Commercial Development News - Appraisal Development International

Fannie, Freddie agree to tighten appraisal rules
By David S. Hilzenrath
Washington Post
Published: Mar 5, 2008

WASHINGTON – March 5, 2008 – Fannie Mae and Freddie Mac, linchpins of the nation’s mortgage system, yesterday promised to crack down on inflated home appraisals, which can take a toll on borrowers, lenders and mortgage investors.

The government-sponsored companies agreed to hold their customers to a new code of conduct, and in return, New York Attorney General Andrew M. Cuomo dropped a nearly year-long investigation of their appraisals. Both companies denied wrongdoing.

“With these reforms, we will have a safer, better valuation process,” Cuomo said.

Home appraisals determine how much money lenders can lend against a property. If an appraisal is inflated, the borrower may end up borrowing more money than the home is worth, the lender’s collateral may be insufficient to cover the debt, and homeowners may be charged too much in property taxes.

Inflated appraisals can contribute to market bubbles and compound the losses when bubbles burst.

Appraisers have long complained that they are pressured by real estate agents, mortgage brokers and loan officers to deliver the desired numbers. Even when there is no overt pressure, there can be potential conflicts. Appraisers often depend on referrals from people involved in real estate transactions – people who may collect fees or commissions only if the appraisal supports a proposed transaction and the deal goes through. Some lending institutions have their own appraisers.

“We believe that the appraisals were often fraudulent because there were conflicts of interest and pressures on the appraisers,” Cuomo, who was secretary of housing in the Clinton administration, said at a New York news conference.

The code of conduct unveiled yesterday would prohibit lenders from trying to influence appraisals. For example, they could not promise future business or threaten to withhold business. Nor could they use appraisal companies in which they have more than a 20 percent ownership stake.

Lenders would continue to choose and pay appraisers, but employees involved in the lending process would be barred from dealing with the appraisers. Appraisers still could be given copies of documents that would show them the proposed sale price.

The code would apply only to lenders doing business with District-based Fannie Mae and McLean-based Freddie Mac, but Cuomo said he expected others in the industry to follow their example.

Fannie Mae and Freddie Mac also agreed to fund an institute to monitor home appraisals and field complaints from consumers and appraisers.

Fannie Mae and Freddie Mac, which were chartered by the government to support the housing market, package mortgages into securities for sale to investors and earn fees for guaranteeing to pay the loans if the borrowers default. The two companies also buy mortgages and mortgage-backed securities for their own investment portfolios.

“We have no evidence that there was a problem,” Freddie Mac spokeswoman Sharon McHale said. Fannie Mae spokesman Brian Faith declined to say to what extent, if at all, Fannie Mae’s appraisals were inflated.

Fannie Mae and Freddie Mac’s revenues are related to the volume of loans they buy and guarantee. More loans and bigger loans can generate greater revenue from guarantee fees and mortgage interest. But if their loans are based on inflated real estate values, Fannie Mae, Freddie Mac and the investors who buy their securities have less collateral than it appears, magnifying losses in the event of foreclosure.

Fannie Mae and Freddie Mac were always able to set appraisal requirements for the loans they buy or guarantee, said financial services analyst Josh Rosner of Graham Fisher & Co. “So if this is really needed, it suggests that their models have failed. If this is not really needed, then it’s nothing more than public relations.”

A survey last year by October Research, a publisher of real estate industry newsletters, found that 90 percent of appraisers said they had been pressured to change appraisals.

Appraiser Peter M. Scalise of Bruce W. Reyle & Co. in Fairfax said that he had not encountered pressure but that he can remember “some instances of begging.” Scalise said he could not tell from the new code of conduct what criteria lenders would use when choosing appraisers.

The conflicts of interest in the appraisal business have been much like those that have affected other financial gatekeepers, such as Wall Street analysts who rated stocks that their investment banks underwrote and outside auditors responsible for acting as watchdogs over the companies that hire them.

The government tried to assure the independence of appraisers through legislation adopted in response to the savings and loan crisis of a generation ago, but the provision wasn’t enough or wasn’t enforced well enough, said John Taylor, president of the National Community Reinvestment Coalition.

Monday’s agreement is subject to a period of public comment and would not take effect until Jan. 1, 2009.

Copyright © 2008 washingtonpost.com, David S. Hilzenrath. Staff writer Carrie Johnson contributed to this report