Appraising the Mortgage Crisis

by Dan Krell

Although the mortgage meltdown and crisis is not new news, new information continues to shed light on what led to the mortgage meltdown. In addition to the scandals and fraud allegations at many levels, many are still unaware of the impact of appraisal practices on present market conditions.

Stories of appraisers being coerced into inflating values or providing favorable appraisals are not news. However, as Justice Department probes expand beyond subprime lenders to some of the country’s largest lenders, we may hear more about how underwriting and appraisal practices played a part in creating the bubble that burst. As the probes expand, we may begin to hear more about appraisals that were artificially inflated by coercion, collusion, and/or fraud. Some appraisers purportedly have already come forward to report how they were forced to provide appraisals that were consistent with an inflating market. Supposed consequences for not complying with lenders’ demands would result in loss of business for the appraiser.

Along with other factors, artificial, fraudulent, or misleading appraisals have played a role in historical mortgage crises, such as the Savings and Loan Crisis (of the 1980’s) and the flipping schemes (of the 1990’s). Prior to the critical mass of the S&L crisis, obtaining a real estate loan seemed relatively easy (at the time); the result was a $120 Billion (plus) government bailout. An article published in the CPA Journal (December 1989) reported that a 1988 FLHBB (now the FHLB) report to Congress referred to fraud and insider abuse as the leading factors leading to the S&L collapse; other factors identified by the report leading to the crisis was the collusion by thrift management, borrowers and appraisers to conceal losses and liabilities.

As a result of the S&L crises, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) was created. FIRREA was to ensure that type of fraud and abuse that occurred in the S&L crisis would not happen again. Consequently, title XI of FIRREA led to licensure of appraisers, the creation of the Appraisal Foundation, as well as the Uniform Standards of Professional Appraisal Practice (USPAP).

In the mid to late 1990’s, mortgage and appraisal fraud hits again in the form of flipping schemes. Although not as widespread as the S&L crisis, the flipping schemes hit the subprime mortgage market very hard. In many cases, flipping schemes used artificially inflated appraisals to net a large gain to the seller (the loan officer, appraiser, and/or title agent were often in collusion).

Interestingly, real estate market declines followed both the S&L crisis and the flipping scandals. The large buyer’s market and recession occurred at the tail end of the S&L crisis in the early 1990’s.

Currently, investigations are reportedly focusing on practices to hide decreased portfolio values sold on secondary markets. In addition to the allegations surrounding appraisals, lenders’ have also used Broker Price Opinions (BPO) to ascertain values on portfolios as well as for lending purposes. BPO’s are usually completed by real estate agents or brokers who typically have no appraisal training; additionally the BPO typically does not follow USPAP.

If it is not yet clear, history is repetitive and cyclical. Our response this time, however, can undermine the next real estate crisis.

This article is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of March 10, 2008. Copyright © 2008 Dan Krell.


(Post Script – Today, Congress is to release report outlining causes for present mortgage crisis.)

Looking for Blame in the Mortgage Crisis

by Dan Krell © 2007

The daily media reports of abuse, fraud, and other problems in the sub-prime mortgage industry attempt to make sense of a real estate industry in turmoil. It appears that the problems in the real estate industry are similar to those in Big Business. Like many of the recent business scandals, schemes and wrongdoing are carried out because the financial rewards seem greater then the risk. Those who are caught usually point their finger at their boss claiming that they were told to do so in fear of losing their job.

The present mortgage crisis is similar to some extent. Sensationalized media accounts of what went wrong and who is to blame seem to be in the daily headlines. The blame of the present crisis was first placed on the lenders and investors, who with their lenient underwriting guidelines, allowed many to borrow beyond their means. The new focus in the crisis is on inflated appraisals and how appraisers are “forced” to provide these appraisals in order to maintain business. Additionally, there has been some discussion about the loan officers who originated the loans, without regard to the consequences to the borrower.

The story of inflated appraisals on the mortgage industry is about how some appraisers are “forced” to provide appraisals with an inflated price or they will lose business. For a real estate appraiser, the pressures of complying with lenders’ requests to inflate appraisals are inherent to the business, but not necessary. To demonstrate the extent of the problem, the Baltimore Sun reported (April 10, 2007) that appraiser groups are asking regulators to crack down on the lenders who pressure appraisers for inflated appraisals.

On the other hand, not enough has been said about the loan officers who originate these loans. Many loan officers who originate sub-prime mortgages are mortgage brokers and are paid on commission; they only get paid if the loan closes. Most mortgage originators act ethically in the borrower’s best interest. However, some will say or do just about anything to get the loan to close, including making unrealistic promises to the borrower as well as pressuring others to ensure loan closure. Unless there is blatant fraud, loan originators are not usually held responsible for a “bad loan.”

There are reports of possible federal investigations of mortgage misrepresentation and non-disclosure of loan terms. A recent MSNBC article (April 10, 2007) reports that many sub-prime borrowers who were deceived by mortgage brokers and loan officers are filing law suits for violations of the Federal Truth in Lending Act. These borrowers include those who were misled to believe the terms of their mortgage, as well as others who were misguided to obtain a high interest rate mortgage when they qualified for a more favorable loan. Under the law, the full terms and conditions of loans must be disclosed to consumers. Additionally, some have interpreted that any misrepresentation, written or verbal, is a violation of this law.

Although most real estate professionals are reputable and act within the guidelines of the law and the ethics code of their profession, unfortunately some do not. Like Big Business, it appears that some of the problems in the real estate industry exist not just because of a lack of ethical behavior, but a lack of character as well.

This column is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of April 23, 2007. Copyright © 2007 Dan Krell.