Matrix Blog

Credit, Finance, Mortgage, Rates

The Responsible Lending Act (HR 1295)

July 27, 2005 | 10:12 pm |

The Responsible Lending act introduced in the house this spring addressed the issue of appraisal pressure. The section of the bill to refer to TITLE IV–APPRAISAL ACTIVITIES primarily addresses predatory lending in the sub prime market.

The appraisal portion of the bill has been covered in the media and here and here and here and here.

You get the point.

This was probably in response to a rash of appraisal fraud that has been happening in then the relaxed lending guideline environment, proliferation of sub prime lending, increased wholesale mortgage origination, specifically in markets like the Poconos, which was highly publicized.

The bill provides terminology that specifically equates appraiser pressure to a criminal act. Its a giant step in the right direction but at the end of the day, we believe nothing will change to prevent overall fraud in the industry within the bill’s current format.

With 72,000+ licensed appraisers nationwide, state enforcement is limited at best. The average enforcement department for each state is something in the order of a few staff members and limited funds.

The government is currently analyzing the appraisal industry and will produce a detailed analysis. Hopefully, it will show that the lack of separation between the sales function and the underwriting function promotes fraud. In other words, those individuals paid on commission, should not decide which appraisers get the assignment.

One of the best descriptions of the current problem can be found from the think tank DEMOS.

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Testimony Before the Subcommittee on Oversight

July 26, 2005 | 8:45 am | |

Committee on Ways & Means :: U.S. House of Representatives : Testimony

Someone from the research staff of the House Ways & Means committee actually called me on this issue as well and I volunteered to testify. I wanted to discuss the problem of the lack of independence of the appraiser but they wanted me to name names. They completely missed the point. Its not specific individuals, its the way the industry is set up. I got the distinct impression from my conversation that the committee already knew what they wanted to hear. They went wih an appraiser from Virginia, David Lennhoff, who didn’t name names either, but basically said that the 10% rule – of – thumb adjustment is not valid.

Most appraisers who do facade easement valuations are using 10% to 15% adjustments as a guideline which originates from the now infamous original Primoli Letter [pdf] , since replaced by a revised version from the IRS [pdf] that omits the 10% to 15% verbage. Since it could be interpreted that the IRS seems to be re-writing history, I suspect that is the motivation for the National Architectural Trust to document the changes in policy by the IRS on this matter [NAT].

The Problem: Most appraisers are simply performing a valuation and making this discount. The problem is that the disclosure of whether the seller has taken advantage of the deduction is not available to the public, in a practical manner. The inability to use empirical data (because it doesn’t exist) provides the classic catch-22. You need empirical evidence to appraise the first property in your market, but yet the IRS says you can’t appraise without using empirical data. However, there is no definition as to what constitues empirical evidence. Using court cases, sales data, equity stock trends, what conference wins the Superbowl (well, thats a stretch) might be interpreted as appropriate since they are all empirical evidence.

Our firm grew disaffected as homeowners caught on to the process and pressured appraisers to appraise the properties on the high side to get a bigger deduction. We refused to do that so we stopped getting this type of work. We were openly complaining that there was a problem, but from their perspective, they do not have the ability to police the appraisers.

Who is going to say the value is too high? No one. There is no review function or policing of these reports done for any facade easement organization. It falls in the lap of the IRS agent during an audit.

The loss in tax revenue due to inflated appraisals has got to be staggering to the Treasury. Many appraisals are inflated because there is no oversight and like the wholesale lending process (mortgage brokers), the benefactor picks the valuation expert. And once again, appraisers, including good appraisers who don’t play this game, will be blamed.

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The beginning of the end, or how this mess got started.

July 18, 2005 | 9:13 pm |

It amazes me how flawed the structure of the wholesale lending process is. Someday during an economic downturn or future lending crises, this will come out with the wash. Until then, its status quo.

How it began…

As banks floundered in the early 1990’s during the recession, the non-revenue departments were cut back, which included…you guessed it…appraisal departments. The order and review function, which requires administrative overhead, was shifted to mortgage brokers who would bear the staffing risk. Mortgage brokers are generally paid a commission of 1 point, or 1% of the mortgage. The appraisal fee, which generally starts at $300 to $500, is either paid in the borrower’s application fee or the absorbed by the mortgage broker.

In relatively short order, the wall between the sales function and underwriting essentially went away and so did the buffer between bank loan reps driven by a commission incentives and the appraiser, who is supposed to be assessing the collateral for the lending institution.

Large appraisal factories sprang up across the country hiring trainees who would simply fill out appraisal forms and make the deals. Without inhouse appraisal departments to review these reports, they were essentially accepted at face value. Many experienced firms either shut down or moved into other areas of valuation.

Why does this matter?

Lets count the ways.

  1. The borrower is under the assumption that the licensed or certified appraiser is independently assessing the value.
  2. Lending institutions have no idea what their collateral is really worth and the implicit risk to their portfolio.
  3. These lending institutions are government insured.
  4. Guess who pays the bill in the next banking crises?

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