Reconciling the Erosion Within My Profession
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On June 14, 2005 Steve Jobs told a class of graduates, “you can’t connect the dots looking forward; you can only connect them looking backward” Around the same time, I was appointed as the sole residential member of the appraisal licensing board of my state. Little did I realize that this 2005 governor-appointed position would eventually lead me to sharing a stage in 2018 with William K. Black, which lead to an interview for The Con. And little did I realize there was more to the residential appraisal profession’s story that needed to be told.
How did “appraisers” become the easy answer to “why is there mortgage fraud?” Generally, appraisers are the only ones who examine the collateral asset (property) on behalf of the lender. Appraisers are typically the only professional in a mortgage transaction a borrower will encounter when we inspect the property that is the subject of the mortgage loan. The borrower has a face with the name and profession. Appraisers are charged by Congress with promoting and maintaining a high level of public trust. Since the time Congress enacted Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), the appraisal profession has been under attack.
Title XI of FIRREA provided protection for federally related transactions in real estate. The appraisal profession became the only profession in the mortgage lending industry that is monitored by Congress through the formation of the Appraisal Subcommittee and The Appraisal Foundation, who was authorized by Congress and is the source of appraisal standards and appraisal qualifications. This also required appraisers who developed opinions of value for federally related transactions to be licensed by their individual states.
Per our professional standards, appraisers must not perform an assignment with bias, must not advocate the cause or interest of any party or issue, and must not agree to perform an assignment that includes the reporting of predetermined opinions and conclusions. Appraisers must not intend to mislead or defraud, and must not use or rely on unsupported conclusions relating to characteristics such as race, color, religion, national origin, gender, marital status, family status, age, receipt of public assistance income, handicap, or an unsupported conclusion that homogeneity of such characteristics is necessary to maximize value. Further appraisers must not engage in criminal conduct. All states and territories have parts or all of The Uniform Standards and Professional Appraisal Practice (USPAP) incorporated into their laws. Violations of USPAP can result in an appraiser losing their license or going to jail.
The federal government created a national appraisal licensing system to insure we would never face another savings and loan disaster like there was in the late 1980’s. FIRREA originally set the de minimis threshold below which an appraisal is not required for a residential mortgage transaction as $50,000. The lending profession complained that there were too few appraisers which would result in higher appraisal fees. Per the National Association of Realtors, in 1989 the median house price in the United States was $89,500. By 1992 the median house price was $99,700 and the lending de minimis threshold for residential lending increased to $100,000. This means that a licensed appraiser was not required if the mortgage amount was $100,000 or below. By 1992 the intention of FIRREA was deteriorating.
By 1993 appraisers were feeling the pressure to overstate the value on properties from mortgage lenders. The cost of an appraisal did not increase as anticipated, rather it was flat or declining. This did not stop James McLaughlin, director of agency relations for the American Bankers Association, to encourage the Clinton administration to waive mandatory appraisals on residential and commercial transactions of less than $900,000, in part because of supposed high appraisal fees.
Effective June 7, 1994, the Office of the Comptroller of the Currency, Treasury (OCC); Board of Governors of the Federal Reserve System (Board); and Federal Deposit Insurance Corporation (FDIC); ruled to raise the Appraisal Threshold from $100,000 to $250,000. During the open comments period prior to the vote, “a large number of appraisers commented that the proposed changes would lead to abuses that caused savings associations to fail in the mid-to-late 1980s and that the changes would violate the intent of Congress.” The agency decided to raise the threshold from $100,000 to $250,000 anyways. They said, “Such an increase would benefit consumers and lenders and will not threaten the safety and soundness of financial institutions, particularly as an evaluation will be required for all loans exempt under the threshold.”
In 1994 the median house price was $107,200.
In 1994 those who FIRREA and USPAP were intended to protect, such as first-time home buyers whose mortgages and home equity loans were less than the de minimis of $250,000, were no longer protected by having their collateral asset (home) appraised. The lender could use evaluations done by bank employees, real estate agents, and/or mathematical modeling; and they did.
When a mortgage applicant with a de minimis of less than $250,000 apply, lenders typically consider the size of the down payment, the credit history of the applicant, the work history of the applicant, the debt to income ratio of the applicant, and the type of loan the applicant is interested. The “value” of the collateral asset could be provided by an Automated Valuation Model (AVM) as an evaluation, which is not an appraisal. AVMs were designed to speed up the valuation process and reduce costs. AVMs were designed to replace the work completed by the licensed real estate appraiser. An AVM is a mathematical model which estimates real estate property value. No interior or exterior inspection is made to the collateral asset/property. Big Data companies that provide AVMs were not and are not regulated. Their valuation process and sources of information are not verified, regulated, or publicly available. The Big Data companies are not required by Congress to protect the public trust.
In 2007 I was a speaker at the financial crimes conference that Patrick Madigan, Iowa Assistant Attorney General, referenced in Episode 1 of The Con. My topic was Appraisals and Fraud. At that time, over 90% of appraisal complaints were residential appraisals. Many of these complaints were based on competency, which could be helped through proper education. There were more than a few that were criminal. In 2007, identity theft was one of those crimes.
The appraisal industry standard for transmission in the 2000’s went from paper reports to digital reports that were sent electronically. Digital signatures rather than ink on paper signatures became standard. This led to identity theft, which is where the criminal facilitates mortgage fraud through stolen identities. Digital signatures on appraisals became an easy method for unethical appraisers, supervisors, or owners of appraisal firms to steal identities. The unethical appraiser, supervisor, or owner had access to other appraiser’s signatures, sometimes without the appraisers’ knowledge. The victim appraiser, thinking they were following company policy, would not realize their identify was stolen unless a complaint was filed. There were several cases in Illinois, with one that settled in 2007. This unethical appraiser admitted to forging approximately 600 signatures.
Illinois was not alone. There were other states and more identity theft. Unfortunately, appraisal boards could only punish the license, not the licensee. We needed the help of law enforcement.
In 2007 real estate appraisal issues were low on many law enforcement agencies priority list. Many law enforcement agencies did not have the funds in their budgets or the staff to do the work. It was frustrating for those of us who were witnessing bad things happening to good homeowners. Eventually, mortgage fraud task forces formed throughout the country to address the growing list of mortgage related state and federal crimes.
In The Con, Addie Polk had a mortgage loan for $46,000. Becky Weise had a mortgage loan for $87,400. Both mortgage applicants had equity in their homes and no existing mortgage. In the case of Addie Polk, did a licensed appraiser develop an opinion of value for her mortgage, or did the lenders use an evaluation, such as an AVM as an appraisal alternative, and call it an appraisal?
As of today, the total amount of fraudulent loans generated by appraisal waivers, evaluations done by non-appraisers, and/or AVMs has never been revealed by any lender, government agency, or secondary market investor, including Fannie Mae, Freddie Mac, or any Wall Street investment company.
In 2007 there was hopeful discussion of Senate Bill 2280 (109th): The STOP FRAUD Act (Stopping Transactions which Operate to Promote Fraud, Risk, and Underdevelopment Act). This bill stated that it shall be unlawful for any mortgage professional to knowingly execute, or attempt to execute, a scheme or artifice to defraud any natural person or financial institution in connection with the offer or extension of consumer credit, which is to be secured by an interest in real property. It also stated it shall be unlawful to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property, an interest in real property. This bill was introduced on February 14, 2006 by Illinois Senator Barack Obama. The bill was never enacted into law.
What did change was a policy by the Federal Reserve called the Home Valuation Code of Conduct (HVCC). Enacted on May 1, 2009, the HVCC was a set of federal guidelines designed to make the home appraisal process more reliable. The HVCC prohibited mortgage brokers and real estate agents from selecting or paying appraisers. This forced many independent appraisers to work with Appraisal Management Companies (AMCs). Until state licensing, the AMC was the unregulated, profit driven entity between the regulated lender and the regulated appraiser.
In 2009 when the HVCC was enacted, many of the Too Big to Fail Banks had their own AMCs. The AMCs added an additional layer, including additional fees added to the cost of the appraisal on the closing documents. These added fees by the AMC are not disclosed even today and are paid by the borrowers. In spite of the added costs generated by the AMCs, appraisers rarely received additional payment, and in many cases, the fees paid to the appraisers were reduced. The unregulated AMCs owned by some of the Too Big to Fail Banks and title companies soon became a recipe for potential kickbacks and potential anti-trust violations. The banks and title companies eventually sold their interests in the AMCs. Today the AMCs take the place of many banks and lenders in-house appraisal departments.
Many of the AMCs require the appraiser to upload the finished report through a portal. The cost of the upload and sending can add additional costs that are paid by the appraiser. Further, several of the portals and appraisal software providers are now owned by Big Data companies, who have access to appraisal reports for which they are not noted as intended users.
In 2010 the Federal Reserve replaced the HVCC with New Appraisal Guidelines that Fannie Mae and Freddie Mac implemented through the Dodd-Frank Wall Street Reform and Consumer Protection Act.
On October 9, 2019 the Office of the Comptroller of the Currency, Treasury (OCC); Board of Governors of the Federal Reserve System (Board); and Federal Deposit Insurance Corporation (FDIC); ruled to increases the de minimis threshold level from $250,000 to $400,000.
By March 2020, the use of hybrid and bifurcated appraisal products became an additional alternative to an appraisal report with an interior observation.
Today we know that 85% to 90% of all mortgage transactions backed by the federal government and U.S. taxpayers are currently not subject to the protections Congress enacted through Title XI of FIRREA. Big Data companies that provide AVMs are not regulated. Their valuation process and sources of information are not verified, regulated, or publicly available. How does relying on an unregulated private industry running aggregation models protect the public trust? I don’t believe it does.
The appraiser is central to the checks and balances in the home lending system. The appraiser is hired by the lender to ensure that there is value in the property being used as a collateral asset by the lender to provide funds to the borrower. The licensed broker/Realtor negotiates the price of the property, but they are not qualified or licensed to determine the value. Providing valuation services is the appraisal professional’s job. The appraisal professional provides checks and balances in the housing system, as the appraiser is entirely unrelated to the transaction and is not paid based on the amount of the valuation nor contingent on the closing of any loan.
Public trust is key in promoting the stability in the housing market. The continued reliance of unregulated aggregators and bifurcated products continues to erode the public trust at the expense of discarding the profession specifically intended to promote the public trust. How does this protect the public?
David Bunton from The Appraisal Foundation said it best in 2019: “The last thirty years were witness to federal agencies doing their best to circumvent using these trained professionals. Likewise, the government sponsored enterprises are taking on riskier practices that leave appraisal protections on the sidelines. Through exemptions, appraisal waivers, promoting evaluations in lieu of appraisals, and encouraging lenders to use unlicensed individuals, the federal financial institutions regulatory agencies estimate that a mere 10 to 15 percent of all mortgage transactions backed by the federal government and U.S. taxpayers are currently subject to the protections Congress enacted through Title XI. ”
Appraisers reflect the market; we do not create it. We observe, we verify through credible sources and analyze our data, and we report our findings in a manner that is meaningful and not misleading. We preserve the public trust inherent in appraisal practice by observing the highest standards of professional ethics. I will continue to look forward on this professional path, knowing that The Con will open the minds of those who were unaware of the con that is in place.