Matrix Blog

Every so often I include a guest post that stands out. It was written by my friend and colleague Constantine A. Valhouli, the co-founder and Director of Research for NeighborhoodX. I hope you enjoy it.

How racist and misguided planning put America in its housing crunch

How racist and misguided planning put America in its housing crunch.

Detail of Edward Hopper, “From Williamsburg Bridge”

Constantine A. Valhouli   |   August 15, 2017 12:31 PM

Real estate markets are cyclical, and prices appear to be near the peak of this cycle. But prices have not risen evenly across U.S. real estate markets. The biggest gains have been concentrated in the major cities, and often concentrated to a few neighborhoods within those cities. That said, the housing prices in these cities have largely outperformed the towns around them, and have risen significantly faster than most of the commuter suburbs.

However, what is happening right now – a sustained rise in city real estate prices – may not be a part of the regular real estate cycle.

Instead, the two-decade long rise of housing prices in some city neighborhoods may be driven in part by the gradual correction of effects from the misguided and racist urban planning policies like redlining and racist covenants. In these neighborhoods, prices for historic housing stock are pulling closer in line with those for adjacent neighborhoods.

In addition, neighborhoods hit hard by redlining retain their historic architecture and have one path to recovery. The neighborhoods affected by urban renewal have a different path to recovery – one driven by new development, where the upside goes to developers rather than to individual owners.

A Boston neighborhood that was under radar in 2000 is now asking up to $900/sq.ft. 65 Lewis St. in East Boston via RedFin

The diverging housing prices of cities and suburbs

To use Boston as an example, between 2000 and 2015, prices per square foot rose 12-185% depending on the neighborhood. A prime neighborhood like Back Bay increased 131%. But the biggest gains went to city neighborhoods that had been under the radar in 2000: South Boston (+185%) and East Boston (+152%). By contrast, housing prices in the surrounding towns increased much more modestly, and the commuter towns increased only marginally by comparison.

This pattern has played out in other major cities, too.

“The gains seemed to be driven by some combination of proximity to core neighborhoods, transportation hubs and a housing stock conducive to conversion,” said Jonathan Miller of Miller Samuel.

In addition, one of the reasons for the dramatic price increases in neighborhoods like South Boston and East Boston is that the starting points were so low. For a neighborhood where the average price is, for example, $200 per square foot, an increase of $100/sq.ft. represents a 50% increase. On the other hand, for an established neighborhood with an average price of $800/sq.ft., an increase of $200/sq.ft. only represents a 25% increase.

On one hand, the real estate data tell a story of diverging paths of major cities and suburbs: how cities could become considerably more affluent across neighborhoods, and how both poverty and the middle class might be pushed to the suburbs.

Above all, this data offers a chance to examine the urban planning and policy decisions that contributed to the decline of city real estate prices decades ago and simultaneously propped up the prices in the suburbs – and how these trends have been gradually reversing. But why?

Perhaps what we have been seeing isn’t a dramatic rise in housing prices so much as a return to the intrinsic value of historic neighborhoods that had once been desirable places, before poor planning and policy decisions artificially reduced their value.

If this is the case, then housing prices in major cities may continue to rise much higher and faster than those in the suburbs.

Levittown was the archetypal model for post-World War II suburban development – including the shameful racial covenants restricting sales to whites only.

Did policies like redlining and urban renewal depress values in parts of cities – and subsidize values in some suburbs?

In order to understand why housing prices may rise further in these cities and comparatively lag in the suburbs, it is important to first understand the adverse effects that misguided urban planning policies had on cities from the 1950s to the 1970s. Specifically, how redlining, racially-restrictive covenants, and urban renewal affected neighborhood housing prices for decades – and what this means for us today.

Until World War II, American cities resembled European ones in that wealth was largely concentrated in the urban core. However, in the decades after World War II, the United States pursued policies that in hindsight were both misguided and racist – but which centrifuged affluence outwards and concentrated poverty in certain city neighborhoods.

Collectively, these policies blighted many city neighborhoods and simultaneously acted as a subsidy for the suburbs. More importantly, these policies served as what economists call ‘market distortions’ by artificially depressing prices in some neighborhoods of major cities, and boosted prices in some suburbs. These price distortions partially set the stage for the real estate bargains of the 1980s and 90s, as well as the meteoric rise of property values since then – not to mention the important questions over gentrification and displacement we’re facing today.

But these policies affected neighborhoods in different ways – and this in turn affects how (or even if) the neighborhoods will recover their intrinsic value. Looking at Los Angeles, New York, and Boston, some historic neighborhoods affected by redlining seem to have recovered far earlier than neighborhoods that were reshaped by urban renewal.

Let’s examine these policies. Restrictive covenants were clauses in the bylaws or deeds of a building or housing development which prohibited the sale of the property to minority or Jewish buyers. These clauses were also used to preserve the whiteness of many suburbs. At the same time, at the federal level, banks were encouraged to pursue a policy of redlining that made it almost impossible to get a loan in a city neighborhood that was too racially diverse, because it was deemed ‘too risky.’ There was literally a red line drawn around certain neighborhoods on a map, and no loans were made within this area. The policy was, at its core, segregation.

Lastly, urban renewal was a euphemism for the wholesale demolition of historic downtown neighborhoods. For the affected neighborhoods, urban renewal resulted in permanent and unwelcome change. Historic houses were replaced by dense housing projects and the street grid was often de-mapped for de-humanizing megablocks – and both of these planning strategies have been since discredited. Adding insult to injury, highways were often run through these neighborhoods – causing air and noise pollution, as well as higher asthma rates for generations of poorer residents.

In many ways, this clash of ideologies was symbolized by the confrontation between visionary urbanist Jane Jacobs and misguided and racist planner Robert Moses. Jacobs valued neighborhoods and a bottom-up approach to planning, one that involved the residents of a place. Her Death and Life of American Cities offered a scathing and well-reasoned critique of Moses’ city-scale, top-down, and racist urban planning. For example, in order to restrict minority access to the suburban beaches, Moses intentionally designed the bridges too low to permit buses, thus restricting the beaches to the mostly white, affluent families who could afford a car.

For decades, these policies distorted the living conditions and real estate prices for entire neighborhoods. Furthermore, by creating concentrations of poverty, they caused ripple effects that were felt for years.

In a formerly redlined neighborhood like Crown Heights, architecture like this helps spur revival. | 982 Sterling Place via Corcoran

Did redlining and urban renewal affect housing prices differently?

Today, the central question is whether city neighborhoods affected by redlining are reviving differently from those affected by significant urban renewal.

In the last two real estate cycles, prices in many of these city neighborhoods have been rising. Perhaps what we’re seeing now isn’t speculation or gentrification, but simply a return of many neighborhoods to their inherent value as they repair the damage from these misguided policy decisions – at least the neighborhoods that are able to do so.

Redlining generally did not affect the architectural fabric. Redlining led to disinvestment, but most of this neglect can be fairly easily repaired. Neighborhoods that remained architecturally intact are likely to see housing prices improve for the existing buildings. By contrast, the damage done by urban renewal is often so significant that it renders the land more valuable than the buildings.

Redlining and racial covenants temporarily affected living conditions but not the underlying architectural fabric. As a result, the neighborhood may have desirable historic buildings which can be purchased for a fraction of the price of other, more established neighborhoods nearby. In New York City, this was the pattern seen in the revival of Brooklyn Heights and Park Slope, and more recently in Crown Heights and Bedford-Stuyvesant.

But at the time, and for decades later, these policies enforced segregation and created economic ghettos. This in turn created other problems which changed the daily experience of living in the neighborhood.

For example, in a healthy city neighborhood, street-level retail commands a significantly higher price per square foot compared to residential space. However, the concentration of poverty and the lack of disposable income caused landlords in these neighborhoods to convert valuable retail spaces into makeshift apartments. In turn, the lack of retail made the streets less lively and more dangerous, creating further downward pressure on housing prices. At the time, properties near certain city parks were regarded as less valuable because the parks were so dangerous. In a healthy real estate market, these properties should command a higher price for the park views and access.

As a result of the effects of these policies, many city neighborhoods regressed from neighborhoods of choice (places where people aspired to live) to neighborhoods of necessity (places where people lived only because they could not afford to live elsewhere).

However, many neighborhoods affected by redlining and disinvestment retain the qualities which have made them inherently desirable. People are drawn to traditional, walkable neighborhoods with attractive historic housing and a potentially lively mix of uses at street level. While these core qualities that were devalued during the mid to late 20th century, thoughtful urban planners are trying to encourage the development and restoration of these neighborhoods today.

Neighborhoods hit hard by urban renewal require institutional-level investment to recover. | Brush Park, courtesy of City of Detroit

Neighborhoods hit hard by urban renewal have a different path to recovery

On the other hands, neighborhoods affected by urban renewal have a different – and more difficult – road to recovery.

The planners of the 1950s-70s demolished the very historic buildings and walkable, human-scale streets that have helped other traditional neighborhoods revive. These lost buildings would have been a natural catalyst for the neighborhood’s revival, and would have needed only a comparatively modest investment to do so. Instead, these neighborhoods were destroyed by institutional-scale planning and will require institutional-scale investment to revive. These neighborhoods will likely never recover their previous charm, but it is possible – with tremendous vision and care – to transform them into something new and desirable.

The historic neighborhoods which escaped urban renewal offer a glimpse of where prices might have been if other, comparable neighborhoods had remained intact.

In the 1960s, planners would begin the urban renewal process by designating certain neighborhoods as ‘slums’ as a pretext for the need for demolition. The neighborhoods which successfully fought the slum designation, like the West Village in Manhattan and the North End in Boston, are today among the most valuable neighborhoods in their respective cities.

In an effort to spur demolition, Robert Moses declared Greenwich Village ‘blighted’ and a ‘slum.’ The existing buildings now command some of the highest prices for Manhattan real estate.

However, whereas the upside in intact historic neighborhoods goes to individual homeowners, the potential housing gains in a neighborhood leveled by urban renewal are often driven by the land value and rezonings that benefit developers rather the homeowners.

The neighborhoods hit hard by, or entirely demolished by, urban renewal were positioned as development opportunities at the time. But it took decades for that land to become a compelling opportunity for development. The same policies which demolished these neighborhoods encouraged residents to leave for the suburbs, making that urban land less valuable. Ironically, the development opportunities did not become truly compelling until, ironically, the nearby intact neighborhoods recovered in an organic manner.

Comparatively stagnant housing prices in the suburbs

There is a significant contrast between the rise in housing prices of the major cities since 2000, with the comparative stagnation of the suburban housing prices during the same period. According to Jonathan Miller, “Suburban counties outside of New York City have underperformed Manhattan price trends since 2000. For example, Westchester County housing prices increased 62.7% from 2000 to 2015, trailing Manhattan which more than doubled. And no towns in Westchester experienced four-fold gains observed in some Manhattan neighborhoods.”

The same policies that damaged housing values in cities also artificially boosted values in many post-war suburbs. And just as housing prices in certain urban neighborhoods are rising as the price-distorting effects of these racist policies wears off, housing prices in some suburbs may be returning to their intrinsic, lower levels.

The phrase “white flight” is often used to describe the shift in preference from city to suburb after World War II, but the phrase doesn’t convey the nuances of how things actually happened. There were massive systemic mechanisms in place that made it difficult for white buyers to purchase in walkable city neighborhoods that were diverse, partially in order to drive demand for the new suburbs that were being developed as a result of the highway system.

The current shift in preferences from suburb to city is driven in part by the recognition that many suburbs have inherent drawbacks: long commutes as well as a lack of walkability, restaurants, nightlife and a sense of community. For years, redlining steered white buyers to the suburbs by prohibiting them from purchasing in diverse, urban neighborhoods. This stimulated demand for what might have otherwise been a less desirable alternative. The stagnation of suburban prices since 2000, particularly in contrast to the increase in value of walkable city neighborhoods, reflects that for many buyers, the decision to live in the suburbs is one of economic necessity rather than choice.

The diverging housing values of the cities and the suburbs raise some important questions.

Going forward, what are the implications for residents of the suburbs and commuter towns? Will they be able to sell their place in the suburbs and buy into the city, thus tapping into the opportunities for upward mobility through better education and job opportunities?

Certain suburbs may fall victim to the same misguided and racist practices which affected less-affluent city neighborhoods during this time.

Under these policies, city neighborhoods that lacked political clout became the site for contentious projects, including infrastructure (incinerators, municipal dumps, trash transfer stations, and wastewater treatment plants) as well as concentrations of public housing.

In New York City, sections of the Rockaway peninsula, a former beach resort, were demolished for a massive low-income housing complex. The area was wholly unsuited to public housing, given an hour-long commute to midtown and the lack of job opportunities nearby. Decades later, that section of the Rockaways has the highest concentration of poverty, the lowest-income census tracts, and among the highest rates of violence in New York City.

As major cities become more desirable and more affluent overall, poverty and the working class are being pushed out to the suburbs. And as certain suburbs become poorer and less able to organize effectively, they may find themselves in the same position as the Rockaways.

For example, when Rudolph Giuliani served as mayor of New York City, he externalized the issue of homelessness to the suburbs by offering one-way tickets for the city’s homeless to Brideport, Connecticut. He did not address the issue in a meaningful way, he simply created conditions that led to a sharp rise in poverty, violence, and a need for social services in Bridgeport.

Conclusion

The diverging price trajectories of cities and suburbs could become a major issue. Cities appear to be recovering their intrinsic value, and are becoming more expensive, even in outlying neighborhoods. At the same time, suburbs are falling behind in value and desirability. What was once a sign of the American Dream is now a neighborhood of necessity rather than one of choice.

But for those who live in the suburbs and are hoping that a market correction may provide an opportunity to sell there and buy in the city, this may not necessarily be good news. [if the suburbs have been this stagnant in price during a strong market, what will happen when the markets correct as they inevitably will]

Going forward, what are the implications for residents of the suburbs and commuter towns? As prices diverge, selling a 2,000 square foot house in the suburbs might only buy a one bedroom apartment in the city. It may be increasingly difficult for those in the suburbs to access opportunities for upward mobility through better education and job opportunities found in cities.

It is difficult to judge decisions of another era by the standards of our own. But the racism that underscored redlining and much urban renewal created a shameful legacy of economic, social, and health repercussions that we are still struggling to understand and address today.

Constantine A. Valhouli is the co-founder and Director of Research for NeighborhoodX.

Tags: Redlining and Predatory Lending, Constantine Valhouli, restrictive covenants, racism

1 Comment

This post was also presented on Matrix.

Back in September 2007, US Senator Dodd from my home state of Connecticut submitted what appears to be hastily conceived legislation to solve the mortgage crisis in response to the prior month’s credit market meltdown. I believe it was created to address subprime lending, but because it was so loosely presented, it casts a wide blanket over the lending process to little effect and likely causes more problems because it embraces conventional wisdom rather than actual practices. As far as appraisals go, it clearly doesn’t recognize the fundamental problems that New York AG Cuomo has already recognized.

The appraisal related language in the bill is sloppy and contains slang, suggesting that someone with little experience drafted it or the the bill was not understood by the Senator. I am very disappointed. It found co-sponsors because it contains buzzwords like “appraiser”, “mortgage” and “meltdown”.

In fact, the language of the bill was so vague and misdirected (the appraisal part) that most appraisers never took it seriously, instead focusing on efforts by Senator Frank and NY AG Cuomo. However, it still has life and is being taken seriously.

The bill is now in the Banking, Housing and Urban Affairs Committee.

I think Senator Dodd’s introduction of the concept of bonding was to incentivize the appraiser to do good by having “skin in the game” but it does nothing to solve the current lending problem. Is this the best that can be done by Congress? It’s damaging to the lending industry and poorly written and thought out, and in my opinion, it allows Congress to say this takes care of the problem, when in fact, it makes it worse.

Here is the appraisal-related content summary provided by Senator Dodd’s web site.

V. Require good faith and fair dealing in appraisals.
– Prohibit pressure from being brought to bear on appraisers.
– Hold lenders liable for appraisals to avoid the appraisal problems created in the current climate.

Here’s the actual language of the appraisal related portion of the bill:

Title IV Good Faith and Fair Dealing In Appraisals

Requirements for Appraisers

• Appraisers owe a duty of good faith and fair dealing to borrowers.

My comment: Generic boilerplate that probably needs to be said. On that note I propose legislation that government officials never abuse their power, the public shouldn’t commit crimes and all school kids show do their homework. In other words, its an ideal, but it has nothing to do with addressing the core systemic problem – remove the possibility of collusion from the process.

• No lender may encourage or influence an appraiser to “hit” a certain value in connection with making a home loan. In addition, a lender may not seek to influence an appraisers work, nor select an appraiser on the basis of an expectation that he or she will appraise a property at a high enough value to facilitate a home loan.

My comment: They actually use the word “hit” in the legislation. Who wrote this? How is a lender prevented from attempting to “seek to influence an appraisers work.” These are just words.

• A crucial cause of the current mortgage meltdown has been inflated appraisals. Many ethical appraisers complain that lenders will only use appraisers who consistently value properties at the levels necessary to allow the loan to close. Appraisers who do not cooperate simply do not get hired. This is particularly detrimental to the homeowner because it leads the homeowner to believe he or she has equity where little or none may exist.

Comment: “A crucial cause” implies appraisers initiated the problem. Wrong. They were the enabler of the lenders and the bad ones were rewarded for unethical practice. They actually use the word “meltdown” in this bill? This paragraph also infers that good appraisals are always low. You can say stuff like this all day long but that doesn’t stop it from happening.

• Appraisers must obtain bonds equal to one percent of the value of the homes appraised.

Comment: “How do the costs of the bonding enter into this? I am not familiar with getting bonded I assume that means appraisers would file for a bond with a predetermined amount so we get enough coverage. That violates federal licensing law (USPAP). This does nothing to fix systemic fraud and burdens the appraisers that do the right thing with additional costs. How does it keep a bad appraiser from doing bad work? They charge the bond costs to their unwitting (or not) clients and it’s no skin off their back. Good grief.

• Remedies available to borrowers

— Lenders must adjust outstanding mortgages where appraisals exceeded true market value by 10 percent or more.

Comment: Can you imagine the litigation costs that would result if this passes? Who determines whether the value is off by more than 10%? Another appraiser who is hired by the homeowner? An AMC? A real estate broker? Zillow? A lender using an Automated Valuation Model? What is “True” market value? Is this a new definition of market value and all other forms like “Fair” used by GAAP are “False”? I find it hard not to say the word “true” in this application without sounding sarcastic.

— When an appraisal exceeds market value by 10 percent (plus or minus 2 percent) or more, a borrower has a cause of action against the lender. A consumer who is awarded remedies under this section shall collect from the appraiser’s bond.

Comment: Can you imagine the the costs that will be endured by the consumer? I understand that bonding costs for the typical appraiser would be $10,000 to $40,000 per year (per appraiser). For what? Appraising is already a razor thin margin business. Two things are going to happen: appraisal services are going to probably double, and many good appraisers will be forced out of business.

— Actual and statutory damages up to $5,000.

Comment:The further destabilization of the lending industry is worth $5k?

Here are the Senators who think this is a good idea:

Sponsored by Christopher Dodd(D-Ct), with co-sponsors: Sen. Daniel Akaka [D-HI]
Sen. Barbara Boxer [D-CA]
Sen. Sherrod Brown [D-OH]
Sen. Robert Casey [D-PA]
Sen. Hillary Clinton [D-NY]
Sen. Richard Durbin [D-IL]
Sen. Dianne Feinstein [D-CA]
Sen. Thomas Harkin [D-IA]
Sen. Edward Kennedy [D-MA]
Sen. John Kerry [D-MA]
Sen. Amy Klobuchar [D-MN]
Sen. Frank Lautenberg [D-NJ]
Sen. Claire McCaskill [D-MO]
Sen. Robert Menéndez [D-NJ]
Sen. Barbara Mikulski [D-MD]
Sen. Barack Obama [D-IL]
Sen. John Reed [D-RI]
Sen. Charles Schumer [D-NY]
Sen. Sheldon Whitehouse [D-RI]

I’ll bet if the situation was explained to the Senators with clarity, they would have issues with the bill as written. Time is of the essence, but the solution needs to solve the problem. The problem is about self-dealing and allaying investor’s concerns with the products they are purchasing.

Tags: Zillow, Soapbox Blog, Appraisal Process, Redlining and Predatory Lending, USPAP

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Here is an appraisal-related post on our other blog Matrix: Molasses Primer: The Subtext on Subprime that discusses Fed Chair Bernanke’s muted reaction to the subprime lending problem.

Tags: Soapbox Blog, Appraisal Pressure, Mortgage Fraud, Redlining and Predatory Lending

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Sounding Bored is my semi-regular column on the state of the appraisal profession. This week, all the pressure venting starts to get the word out.

For the past 5 years I have watched the appraisal profession go through a pretty dramatic change, most of it bad, accelerated by the housing boom. In 2005, I decided to beginning blogging about it to try to get the word out because going through normal channels (ie appraisal organizations and politics) didn’t seem to be effective enough, plus, I had no idea how to do any of that.

So I simply said what was on my mind in this blog, and later on, got others to join me. These include appraisers and former appraisers that I have met during my career including Chip Wagner from Chicago, my commercial appraisal business partner John Cicero, Marty Tessler from New York City, Butch Hicks from Virginia, John Mason from suburban New York and Todd Huttunen from suburban New York.

The subprime mortgage market woes expose the problems we have been discussing for years. Two articles were released this week that are starting to shed light on the situation. These authors got our attention through Soapbox and my other blog Matrix.

“Drive to make deals fuels mortgage woes” by Holden Lewis of Bankrate.com who writes an excellent blog called “Mortgage Matters“

“In the current real estate market, an accurate appraisal is more important than ever” by Carol Lloyd of the San Francisco Chronicle who writes a must-read weekly column “Surreal Real Estate“

The subprime lending woes we are all reading about illustrated the problems all of us have been shouting about in this blog and on a personal level for the past several years if not more.

• Competent appraisers are being replaced by form-fillers and 10-percenters.
  
• The lending industry structure has evolved into a flawed system where those on commission determine which appraiser gets the work.
  
• The appraisal industry is being commoditized into the equivalent of a title search or flood zone certification rather than a professional analysis.
  
• Appraisal licensing, while a good idea overall, has legitimized a legion of hacks and given the good ones a bad name.
  
• The lack of political clout for the industry has made appraisers the poster child for all that is wrong with lending (aka mortgage fraud).
  
• Lending institutions don’t understand the value of their collateral, affecting compliance with bank reserve requirements by federal regulators.
• Mortgage portfolio pricing in many cases is grossly inaccurate, because the secondary mortgage market investors don’t realize nor have access to accurate collateral valuation.

Let’s hope there is more coverage of this specific issue in the future.

Tags: Soapbox Blog, Appraisal Pressure, Appraisal Process, Mortgage Fraud, Redlining and Predatory Lending, Jonathan Miller

1 Comment

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. This week, Marty explains the smoke and mirror lending process.
…Jonathan Miller

My original commitment to authoring Fee Simplistic was that it would only be written when commentary would be warranted by current events in the real estate market. And so the imploding of the sub-prime mortgage world on investors and the fallout of lenders and borrowers going into default makes it seem that the mortgage market is caving in.

The term “sub-prime” connotes a loan that is related to prime when never the twain ever met or will meet. Reading the individual anecdotes of some of these sub-prime borrowers reflect histories of people who would score exceedingly low in credit ratings; were either fraudulent in reporting income or else their broker was fraudulent in reporting on the borrower’s income and assets; executed sales contracts that had excessive sales prices where the buyer would get a kickback and use the proceeds to pay his first few mortgage payments and/or split some with the seller or broker; and finally broker “sweet talk” lulling the borrower into refinancing where mortgage payments would eventually end up higher than what was previously paid. So what prevailed was a sub-prime lending world comprised of smoke and mirrors if not outright chicanery.

This time, instead of Uncle Sam having to step in with the establishment of an RTC to keep the banking system afloat it appears that the only ones being hurt are those investors who played the high risk game of buying the bonds of the sub-prime CDO’s that were issued by Wall Street. The “invisible hand” of the marketplace so aptly described by Adam Smith is at work in culling out the bad from the good and the risky investment from the prudent one. High risk and high yield vs. low risk and low yield have always governed the marketplace and now is no exception.

It is not a far stretch to remember the principles most of us were brought up on by our parents:

* Don’t play with the bad kids, you’ll get hurt
* Don’t skate on thin ice
* It may look good now but it may give you an upset stomach later
* If it looks too good to be true it probably isn’t
* What makes you think you can get away with it?

And for those who know their Latin
* Caveat Emptor

Tags: Soapbox Blog, Martin Tessler, Appraisal Process, Mortgage Fraud, Redlining and Predatory Lending, Fee Simplistic

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This recent editorial Tough action needed to stop the deceit [KC Star] illustrates how far gone the appraisal industry is. Betrayal of public trust is something that you can’t undo very easily. The sad thing is that its not an easy fix.

Although we are responsible for the lion’s share of the problems, don’t heap it all on the appraisers because thats incredibly simplistic. Its like telling someone who is overweight “Well, just eat right.”

Here’s a recap of the problems with the appraisal industry today:

• The lobbying efforts of the lending industry and the GSE’s to reduce costs and reduce the appraisal report to a commodity. Faster turn times and lower fees all that seems to matter since thats all that can be readily measured.

• The government solution to this problem was to create licensing and pile on the requirements yet appraisal fraud is seemingly as rampant as during pre-licensing (pre-1991). Enforcement non-existent because of lack of resources and is largely a clerical function. In fact, a portion of licensing fees in many states are re-directed to other departments in the government.

• The appraisal organizations have been largely out of touch with the needs of residential appraisers for decades and have had a limited lobbying role in Washington. This is evidenced by the large drop in membership since licensing. If their services were essential to the appraisal industry prior to licensing, then this would not have occured. Self-policing has not been effective and was largely the impetus for licensing in the first place.

• Appraisers do share in the blame however, and in a very big way. As an industry, we have been unprofessional in the sense that our loyalty can be sold in exchange for volume. Many of the remaining appraisers that are competent and ethical are leaving the business, which is an incredible loss of a significant intellectual resource to the lending community.

We’re the only profession where you are begged to be dishonest.

AVM’s have already replaced appraisers in home equity lending and there is talk about testing it for first mortgages. However, AVM’s are well-known to be inaccurate and are not the panacea for responsible lending.

It doesn’t have to be this way. In some ways, a correction of the housing market will remove much of the fly-by-night elements of the lending industry.

The solution? Its not as the editorial suggests: Curbing the problem will require a change of culture within the industry itself, as well as a tougher regulatory climate and stricter licensing laws. Also needed: more rapid response by professional boards to complaints. These suggestions are simply window dressing and demonstrates the lack of understanding as to the real issues (which is one of the problems of righting this ship):

• Protect the appraiser from the sales function of the lending process. This needs to be done with banks, mortgage bankers and especially mortgage brokers. In other words, build a clear and succinct wall between the sales and underwriting functions and the appraiser sits on the underwriting side.

• Create some sort of mediation board of review within each state that is legally binding. Make the appraiser professionally liable for fraud and negligience but at the same time, allow them to protect themselves against unfair accusations. Provide a practical process for lenders and appraisers to submit suspect appraisers for review but protect the appraiser from frivolous actions.

Until these two issues are dealt with directly, there will be no change in the status quo and eventually, the profession, as it relates to lending, will be obsolete. This will not be because of competition from technology, but because of the lack of trust by the lending community.

Lets rebuild ourselves into an industry of appraisers and lose the “form-filler” moniker.

Tags: Soapbox Blog, Appraisal Pressure, Appraisal Process, Mortgage Fraud, Redlining and Predatory Lending

Comments Off on When Machines Take Over The Earth, Or At Least The Appraisals

John Philip Mason is a residential appraiser with 20 years experience and covers the Hudson Valley region of New York. He’s a good friend and a true professional who provides unique insight to appraisal issues of the day. Here is his weekly post called Solid Masonry. Jonathan Miller

“Ameriquest Mortgage Co.’s recent $325 million lawsuit settlement with 49 state governments suggests all isn’t well in [the] home-loan industry.” But if you read between the lines, it may also not be well for the venders who service these lenders.

As indicated in the recent article Cleaning Up Subprime Mortgages [Boston Herald] it becomes all too clear just how far some members of the lending industry might have to go to make things right. And the sad truth is Ameriquest isn’t alone. While Ameriquest denies any wrongdoing, the settlement attempts to correct numerous issues concerning the application, processing and settlement of mortgages.

For one thing Ameriquest has agreed loan officers must also provide good-faith estimates of closing costs in a timely manner – and can’t “disparage, discredit or otherwise encourage (borrowers) to disregard” these figures.” In short, Ameriquest will have to adhere to the estimates they provide. It’s well known throughout the lending industry that some banks and mortgage brokers understate the good-faith estimates when borrowers are applying for loans. The technique steers borrowers away from honest lenders who are unwilling to play the “bait and switch game”. Some individuals claim these fraudulent estimates represented less than half the funds needed to close the loan. In addition, lowball estimates can be used to make higher lending rates look more attractive.

To be sure, this deceptive practice is a major issue for both consumers and honest lenders. But wait, national lenders smell a marketing opportunity, especially in light of a slowdown in mortgage applications during the past several months. In Kenneth R. Harney’s A Good-Faith Effort To Clean Up Estimates [Washington Post] he spells out how SunTrust and LendingTree have recently announced programs where they too (without any allegations of wrongdoing) will guarantee good faith estimates, in an attempt to lure more borrowers.

So what does all this have to do with venders? Well if this trend catches on, either through legal settlements, revisions to the laws pertaining to lender requirements or from promotional programs aimed at increasing market share, it will force lenders to sharpen their pencils. And guess who they’ll turn to? The easiest and most cost effective option is to ask the outside venders to lower their fees, as it requires nothing of the lenders and only impacts the profitability of the venders themselves. Only as a last resort will the lenders consider reducing their internal fees or profit margins.

While increased efficiency and reduced costs are good for consumers, the race to the bottom, in terms of vender fees, could further compromise the quality of services provided. At a time when real estate deals are becoming more complex and technical and many real estate markets are in some sort of transition, this could prove unwise and lacking in good faith.

Tags: Soapbox Blog, John Mason, Appraisal Process, Mortgage Fraud, Redlining and Predatory Lending, Solid Masonry, Appraisal Fees

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In fact it will cost you $325,000,000.

“The Law News Network – Attorney General Eliot Spitzer and the Attorneys General and banking regulators of 48 states today announced a $325 million agreement with the nation’s largest subprime mortgage lender to overhaul its existing sales, appraisal and closing practices” [LawFuel].

Ameriquest primarily makes refinance loans to homeowners seeking to consolidate credit card and other debt and generate overall monthly savings. After refinancing with Ameriquest, however, consumers were often trapped in mortgages they could not afford, and were left with little or no equity in their homes.

Marketing Opportunity
Of particular interest to me was that the settlement requires Ameriquest to:

Overhaul its appraisal practices by prohibiting sales personnel from selecting, contacting, or attempting to influence appraisers

That is encouraging but there are two major questions here as it relates to appraisers:

• How does an organization with wide-spread problems in their appraisal process, which sees influencing appraisers is part of the aggressive culture, reform itself? How would they know where to begin? How would they know what is right and wrong?
• And why are these issues with Ameriquest ANY different than the majority of wholesale lenders?

Tags: Soapbox Blog, Appraisal Pressure, Mortgage Fraud, Redlining and Predatory Lending

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A friend of mine passed along an article by William Apgar called Unraveling the Pyramid. Mr. Apgar is the former Federal Housing Administration commissioner and senior scholar at Harvard University’s Joint Center for Housing Studies and lecturer in Public Policy at Harvard’s Kennedy School of Government.

I found it to be a great article because someone with the gravitas of Mr. Apgar addresses the primary reason that the appraisal profession is in deep trouble and why I started Soapbox to begin with:

The appraiser has not been allowed to remain independent.

The Article

“It cannot be tainted by self-interest or the desire of others to profit from a mortgage transaction. In fact, one of the key features of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 was to make certain that trained and certified licensed professionals completed the valuation process. Ever since FIRREA, legislators, bank regulators and consumers groups alike have weighed in on the issue of ensuring sound residential real estate valuations. On Oct. 27, 2003 the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the National Credit Union Administration, issued a Joint Statement that requires the separation between loan production, appraisal ordering, and the appraisal review function.

The reason for this independence is obvious; everyone, except the appraiser and borrower, benefits monetarily in fees and performance bonuses from a higher-priced home. As it is not uncommon today for a lender to be on both sides of the equation, making the loan and picking the appraiser, the federal regulations seek to separate the appraisers’ work from other aspects of the transaction. That is the idea, anyway, but not always the practice. In practice there are lenders that hire staff appraisers who are picked by and report to the lender’s loan officers. Certain lenders and title companies own or are part owners in appraisal companies.

There are agents and brokers that refer appraisers to lenders who are referred to borrowers by the same agents and brokers. This is all perfectly legal under RESPA, but gets in the way of independence. In May 2005, following the Joint Statement, the regulators again issued guidelines, warning that financial institutions “may not fully be recognizing the risk inherent in their aggressive lending standards.” In June, on the heels of this “shot over the bow” The National Community Reinvestment Coalition, a nationally recognized consumer group, released a report entitled Predatory Appraisals: Stealing the American Dream. [Soapbox] As they determined in their study “problematic appraisal practices exist as a serious impediment to responsible lending, impede fair housing and equal access to credit, and place the American Dream of homeownership and the safety and soundness of the mortgage marketplace at risk.” Today, no one can accurately assess how many homes are overvalued in the U.S. housing market and for how much. There are those who argue that there is no such thing as appraisal inflation and therefore, no problem exists; if a buyer is willing to pay an asking price, then the price isn’t inflated. True enough. But, when appraisal inflation becomes systemic to the loan process and when almost half of appraisers say they are pressured to inflate appraisals by others involved in the loan closing, then maybe it is time to change the way appraisals are ordered. The increased use of creative mortgage products and slowly rising interest rates, combined with predictions of falling prices in the hot real estate markets, concerned Julie Williams, the then- acting Comptroller of the Currency.

In a speech given in March 2005 Ms. Williams raised price declines as part of her warning about the growing credit risks stemming from aggressive retail lending. She said, in an article titled Amid the Housing-Bubble Din, Something Different? [American Banker] that some of the increasingly popular hybrid mortgage products “are often predicated on continued healthy price appreciation for residential properties. No one knows how these loans will perform if housing prices stabilize or fall or, worst yet, if the value of homes fall below what the borrower owes.”

This is a time of transition for the mortgage marketplace. Economists agree that although there is no nationwide housing bubble there are “regionalized bubbles” where housing prices seem to have risen to unsustainable levels and price declines have been predicted over the next two years. The mismatch between income gains and higher real estate values in some cities is particularly striking. How can someone earning $70,000 a year afford a $500,000 home? They can’t over the long run. Regulators have taken steps in the past several months that could exert strong influence on lenders and all vendors providing services to lenders.

Due to the volume challenges of the past two-to-three years, for some time now lower price and fast turn time have been favored over accuracy concerns. It remains to be seen if the real estate market changes and increased delinquencies put lenders in a more cautious posture. The ascendancy of credit risk over production in overall lending management may actually be on the near horizon, where it should have been all along. I applaud NCRC’s report, their veracity on the subject of predatory lending and for asking the hard questions. This issue is systemic, as the entire process from regulators to lenders to the third party interactions of loan officers and the Realtors/builders is broken.

It certainly will take a collaborative effort from the entire industry to unravel the pyramid of bad practices that have occurred over the past ten years.”

Webmaster’s Note: Lets hope we start seeing some movement in the right direction soon. The American public is not served well by the current state of the profession.

Tags: Soapbox Blog, Appraisal Pressure, Appraisal Process, Mortgage Fraud, Redlining and Predatory Lending, RESPA

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Several months ago, our appraisal firm completed an appraisal of a one family in an urban market that has been undergoing gentrification for about five years. The property was renovated (not to excess) and if it closed, would be the highest property sold there recently. It was exposed to the market for a typical period of time and sold near the list price. We used sales from the immediate area that were renovated and recently transferred. The market is rising rapidly and this property was slightly larger than the recent sales, hence its record price. It was not a white elephant.

Because the sales price was above $1M, two appraisals were completed as SOP and we believe the other firm also came in at or near the purchase price.

The lender then ordered a field review and their local staff appraiser (who was located out of state) commented to the real estate broker before walking into the property that “There is no way any house in [neighborhood] could ever be worth more than [price]. Needless to say, this field review came in approximiatley $1M low or about half the purchase price. The field review contained sales that we either inspected or we were familiar with. The sales were basically shells (wrecks), or multi-family properties with rent stabilized tenants. Amazing.

The buyer went to another national lender who did the deal and I believe they relied on the two appraisals.

Myself and another principal, who was the appraiser for this assignment, were removed from the approved appraiser list without notice (because I reviewed the report), yet the remainder of my staff, including trainees were still approved. A mortgage broker who submitted our reports to this lender was told they would accept our firm’s reports if we would simply remove our names from the reports and they could jam it through the system. Of course we would never do that.

We dogged the lender for weeks for an explanation since we did nothing wrong. Ultimately we were reinstated after other work of ours was reviewed.

In summary, it appears that:

• This lender was redlining.
  
• Their appraisers are being pressured to come in low on sales in marginal areas because of pre-conceived opinions about values and risks. It ironic that appraisal pressure in this case is clearly the opposite of what we typically see, which is to come in higher than the value.
  
• Competent appraisers can be easily weeded out in favor of form-fillers. We fought them on principal for our reputation despite the fact that we do very little work for them.
  
• Out of state review appraisers are not always experts in the markets they review. How can lenders base significant loan decisions on out of state review appraisers, even if they are on staff?
  
• If lenders take this position, how do emerging neighborhoods have a chance to develop?
  

Is anybody out there listening?

UPDATE Since this incident, there have been a number of sales in this neighborhood over the $2M threshold. I forgot to mention in the first paragraph of this post that we also received calls from their underwriter telling us to bring down the value because they didn’t think the neighborhood could support the price.

Tags: Soapbox Blog, Appraisal Pressure, Appraisal Process, Redlining and Predatory Lending

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We have outlined in great detail within Soapbox, that appraisal pressure is prevalent in the lending industry, encouraged by the structure of the lending process and the lack of political clout held by the appraisal industry.

A consumer activist group National Community Reinvestment Coalition has set up a trade group to arrange for the arbitration of business disputes over appraisals [American Banker]. “Members of the Center for Responsible Appraisals and Valuations would also agree to follow a “code of conduct.” They would include all parties to the process – lenders, appraisers, and various intermediaries.”

Here is the NCRC press release. [PDF]

One of the issues the lending industry has problems with, and rightly so, is that in a mortgage situation, the appraisals is being done for the lender, not the borrower. However, the problem with this structure, is that the lender is not incentivised to weed out appraisers that are there strictly to make the deal. Problems usually occur years down the road. Lack of focus on competency is clearly evidenced by the proliferation of appraisal factories (very large shops largely manned by trainees) and appraisal management companies who largely measure appraisal quality by turn around times.

Curently, lenders typically sue the appraiser’s E & O insurance company which is difficult because the insurers are in the business of litigation and its often difficult to extract claims.

I believe the objective here is to improve the reliability of appraisals. Since appraisal licensing came into effect in 1991 through FIRREA, the focus has been on licensing, required coursework and continuing education.

However, the reality is that licensing has been ineffecive because the states, who are charged with administering their interpretation of the federal law, have limited budgets and minimal staffing. Even if they did have adequate staffing, is a state agency really in the position to determine whether the appraiser used reasonable comps? I don’t believe so.

Erick Bergquist, the author of the American Banker article provides a quote from a lender:

[A National Lender’s] spokeswoman said Tuesday that appraisals are “something we already have some pretty stringent guidelines around and monitor on an ongoing basis.” As a result, “we really haven’t seen a big issue.”

This is the typical lender response to this issue which shows how, in rising markets, there are generally no problems since the deals usually get done. Stringent guidelines usually refer to more quantifiable requirements that generally do not impact quality. Its very difficult to measure quality and therefore most emphasis is placed on turn times. For a lender to say there is really no issue, really is the issue.

Perhaps the outcome of this effort will be to create additional awareness of the problem, but I doubt it will be universally accepted by the lending industry. It has to be for this to be universally accepted. However, I believe it is a step in the right direction.

Tags: Appraisal Management Companies, Soapbox Blog, Appraisal Pressure, Appraisal Process, Mortgage Fraud, Redlining and Predatory Lending

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“The Colorado Association of Mortgage Brokers submitted a plan last week to regulate the industry in Colorado, one of just two states with no such requirements on the books.” They believe that regulation may stem some of the fraud [Pueblo Chieftain] In every scam, one of the parties to the fraud in that state is usually a mortgage broker.

They list types of mortgage fraud are (in no particular order of importance) as:

• Equity Skimming — The mortgage broker qualifies the consumer for a larger loan then they need, quitclaims the property to the mortgage broker who rents the house back to them and then the mortgage broker does not pay the mortgage.
  
  
• Inflated appraisals — Overstated appraisals are usually done by appraisers who depend on a few mortgage brokers for business. The lender has less collateral then they think. The borrower has debt greater than the value of the house. Sales of properties in the neighborhood may be influenced by a few above market sales.
  
  
• Flipping — The mortgage broker works with an appraiser to create a false identity for a borrower and artificially inflate the value of the property multiple times within a short period. These closed sales appear in public record and are also used by unwitting appraisers.
  
  
• Silent second — The seller provides a non-disclosed (to lender) down payment to the buyer as a gift. The buyer doesn’t realize that they have to pay taxes on the gift and can’t afford the house.
  
  
• Air loans — Providing mortgages on properties that do no exist.

Tags: Soapbox Blog, Appraisal Pressure, Appraisal Process, Mortgage Fraud, Redlining and Predatory Lending

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