Home appraisers played one of the less well-known roles in pumping up home values and contributing to the current financial crisis. Retained by lenders or brokers, they frequently colluded—explicitly or tacitly—in overestimating the worth of houses to justify large mortgages and the lucrative fees each member of the real estate food chain received at closing.
Faced with investigations and lawsuits, the home-finance industry has agreed to a government-approved code of conduct for appraisals that takes effect on May 1. The new rules promote the use of middlemen between the nation's 60,000 freelance appraisers and the lenders and brokers. The middlemen, known as appraisal management companies, or AMCs, are supposed to prevent lenders and brokers from pressuring appraisers to exaggerate assessments. But among those joining the swelling ranks of this formerly niche business are some of the same subprime players that helped inflate the real estate bubble in the first place.
Take NovaStar Financial (NFI) in Kansas City, Mo. A large subprime lender during the housing boom, NovaStar was disciplined by three states—Massachusetts, Nevada, and Washington—for such infractions as employing unlicensed brokers and charging unlawful fees. Without admitting wrongdoing, the company paid $5.1 million in 2007 to settle similar allegations in a class action brought on behalf of borrowers. After its mortgage business collapsed, NovaStar morphed into an AMC last year by acquiring another company and renaming it StreetLinks National Appraisal Services.
Steve Haslam, NovaStar's former chief of retail lending, is now CEO of StreetLinks. He defends NovaStar's past lending as legitimate, noting that the company avoided bankruptcy proceedings, unlike many of its rivals. "We have gone through the fire and come out better for it," he says. His 100-employee AMC will contract with independent appraisers, Haslam says, paying them generous fees, and will issue a "Certificate of Noninfluence" with every appraisal. "This assures Wall Street and lenders that this appraisal was conducted in an independent fashion," Haslam says.
But Bill Garber, director of government affairs at the Appraisal Institute, a nonprofit trade group in Washington, isn't reassured. He worries that subprime foxes have been invited into the appraisal henhouse. The new industrywide rules "have transferred the [improper influence] problem to these appraisal management companies, which are not regulated by anybody," Garber warns.
The new rules grew out of an investigation by New York Attorney General Andrew M. Cuomo. His probe found that one of the biggest companies in the appraisal business, First American (FAF) in Santa Ana, Calif., allowed the huge savings and loan Washington Mutual to exert pressure for higher valuations. Cuomo sued First American's eAppraiseIT unit in November 2007 for fraudulent and deceptive practices. The suit, which is pending in New York state court, spurred the drafting of the Home Valuation Code of Conduct. Mortgage finance giants Fannie Mae (FNM) and Freddie Mac (FRE), now controlled by the federal government, helped negotiate the code with others in the industry and have said they won't buy loans after May 1 that don't adhere to it. Fannie and Freddie have wide influence because they purchase a large share of all U.S. mortgages, providing fresh cash to lenders.
The new code bans mortgage brokers and loan officers from directly ordering appraisals, which has been the common practice. Instead, it encourages the involvement of AMCs, which are supposed to impose discipline on freelance appraisers and minimize the sway of brokers, agents, and lenders.
Some housing experts and state regulators express skepticism that AMCs are the answer. For one thing, Bank of America (BAC), Wells Fargo (WFC), and several other major banks operate their own appraisal-management companies, so the incentive to inflate home values hasn't been eliminated in those cases. Another concern is the lack of oversight for AMCs, particularly those started by former subprime lenders and appraisers who ran afoul of state rules.
"[The marketplace is] still vulnerable to appraiser pressure because the incentives are still there to get deals done and collect the fees," says Susan M. Wachter, professor of real estate at the University of Pennsylvania's Wharton School. Appraisers helped inflate mortgage values by $135 billion in 2006 alone, she estimates. "Getting this issue right is critical for the housing market to recover."
The federal housing officials who helped craft the code say they will hold AMCs accountable. "The code doesn't do away with appraisal management companies, which some people may have wanted," says James B. Lockhart, director of the Federal Housing Finance Agency, which oversees Fannie and Freddie. "If [AMCs] are applying undue pressure, that would be a violation of Fannie and Freddie rules, and we would take action." Lockhart says Fannie and Freddie can force lenders to buy back loans tainted by inflated appraisals. "If an appraisal management company does not live up to the standards, that will be extremely bad for their business," he adds.
The Cuomo suit alleges that eAppraiseIT, the First American unit, allowed WaMu loan officers to "handpick" appraisers who submitted high valuations. Bank employees allegedly pressured appraisers to boost low initial estimates. In one instance, New York investigators said eAppraiseIT lifted the estimate of a property to $2.3 million from $1.6 million after WaMu told the company the loan would close only at the higher figure. The suit disclosed a Feb. 22, 2007, e-mail from eAppraiseIT's then-president, Anthony R. Merlo Jr., who wrote that the company would "roll over" and submit to WaMu's demands.
WaMu wasn't named as a defendant in the New York suit. A spokesman for JPMorgan Chase (JPM), which acquired the failed thrift last year, declined to comment since the alleged impropriety occurred before the takeover. A First American spokeswoman declined to comment. In a press release, the company previously said its e-mails "have been taken out of context" and that Cuomo's allegations "belie our record of compliance with applicable law."
Former appraiser Pamela Crowley in Palm Bay, Fla., says the new code has unwisely given "a free pass to the AMCs" to expand their market share. Disillusioned with her profession, she has become an online gadfly advocating for consumers' interests. In June 2007, eAppraiseIT went to court to try to stop her criticism of the company on her Web site. But a county judge in Florida wouldn't issue an injunction to prevent her from posting skeptical material about eAppraiseIT.