Wednesday, August 19, 2009

Changing Who Orders Appraisals is not Transparency

Sometimes the fix or repair for a situation gone bad has no apparent material impact and may do more harm than good. Such appears to be the case with the Home Valuation Code of Conduct.

In the middle of the decade when many shady mortgage deals were done one of the participating factors was that a number of independent appraisers fudged their opinions on property values so that mortgages could be approved. Sometimes, one supposes most times that this happened it was in fear of being shut out of the next set of jobs. In some cases, no doubt, money changed hands. Regardless, Andrew Cuomo and others noticed that appraisers were helping mortgage brokers and realtors complete deals on over valued houses or houses with substantive structural problems. The designed solution has been to insist that only lenders can hire appraisers, not mortgage brokers.

It is unclear how, in changing which team the fox plays for,
i.e. who orders the appraisal, we have made the hen house any safer.

Arguably, in the
not-long-past high-flying days of mortgage exhuberance lenders had more interest in appraisal manipulation than brokers and realtors. Lenders were dealing in billions of dollars. Brokers and realtors were only scratching out their local, individual income. Had the new code of conduct been in place its hard to see how things would have worked out differently. Lenders still would have wanted the "imaginative" deals of 2005-2008 to go through.

The accounting industry provides a better model for transparency and independence. Add a little basic technology for data analysis and we can do much better. As in accounting some percentage of all appraisals should require a second, independent appraisal. When and by whom would in no way be decided, much less known by the participants in a mortgage transaction. When an appraisal is ordered a simple wwweb transaction would be sent to a central system which randomly orders a second appraisal from an appraiser independent of all other players in the transaction at hand. The costs of all second appraisals, and the system to order them and store their results, is shared by all mortgages. If an appraisal costs $500 and 2% are sampled then each mortgage carries a $10 fee for the process plus a fee for the system that manages it. Call it $20/mortgage, all in.

The system then examines the difference between the appraisal ordered by the lender (or, if we go back to the previous system, the broker or realtor). If the variance in two appraised values exceed a set statistical range then many things could happen. Third appraisals could be ordered. Disclosure may be enough, etc.

Over time the data on the appraisal variances, the selling price, and the assessed value, along with data on who were the lender, borrower, broker (and third basemen), and fairly straightforward and inexpensive analysis be constantly done to find outliers, high and low, by company and by individual and then counseling and/or enforcement fun can begin.

But the key is that an agent/entity that is independent of the transaction at hand is randomly ordering second appraisals and that all parties know that this is happening and that the data can and will be used to keep behavior in line with an efficient market's needs. The current plan merely changes the team the fox plays for. Our mortgage appraisal hen house is no safer for it.

Doug Brockway

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