Fannie Mae is saying that WaMu will take back any loans with dubious appraisals this "independent examiner" digs up. WaMu is saying that it will "rigorously" avoid doing so.
WaMu is also saying, in effect, that it signed a contract with eAppraiseIT that puts all liability for inflated appraisals on eAppraiseIT. Fannie Mae is saying, in effect, that it signed a contract with WaMu that puts all liability for inflated appraisals on WaMu. Cuomo, you note, is pursuing a civil complaint against eAppraiseIT and its parent First American, not against WaMu or Fannie Mae.
This is very interesting precisely because it isn't going to be about inflated appraisals. It's going to be about how far anyone can get away with two practices that are the lynch-pins of the mortgage industry: outsourcing regulatory liability to a third party bag-holder and doing business on a representation and warranty basis without pre-sale due diligence.
Neither Fannie Mae nor Freddie Mac nor most any other secondary market participant actually examines appraisals on individual loans prior to purchasing them. Some percentage of loans are chosen after purchase for a "Quality Control" review; if problems are found at that point, the investor demands that the seller repurchase (or indemnify) the loan.
This process works only to the extent that the representations made in the loan sale contract are clear, specific, and wide enough to capture all the serious problems an investor might have with a loan. In Fannie and Freddie's case, the loan seller represents that the loan meets every guideline currently published by the GSE or specified in the individual contract. The Fannie and Freddie guides themselves run to hundreds and hundreds of pages; in the case of something like appraisals, the GSE guidelines incorporate by reference things like USPAP (the standards promulgated by the Appraisal Foundation), which themselves run to a lot of pages.
All of that stuff is detailed and specific enough that it isn't that hard to find contractual grounds to declare breach and demand repurchase of a loan. WaMu knows that perfectly well, as do all mortgage lenders: those loan sale contracts with all those warranties against all those representations add up to major potential repurchase liability. And the ugly thing is that it's repurchase liability. If your loans were all subject to 100% pre-purchase detailed QC review, your risk would be that the squirrelly ones get kicked out of the sale (you don't get to sell them). Post-purchase QC based on rep & warrant means you risk having to take them back in the future, at par, when they might be worth 90 cents on the dollar (or less), at exactly the wrong time to be owning nuclear waste. It's just like foreclosures: lenders don't make money on REO because they don't own much REO except in time periods when RE is worth a lot less, since they wouldn't be foreclosing so much if the RE market were hummin' along.
WaMu's statement is that it took all the "warranty" part of all of this off its own back and put it onto eAppraiseIT's. The plan all along was that if Fannie Mae (or anyone else) tried to force these loans back because of appraisal problems, WaMu would make eAppraiseIT take the losses. In essence, eAppraiseIT was writing an "appraisal default swap."
Anyway, this is why the whole flap is scaring the panties off everyone in the mortgage industry, far, far beyond any worry over stiffer appraisal regulation. The core issue here is a cornerstone of the whole "originate and sell" model that has created such a crisis. If Cuomo's suit makes any headway at all, it will put eAppraiseIT out of business one way or the other. That's because if appraisal management companies are no longer willing or able to write these liability swaps into their contracts, they won't be able to offer what the lenders really want from them. The advantage of doing business this way isn't really about saving a few dollars on outsourcing administrative work for the lenders, it's about getting out from under a huge expensive compliance and legal risk.
This thing really isn't about appraisals, it's about stopping the game of risk-layoff. The weakest (financially and politically) party in the chain, eAppraiseIT, appears to have taken on all the residual risks from WaMu and Fannie Mae, and now Cuomo is going to force those losses to materialize. You can bet that every General Counsel at every mortgage lender still operating is busy reviewing many, many contracts right now. The results will be very, very ugly.
