Before the champagne bottles could be uncorked by appraisers who felt vindicated by the potential agreement to be reached where Fannie Mae and Freddie Mac would agree to only buy loans from lenders who took some logical precautions on the valuation of the collateral (install the protections for competent appraisers, by creating firewalls), I think we all need to consider what the incentive for change their approach to lending would require, and its made me more skeptical after a good nights sleep.

Both GSE’s are likely to show reduced earnings throughout 2008 because of the rise in default rates. Their stock prices have fallen by more than half since last summer.

As of December, 2.2% of all prime mortgages were at least 60 days past due, up from 1.5% a year earlier, and the highest level since 1998, according to First American CoreLogic. More than one-fifth of subprime loans were 60 days or more past due. A check of delinquency rates for large, high-quality mortgages shows that “credit quality is now deteriorating sharply even for prime mortgages,” Morgan Stanley analyst Kenneth Posner wrote in a recent research note reiterating a negative outlook on Fannie. Delinquency and foreclosure rates for jumbo loans in December were more than double the previous January.

So if their don’t ask, don’t tell mentality still exists (avoiding focusing on the problem of realistically estimating the value of collateral pledged against mortgages by lenders), why would the GSEs want to place additional burdens on the lending industry right now which would slow down sales activity?

They need the flow of new mortgages through their pipeline to boost potential revenues don’t they? Investors seem to be more likely to buy conforming paper than jumbo paper these days but as new problems come to light, that sense of safety with the GSE’s could vanish too.

I suspect that NY AG Cuomo is going to have to play hard ball to get this deal done with Fannie and Freddie. His office has been impressive on this front and gets what the problem. From the news coverage yesterday, it sounds like negotiations have been ongoing for a long time (probably due to their scope of suggested change) and there will be future litigation if it doesn’t happen.

There probably needs to be the same actions from other state AG offices to turn this ship around. AG’s in Ohio, Colorado, Massachusetts and Georgia have been particularly active on dealing with the appraisal situation but not in the national context like New York has.

If investors can’t feel comfortable with appraised values as they relate to mortgages, the perceived risk level goes off the chart. Let’s start dealing with common sense and reality and break away from past practices. If an appraiser can’t perform their valuation without pressure to hit the needed number, the credit markets are not going to get comfortable with the risk/value relationship in mortgage lending.

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