The crash of the real estate market is a true national crisis. But if the right people had looked hard enough, they might have seen it coming a mile away. A lot of home appraisers did. They knew the whole market was being built on a house of cards. And they've been raising red flags for years but nobody seemed to be listening.
According to regulators, appraisers are designed to be the linchpin in the home sales process – the only ones in the chain that don't have a financial incentive to inflate the value of a home. They're paid a flat fee rather than a commission on the sale.
But the whole works got messed up when, appraisers say, lenders and realtors started telling them what value to hit ahead of time. If appraisers wanted an appraisal job, they'd have to guarantee the appraisal in advance ... often sight unseen.
That's against the law in almost every state, according to appraisers, but nobody was cracking down on it. Many appraisers found that when they wouldn't agree to an inflated appraisal, they wouldn't get work. Some went along with it. Others didn't and went out of business. And the value of real estate kept going up and up and up.
There are all kinds of reasons why this contributed to the current mortgage crisis. When appraisals are too high, buyers start out happy: They may have to put less cash down, or it can let them appear they made a bigger down payment than they did. They may even get money back on a refinancing ... enough for a home improvement or a vacation. Problem is: none of that comes free. They're committed to big payments on their big loans and can't, in the end, afford them. Or maybe the payments started out reasonable, but the homeowner got talked into an Adjustable Rate Mortgage (ARM); their monthly payments quickly skyrocket into unaffordable territory. They try to sell the house, but find they can't sell it for as much as they owe ... because the original appraisal wasn't true. Even the bank or other mortgage holder is stuck: If they foreclose on the property for missed payments, they lose money too because the home isn't worth what's owed.
Why did the lenders go along – even solicit the inflated appraisals – if they were going to get left holding the bag at the end of the day? Because there's such a lucrative market in selling the mortgages. A lender that makes a risky loan with a bad appraisal and simply sells the mortgage (along with the undisclosed risk) on the secondary market before anyone figures it out. Who's to know? It's sort of like the old game of Hot Potato: If you can make your money and then get rid of the loan (by selling it to another bank) before it goes belly up, you're in the clear. But a lot of the loans are all going belly up at the same time now, and the financial institutions holding the mortgage are the ones getting burned by the Hot Potato.
Finally the issue of appraisal fraud is getting some attention, albeit a bit late. Two home mortgage giants, Fannie Mae and Freddie Mac, under pressure from New York's Attorney General, have agreed to change their practices. They will soon only buy loans from banks that have processes to ensure independent, reliable appraisals. There's some hope, says the attorney general, that those practices will become the industry standard.
Ideally, it will help do away with the kinds of inflated appraisals on which this house-of-cards real estate market was built.