Housing Appraisals: The Accounting Scandal of the Housing Bubble
Financial bubbles breed accounting fraud. Those of us who warned of the stock bubble in the late nineties were not surprised by the Enrons and WorldComs that surfaced when the bubble deflated. Bubbles make it possible to paper over all sorts of questionable accounting or outright fraud. When the bubble deflates, these practices can no longer be hidden.
The analogous problem in the housing bubble is with appraisals. The basic story is simple. Mortgage issuers make their money by issuing mortgages. Once the mortgage is issued they sell it to someone else (in many cases, the key figure is actually a broker who never holds the mortgage), so they have little interest in accurately assessing the quality of the mortgage. To get a mortgage issued, it is necessary to have a house appraised at a value that justifies the mortgage.
The issuer generally chooses the appraiser. Okay, suppose an appraiser comes in with a low number and the mortgage can’t then be issued? The issuer is very unhappy – no money here. The issuer then finds another appraiser, who will come in with a higher number for the value of the house. Appraisers, being intelligent people, come to realize that they don’t get jobs if they give low appraisals, so appraisers come in with high appraisals so that the mortgages can get approved. Everyone is then happy, until the bubble bursts.
The Wall Street Journal has a good piece on this topic today. It would have been nice if they had run this piece three years ago, before the damage had been done. But, maybe this can help stop the next financial bubble driven train wreck:)
posted by Dean Baker @ 10:41 AM
3 Comments:
At 11:24 AM,
Jonathan Lundell said…
Adding insult to injury, the buyer (at least here in California) foots the rather hefty appraisal fee. Having bought four (and sole three) houses in the SF Bay Area over the last three decades, I can say from personal experience that what Dean describes is exactly what happens.
Of course, the other parties to the deal--buyer, seller, and real estate salesfolk--are all eager to do the deal as well, and collude happily.
At 11:56 AM,
Buce said…
The malleability of appraisals has been a fact of life since for as long as I can remember, and that is probably longer than most readers have been alive. Down around the bankruptcy court, they used to say that "MAI" stands for "Made as Instructed."
At 4:10 PM,
Anonymous said…
Posted by Cochise on November 25, 2006 at 14:26:32:
"While towns sell land cheaply to developers as a means of subsidizing projects, a large section of the property Inglewood sold to Haagen Was originally purchased with federal funds that prohibit its resale at below-market rates.
To devalue the land, the city's redevelopment agency discarded an original appraisal that valued the 16 acres as one parcel. That appraisal was never released publicly.
In a second appraisal, the land was split into two less-valuable tracts. That enabled Inglewood to sell the entire site at 3250-3502 W. Century Blvd. to Haagen for $3.7 million, or $5.30 a foot, when parcels across the street are selling for nearly four times that amount."
"Dom said he was surprised when he first saw how low the appraised price was, but noted that the city council was only following the advice of its consultants when it approved the sale.
The Inglewood Redevelopment Agency first received an appraisal for the land from Pomona-based appraisal from PCV/Murcor (A MAI FIRM) in January 2003. But four months later, at the behest of the redevelopment agency, PCV/Murcor abandoned the unreleased valuation of the 16-acre site and split the parcel into two. (Dorn, who is on the redevelopment agency board, said he didn't have specific information about the first appraisal.)
In the second appraisal, a 10.8-acre tract purchased by the city of Inglewood with Federal Aviation Administration funds was split from a 5-acre patch purchased with Inglewood redevelopment money."
"The appraisers found that the larger site, when broken away, was inaccessible from a main thoroughfare and unsuitable for commercial development. Meanwhile, the 5-acre band that fronted Century Boulevard was too narrow for a large commercial development. Separately, the sites were appraised at an average of $5.30 a foot, significantly lower than amounts developers have paid nearby."
From:
http://www.findarticles.com/p/articles/mi_m5072/is_34_27/ai_n15384498
http://www.harriscompanyrec.com
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