Advocacy or Independence?

Would any American go to a football game in a league where the referees are legally allowed to be advocates for one of the teams? Football is only successful if its referees are viewed as being fair and non-advocates. They may miss a few calls, but overall, they are viewed as fair. Conversely, our real estate marketplace is not fair. Cheating is allowed. Agents, when rendering broker price opinions (BPOs), are legally allowed and, in fact, required to be advocates. Conversely, appraisers are prohibited from being advocates.

Isn’t it obvious that in situations where non-advocacy is required, policies which allow and permit advocacy do not work and are not sustainable?

Regulators made it clear in the 2010 Interagency Appraisal and Evaluation Guidelines (; Sidebar Info) that BPOs are not appropriate for lending. However, I am not seeing or hearing that this has had any effect on the huge volumes still being performed for lenders. In fact, one clever solution is BPO providers are now being identified as “appraisers” and their BPOs referred to as “appraisals.” This is how lenders and appraisal management companies (AMCs) are getting around the law.

Whose Fault?
In the 1990s banking crisis, appraisers were held accountable for the huge volume of fraudulent appraisals. Thousands lost their licenses and/or were subject to civil and criminal litigation. This time around, when I dive into the details of many cases, I see fraud and abuse on the part of the lender, motivated by a desire to do more loans, with a lot less appraisal abuse. BPOs and automated value models (AVMs) are often included in the files to support poor lending decisions. Advocated BPOs are very easy to obtain, inexpensive, and come with no requirement to be independent and non-biased, so value inflation is actually legal and allowable for BPOs.

If regulators are serious, they should be clamping down on advocacy and the use of BPOs in lending transactions. The use of BPOs in lending is no different than legally allowing a referee to favor one of the teams in a football game – it is just plain nuts from a regulatory perspective.

The decision in 1992 to lower the deminimis level to $250,000, below which appraisals are no longer required, gave birth to the use of AVMs, BPOs, and other non-appraiser-produced valuations in lending transactions for the first time since the Great Depression of 1929. The decision was supported by lenders, Fannie Mae, Freddie Mac, Treasury, Federal Reserve and all the banking agencies, to purposely lower appraisal standards and force appraisers to compete with advocated BPOs and AVMs. This created a market climate where the message is this: the underlying collateral value and therefore the appraisal, is immaterial: something to put in the file but to be ignored. The belief, which persists today, is that only the credit score is relevant.

Part of the problem is that regulators continue to mistakenly believe that today’s crisis is a credit crisis only. The fact that fraud rates, loss rates and loss severity are greater in this crisis than the last crisis, demonstrates that losses have been amplified because of collateral issues and valuation issues. An AVM for example, can be used to support a subprime loan below $250,000 but an AVM can’t verify that a house is actually there. The use of AVMs, BPOs and other non-appraisal products inherently increase collateral risks. Make no mistake, today’s crisis is BOTH a credit and a collateral crisis because appraisal regulations were weakened in the 1990s to help artificially increase homeownership. Not only did the government encourage banks to make loans to people who were not credit qualified but loss rates are greater because the collateral used to secure the loan was over-valued.

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