Appraisal Reform Efforts: Too Little, Too Late

Submitted by Rich Toscano on January 3, 2006 - 9:00am

The Voice of San Diego has run a followup story on appraisal fraud, this time discussing the middling reform efforts currently underway. As an example, the state senate is considering a bill "that would require any person who initiates a mortgage to have a certified broking license."

While it's encouraging that the appraisal fraud issue is being recognized, I don't think that a few grasping attempts at further oversight will solve this problem. It is the nature of end-stage speculative bubbles: there is too much to be gained by continuing fraudulent behavior, and too much to be lost be halting it. Once the bubble is deflating in earnest, the appraisal fraud problem will fix itself. By then, however, the damage will have been done. I can only hope that the powers that be use the opportunity to put in place a regulatory system that will prevent fraud from getting out of control during the next housing boom.

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Submitted by Bugs on January 3, 2006 - 11:26am.

"Appraisal Fraud" occurs as a result of an appraiser agreeing to lie on behalf of their client, the loan originator. The appraiser does the lying, but the impetus for telling the lie comes from the loan originator. Absent a request or demand from a loan originator to the appraiser to "hit the number" the appraiser has no reason to tell the lie. Why does the loan originator have such influence over the appraiser? Because the loan orignator is the one who orders the appraisal, "employs" the appraiser, and pays for or arranges for the borrower to pay for the appraisal fee.
This type of fraud occurs primarily because the lending institutions buy complete loan packages from the independent mortgage brokers on a wholesale basis. The system saves the lenders costs in that they only pay overhead for the loans they close. Appraisal fees are part of that overhead, and can thus be classified as an origination expense rather than what they truly are, which is an underwriting expense for the lender.
If our government ever wants to get serious about controlling appraisal fraud, which as a point in fact is a subset of mortgage fraud, the simplest and most efficient method of doing that is to make the lending institution directly responsible for engaging the appraiser - cut the loan originators out of the appraisal loop.
What's ironic is that the federal government already tried to do this back in the '80s when they originally wrote the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (aka FIRREA). In FIRREA, the feds originally dictated to the lenders that they could only use appraisals engaged by a regulated lending institution. However, the mortgage bankers lobbying groups put up a howl of protests because this would have cut into their wholesale trade. In the end, the feds rolled over and included the clause "or it's agent" (meaning mortgage brokers) in with the restriction. So now the federal law reads "A regulated institution or its agent shall engage the appraiser". This allows the third party, comission-compensated loan originators to continue to engage the appraiser. As we all know, the modern definition of the Golden Rule is "He who has the gold makes the rules."

This is not to say there isn't room for improvement of enforcement of applicable appraisal laws and regulations. In California, the state's Office of Real Estate Appraisers (OREA) is charged with regulating appraisers. And they do regulate appraisers. Over 200 appraisers have had their licenses revoked since licensing began in 1991, which is a much higher rate of enforecement than you'll find for most other licensed occupations such as medicine, law, accounting, etc. Nevertheless, the process is complaint driven, mostly administrative law, wherein the squeaky wheel gets the grease and the government is at a bit of a disadvantage if an appraiser can afford an attorney to run the clock. More citizen complaints will result in more funding for enforcement actions, but I doubt that will happen until lenders and homeowners start losing a lot more money. It took the 1980s S&L bailout to force appraiser licensing into being, and I'm afraid it's going to take another catastrophe before the program is given the teeth it needs to be effective enough to act as a deterrent. It's like the war on drugs - the crooks define right and wrong in terms of the liklihood of getting caught and punished.
Sorry for the long rant but these are complicated issues.

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