The Fraud of Appraisal Regulation
by Larry S. Levy
~ Guest Editorial ~

Let us be clear before
getting too deeply into this subject. The bread and butter of the real
estate appraisal industry are provided by the financial services
sector. No other class of clientele comes close, and most appraisers know
no other source of business. Given that so many are so dependent on
lenders as their source of work, they are quite subject to that outside
influence over their standards of practice, even if they don’t see it
themselves. Any class of business as powerful as the financial services
industry would be foolish not to recognize, and not employ such an opportunity
to advance their own interests. 

that fact of life out of the way, let us take a cursory look at the current
regulatory environment influencing the appraisal industry, and the
ramifications to the public interest. Our backdrop is The Savings and Loan
Crisis of the 1980s. It culminated in the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 (FIRREA). That was the outgrowth of
Congressional inquiry into the reasons behind the S&L debacle.  Among
other things, Congress found repeated instances of disreputable appraisers
working in collusion with unethical lenders to fraudulently inflate the
appearance of property values. Though well intended, FIRREA did little to
prevent such abuses.

FIRREA did mandate that states regulate the activities of real estate
appraisers. Oversight is by way of Federally supervised guidelines
promulgated by the newly formed — and by all appearances independent —
Appraisal Foundation. Separately, guidelines for appraisal practice and
the engagement of appraisal services are issued by certain government sponsored
entities (GSEs). [Examples of GSEs are agencies such as Freddie Mac and
Fannie Mae, etc.]

From the beginning of this
new era, however, and with a compound effect over time, appraisal usage
standards and guidelines have been changed (centralized) at various levels in
ways shocking to conscientious appraisers familiar with 1980s
practices. What we have now is heavily influenced by the lending industry,
which continues an increasing level of de facto usurpation of appraisal
practice standards. New, "improved" appraisal reporting abbreviates
former practices, helping to speed along the loan process and lower fees,
particularly in the housing market. [Lower fees is in terms of overall annual
costs to borrowers compared to what would be the case without these changes in
reporting practices, including di minimus thresholds.] Who, then, can
expect the general quality of appraisal work to exceed that of earlier times?

The system, as it has
evolved since FIRREA, has helped financial institutions earn higher returns, at
least in part, because appraisals are delivered swiftly, at low cost, and with
more leverage toward influencing market prices. Note that the current
regulator environment allows packages of loans (backed in part by regulated
appraisal products) to be more easily bundled and sold to global
investors. These are mortgaged backed securities in the game of two-tiered
structured finance. In the process, risk is shifted to the buyer, and liability
is transferred to the government (i.e., the taxpayer).

In one example, there are
now "thresholds" of value below which appraisals are not required at
all, or which may be conducted by appraisers who have demonstrated the lowest
levels of competency.  Would it surprise you to know that Federally
related lending institutions (i.e., those covered by various forms of Federal
oversight) have the option to avoid acquiring appraisals on real estate loans
of $250,000, or less?  It’s true, and such things did not exist prior to

Under the current system of
funneling money into the mortgage system, appraisals more than ever impart a
high level of security. That is because they appear to come from unbiased
experts who are regulated by Federal mandate.  Further, the higher the
volume of loans, and the higher the appraised values of the collateral, the
greater the power to increase the size of the lending
institutions. Lenders, and GSE to some extent, therefore, have a very
great interest in influencing the results of appraisal reports (and if risk can
be transferred in the process, so much the better).

Appraisal regulation, it
would appear, assists in pushing up the money supply (by way of helping to
increase the value of collateral), economic activity (via higher and higher
loan amounts in cash out refinancings), and lender profits.  As such, regulation
is little more than a ruse designed to shift financial liability for losses
from the appraisal client (i.e., the lending industry) to the Federal
government who is now responsible for appraisal oversight.

Should the Nation
experience another serious financial "adjustment" like the S&L
Crisis, lenders (and GSEs) will be able to point to Federally mandated
appraisal regulation as their free pass to escape a Congressional inquisition
(where property valuations may be called into question).  They will have
the appearance of having done everything according to "the
book."  The investor groups suffering damages from having purchased
loan packages (with this designer gift wrap) will have to seek a bail out from
the government, the ultimate underwriter (and the overseer of lending and
appraisal regulation).  Naturally, the government will not accept blame,
but it will go looking for a villain. Guess whom they will find?

This is not to say, of
course, that we are going to suffer through another event like the Savings and
Loan Crisis. But if we do, the foundations for lenders and GSEs to escape
culpability have been laid (in so far as valuations may be to blame), and
appraisal regulation in it’s current form will have assisted.

Meanwhile, users of
appraisal services have become less selective in regards to the quality
performance of their contractors.  Why bother?  They are all
regulated, right? Contrary to intent, the quality of service has
diminished with the advent of regulation.  This is not surprising when seeing
that reform means faster and cheaper appraisals. [Again, fees for some
types of appraisal services have gone up in the last 15 years, but
comparatively speaking, the overall cost in bundles of loans is much lower than
would be experienced otherwise. Lower, too, are the overall returns to the
appraisal industry.]

The decline in appraisal
quality is also revealed when contemplating the development, and dramatic
growth of the independent appraisal review field, something that was a nominal
part of appraisal quality control before the introduction of
regulation. If appraisal quality has been improved by regulation, would
this large appraisal review field be necessary?

In actuality, it came about
because of the higher incidences of failed quality control examinations on
bundled loans. This generally lower quality performance from appraisers as
revealed in these examinations is what forced the blossoming of the review
field. It assists in providing cleaner looking appraisals in bundled loans, not
necessarily more reliable valuations.

And, just as appraisal
regulation tends to lower the general quality of appraisal performance, so does
it also in the review field, and for the very same reason. It does, however,
provide the user of appraisal services another level for escaping liability,
while reducing the perception of risk.  In other words, it’s the existence
of the process that matters, and not the quality of it.  If an appraisal
has been performed by a Federally regulated individual, and been successfully
reviewed by another regulated individual, it has an enhanced appearance of
quality.  That makes it much more attractive as wrapping paper for bundled
loans.  In practice, however, many competent appraisers will tell of a
need for a review of the reviewers. The quality implied by the practice is
generally lacking, and it often contributes to higher closing costs for
borrowers, who are sometimes asked to pay this cost. The loan seller,
however, does not care, so long as the appraisal and the formal review (if needed)
look good on paper. It is the appearance of quality valuations that helps to
make loans marketable, not the competence, dedication, experience, or ethical
conduct of the appraisers.

Another development since
FIRREA is the massive expansion of so-called appraisal management
companies.  These are firms that effectively warrant lenders a passable
appraisal, supplied speedily, in any location, and for a competitive
fee. On the surface, nothing is wrong in that. It is business fulfilling a
need. These firms, however, generally award appraisal assignments to most
any appraiser who is willing work for half the fee they could get on their own,
and who must bear all the expenses of providing the report office space,
clerical support, computers, software, research materials, photographic
equipment, supplies, etc. This is quite unlike earlier times, when
substantially more of the after expenses fee went to the appraiser who
accomplished the work.

This system of engaging
appraisal management companies benefits lenders in their not having to maintain
lists of qualified appraisers, and not having to engage staff for the purposes
of supervising appraisal orders and fulfillment. The result, of course, is
legions of lesser skilled appraisers who are willing to accept after cost
returns far lower than the industry had been used to receiving. It cannot
be unexpected, then, that quality is diminished. The practice also
contributes to driving the more experienced and better skilled appraisers into
other lines of work, because the appraisal management companies have
commandeered so much of the national volume of appraisal requests. The
best appraisers, therefore, generally are not as well rewarded for their more
advanced years of experience, or their generally higher propensity toward
professional self-improvement.

Another damaging part of
the system is that which divides appraisers into two different classes of
competency one for the minimally qualified (the licensed level), and another
for the more highly qualified (the certified level). The dividing line for
appraisal assignments is based on rather randomly chosen benchmarks of loan
value, or assignment complexity. [This is a separate issue from the
distinction between commercial versus residential property.] The result of
this division, however, is that highly qualified appraisers, particularly in
the residential field, are forced to compete for the same assignments (and
fees) as the lesser skilled appraisers. It gives a competitive advantage to the
lesser skilled who are more eager to accept lower fees. It also results in
higher proportions of mortgage portfolios containing valuations by the most
minimally qualified valuers. Does this not actually increase risk, while
disadvantaging the most qualified appraisers in the industry? Of course!

Don’t the lenders/mortgage
brokers care? Not really. They are increasingly playing the odds, knowing
that, historically speaking, very few real estate loans end in foreclosure
anyway, and the risk is transferred to investor groups in bundled loans.

Consider also that the
lending industry routinely supplies appraisers with the very essence of what
produces bias in the valuation process, the loan amount.  By providing the
loan information, the typical appraiser responds by trying to make the appraisal
fit the loan request.  Obviously this has little effect on markets where
borrowers are seeking mortgages with low loan-to-value ratios.  In the
case of 80, 90, and 100%+ loans — the majority of transactions — appraisers
who "make the deal work" are influencing the market cycle, whether
they know it, or not, and increasing the risk to the ultimate holders of these
loans. Were facts otherwise, real estate lenders would be less inclined to
reveal the size of a loan when requesting appraisal services.  In that
they do so routinely (in purchase money appraisals as well as in refinancings),
it must serve their purposes. And it does.

Appraisal industry mantra
says appraisals do not influence market prices.  Yet, when nearly 100% of
purchase money appraisals "hit the number," and when the vast
majority of real estate sales are facilitated with high loan-to-value ratios,
appraisers are pushing the envelope of real estate prices.  To argue
otherwise says that every buyer and every seller is typically motivated in
almost every real estate transaction, and that they fully appreciate the
concept of Market Value when negotiating their deals. It ain’t so, or the words
typical and normal would not appear in the formal definitions of Market Value.
Typical and normal mean most often, not all of the time.   Most
transactions, therefore, will qualify as typical or normal, when others should
not. Therefore, if the facts are known, not all sales contracts should be able
to meet the test of Market Value.

industry guidelines say that purchase contracts may represent the best
"evidence" of value in an appraisal. Evidence is not proof, yet the
typical appraiser will represent the contract as typical, though in practice
they never see the contract, nor interview buyer and seller about their
motivations. They also accept the negotiated price as "proof" of
value.  Were it indeed "proof," appraisals for purchase money
would not be needed. However, as appraisals are a required part of prudent
lending behavior, and because the typical appraiser always, or almost always
tends to prove the evidence of value disclosed in the contract price,
appraisers have the effect of helping to push prices higher. It cannot be
otherwise. Part of the proof in that comes from the fact that every
appraiser uses comparative market data wherein the evidence of value behind
those transactions was accepted as proof of value by other appraisers writing
purchase money appraisal reports, and who also assumed those contracts were

And, while real estate
buyers may be relying to some degree on the loan appraisal to tell them
whether, or not they may be overpaying for a property, appraisers routinely
give no thought to that possibility.  They labor under the impression that
their job is to help complete the transaction for the lender.  The cycle,
then, as it gets repeated in purchase money transactions, tends to assist in
ratcheting sales prices higher and higher, at least for as long as the market
can tolerate that effect. [Please note, however, I am not arguing that
appraisers are the cause of escalating property values, only that they play
some part in it.]

Lest anyone think
otherwise, consider what the effect on real estate values might be if
appraisers were denied the information on their subject properties proposed
loan-to-value ratios. In fact, the loan amount is completely irrelevant to the
appraisal process most of the time in residential matters, and regulation does
nothing to remove this form of manipulation. [We are speaking here, of course,
about typical financings from traditional lenders. Atypical financings,
even as components of financial packages, are relevant to the appraisal process
where they exist. Such is rare in today’s market, however.]

Most appraisers are caught
in this game 1) because they are paid employees of the lender (sometimes quite
indirectly), or 2) are contractors who will suffer a loss of repeat business
for not "hitting the number." Some appraisers wisely and
routinely discount the loan information, but not the vast majority who depend
on the lending industry for their bread and butter, if not their entire means
of sustenance.  Hence, far too many appraisers are motivated by the need
for sustained income, and have little regard for the lack of bias intended by
regulation.  This makes most of them little more than clerks, filling out
forms and/or expressing narrative talents in completing commercial reports, all
the while the users of appraisal services provide increasing influence over
what constitutes their work product.  Here may be at least one of the
reasons industry vernacular has appraisers working out of "shops," as
opposed to offices.  Offices are where professionals work.  Shops,
however, cater to customers, and "the customer is always

OK, you may say, but isn’t
regulation supposed to mitigate lender influence in the appraisal process?
Perhaps, but as has been shown, the reality is something else. Besides,
regulation does not make work product more professional, more ethical, or more
accurate.  It merely serves to support attractive "wrapping," if
you will, of a more easily marketable product.  That product is globally
marketed bundled loans, and therein is how collateral risk — supposedly
mitigated with quality appraisals — is transferred.

So, does this not sound
like a flawed system, or even a fraud? If it does, and it does to many
observers, can appraisals backing the Nation’s mortgage portfolios generally
pass the test as being truly unbiased documents? Probably not.

What’s the answer? 
How do we improve the quality of appraisals backing the nation’s mortgage loan

I’m not sure anything can
be done at this stage. Practical and feasible solutions are not going be
considered by anyone at any level, until the fact of a problem is
understood. That will take some looming threat, or actual damage to the
system. By then, it may be too late. That aside for the moment, I
have a few thoughts I will share with the reader. One place to start might well
be to trash appraisal regulation and GSE appraisal guidelines in their current

Doing away with the system
and starting over is hard for me to propose. I was one of the early supporters of
the concept of appraisal regulation, and I volunteered long hours to help
ensure its creation.  Like many, I was under the mistaken impression that
regulation would lead to generally higher standards of performance from the
industry, and a new level of recognition as a profession. Against my own
expectations and that of others, the effect of the Federal mandate, born of the
S&L calamity, never materialized in an independent committee of broad
jurisdictional authority capable of discounting the needs of lenders in favor
of the public interest.

On a personal level, I
moved on some years ago — retired from the appraisal field after nearly 30
years of practice. In my time I worked several years as an in-house appraiser
for a blue chip corporation that was then the largest private property owner in
the United States.  Thereafter, I was an independent appraiser. In the
last half of my career, and while carrying leading credentials from two major
trade groups, I almost never accepted appraisal assignments from traditional
mortgage lenders, or brokers, except for reviews under special circumstances. I
intentionally avoided these types of clients, having learned that they are
generally the most cost and time sensitive of clients. Additionally, they
are also the most demanding, the most fickle, and the least appreciative of all
users of appraisal services. And they can afford to be arrogant toward
appraisers. There are far too many willing to do their bidding, and herein
lies the source of their power (to say nothing of their dominance at public
hearings on appraisal subjects).

Though retired, I still
remain in touch with the appraisal field. I have an emotional vested interest,
social contacts, and I am a taxpayer who may one day be called upon to help pay
for the errors of the current regulatory environment.  I am, therefore,
not an inexperienced, or out-of-touch observer. Having set the stage by
that let me offer a few thoughts toward more responsible appraisal oversight in
the public interest.

1) Especially in regards
to residential property, any communication between lender and appraiser
regarding loan amounts, or other suggestions toward appraisal conclusions
should be prohibited by all authorities supervising the activities of lenders,
and loan brokers, unless the loan structure happens to be atypical. Fines and
other penalties should be imposed for violations.

2) All lenders and
mortgage brokers who retain appraisal services should be made primarily
responsible for the value of assets held as collateral (as of the valuation
date) for the life of the loans, whether sold or not, keeping the taxpayer out
of the loop. If the responsibility for appraisal quality were entirely that of
the lender for the life of the loan, appraisal regulation would be less an
issue, and the relationship between lender and appraiser would tend to be
self-policing to a much larger degree.

3) Eliminate the division
of lesser qualified and higher qualified appraisers in Federally related
transactions. Make them all qualify at the same high standards, dividing
only residential and commercial appraisal skills.

4) Require all appraisals
reports and reviews thereof to include the appraiser’s/reviewer’s Statement of
Qualifications, professional resume, or other such document, allowing readers
to better evaluate the experience, training, trade group association(s), and
conceivably, the competence of the author. A mere signature over a typed name
and license number generates no credibility of it’s own. Though such brag
sheets are often ridiculed, the fact of such a requirement will force many
minimally qualified appraisers to improve their credentials, or expose
themselves too appearing unprofessional. Users of appraisal services and
the public will benefit. The leading trade groups should recommend common
guidelines for such disclosures. 

5) Force appraisers to
organize in a more efficient manner to effect self-regulation removed from the
influence of their major clients, the financial services industry.  In
this way, they can be more collectively sensitive to the public interest, while
discounting the clients need for faster, cheaper — but not better quality —
appraisal reports.

In regards to point five,
an industry fragmented by as many special interests groups as the appraisal
field, is no profession, no matter how the various trade groups view
themselves. Society cannot have scattered clusters of specialists in the
same field calling themselves professionals, while each group tries separately
to advance their own membership base, and public visibility.  Such
fractionalization promotes manipulation through weakness (as in the current
situation), and suppresses the appearance of professionalism in the public’s

Appraisers need one
representative organization emphasizing qualifications, and standards of
practice, while maintaining an overriding interest in, and dedication to
self-regulation IN THE PUBLIC INTEREST. Is that possible? I don’t
think so, but without it, the industry will remain a tool of its primary
client, and a participant in the fraud of appraisal regulation.

2004 Larry S. Levy

About the Author

In his retirement, Larry S.
Levy is a private email newsletter writer on metals and mining shares, and
occasionally contributes economic and historical commentary on these subjects
to international publications.  In his former practice as a professional
real estate appraiser, he held leadership roles in the leading trade
associations, lectured, and published articles on valuation topics.

Editor’s Note by Gale Bullock:

Mr. Levy describes in his
succinct essay the stranglehold that the banking cartel has on the realty
valuation industry. The Appraisal Institute has an affiliate appraisal
management company called REAS (Real Estate Appraisal Services) which operates
REAS is owned by Charter One Financial Corporation, the 25th largest
bank holding company in the USA, home based in Ohio. Royal Bank of Scotland is
in merger and acquisition negotiations with Charter One to become the 7th
largest bank holding company in the USA, after the Bank One and JPChase
Manhattan merger as the second largest banking conglomerate. This conflict
of interest
doesn’t get any more blatant than these facts.

In Mr. Levy’s professional
career as a realty valuation expert he attained a high level of proficiency,
exemplary of expertise in both residential and commercial realty valuation. We
are grateful for Mr. Levy’s guest essay, which documents the centralization of
the realty valuation profession since the scam of FIRREA in 1989 — basically the
setup for The Sting.