Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. In this post, applies a caffeine-induced response to the issue of “undue stimulus”.
…Jonathan Miller

How many of us who think we can quote the definition of “market value” remember that it includes the phrase, “and assuming the price is not affected by undue stimulus”? As appraisers, were we, the past several years, reporting values or were we reporting “prices” generated by a frenzied market? The repercussions from the subprime implosion that has affected the credit markets for even standardized commercial real estate transactions should make us pause to take stock.

Data reported in the 2006 annual report of “Inside Mortgage Finance, Mortgage Market Statistical Annual, Top Subprime Mortgage Market Players & Key Data” revealed some startling statistics on the run-up in subprime mortgages and their Siamese twin mortgage backed securities. The magnitude of the subprime market can be readily understood by the following parameters.

* Between 2001-2003 subprime mortgage dollar value ranged from $190-$335 billion and comprised 8.5% of all mortgage origination value. Between 2004-2006 subprime dollar value increased to $600 billion (peaking at $625 billion in 2005) or 20% of total mortgage origination value.
* In 2001 the dollar value of subprime securitizations amounted to $95 billion which peaked at $507 billion in 2005 and leveled off at $483 billion in 2006. This represented an increase in subprime securitization value market share from 50% in 2001 to 80% in just 5 years.

To bring this into a more comprehensible perspective, Merrill Lynch’s participation in this frenzy cost their stockholders a $7.9 billion writedown and their CEO, Stan O’Neal his job. And so the question is: was the run up in the housing market attributable to “undue stimulus”, or the low interest environment that spawned the subprime world?

I have always been a firm believer in letting the facts speak for themselves when it comes to reporting the sales market but I have also been a firm believer that market value does not sit off by itself when it comes to mortgage or bond underwriting. Nothing lasts forever including the value of a property and that’s why appraisals always have a date of value. Understanding the dynamics of the market, we know that all cycles must come to an end-the question is when?

Concluding to and reporting market value is only one part of the equation when it comes to securitization and in the final analysis the buyer of CDO or CMBS bonds had better heed the Latin saying “caveat emptor” and if they do not understand Latin at least read the prospectus that accompanies the offering. High yields come with high risk and nobody should be shedding tears for the investors holding these bonds but the clueless homeowners who are at risk of foreclosure are another story.

Yes, it was “undue stimulus” caused by the easy or no credit history verification chicanery on the part of the originators that hoodwinked many innocent single family borrowers and fed a voracious market that could not gobble up the volume of loans fast enough to securitize and sell to investors who thought the cycle would go on ad infinitum. No appraiser worth his three approaches could have stood in the breach and claimed, “no this frenzy is not market value-it is undue stimulus”. The only ones able to do this would have been the underwriters and rating agencies who could have said that their experience on subprime loan failure rates was insufficient to assess the true risk and thus they would have to build in a higher premium to account for this. But this would have cut into their business model and it obviously would not have been managing their customer’s expectations.

One final thought. The losses on Wall Street so far for the subprime debacle have totaled $27 billion which is about $10 billion shy of the 2006 year end Wall Street bonus outlay. I haven’t heard the bondholders asking for disgorgement which just proves that everyone should master Latin.