How U.S. Home Valuations Are Being Subverted

Sometimes when the hair on the back of your neck stands up, there’s a reason for it.

The nation’s $11 trillion mortgage market has been nationalized. This coup occurred in broad daylight and gradually. With Freddie and Fannie now in their second decade in federal conservatorship, the prospect that they will ever again be subjected to the watchful eye of shareholders is a pipedream. Their employees will continue to operate as de facto federal employees – but ones scarily outside the civil service constraints contained in Title 5 of the U.S. Code.

Fannie and Freddie’s status – neither government agency nor private corporation – is a peril to free enterprise and a peril to the U.S. economy. Their conservatorship has made them only more dangerous. They inhabit a Bizarro World where they can harness the coercive powers of government while enjoying the spoils of the private sector.

Wielding the full faith and credit of the U.S. government and subject to limited accountability, Freddie and Fannie have increasingly been targeted by technocrats, opportunists, disrupters and schemers. The best way to view these government-sponsored enterprises is as politburos.

a campaign to weaken or eliminate valuationsAt the crossroads of it all is a campaign by the fintechs, nonbank lenders, Realtors and homebuilders – the traditional allies of Fannie and Freddie – to weaken or eliminate valuations. It will eventually lead to a failure of the U.S. mortgage market and a drawn-out crisis of confidence as market participants come to identify the institutional corruption. Below are three ways residential appraisals, a critical guardrail for investors and taxpayers, are being subverted by malign interests.

Takeover of Obscure Publisher – A little-known 501(c)(3) controls a congressionally authorized monopoly as the officially recognized purveyor of national appraisal standards for federally backed mortgages. Those who track this unusual nonprofit publisher, known as the Appraisal Foundation, find it hard to imagine a scenario in which an organization could be more wasteful, more abusive or more influenced by special-interests. But they may need to think again. The fiefdom is run by a long-tenured chief executive and world citizen named David Bunton. His nonprofit sells the continually changing standards on a website to captive licensees, and then he and a group of favored trustees travel the globe on the nonprofit’s dime and host foreign delegations. (These types of bon-vivants could only exist in the Beltway.)

In a recent letter, a grievance organization called the National Fair Housing Alliance, which appears to view all fields of human endeavor through the narrow lens of race, along with nine similarly predisposed groups, correctly pronounced the Appraisal Foundation a “pay-to-play” operation. Kudos to them.

But the pay-to-play pronouncement hasn’t stopped a D.C. law firm with a social-justice bent, Relman Colfax, from providing the shadowy nonprofit with protective cover. Because appraisers have not paid close attention to what has been happening at this nonprofit over the years, it has become a juicy takeover target. There is much to loot – not least the $10.5 million in cash and publicly traded securities the 16-employee nonprofit reports in its 2020 IRS Form 990, the most recent filing available.

The money once belonged to captive licensees who have had to pay monopoly prices to purchase the foundation’s fluid standards and related products in order to learn their respective state laws and renew their state licenses. (Yes, in many states, the copyrighted standards represent binding state law.)

Expect greater distortions from Freddie and Fannie’s plodding and committee-driven foray into automated valuations.The nonprofit is now exploring ways it can set standards for automated valuation models. Scholars of the 2007-2008 financial crisis will recognize similar valuation models used by Fitch, Standard & Poor and Moody’s with disastrous results. During the lead-up to the crisis, the obtuse computer models had a habit of spitting out investment-grade ratings for junk-quality mortgage-backed securities. Last November, listing giant Zillow shut down its Zillow Offers business. It reported losing $880 million and taking a half-billion-dollar write-down on homes it owned as part of the venture. The reason for the failure? Zillow’s algorithmic-driven tech platform failed to adequately forecast changes in home prices. Expect greater distortions from Freddie and Fannie’s plodding and committee-driven foray into automated valuations.

The nonprofit publisher also shills for a special licensing wormhole dishonestly called “the Practical Application of Real Estate Appraisal.” This special dispensation allows lenders to simply purchase state appraiser licenses for their employees by signing them up for online classes and computer simulations with no on-the-job training required. The scheme promises the opposite of its name.

Going forward, expect special interests to have an outsized say in what the Appraisal Foundation does. With Bunton aging, the stage is now set for a Putsch with new cronies and bad actors taking over its board, since a majority of trustees will no longer have to be appraisers (though, truth be told, the latter restriction hardly prevented cronyism).

The bigger prize is the ability to change the standards by which nearly every piece of real estate in the nation is appraised for collateral-risk management and, in most states, as a basis for ad valorem taxation.

Mischief by Rogue Federal Entity – A tiny federal entity known by the tortuous name the Appraisal Subcommittee of the Federal Financial Institutions Examination Council has gone rogue. The obscure entity oversees what has become a slush fund. Like the nonprofit publisher, it uses its funding stream for gratuitous travel but also to create problems, or exacerbate existing problems, it can later be seen as “solving.” Call it a form of Munchausen’s Syndrome by Proxy.

The agency routinely violates its authorizing statute and the federal Administrative Procedure Act by failing to submit each new version of the publisher’s continually changing appraisal standards to a federal NPRM rulemaking. The agency then pressures state boards to enforce always the most recent version of the standards. Officials from the agency also regularly meet and deliberate behind closed doors with the publisher’s paid panelists. This puts it in open violation of the Federal Advisory Committee Act, but whatever.

Its budget skirts the congressional appropriations process, and that’s the heart of the problem. Its funding violates the Constitution’s Spending Clause. The Fifth Circuit ruled in a near-identical situation in Community Financial Services Association of America v. Consumer Financial Protection Bureau. Congress isn’t permitted to create mercenary agencies that are impervious to congressional appropriations and review.

Because there is no congressional oversight, the tiny agency was able to award $1 million to a Kentucky-based 501(c)(3) run by a man whose LinkedIn page identifies him as living in Bristol in the United Kingdom. The nonprofit’s website was recently changed, removing the man’s overseas telephone line. The group has been used as an intermediary to funnel money to still other organizations, such as the aforementioned National Fair Housing Alliance, for purposes related to justifying the existence of the federal entity. The agency’s authorizing statute only allows it to make grants to the Appraisal Foundation and to the states directly. It isn’t authorized to sprinkle money around to other groups.

For a decade, the tiny federal entity diverted grant money owed the states to the nonprofit publisher. The publisher then used the money to send state regulators on all-expense-paid trips to places like Tampa, Florida, to promote the use of its copyrighted standards at the state level.

The federal entity receives its sole funding from license renewal fees paid to the states by licensed appraisers. The states then forward a portion of the license renewal funds to the federal entity. Besides violating the Spending Clause, the use of state boards as a collection mechanism for a federal agency’s budget may also violate commandeering prohibitions in the U.S. Constitution’s 10th Amendment.

The rogue agency and the mischief it manufactures is a danger to trillions in collateral valuations.

Capture of Freddie and Fannie – The capture of Freddie and Fannie by the powerful interests of the lenders, homebuilders and Realtors has become a fait accompli. And it happened quickly, as if it had been war-gamed in advance.

In a matter of months, Fannie has eliminated critical checks and balances in an utterly radical experiment with the U.S. taxpayer and U.S. economy on the hook. The mortgage giant began scrapping or weakening long-accepted underwriting safeguards like FICO scoring, title insurance, mortgage insurance, downpayment requirements and appraisals.

Fannie is even encouraging a new form of the “liar loan.” It’s called “Value Acceptance.” It allows a collateral value to be pulled out of the ether by parties with a monetary interest in the loan’s successful closing. But don’t worry. Fannie checks the stated value against its algorithm – the equivalent of a “Zestimate.”

On March 10, Fannie Mae announced it had approved six vendors who will help the mortgage giant skirt appraisals in favor of algorithmic solutions similar to the one that cost Zillow’s investors a half-billion dollars.

But what of the risk all of this has created? Fannie has a plan for that, too. It has begun dumping the surplus risk into capital markets in the form of junk-rated credit default swaps it calls “CRTs.” Fannie has found itself propping up an over-the-counter marketplace for the synthetic derivatives. This was never part of Fannie or Freddie’s mission and will end badly.

Onlookers should not be optimistic about the corrective mechanisms of Freddie and Fannie’s regulator, the Federal Housing Finance Agency. This agency tends to blow with the political winds. The only actual regulator of Freddie and Fannie is the agency’s Inspector General’s Office, though the latter lacks the manpower to do the job of the regulator.

If the hairs on your neck stand straight up, there’s probably a good reason for it.