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[Fee Simplistic] Move Over FIRREA-Make Way for FURREA: A Brief History of Real Estate Finance Follies

Fee Simplistic is a semi-regular post by Martin Tessler, whom after more than 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. In this post, he ads a new acronym to our tool box while giving us a lesson in how we got here. Great, great stuff.” …Jonathan Miller

One of the few advantages of being an “old fogey” with 30 years of real estate counseling experience notched on the belt is that if you hang around long enough you will see history repeating itself in cyclical aspects of real estate finance-roughly every 20 years. My career started back in the early 70’s when the REIT world imploded as the result of mostly borrowing short but investing long at a time that the economy underwent something the economists called “stagflation” following the first oil crisis. It was a time of double digit inflation, a stagnant economy and it also featured a phenomenon called “disintermediation”- a PhD word that denoted the massive withdrawal of deposits from fixed interest savings accounts that resulted in the devastation of real estate financing and many REIT’s. Somewhat similar to today’ subprime and hedge fund world of investing it was a time of money chasing deals.

Recovery from stagflation culminated in the mid-late 80’s when Wall Street and the real estate markets hit its stride with a booming stock market-think Gordon Gekko a/k/a Michael Douglas’s “greed is good” [1] and the unscrupulous S&L bankers and their crooked appraiser cronies [2]. As banks hemorrhaged loan write-downs from fraudulent appraisals Congress went after the appraisal profession (the bankers, for the most part, escaped punishment owing perhaps to the fact that the American Bankers Association [3] is more generous to Congressional campaigns than the penurious appraisal world) and we got FIRREA [4] in 1989. FIRREA, as we all know by now, was the Feds pointing the finger at the appraisers while telling the bankers to beware whom they sign up on their appraisal “dance card”.

Fast-forwarding to the late 90’s and the post millennium a new crop of miscreants surfaced, namely the underwriters and the rating agencies. The advent of the slice and dice tranche in the RMBS and CMBS world gave rise to the subprime and its not-quite illegitimate but certainly suspect “piggyback” loan. A recent article in the Wall Street Journal noted that in 2000 Standard & Poor concluded that “piggyback” loans were no more likely to default than those of standard mortgages. A new symbiosis evolved between the lenders eager to lend, the home buyers and speculator investors eager to borrow on easy credit, the Wall Street underwriters eager to sell their bonds and collect their up-front commissions and the bond rating agencies eager to capitalize on the lucrative and expanding rating business.

As with the appraisal world you had lenders shopping around for the “right” value from cooperating so too with the bond world you had underwriters shopping around for the right credit rating from the rating agencies. Moody’s had revenue of roughly $3 billion from 2002-2006 for rating securities from a variety of debt pools including mortgages and other types of loans. Standard & Poor did not change its mind on “piggybacks” calling them more likely to default until 2006 at which time the subprime mortgage market ballooned to $1.1 trillion.

Now that the chickens are coming home to roost and the appraisal world is, for the most part, guiltless will the Feds move to reign in the underwriter/credit rating agency cabal? Is it time for FURREA-the Financial Underwriting Reform and Recovery Enforcement Act? Perhaps New York Senator Chuck Schumer [5], who never saw some skullduggery that did not warrant a Congressional action should be asked, “How about this one Chuck”?