Its all about appraisal pressure.
In Bloomberg News Appraisal Problem Opus by Sharon Lynch and Bob Ivry called Appraiser Exposes Toxic Debt Tie to Inflated Values
The article quotes Susan Wachter from Wharton Business School who states that mortgage appraisals are inflated by as much as 10%.
>…exaggerate U.S. mortgage values by as much as 10 percent, or $135 billion, in 2006, according to Susan Wachter, a real estate professor at the University of Pennsylvania’s Wharton School in Philadelphia. Such appraisals artificially inflated the value of collateral supporting mortgage-backed securities and are contributing to record foreclosures because borrowers end up owing more than their houses are worth.
The most important concept here is:
>”There has to be an appraiser who basically blesses the loan,” she said. “There are lenders who are deciding what terms to extend and then there are appraisers indicating it is appropriate or isn’t appropriate.”
When my appraisal firm reviewed appraisals done by other firms in my region of the years, I found +10% to be a reliable number and most often these appraisals done for mortgage brokers or appraisal management companies. The 10% factor was so consistent that we would refer to this caliber of appraisers as “Ten Percenters.”
We could see how easily appraisal reports could be tweaked by comp selection and adjustments made to result in the value needed to make the deal. The reports looked fine to people not familiar with the market. So now remove the local expertise from appraisal review process (which is what has been the ten year trend) and its a recipe for disaster.
Here’s what I said about the topic to Bloomberg.
>Lenders and mortgage brokers routinely pressured appraisers to boost values, said Jonathan Miller, a New York property appraiser for more than two decades who writes a blog about the problem [Soapbox]. Protections established by the Washington-based Appraisal Foundation, a non-profit that sets industry qualifications and standards, came under attack in the 1990s as banks cut their appraisal departments to save money, Miller said. The system was further corrupted when lenders began moving mortgage applications to third-party brokers who only got paid if a loan closed, he said.
>”There just became less and less emphasis on quality,” Miller said. “You started to see more and more loan products that would keep payments low, and I see that as correlating with appraisal pressure because those products only work in a rising market.”
As the underwriting pendulum swings to the more conservative end of the spectrum, “done deals” are on the decline. Most housing markets are not rising and appraisals are under more scrutiny by lenders [picture a video of a light bulb turning on] than seen in prior years, which is making deals harder to put together.