Chicago Tribune, August 26, 2001
BYLINE: By Patrick Barta, The Wall Street Journal.
BODY:
Feeling good because your house is worth a fortune? Sorry to rain on
your parade: It might not be worth as much as you think.
Home values in some major metropolitan areas have risen more than 10
percent annually during the past three years, with median sales prices
hitting $152,600 in June, a record, according to the National Association
of Realtors. During the 1980s and 1990s, home prices rose just 3.9 percent
a year. There's little doubt that classic supply-and-demand issues are
largely responsible for home prices' recent surge. The rising income of
American workers, rapid population growth, and relatively low mortgage
rates, which makes home buying more affordable for more families, have
combined to boost demand. Meanwhile, constraints on builders have kept
a lid on supply.
But some industry observers believe another factor is inflating home
values: overly generous appraisals. Every time a home is financed or refinanced,
it must be appraised by a professional to make sure the value isn't being
overstated. In theory, appraisals reduce fraud, foreclosure risk and the
possibility that buyers -- and lenders -- will get stuck with homes worth
less than the mortgage amount.
Appraisers, however, say their mission is in jeopardy and the risk to
the market is great, because they're under pressure to raise prices as
high as possible so brokers and lenders can make more and bigger loans
and thus collect more fees.
Richard Grace, a Shawnee, Okla., appraiser, says he and other appraisers
are frequently encouraged to fudge the numbers. A case in point came earlier
this year when he was asked to determine the value of a two-bedroom log
house in rural Oklahoma. The buyer was willing to pay about $87,000 for
the home, but Grace appraised it at $68,200, the value of comparable homes
in the area. While it's common for home prices to rise in a healthy market,
price increases that far exceed average price gains are suspect, he says.
Grace says he's lost business because of his low appraisal; the house
later sold for close to its asking price after being appraised by someone
else. Soon enough, warns Grace, other houses in the neighborhood "will
be appraised at $85,000 instead of $65,000, and two or three transactions
down the road, we'll have doubled where all the houses ought to be."
Richard D. Powers, an appraiser in Keene, N.H., says pressure he gets
from mortgage companies is usually subtle. Once, he got a letter from a
lender with the note: "Minimum value: $165,000." Another time, a mortgage
banker instructed Powers to notify him before heading out to the home if
he couldn't come up with a requested $105,000 estimate.
To some, this is the type of behavior that's characteristic of bubbles.
The "upward spiral of prices becomes self-reinforcing," says Mark Vitner,
an economist at First Union Corp. in Charlotte, N.C. Some believe home
prices are beginning to act like technology stocks before the bubble burst
last year, and Vitner says they're moving up so fast that any value seems
reasonable.
So far, no one is predicting a major meltdown akin to what happened
in the late 1980s and early 1990s, when inflated appraisals contributed
to the pain of a real-estate slump that pushed thousands of homeowners
into foreclosure. But if the economic slowdown turns into a protracted
recession, lofty appraisals could exacerbate any economic problems.
Mortgage bankers and brokers say the value-inflation problem is overstated.
They argue some appraisers are raising flags because they are afraid they
will be made irrelevant by new computerized appraisal systems. Evidence
of coercion is "at best anecdotal or hearsay," says Joseph Falk, president
of the National Association of Mortgage Brokers.
But the appraisers may have a point. Rep. Jan Schakowsky (D-Ill.) has
introduced a predatory lending bill that includes a provision making it
illegal for lenders to coerce appraisers.
Why, you might ask, would lenders and brokers engage in practices that
could undermine the health of their industry?
In the past, most mortgages were made by banks and savings and loans,
which held most of the loans themselves. Now, however, more people are
getting loans through mortgage brokerage firms, relatively unregulated
operations that take applications from consumers before shopping them to
lenders to get the lowest interest rates.
Since brokers at times collect fees based on loan size and have little
or no stake in whether the mortgage defaults, they could be tempted to
pressure appraisers to come up with bigger values. Similarly, traditional
banks are increasingly selling loans they make to the secondary market.
This theoretically would give traditional banks and lenders less reason
to worry about whether an appraisal is correct, although lenders counter
that they still retain liability for the loans in some cases.
A report issued this summer by Graham Fisher in New York, a securities
research firm, noted that until recent years, many lenders were randomly
assigned appraisers from "blind pools," in some cases operated by HUD.
But the mortgage market has increasingly shifted away from using such pools,
in part because it's faster and easier for lenders to simply call hand-picked
appraisers directly. Changes of that sort, the report noted, have "jeopardized
the soundness of the process and skewed real-estate prices."
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