Housing Hell: Revenge Of the Appraisers
Among the many guilty co-conspirators in the housing bubble were appraisers who succumbed to pressure from loan officers, buyers and real estate agents eager to get deals done. Wary of losing business, these appraisers submitted home valuations that were unrealistically high, contributing to an upward spiral of prices that was unsustainable.
Appraisers' lack of independence brought calls for reform once the market melted down, including a spate of new federal regulations commencing in 2009, the latest in a long string of efforts by the government over the last half century to reform the business. Now, ironically, those new regulations are being blamed for some of the housing market's current struggles, as exceptionally low home valuations kill deals, including those between highly qualified buyers and eager sellers.
On the surface, the very notion that the government needs to reform the appraisal business seems absurd. The practice of property appraisal, which goes back centuries, grew out of the desire by buyers and lenders to have independent assessments of the worth of a piece of land. There was little reason to suppose any buyer or lender would want to see a piece of property over-valued, because he would bear the risk of that miscalculation. It is only in the last 50 years, as government involvement in housing has transformed the market and taken some of the risk out of it for buyers and lenders and shifted it to the taxpayer, that we've watched the appraisal business melt down time and time again, contributing to several housing market disasters. Nothing illustrates how convoluted and rigged our housing market has become as the government's long and unsuccessful struggle to take a business once valued by parties in private transactions and make it respectable again.
Until nearly the middle of the 20th century, appraisals were conducted by anyone familiar with local real estate conditions, including land agents, contractors and architects. In Middlemarch, George Eliot's novel of life in a provincial English town in the 1830s, Caleb Garth, a land agent and manager of estates for the rich, talks of finding himself sought after by both the local banker and a landowner to value the same piece of property, and having to decide who he will represent in the transaction.
All of that began to change here in the United States in the 1930s, when the federal government decided to professionalize the industry, chiefly through the Home Ownership Loan Corp., the New Deal agency designated by Congress to bail out some 1 million homeowners pinched by the Great Depression's credit squeeze. To accomplish its task HOLC hired some 20,000 loan officers, auditors, investigators and yes, appraisers, and began setting standards for how to value properties so that the agency could determine which homes qualified for the government mortgage rescue program. By 1939, HOLC was holding training courses around the country for government and private appraisers.
It wasn't long afterwards that signs of trouble emerged. In 1946, federal regulators and bankers began warning of vastly inflated or ‘loose appraisals' in the new G.I. home loan program designed to help returning veterans buy homes with federal backing. The head of the Federal Housing Administration even told bankers and appraisers it was their duty to restrain the enthusiasm of buyers and sellers in this government-enabled market, or face the wrath of ordinary citizens when foreclosures rose.
But the pressure on appraisers and bankers was coming from Washington itself, where Congress continually renewed and extended veterans lending programs and watered down their underwriting requirements so that more applicants could qualify. By 1950, 40 percent of all mortgages were government subsidized, and by the mid-1950s the government had a mini-foreclosure crisis on its hands. Foreclosures of FHA loans spiked fivefold in the 1950s and the failure rate of mortgages backed by the Veterans Administration doubled, according to a 1970 National Bureau of Economic Research study, even while foreclosure rates on private mortgages barely increased in the decade.
The 1950s mini-bubble was only a prelude to much worse. In the mid-1960s Washington decided to extend its FHA mortgage coverage to low-income buyers in urban areas, bringing them government backed home ownership. Federal appraisers were supposed to be one of the government's lines of defenses against bad lending practices by providing realistic valuations upon which loans were made. But at a time when urban decay was knocking the foundations out of the private market, the appraisers came under enormous pressure to provide valuations that allowed deals to go forward, that is, inflated appraisals.
Some went further. With the prospect of big profits thanks to government financing, they took bribes and participated in scam operations with local real estate agents and bankers, who foisted overpriced homes on unsuspecting low-income buyers. Prosecutors indicted appraisers in Detroit, Newark and New York City for taking bribes and joining in lending scams through the FHA program after tens of thousands of loans failed, costing the government $1.4 billion and sparking widespread abandonments in dozens of cities.
It took much of the 1970s to clean up this mess, but even before the government had finished, the next crisis was upon it. By the late 1970s our nation's savings and loan institutions were in a squeeze, caught between rising interest rates that boosted the cost of financing their deposits and long-term mortgage portfolios that featured loans made at much lower interest rates. To survive, S&Ls rushed out after new mortgage business at higher rates, lending out government backed deposits in a Wild West atmosphere. Appraisers willingly played along, doubling and tripling their business with S&Ls but inflating the market until home prices came crashing down, sparking foreclosures and bank failures that cost the taxpayer some $500 billion.
Once again the government responded with new regulations, including a requirement that states start licensing and certifying appraisers. By 1990, some 39 states had passed new licensing requirements. The new rules debuted just as the foundations of the next real estate bubble were forming with the gradual loosening of underwriting standards on loans purchased from banks by Fannie Mae and Freddie Mac. Motivated by the prospect of selling off loans to the quasi-government agencies, including many loans the government-sponsored enterprises would not previously have purchased, bank lending supervisors adopted slogans like, "a thin (mortgage application) file is a good file," and loan officers sought out appraisers who would produce inflated valuations that allowed pricey deals to go forward, until the whole edifice collapsed in 2008.
To "fix" this, the government began in 2009 requiring lenders to step away from the process of hiring appraisers, inserting middle-men into the process and forbidding various parties to a transaction from discussing the elements of a property during the valuation process. The result has been to siphon a portion of their fees away from appraisers, driving knowledgeable ones out of the business, and sending evaluators into unfamiliar neighborhoods where they often get market conditions wrong. Some real estate agents and lenders estimate low appraisals are killing from 20 to 40 percent of deals. Even allowing for a certain amount of exaggeration endemic to the real estate business, low valuations have become a significant problem in the market's struggles.
The government is already tweaking its new regulations, but the last 50 years hardly inspires confidence. Only those with an unflappable sense that eventually Washington will get it right would believe at this point that the solution to the problem is just one more rule or regulation. The real problem is that the appraisal business is symbolic of our whole housing market, where risk is often displaced and those who should have a stake in seeing that the process is honest and accurate often instead have the opposite motivation, to see a deal go through at any cost. And appraisal, once a legitimate function in private property transactions, is now merely an appendage of government whose usefulness is hard to discern.