold a large portion of
its mortgages to Fannie Mae and Freddie Mac, Coumo embarrassed the
agencies into issuing a Home Valuation Code of Conduct (HVCC). The code
declared that the agencies thenceforth would only purchase mortgages
that were supported by an “independent” appraisal.
The objective of HVCC was to insulate
the appraisal process from influence by any of the parties with an
interest in the outcome. Mortgage brokers and Realtors could no longer
have any contact with appraisers, and lenders had to obtain appraisals
in some manner that prevented them from exercising any control.
The problem with this well-intentioned
rule is that it was issued in December 2008 to become effective May 1 of
this year, or squarely in the middle of the worst housing market since
the 1930s. With house prices declining, the upward bias in appraisals
that had prevailed during the bubble had morphed into a downward bias.
Many deals are not getting done because appraisals are coming in too
low, and HVCC is seriously aggravating the problem.
To protect themselves from liability,
most lenders are ordering appraisals from appraisal management companies
(AMCs), which intermediate between the lender and the appraiser. The
Because AMCs operate nationally but do
not have appraisers everywhere, more appraisals are being done by
appraisers who are not familiar with the local market. Appraisers
working for AMCs are also paid less per appraisal than independents,
which may induce them to invest less time. Less knowledge by appraisers
means more scope for bias, and in a declining price market, the
prevailing bias is toward lower values.
Intermediation by AMCs also lengthens
the period required to complete purchase transactions. People involved
in the process tell me that it can add an extra week. In an increasing
number of cases, the paperwork doesn’t get done by the contracted due
date, or the buyer’s mortgage lock expires, either of which can derail
the transaction.
The objective of HVCC was to prevent
pressures being imposed on appraisers to raise values. But HVCC also
prevents the loan officers, mortgage brokers and Realtors who work with
borrowers from pressuring appraisers to get a deal done in time to meet
a deadline. Further, they can no longer keep their clients informed
about the status of an appraisal because they are no longer in the
loop..
In addition, the loan officers, brokers
and Realtors who fashion deals for consumers used to have access to
informal value opinions from the appraisers with whom they worked. Such
opinions allowed them to abort
house purchases and refinances that clearly would not fly because
of inadequate property value. This source of information is now closed
to them, with the result that deals that previously would have been
screened out are now going through the system to be rejected, imposing
needless costs on everyone involved.
HVCC has also pretty much eliminated the
ability of a borrower to use the same appraisal with multiple loan
providers. Before HVCC, mortgage brokers could use one appraisal with
any of the wholesale lenders with which they dealt, and lenders
sometimes accepted appraisals ordered by others. Today, brokers are out
of it and lenders using AMCs will not accept appraisals ordered by other
lenders because they cannot be sure that the other lenders are following
the HPCC rules. The upshot is that borrowers often have to pay for more
than one appraisal.
In sum, the HVCC “cure” for the
appraisal problem of over-valuation has been implemented in a market
where the problem has become under-valuation, and HVCC is making that
problem much worse. It should be scrapped. When normal markets re-emerge
will be time enough to reconsider how appraisals can be made independent
without disrupting business relationships that have served borrowers
well.
NOTE: I am grateful to Kevin Iverson for
insightful comments.