Arms Length Appraising is Another Band Aid Solution

It seems that the mortgage industry is reacting negatively to plans by Fannie Mae and New York AG Cuomo to create a clearinghouse for appraisals limiting or wiping out the ability of lenders to use in-house appraisers. This effectively would force lenders into arms length relationship with appraisers.

Some have commented that this would add a new facet to Fannie Mae's already hefty burden: appraisal regulator. Not a bad idea but if there is anything to gum up the works, it's government bureaucracy. Granted, only loans sold to Fannie Mae (or Freddie Mac if this sister organization adopts the same procedure) but the giant Government Sponsored Entities generally set trends in the industry when they change policy.

Fannie Mae said it lost $3.6 billion in the fourth quarter 2007 compared to $604 million in fourth quarter 2006. They lost $2.1 billion for 2007 in total. In comparison, in 2006 they earned $4.1 billion.

The impetus for this is that while Wall Street was buying up everything it could find stamped mortgage no matter how risky, lenders were inflating home prices. Cuomo has turned his eye to see if Fannie Mae and Freddie Mac, looked the other way, so to speak, while that occurred. He filed subpoenas against Fannie Mae and Freddie Mac in November 2007. This past week negotiations took place between the AG office and the two giant GSEs but according to a Reuters's report, "Cuomo's office would not comment on the negotiations but said a lawsuit against the two firms was still possible."

Apparently, Cuomo gave Fannie Mae and Freddie Mac a week to consider settling.

Cuomo is reportedly looking at everyone from Fannie and Freddie to companies that rated the mortgage backed securities to find the culprits in this mess. Seems that he is digging real deep. While that is commendable, it would do him good to take copious notes along the way. The more this goes along the more this all seems similar to the dot com bubble; irrational exuberance-a phrase coined by Greenspan when referring to the superheated stock market in the 1990s-on the part of investors put the blinders on to the risk.

Here is the problem with the clearinghouse concept. Loan Officers in particular value their relationship with appraisers. There are as many sloppy and lazy appraisers out there as good ones, so when you find a good one whom you can trust, you tend to stick with him and give him a majority of your deals. Some appraisers are experts in certain property types like co-ops, condos, construction loans, etc. When you use a repository of appraisers with no control over who is assigned a loan appraisal, you tend to get shoddy results. Slow appraisers, ones who will not run out and do a quick appraisal if you need to have a quick loan closing or property evaluation, are also common. A host of difficulties show up when you don't form a working relationship if a few good appraisers.

Granted, this close relationship with appraisers can lead some to push an appraiser to falsely inflate a property value but that is the risk in any industry. Just because of a few shady deals, you shouldn't upset an industry standard. Taking the personal relationship out of ordering an appraisal is bad for business.

Again, the problem is restricting the Loan Officer instead of punishing an entire industry. Appraisers, title agents, real estate attorneys and a host of other people in the industry need to be licensed and take exams to achieve them. Loan Officers remain the few individuals in the industry who do not have a license on the line.

I'd encourage Mr. Cuomo to start using his authority to push for individual certification on a state level for all Lending Officers. The testing doesn't have to be as hard as the bar exam or a Series 7 test but Band Aid solutions will only get us so far. We'll still be behind the ball once we think this mess is over.