Sounding Bored is my semi-regular column on the state of the appraisal profession. There have been more changes made to the profession in the past several years than in the entire history of the profession, and most of the changes have not resulted in a more credible service. Still, I’d like to hope that the latest financial services sector turmoil will bring a clean slate approach to better regulatory oversight (devoid of insanity).
On November 19, 2008, to little fan fare, a joint agency request for comments on proposed Interagency Appraisal and Evaluation Guidelines was made [1]. Comments are due by January 20, 2009.
I called on Jim MacCrate [2] to get his thoughts on this initial foray by the federal government to fix what is broken in the appraisal industry. Jim is a highly respected appraiser and teacher in the valuation community and who holds the MAI, CRE and ASA designations. He also contributes to this blog in his widely read “Straight from MacCrate” [3] column.
Like many things in my life, I was delayed in posting his commentary to Soapbox.
I asked Jim to run down the document as presented and I throw in a few observations of my own:
Jim
First, the government has acted in haste with outlining the causes of the collapse in the credit markets. I believe, based on my experience, it was poor underwriting standards and lack of enforcement by the FEDS, state governing agencies, accounting firms and others who were responsible for sound underwriting practices. This was a repeat of the 1970’s but it will be far worse.
The OCC regulations and the regulations from the other duplicate agencies had similar guidelines after the bust of the seventies and eighties. Why were they ever changed?
Licensing weakened the quality of reports nationwide. It established minimum qualifications, not experience and expertise.
Jonathan I agree. Appraisal quality diminished with licensing because it was used as a placebo for competence.
Jim
Professional organizations, whether it be appraisers or lawyers or accountants, can not self regulate. That was a joke of the nineties and in to the 2000 error.
Jonathan I remember in 2005 when the Mortgage Bankers Association said there was no real issue with appraisal pressure and the solution was to have appraisers simply do a better job at self-regulation. Of course now 60% of mortgage brokers are gone.
Jim
My understanding is that the employees of the regulatory agencies have very little experience in valuation. For example, there is only one MAI at the Federal Reserve. Economists do not understand what we do. See article from the FED on the value of an acre of land in NYC in 2006 [4].
Real estate lending was always a credit decision first. You look to the collateral when the credit fails.
Jonathan Exactly.
Jim
Personal guarantees are meaningless. AVMs are part of the problem. Economists and statisticians believe in them. The databases are screwed up. They are reportedly using BPOs and that further weakens the reliability. Brokers have a conflict of interest. See Wall Street for Support. Of course no conflicts of interest between Goldman, AIG and others.
Independence
Jim
You know ethics, honesty, etc. are more important than independence. It is this generation that has done anything for a buck and failed to consider the consequences.
Jonathan Absolutely, but if the appraisal industry can not work without being pressured to “make the number” as has been past practice, then honesty and ethics fade away as those individuals are driven out of business. How can I compete with someone who is fast, cheap and always comes in with the exact number needed to make the deal?
Selection of Persons Who May Perform Appraisals and Evaluations
Jim
There is no comment on years of experience. That is caused by the licensing. Back in the seventies (and there were problems too) appraisers were selected because they had the MAI or SRA. Those standards were way above today’s. States do not have the money, knowledge or resources to enforce compliance [with state licensing]. Folks who order appraisers should be knowledgeable and qualified to do the appraisal; otherwise how do they know who to hire?
Jonathan I agree with you – Take Appraisal Management Companies: We are often dealing with kids just out of high school who have no real estate valuation experience, let alone understand the problems with valuation. And revenue collected from state licensing boards for oversight is often diverted to other areas of the government. The problem with “pure” enforcement is that it becomes an argument of semantics because valuation is an opinion. Fraud aside, how legally viable is it for a state agency to reprimand an appraiser who estimated the value of a property as $500,000 when the state employees think its $475,000, especially when there is limited market data? It’s tough to say anything a certain percentage below or above the state value is unethical. And what if the state is wrong? It’s not a realistic solution.
Minimum Appraisal Standards
Jim
The Appraisal Foundation weakened its standards with the latest version and previous version. Economic principles drive valuations. Three approaches to value are the support to a supportable, defensible estimate of value. You knock off one leg of a three legged stool and what happens. The stool falls over.
The comment on AVMs should be stronger.
The Scope of Work is correct. It is up to the agencies and the financial institutions to determine the scope of work; not an appraiser. Risks are determined by the financial institutions who then should determine the scope of work required to protect the financial institution if the credit fails. The collateral is the default to protect from losses.
Tract Developments with Unsold Units
The appraiser should include and analyze the developer’s projections. The appraiser can not work in a vacuum. They need the information to properly analyze these types of projects. See what was written in the 1990’s by Prittenger and others for the OTS. Why are we reinventing the wheel? We spent tax payers dollars on this issue in the 1990’s and late 1980’s.
What happened to a market analysis? That led to failures in the 1970’s, 1980’s and now with REITs. I guess supply and demand are not important criteria that determine pricing.
market analysis should be performed by state-certified or licensed appraisers in accordance with requirements set forth in the appraisal regulation..
experience is the key. A license does not make you qualified.
Transactions That Require Evaluations
All transaction should be evaluated to prevent fraud.
the reputation and qualifications of the person(s) who perform evaluations are the key.
Reviewing Appraisals and Evaluations
Who is doing the review for the financial institution? A check is needed. They cut costs and relied on unqualified appraisers to the work. Knowledgeable folks in the appraisal process must do the review. I know it’s a pain but it is a safeguard that the system had and it was eliminated by many financial institutions. A loan officer has a conflict of interest because how they may be paid or compensated.
USPAP sets minimum standards. The financial institution must set the standards that exceed USPAP and they must be enforced at all levels, including the CEOs who tell lending officers oh, it is not necessary this time around..
Referrals
Jim
They will not do it. That is a joke. It is up to the regulatory agencies to sample the loan documentaion and if they see a problem, they should make a referral.
I think the first part indicates that the authors do not have experience or knowledge of the past or what has been written by the OCC, OTS, FDIC, etc. in their regulations. The real culprit was greed by CEOS and Wall Street who had no interest in the future but only current earnings now. The MBS market allowed lenders to off load loans without recourse by the investors in the final packages put together by the likes of Goldman Sachs, etc. who indirectly got bailed out by lending and supporting AIG.
This document does not address what has caused the problem and that is to hold those at the top, lending officers, accountants, etc. accountable financially and responsible over the life of a loan.
The Addenda
Jim
Item 2 Page 41- In today’s day and age with bankruptcies increasing appraisals are needed. Abundance of caution you need all the tools to be used to protect against defaults. In the current environment there is no certainty of repayment. Personal guarantees, etc do not exist once an individual or company falls on hard times. During audits at old PW the staff was directed not to consider personal guarantees at all.
Item 5 Page 43 same comments. Taxpayer funds are at risk. Fraud occurs at all levels. Appraisals should be required even on loans $500,000.
Item 8 Page 47 “These transactions should have been originated according to secondary market standards and have a history of performance.” Standards were not enforced so that’s a dumb statement. How does one know in the current environment without proper due diligence which would include a thorough review of all appraisals.
Item 10 Page 49 Freddie and Fannie made mistakes. Why should these transactions be exempt? Do not exempt them and it becomes a check of the system and does not cost the taxpayers a dime. There was fraud in the appraisal and lending process that Freddie and Fannie did not catch. Now it can passed on to others?
Item 13- Page 50 Same as above. Why? It is a check on the system. Fraud has occurred in the same organization transacting business with subsidiaries.
Page 52- AVM’s – The databases are not perfect. Statistics are not always correct – look at what the FEDS have done relying on statistic modeling. You know what is wrong with AVMs.
Now, good I see a definition of market value again and some other terms.
Jim
There ya go sorry I can’t spend more time right because no one is bailing me out and our retirement accounts. I guess I am small and can fail at no cost to society.
Jonathan Thanks Jim!