Dazzled by Wizardry, Federal Mortgage Regulators Ignore Zillow Debacle

Dazzled by Wizardry, Federal Mortgage Regulators Ignore Zillow Debacle. 

This rulemaking is one more sign that federal bureaucrats are all in on a whacky plan to use technical wizardry to tease out the value of individual properties across the country…

Secretary of Defense Robert McNamara was a committed technocrat. Under his direction, a team of policy advisors descended into the Pentagon’s cavernous basement in 1967. They fed punch cards into the basement’s IBM mainframe computers with everything that could be quantified about the Vietnam War. Numbers of ships, tanks, transport helicopters, gunships, fixed-wing aircraft, artillery, troop strength, machine guns, ammo. They queried the computers, “What year will we win in Vietnam?” They went away on a Friday and let the computers work on the problem all weekend. When they returned the following Monday, there was one card in the output tray. It said, “You won in 1965.”

While computing power might have “solved” the Vietnam War on paper, the results clearly didn’t square with reality.

Fast-forward to 2023. Six federal agencies are seeking public comment on a newly-proposed rule designed to “ensure” the credibility and integrity of computer models used in automated real estate valuations. This rulemaking is one more sign that federal bureaucrats are all in on a whacky plan to use technical wizardry to tease out the value of individual properties across the country. The wager? The nation’s $12 trillion residential mortgage market, much of which is now backstopped by the full faith and credit of the U.S. Treasury.

These algorithmic valuations replace trained human appraisers with knowledge of local real estate markets. The so-called “black box appraisals” rely on mathematical formulas and Big Data to produce an opinion of value. The problem? The models aren’t able to think like buyers and sellers. They don’t pick up design flaws, emotion-based style preferences, ambient noise levels, smells, street parking issues, market tastes, perceived quality of school districts and responsiveness of local government. It’s too much to ask of a machine.

Rohit Chopra, director of the Consumer Financial Protection Bureau, rightly sounded the alarm in a recent blog post – the models have the potential to do great harm.

The evidence is there for anyone wishing to look. In a disastrous bet made by Zillow – one in which the company staked its future on investing in residential real estate based on its own algorithms – the company lost $32 billion in market capitalization from February to November 2021. What did Zillow learn about its “Zestimates” when its own money was at stake?

Zillow, a company that gained popularity through its online listings, bet the farm on Zillow Offers, a home-flipping venture that relied on algorithms to identify homes the company would purchase. The plan was to make minor renovations and sell them off quickly for a profit. In a colossal about-face, after a write-down of half a billion dollars, the company announced the closure of the subsidiary, despite it being the primary source of revenue but not profitability. Zillow also reduced its workforce by approximately 2,000 employees, constituting a quarter of its staff.

The company disregarded internal concerns that its algorithms were causing it to overpay for homes, former and current employees told the Wall Street Journal in November 2021.

More than a decade earlier, in one of the first bombshells of the financial crisis, Standard and Poor’s Rating Services abruptly announced it was putting 612 mortgage-backed securities on “CreditWatch negative” and that it expected most to soon be downgraded because of high delinquency and foreclosure rates. Its algorithmic valuation model for the securities was known to spit out investment-grade ratings on junk-quality mortgage-backed securities, after which they could be purchased by pension funds.

Moody’s Investors Service, another purveyor of algorithmic valuations, quickly dropped a similar bombshell. It announced it would be downgrading 399 securities and placing an additional 32 securities on review for possible downgrade. Two days later, Fitch Ratings followed suit, signaling big problems with its own automated valuation models. Many of the once “investment grade” loans were in the portfolios of Wall Street players like Bear Stearns, Citigroup, JPMorgan, Merrill Lynch and Morgan Stanley. Others were held by public employee pension funds as far away as Norway.

In 2009, Calpers, the largest public pension fund in the United States, sued Moody’s, Standard & Poor’s and Fitch for assigning their highest ratings to securities that later suffered enormous losses. The suit would not be settled until 2015. This part of the crisis traces directly to the flawed automated valuations of homes whose mortgages were packaged up in the securities.

The rule now being proposed by six vast federal bureaucracies blithely assumes the holy grail is already in hand – the ability to quality-control imperfect algorithms that can never simulate the workings of a complex market involving millions of buyers and sellers. Until this holy grail is discovered, appraiser and podcaster Phil Crawford believes the automated models will introduce something he calls “data cancer” into the increasingly nationalized U.S. mortgage market. He defines “data cancer” as an echo-chamber effect arising from the proliferation, over time, of distorted values as they work their way into sales data, thereby buttressing ever-more distorted values.

“To paraphrase Hemingway’s quote on bankruptcy,” said Crawford, “the resulting crash will happen gradually, then suddenly.”

The agencies involved in the federal rulemaking include the Federal Housing Finance Agency; the Consumer Financial Protection Bureau; the National Credit Union Administration; the Federal Deposit Insurance Corporation; the U.S. Department of the Treasury; and the Federal Reserve System.

Swedish economist Assar Lindbeck famously called rent control “the most efficient technique presently known to destroy a city—except for bombing,” Were professor Lindbeck still alive, he might now have included the automated valuation of a city’s real estate.

Jeremy Bagott
Jeremy Bagott

Jeremy Bagott

Jeremy Bagott is a real estate appraiser and former newspaperman. His most recent book, “The Ichthyologist’s Guide to the Subprime Meltdown,” is a concise almanac that distills the cataclysmic financial crisis of 2007-2008 to its essence. This pithy guide to the upheaval includes essays, chronologies, roundups and key lists, weaving together the stories of the politics-infused Freddie and Fannie; the doomed Wall Street investment banks Lehman and Bear Stearns; the dereliction of duty by the Big Three credit-rating services; the mayhem caused by the shadowy nonbank lenders; and the massive government bailouts. It provides a rapid-fire succession of “ah-hah” moments as it lays out the meltdown, convulsion by convulsion.

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17 Responses

  1. Retired Appraiser Retired Appraiser says:

    One of the best articles I have read on valuation in the last ten years. Well worth reading and coupled with perfect timing!

  2. Baggins Baggins says:

    Excellent, another really great piece, thank you. Does the director of the CFPB read these blog pages? He just might… From the linked page, excerpt from the blog by Mr Chopra;

    ‘While machines crunching numbers might seem capable of taking human bias out of the equation, they can’t. Based on the data they are fed and the algorithms they use, automated models can embed the very human bias they are meant to correct. And the design and development of the models and algorithms can reflect the biases and blind spots of the developers. Indeed, automated valuation models can make bias harder to eradicate in home valuations because the algorithms used cloak the biased inputs and design in a false mantle of objectivity.’

    • The CFPB, FHFA, FRB and everyone else running this country enjoy playing Black Box Casino Games with tge $12 Trillion Residential Mortgage Market.

      • Avatar Spencer Paul says:

        When the tax payers keep paying their gambling debt, they don’t and won’t care.

      • Baggins Baggins says:

        The Federal Reserve. One hundred and ten years of not being federal, and not having any reserves. A private corporation whom creates money out of thin air, backed by nothing. Placing an entire country in a usury debt based currency system. The last jubilee was a mere decade ago, rolling around again soon. You and I will not be the beneficiaries. Bail ins, bail outs, prosperity through debt. The federal reserve seeks to devalue your currency 2%, year over year over year. Lately they’ve lot control of the projection.


      • Baggins Baggins says:

        READ THIS!

        This morning I was reviewing the AVM regulatory standards, fsb, open letter writing period.

        Please take the time to write a letter people.

        So far only one letter posted on their site, but the read is quite remarkable.

        What happens behind the scenes, how much people are additionally put at risk, when companies switch to only automatic valuation models instead of using licensed human appraisers. The comment writer states he was shocked. Absolutely, that is a surprising story. Ocwen related. It does not take a rocket scientist to figure out why a company set like altisource/ocwen would prefer to never have to deal with a licensed human appraiser, when managing the properties they have on their books. One less point of oversight is highly appealing to a company like that. As for the defrauded party in question, the migrant gardener, never stood a chance, toast, finished, all the money is gone. Their life savings vanished through a clever mechanism of stacking fees, transferring the note, and skipping the appraisal. Brought to you by the appraisal management industry. (second link for the comment.)



  3. Great post, agree 100%. So I clicked on the COMMENT link, did not see other than contact informatiion emails, where we can publically comment on this disaster. It looks like it has not been published yet in the Federal Register. Please advise if there is a place to comment that I may be missing.

    Do they never learn? Zillow disaster, AVM’s that have been a part of the landscape for decades which have proven over and over again that they FAIL unless you are dealing with Cookie Cutter homes. I am glad I do complex properties like Lakefront. There is no way in HELL you can use an AVM for those properties!

  4. Another great article about AVMs by Jeremy Bagott at Appraisers Blogs. AVMs are GIGO, i.e. Garbage In Garbage Out. In this case there is not enough pertinent information going into the formula. The Automated Valuation Models don’t consider some of the most important indicators of value because they don’t see the actual property. They don’t consider view which can add 5-50% of value. They don’t see condition, improvements, actual size, actual bed/bath count, view, specific location (next to a dump, strip club), lot type… These factors could change the value by over 50%. That much error is not acceptable in statistical analysis. AVMs don’t even know if the property exists. If the government backs loans based on flawed AVMs, it could cause a huge negative impact on our economy. I’m writing a comment letter and beg other appraisers to do the same. Post your letter online and share it.

    Anyone notice that the specific AMCs that the government will be using are the same ones that have been lobbying the government and kissing their ass in Zoom presentations and press releases?

  5. Avatar Bill Johnson says:

    I have a question for the Federal Mortgage Regulators. I’m doing an appraisal now where its been determined that the lot was not legally split, thus the county has confirmed its illegal. Being illegal, NO permits for development could have been or were ever issued! In short, and not to be confused with a separate encroachment issue on the same property, but tell me Mr. Government, how does Zillow support the purchase price when the entire home and lot are illegal?

    I’ve said it before and I will say it again, pick a percentage (10, 20, 50, 90%) and even if technology gets it right a certain amount of times out of 100, which part of that 100 is right? You need to have appraisers involved 100% of the time in an attempt to find the outlying issues.

    Relating to the issue I discovered, good luck to all parties involved and I hope your insurance is paid in full.

    Considering this discovery took a better part of a day to put together, to those of you who are coached to put together comps in under 60 seconds (if you want a raise), I also wish you luck.

    Seek the truth, as its common practice for other to ignore it, or never seek it.

  6. Avatar Spencer Paul says:

    The sad thing is, any whistle blowers in the industry are being ignored because the funds backing this half baked idea far exceeds any thought to stop it. I may have to pick another profession at some point in time when this all takes over, but I will keep up on the CE and have my license active, so when all of this fails and they return to the appraisal process. I’ll be ready.

  7. Baggins Baggins says:

    Corelogic accompanying program; Realist. This has an avm utility with an avm value confidence score and sell score. Realist tags us with a very high confidence score and very high sell score, and irrationally low value figures.  One wonders what technical relationships the algorithms prioritize which couple sell score to confidence factors. Is the low value number prioritized in order to present a higher sell score and higher confidence score? This avm program does not understand what a distressed seller is, or when to kick out skewed indicators. My neighbors home transferred a year ago off mls not arms length, via date of death probate, reflective of two+ years ago values. The avm picked this up from county records, still uses it as a valid market indicator in it’s twenty home comps set to this day. This skewed many local neighbors indicators downward.
    Systemic data deficiencies created by skewed avm figures is already a current ongoing issue for many home owners, but they are likely not aware of the exact details why. The issue is perpetuated by lackluster realty agents and appraisers whom rely on these avm tools. Damned right that’s a high sell score, as if my sf det home has a value of a townhome or condo. I suspect many agent uses the low avm indicator as a negotiation tool, thereby perpetuating the value disparity. 

  8. Avatar Bill Johnson says:

    What the powers that be don’t seem to understand or care about, is that when the robots get it wrong it’s not an isolated individual incident, but rather that error snowballs throughout the market. In San Diego where inventory is very tight (had an MC form today with 51 sales / and ONE active listing), and sales are down considerably, the repeat use is very high. Meaning, by way of A la mode peer sharing, its not unusual to find the same sale being used by appraisers 10, 20 or 30 times. Garbage in, equals garbage out.

    Seek the truth.

  9. Gregory Beck on Twitter Gregory Beck on Twitter says:

    One of the reasons after 24 years, I am calling it quits!

  10. Baggins Baggins says:

    Related. Better Mortgage is finally no more. Now moving to a London based acquisition company. They were paying the VA rates and using full service appraisal traditional ordering direct methods. However, they were also dealing with innovative approaches that were not tried and true on their creative financing and purchasing assistance side. They had this program where better actually bought the property for buyers, and then after closing would then extend financing to buyers, so the buyers could win out with what equated to a virtual all cash offer. And they had their own sales agents which was odd but appeared to be working. In the end, perhaps not so much. The model was rocking while it was live, they cut out the middle men and paid appraisers more than full fees. I was getting $950 for just the 1004 and a rental form. Going to miss this one for sure, too bad. That is what fees would look like for all of the appraisal community, if the appraisal management companies were not pilfering your paychecks.

    • Just had a meeting with Realtors yesterday at Berkshire Hathaway, who has their own lender company, with regard to PDC’s Value Acceptance, unregulated workforce coming to town. They were all shocked and they agree that Appraisers should not be left out of transaction. The lender was there and said this. I told him they are in the minority. Lenders want to save money, close loans and they just do not care! We are the only gatekeepers to the whole process and yet they want to rid themselves of us “killing deals”. Lender said that they should be counseling borrowers that if an Appraisal waiver is offered they should get their own Appraisal. I said you are the EXCEPTION not the rule. Lenders do not tell their borrowers this at all! I am so glad I am close to retirement and that 80% of my business is personal. Feel sorry for those stuck in this profession for many more years. It is hard to change course when you are years into this profession.

  11. Baggins Baggins says:

    This looks like a promising lender. Too bad they’re not in my state. The many new types of valuation services. There are many lenders out there whom are not necessarily on board with FNMA’s regulatory loophole for sale policies.



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Dazzled by Wizardry, Federal Mortgage Regulators Ignore Zillow Debacle

by Jeremy Bagott time to read: 4 min