Until the start of November few people would have regarded Albany, NY as the center of the foreclosure meltdown, yet in a single week the state’s attorney general radically changed the national mortgage debate.
It all began November 1st when New York attorney general Andrew Cuomo alleged that eAppraiseIT, a subsidiary of First American Corporation, caved to pressure from one of the nation’s largest mortgage lenders, Washington Mutual, and inflated home appraisals.
“The independence of the appraiser is essential to maintaining the integrity of the mortgage industry,” said Cuomo, previously HUD Secretary under President Clinton. “First American and eAppraiseIT violated that independence when Washington Mutual strong-armed them into a system designed to rip off homeowners and investors alike.
“The blatant actions of First American and eAppraiseIT have contributed to the growing foreclosure crisis and turmoil in the housing market,” Cuomo continued. “By allowing Washington Mutual to hand-pick appraisers who inflated values, First American helped set the current mortgage crisis in motion.”
While Cuomo’s allegations will need to be proven in court, his key point is irrefutable: If there have been systematic efforts to inflate appraisals then real estate valuations for some of the world’s largest portfolios will need to be reduced while valuations for other property and mortgage holders will surely be suspect.
The result — in terms of homeowner prices, neighborhood values, corporate assets, shareholder equity, investor balance sheets, Wall Street indexes and derivative valuations — would be massive losses, certainly in the range of hundreds of billions of dollars and possibly far more.
If a broad pattern of appraisal inflation can be shown, it would also impact individual homeowners. Prices would be more difficult to justify and refinancing would impossible for many owners seeking to raise cash or jettison toxic loans. Foreclosure levels would increase because fewer borrowers would be able to sell or refinance for enough money to pay off current loans.
It wasn’t too long ago that Citigroup had a market value of $283 billion. That’s a number you could measure by multiplying the $57 share price by 4.97 billion shares.
Recently Citigroup shares dropped below $33, meaning that in the past year owners lost nearly $120 billion in market value.
What’s interesting about company values is that they’re easy to compute. Just look at the price per share at any given time, multiply times the number of shares outstanding and that’s it. You can easily value any listed company.
Matters are a lot more complex with real estate. Unlike stock, individual homes are not bought and sold minute-by-minute so there’s no instant pricing guidance. The fact that a home down the street sold for $535,000 does not tell us the exact value of any other home on the block. While one share of Citigroup is worth exactly as much as any other share in the same class, that’s not with real estate, even for two condos with the same size and design located in the same building.
Unlike carpeting or floor tile, you can’t value homes on the basis of square footage because there’s no standardized way to measure houses — the square footage guidelines of the American National Standards Institute (ANSI) are voluntary.
To make matters more mysterious recorded sale prices may not reflect the actual money paid to property owners. So-called “seller contributions” — sometimes $10,000 or more in credits to a buyer — are not itemized in public records or MLS reports. Even stranger, property records sometimes show that homes have been sold for good consideration, an expression which means nothing more than love and affection, qualities which are impossible to measure.
The process of valuing real estate is complex because all properties are both local and unique. Since lenders make loans on the basis of a sale price or an appraised value, whichever is less, knowing the fair market value of a home is enormously important to buyers and sellers as well as lenders and investors.
There are several ways to determine the value of a home. Real estate brokers can provide a CMA (comparative market analysis) or a BPO (broker’s price opinion). Lenders, however, will not accept either because brokers inherently have a conflict of interest — their income typically increases as sale values rise.
The alternative is an appraisal, an independent opinion of value by a licensed appraiser or, in a growing number of cases, a fair market sale price determined with an automated valuation.
The attraction of automated evaluations is cost and time: With automated appraisals a home can be valued just about instantly and at far less expense than the cost of a professional appraiser.
The use of automated appraisals is limited, however, because such technology does not work in areas with few sales or where the housing inventory is diverse, such as a community with older Victorian homes. No less important, while automated technologies can often give a good sense of general values they do not reflect specific pricing.
With an automated appraisal there’s a numeric property valuation — but real estate is more than numbers. Townhouse prices in a given community may average $315,000 each, but if they all go on sale tomorrow some units will sell faster than others. Why? The unit with the flooded basement and mold will not sell as fast as the unit with the designer furnishings. Such distinctions are invisible to automated appraisal programs but not to buyers.
For buyers and lenders the obvious preference is to get a full-blown appraisal, but cost is a concern and the result is that many borrowers are perfectly happy to get an automated valuation. The catch is that appraisal money saved may not be money well spent because appraisals tend to be conservative and thus prevent borrowers from over-paying and lenders from lending too much.
But imagine what would happen if the lending process was distorted. Instead of fair-market appraisals, suppose lenders encouraged the most inflated valuations they could find. In fact, imagine if lenders pushed appraisers to increase values.
Appraisers often feel such pressure. According to an online petition from appraisers nationwide, such pressure “comes in many forms” and includes:
“The withholding of business if we refuse to inflate values,
“The withholding of business if we refuse to guarantee a predetermined value,
“The withholding of business if we refuse to ignore deficiencies in the property,
“Refusing to pay for an appraisal that does not give them what they want,
“Black listing honest appraisers in order to use “rubber stamp” appraisers, etc.”
Appraiser coercion appears to be more common than in the past. A recent study by the October Research Corporation found that “90 percent of appraisers were pressured by mortgage brokers, lenders, realty agents, consumers and others to raise property valuations to enable deals to go through, doubling similar findings from three years ago.”
Appraiser complaints should not be ignored. If appraisals are inflated, if bloated valuations are a widespread problem, then more than home prices are being distorted.
The Wider Impact
Since lenders don’t want to lend more than they should, why would they pressure appraisers to produce higher valuations? The answer is money. A large percentage of all mortgages are packaged together and sold, meaning that most “lenders” are really loan retailers. Bigger loans mean larger commissions for loan officers, extra fees for servicing loans, larger revenues when loans are sold, better quarterly results, higher share values and bigger executive bonuses based on performance.
The problem is that exaggerated appraisals also have a downside. Purchasers get hurt because they pay more than fair market value for houses, thus they have bigger-than-necessary mortgages. Larger monthly costs increase the potential for foreclosure and bankruptcy. When overvalued homes need to be sold, buyers are often upside-down — they owe more than the house is worth.
Investors who buy thousands of loans at a time are also impacted. While it’s easy to calculate the worth of a public company, figuring the value of mortgages is not so simple. One has to know the fair market price of the property which secures each mortgage, and if those values were routinely overstated then investors paid too much for their mortgages and asset values must be reduced.
Not only are mortgage investors impacted, so are those who own derivatives based on mortgage values. If mortgage values have been artificially inflated, then derivatives must be re-priced to lower levels.
Right now we can see that mortgage loans and related financial products are being written down on Wall Street. The result is massive losses for stockbrokers, banks and investors of every size.
“Write-downs to this point have largely been based on rising default rates,” says James J. Saccacio, chairman and chief executive officer of RealtyTrac, the leading online marketplace for foreclosure properties. “If it also turns out that appraisals were systematically hyped because of lender pressure, then further write-downs will be required, write-downs vastly-larger than anything seen to date. Not only would the losses be huge, they would invariably spread to homeowners, lenders, pension funds, insurance companies and investors who played by the rules. The damage to the economy would be immense.”
Peter G. Miller is the author of The Common-Sense Mortgage and is syndicated in more than 100 newspapers.