appraisal errors that contributed to the meltdown
Strategically the single most significant error that led to the meltdown was licensing too many ignorant people too fast. The pass rate for the trainee license test was always hovering at or below half. The number of test repetitions to pass was always high and people were licensed who needed half a dozen tries. These sorts of things could have been addressed administratively. The legislature made it clear, however, that their intent was to facilitate licensure. No amount of enforcement will be effective if a large proportion of the affected population is ignorant of or disregards the rules.
Moving on to a slightly more tactical level, in the Revenue and Taxation Code price constitutes a rebuttable presumption of value. By inference there are prices which are not supported by the market generally. During the runup to the bubble, however, it was likely that anybody who failed to “get along” and “make the numbers” was going to be around long (see attached).
At the very basic level, then, the most likely sorts of errors are those committed in an effort of self-preservation. The very simplest is to mis-state the size of the house. A Mr. Minnick of Fannie’s appraisal quality control department boasted at an ASA conference that he got his own house loan because the appraiser exaggerated the size of his house by 50% in order to “make the numbers”. Not only is this ploy easy, but it is relatively time consuming to conclusively prove. Yes, you can often easily tell if the size on the appraisal report matches public records. Public records, though, aren’t always correct. The fallback defense is “well, I was appraising the addition the borrowers said they were going to build”. Sure, that should be fully disclosed and failing to do so is an error, but at least it doesn’t amount to admitting to fraud*. While Brad Ellis, late of Indymac, said that improvement size errors weren’t a significant part of their problems, another reviewer at Indymac told a more subtle story. A new Arizona house they took back was 3,000 square feet. Unfortunately it had not been built with a building permit and the county required that its size be reduced to that of the original house, 1,000 square feet. There was something about water use, but it could as easily have been site coverage or impervious surfaces. The reviewer, who shall remain anonymous, said, “Sure, they care about appraisal quality. But they really get twisted when they can’t make the deal.”
The next easiest error to make in an effort of self-preservation is to cherry pick the comparables. At Val 2000 in Las Vegas a software vendor came to the ASA Real Property Committee with his answer to all appraisers problems: “You put in the value you need here, and the software will fill in the sales you need to support it in the comparable sheet.” What happens in Vegas stays in Vegas, one of the epicenters of the present problem. But software isn’t required. Meatware works fine. A trainee took the borrower’s refinance comparables and duly came up with the needed value. Borrowers never made a payment. The comparables were from the country club, half a mile away. The subject was nice, but not country club.
But if one of the above won’t work, try both. In a San Francisco appraisal the appraiser omitted the fact that the subject property was a legal non-conforming duplex. He combined the basement apartment into the finished living area. Then he cherry picked the comparables. The probable cumulative error was on the order of 50%. It was particularly irksome to the buyer when he actually went down to the City to get a permit to do just what the appraiser implied. No way. It is tough to eliminate legal rental units in San Francisco.
Bubbles make appraisal easy. Six months or a year down the road, who cares? The new price level is higher. But when the music stops... The San Francisco duplex, above, had been sold in Fall, 2005 and resold in Spring, 2006. Strangely, the difference in price was about a 150% markup. In about the same timeframe a Millbrae house sold and resold for a significant markup. Careful examination of sales showed no inflation, maybe even a little deflation. In that case the buyer claimed a non-disclosure, and prevailed in the subsequent litigation. The driveway slope was such that the garage was unusable. But, not too strangely, the loan appraiser never noticed; didn’t even note the absence of grease on the garage floor. Gee, you’d think that was positive... Yes. We’ve all
been cautioned about flips. The two appraisals even mentioned the previous sales, but attributed the difference in prices to inflation.
Finally, the first rule of survival is, “the customer is always right”. In a bubble, time is the survivalist appraiser’s friend for customer satisfaction. Two appraisals in San Francisco assumed that a particular Victorian mansion had gone up in value 400% in less than a year. The borrower maintained that he had gotten a bargain and his place was now worth $10 million. The comparables told the tale. Unfortunately the comparables were not located on Franklin Street a major mid-town one way arterial. Their views were of the Bay, not rush hour traffic.
* So, why aren’t all the lenders clogging the courts with errors and omissions suits? Spoke to counsel of one savings and loan which is considering an effort to recover through appraisers’ E&O insurance. Apparently fraud isn’t covered by E&O. So, an appraiser can probably try the ultimate survival tactic. Cop a plea. “I was just doing my job, just a cog in the machine.” It’s plausible, perhaps even true. Is it worth the effort to try to go after the assets of Flybynight Appraisal, LLC as a civil fraud? And in a couple years, when the storm has blown over, they’ll still just be doing their job, as after the Savings and Loan Crisis.