Unintended Consequences

The appraisal process as it exists today is a direct result of reforms that followed the 2008 economic downturn, and as Jed Stafford, the senior vice president for PHH Home Loans’ Midwest Region, explains, although those reforms set out to correct the exuberant speculation that defined the housing boom years, unintended consequences have resulted.

During the housing boom years, when home prices were rising at such an unprecedented pace, Stafford says the appraisal process became a setting for manipulation and abuse, with loan officers pressuring appraisers to positively value properties in a manner that was in-line with the boom mentality but not necessarily in-line with the true marketplace. It was one component, Stafford explains, of a broken system, one defined by an intense pressure for increasingly strong returns and one that required dramatic action from policymakers to adequately correct.

“The pressure comes from borrowers who want the home to appraise out higher so they can borrow more money; the pressure comes from not killing a real estate transaction. So the system in itself was broke, at that point,” Stafford says. “Now, do I think we’ve gone too far with it? Sure … the process today is dramatically different than it was before. But it’s also what needed to happen; you have to correct to fix the problem, but we’ve definitely over-corrected.”

Today’s appraisal process – the over-correction Stafford refers to – has been primarily shaped by the Home Valuation Code of Conduct (HVCC), a 2009 policy jointly adopted by Fannie Mae and the Federal Housing Finance Agency that established a new era of structure and separation for appraisals. To combat appraisal manipulation, the HVCC stipulates that loan officers are prohibited from influencing the appraisal process, and can have no contact with appraisers. Instead, lenders now interact with what are known as appraisal management companies, or AMCs, which act as the middlemen in the process and choose which appraisers will evaluate which properties. Though mortgage underwriters, who have no direct relationship with the loan, can still drill down to the appraiser level and choose which appraiser they’d like for a certain property, the loan officer maintains no contact with the appraiser. No contact, the new system goes, no pressure, and therefore, no questionable appraisers, no running up of housing prices and no sequel to the housing bubble.

Except regulators, as Stafford alluded to earlier, made one critical error in their formulation of the new HVCC appraisal rules, one they perhaps could not have anticipated. The new rules abolished what are known as “positive time adjustments,” or, an adjustment that an appraiser makes to account for a possible discrepancy in time between the property being appraised and its comps. So as a hypothetical: Property A is being sold, and Comp A matches the property almost perfectly – except Comp A was sold six months ago, and the market, by the measure of the major housing price indices (the Case-Shiller in particular), has appreciated; thus, the appraiser (pre-HVCC) would have made a positive time adjustment, factoring in the market appreciation. It’s a logical tool for appraisers to have access to, but as Stafford explains, with it no longer available, appraisers are often severely limited by the data available to them.

“The appraisers are now very structured by the changes the agencies have pushed through about what data they can use in the appraisal process,” Stafford says. “And the most important data are the sales comparables in the last 90 days. But you take a home in a very unique market” – Chicago’s North Shore communities, he says, are a perfect example – “if there is not a decent comparable in the last 90 days, you go into six months, and there’s not the ability to do what are called ‘time adjustments’ for those things anymore. It makes it dramatically harder because of the lack of data to be able to move those markets.”

The elimination of positive time adjustments, Stafford says, was a decision made during the recession, and was therefore crafted with a depreciating market in mind; what happens, though, when the market inevitably begins to recover? As Stafford puts it, “When the market starts to appreciate, how are we ever going to have an appreciating market when the appraisal process does not take into account an appreciating market?”

But ultimately, the only entity that can reinstitute the positive time adjustment policy is Fannie Mae, and though Stafford and several other influential members of the PHH team have been meeting with Fannie for three years now regarding the unsustainable nature of the current policy, he has yet to hear of any movement on the issue.