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Avm Future ?

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Bob Stainbrook

Sophomore Member
Jan 3, 2003
I stumbled across this and thought someone might enjoy it.

(From Working RE Magazine, summer 2002)
The following is a summary of notes taken from the official audio recording of the sworn testimony of a chief appraiser of a major mortgage lender. The chief appraiser appeared before the United States House of Representatives Banking Committee on June 15, 2006 for the second time in two decades. He had previously appeared before the panel in March 1988 in the wake of the enormous public losses during the Savings and Loan Crisis of the 1980s. In the fiscal year 2005, the banking industry had the highest level of losses due to property foreclosures since the S&L Crisis. The chief appraiser was asked to testify with regard to his experience in both the earlier and the present crisis.

Summary Case Study #1
Presented Before the House Banking Committee
June 15, 2006

The year was 1985, the place was Los Angeles and the scene was the president’s office of a major FDIC-insured bank. The president is telling his chief appraiser that he is no longer needed. The president will assume the duties himself. No appraisers needed or wanted. Business is good. Underwriters can handle the property piece. Losses are a thing of the past. Regulators are in retreat. The government says: “Let the market regulate itself.” The relevant term is laissez faire.

Fast forward to 1988
The bank president is out, the regulators back in and the losses are scandalous. Congress is both culpable and angry. The bill is $500 billion for the industry bail out. The broker originates, the commissioned sales team pushes and the underwriters approve. There are few appraisers left. Those who remain are in “quality control,” standing at the barn door long after it was left open and the horses gone. The former chief appraiser is called back in to unravel the avalanche of inexplicably flawed appraisals, not just the big commercial deals but everything, residential loans submitted and approved without any appraiser’s eyes to police the process. The regulators are now boss. The chief appraiser is considered important enough to be called to testify before Congress. The laws are changed. Appraisers throughout the land are to be licensed (but not the originating brokers) and the internal asset management piece will be taken away from the sales department.

Forward to 2002
The scene is the Loan Risk Committee meeting at one of the largest single family residential mortgage lenders in America. In attendance are the chief appraiser and senior management, including the sales manager, now reinstated as the new boss of appraisers. The discussion centers on saving money by eliminating appraisers wherever possible. In place of appraisers, the system will be policed by automated valuation models and underwriter review. Reasonable risk parameters are set. Any AVM-derived value off by more than 15 percent from the broker’s estimate of value will be sent out for review. Any value within 15 percent of the AMV-derived value will sail through. The regulators are nowhere to be seen. The new Administration in Washington wants to open the gates to allow the financial industry to be truly free and competitive. Besides, the biggest issues are speed and cost and at $10 a pop, AVMs are a bargain.

Forward to 2003
The brokers achieve a breakthrough. When they discover which AVMs are being used, they simply run the value through the same electronic valuation process themselves, using the same calculations as the lender is doing. For example, there is a property in New Jersey being considered for a loan. Two well known AVMs are used. The lender is relying completely on the results. The combined systems arrive at an average value of $400,000. According to its lending policy, this average figure becomes the valuation basis for the loan request. The broker runs the same AVMs and knows the result. He asks his eager-to-please valuation person to come up with a value of $459,000, just within the 15 percent variance allowed by the lender. The loan request is only $395,000. The deal looks good. They are using Fannie Mae guidelines and the loan is sold easily. But there is a problem. The $400,000 AVM value itself is actually 15 percent higher than the true market value of the home because, in this particular market, the mixture of homes and range of values skews the AVM result high. It’s an older home in a pocket of newer homes and it’s not in very good shape. The true value of the property is actually $350,000. Bottom line: the lender is not making an 85 percent loan but a 115 percent loan.

Forward to 2005
More bad news, the economy and the real estate market are experiencing severe recession. The borrower loses his executive job. The home goes into foreclosure. The borrower doesn’t care. The originating broker doesn’t care. The AVM company has no liability. Fannie Mae demands a buy back. The foreclosed property is sold in a softening market for $300,000. No mortgage insurance. With almost 25 percent in REO disposal costs, the net to the lender is $250,000. The loss is $150,000. But this is just one house and one borrower. Actually, the lender has been funding tens of millions of dollars of similar broker originated, AVM-screened and underwriter-reviewed loans. Losses reach $50 million in one year and tilt the lender into bankruptcy. The FDIC is stuck with the bill. Congress is culpable and angry. The regulators start getting tough. Once again they reign as the financial industry’s new bosses.

Forward to 2006
The Chief Appraiser is called upon by regulators, who are now busily managing the nearly bankrupt lender, to investigate the devastation to collateral valuations. Congress calls him to testify again. The question they ask is: How did we ever get into this mess?
The chief appraiser pauses before answering. He mentions that he testified before and that as far as he can see, history is merely repeating itself. He goes on to say that leaving the valuation function to conflicted broker-originated value estimates, screened by machine-generated electronic mass valuations and approved by underwriters under the thumb of sales managers, is and always has been a recipe for disaster. He testifies that the situation is analogous to what happens when police are drawn back and out of a troubled area: there is widespread looting and theft, sometimes by some rather surprisingly respectable people.
The chief appraiser decides to end his day of testimony with a quote by Thomas Jefferson, over 200 years ago as he tried to change the minds of a number of wealthy, self-assured delegates (to the Constitutional Convention of 1787) who wanted no central oversight: “If men were virtuous,” Jefferson said, “there would be no need of government at all.”
The chief appraiser is asked what he means by that statement.
“The laissez faire delegates were defeated back then and the United States of America was born with a government dedicated to protecting the resources of all Americans against the often destructive self-interests of the few. The instinct for excessive profits has ruined the real estate industry more than once and the only real defense we have is a small group of appraisers who are willing to stand up for the objective value of a property regardless of favoritism, pressure or policy. In the past, when these men and women have been removed from the process, the forces of greed have taken over, resulting in disasters like the S&L Debacle. I would advise you in Congress to make the honest, licensed appraiser a permanent check and balance for loans on properties used for FDIC insured institutions. If not, I will certainly be called back to reiterate this testimony before you again.”

Postscript by Stewart HellerThe foregoing tale is, of course, historically-based fiction but the big game of controlling trillions of lending dollars takes place every day. The game is played this way: the brokers submitting the loan try to get as much financing money at the lowest rates possible, using the highest value they can get through the system. That’s what they do. The lender’s part is to bring it all down to earth; to make the course correction required so the deal lands where it’s supposed to: based on a reasonable property value. The function of the appraiser is to be the cynical, suspicious, pain the neck who keeps everyone else honest. As long as I’ve been in this business, we appraisers have been referred to as a “necessary evil.” But human nature does not change. Lenders are business people who act no differently than gas station owners caught up in a gas war – if one guy is willing to cut his throat, everyone will. Lenders have to compete for business. Once one lender begins eliminating appraisals to save the borrower time and money, pretty soon even the toughest lenders give in to the pressure to get rid of the valuation police in order to create an attractive, free-flowing lending environment for brokers. The last few years we’ve had a booming housing market, so the track record of AVM-generated loans (and every other kind of real estate loan) has been pretty good.
Today, we are seeing loans on homes running into the hundreds of thousands of dollars resting on machine-generated results. Lending decisions are not based on the independent analysis of many years experience using AVMs, and especially not where appraisers have been removed from the equation completely or where soft market conditions exist. Instead, these decisions are based on a few years experience during heady times and influenced by the power of greed. The bottom line is this: Once you remove the valuation police from the process and the housing market softens, history will repeat itself. It always does.

Stewart Heller is a Certified General Appraiser based in Northern California and is a regular contributor to appraisal industry publications. He can be reached at [email protected].
Working RE Home

Tawfik Ahdab

Senior Member
Feb 19, 2003
Professional Status
Certified Residential Appraiser
Great article, and thanks for reproducing it here. I will email my gratitude to the author.
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