June 4th, 2008
Mortgage Mess
This is an open letter about the mortgage mess – which is affecting darn near everyone in the country.
via snail mail
to: distribution list /with attachments
Executive Summary
From the FEMA field manual – When you’re up to your ass in alligators, it’s difficult to remember the original objective was to drain the swamp.
Introduction
Everything in this letter is just my opinion. Take it for what it’s worth.
I encourage you to read this letter dated 9/2/05. I sent it to literally everyone I could think of, with attachments. I made a lot of bold statements. Turns out I was right.
I started out very naive. I am less so now. I recently applied for a job as staff appraiser at HUD. I’m not holding my breath.
White Hat
It takes a village to fix a mess the size of this one. We need the best ideas and the best effort from all of the good guys. Are you with me? Or are you asking “what’s in it for me?”
We need to get past the lip service and get past the BS – and get serious.
Spin
To put this in perspective – try this short exercise. See for yourself.
Imagine you stumble on some evidence of mortgage fraud – and you want to report it by calling the Freddie Mac mortgage fraud hot line. The phone number is on this Webpage. Now call the number. What do you think? Did you leave a message? Do you think they will call you back? Do you think they ever call anyone back?
I called the Freddie Mac mortgage fraud hot line at 10:30 am on Wednesday 5/28/08. Hillary Clinton did not answer the hot line. Nobody answered. The recorded message talks about the “unusually high” volume of calls. Unusually high compared to what?
Did I call at a bad time? If so, when is a good time? Are they trying to encourage people like me to shut up and go away?
I know there is a limit to how much they can do. But it’s a fair question to ask – is the mortgage fraud hot line a serious (reasonable) effort at doing something about the problem? Or is it spin?
I’m not suggesting the hot line is the problem. Like a lot of things in life there’s two sides to this story. It’s inconvenient (and therefore expensive) to answer the phone, blah, blah, blah. This is just an example of what I mean when I say the critical first step is to get past the lip service and the BS.
Definitions
In this letter, I try to use non-technical language. I try to keep it simple so that even a CEO can understand. To be clear – let me define my terms:
- We = Big picture “we”. Either the entire country or the mortgage system, depending on the context
- Good Loan = a mortgage loan that gets paid back
- Bad Loan = a loan that does not get paid back a/k/a foreclosure.
- Collateral = lesser of purchase price / appraised value
- Market Value = what you can sell the house for
- Good Appraisal = A reasonable effort at market value. Good (ethical) appraisers tend to produce good appraisals.
- Bad Appraisal = The value needed to make the deal work a/k/a the requested loan. Bad (unethical) appraisers tend to produce bad appraisals.
The Goal
Over the past 4 years – “we” (the mortgage system) have made too many bad loans. Effective asap and for the foreseeable future, the mortgage system goal needs to be:
Goal = Approve all the good loans, and deny all the bad loans.
Sounds simple enough. We’ll never be able to get it 100% right – but isn’t that what works best for the country? It’s imperative that “we” make fewer bad loans. Right?
Strapped
Denver Post 5/21/08: A proposed bill in Washington DC would rescue up to 500,000 strapped borrowers.
A 5/7/08 NY Times article by Charlie Duhigg says
“As the market recovers, we will be a prime beneficiary,†Fannie Mae’s president, Daniel C. Mudd, said in a conference call with analysts Tuesday morning. When the housing market finally stabilizes, the company will “feast†on the mortgages it is currently buying, he added.
About a year ago – Angelo Mozil0 was trying to sell this same story about how Countrywide would emerge the winner. Not so much anymore.
Fannie lost $3.6 billion in the 4th quarter of 2007, $2.2 billion in the first quarter of 2008 = $5.8 billion in 6 months time.
The politicians propose to pay for the rescue (un-strap) by tapping into the profits of Fannie & Freddie. Hello? How much solution can you buy with a $5.8 billion loss?
Somebody at the Federal Government (presumably Ben Bernanke) put up $29 billion of taxpayer money to rescue Bear Stearns and prevent a complete melt down of “the system”. Just imagine how much different this would have played out if it had been Alan Greenspan. But I digress.
Ben Bernanke then put up another $22 billion of taxpayer money in the form of low interest low doc loans for the other Investment Banks. Don’t ask which investment bank got how much money because it’s a secret. I have a problem with the “secret” part. $22 billion is a lot of money to be passing out to Wall Street scoundrels and scalawags.
Item #2 on the list of biggest lies ever told – “I’m from the Government and I’m here to help you”. I wonder if these words were spoken by Ben Bernanke.
Crisis Management
500,000 strapped borrowers = 500,000 bad loans. Think about that for a minute.
Crisis Management means if there is no crisis, there is no management. Can we agree there is a mortgage crisis? Can we get some management? Or not?
Behind every one of those bad loans was a bad appraisal. 500,000 bad loans = 500,000 bad appraisals. The borrower was upside down the day they moved into the house. The borrower had negative equity on day 1.
85% of those bad loans would have never happened if the appraisal process had worked reasonably well.
Just Say No
We have 2 choices. The mortgage loan system will either:
- Be able to say “no”, or….
- Not be able to say “no”
What happens when the mortgage system is unable to say “no”? You don’t need to use your imagination, just open your eyes. We’re all standing knee deep in it. 500,000 foreclosures.
Udder Failure
If the goal is to change the system so it will say “no” to the bad loans – how will “we” do that? Specifically what needs to change?
I propose that we fix the mortgage problem (too many bad loans) by fixing the appraisal function. I’m convinced the appraisal function needs to change. The appraisal function has been and continues to be absolutely positively unable to say “no”. An utter failure.
An appraisal system that never says “no” does more harm than good. Either fix it, or eliminate it all together.
Solution
It’s easy to complain and find fault. It gets harder when you try to come up with a solution.
The executive summary of my solution:
- Un-Denial = Accept the need to change the status quo
- Fewer = Accept fewer loans
- Tell the Truth = Rebates, seller concession, LTV
- Rotation = Mortgage appraisals assigned by an independent disinterested 3rd party
- Appraisal Fee & Turn Time = Must be reasonable
- Carrot and Stick – We need both
- Appraisal Vault = Transparency means accountability
- Apprentice = No more sweatshop appraisers
Status Quo
This is not going to be easy.
In the mortgage industry production means total loans. This is a transaction driven industry. There is no getting around the fact that fewer bad loans will mean fewer total loans. Everyone in the mortgage lending industry gets paid on commission. They are not going to like it.
Don’t underestimate the power of the status quo.
For example:
Dick Fuld and the Bros
Richard S. Fuld, Jr, Chairman and CEO at Lehman Bros since 1994. His 2007 salary was $750,000 and total compensation was $34M. I call that a bonus of $33M.
Dick Fuld is directly responsible for a substantial chunk of the bad loans that got us into this mess. Richard S. Fuld, Jr, made a $33M bonus last year precisely because of all the bad loans at Lehman Bros. I have 2 examples:
- Feb 2006 Vicki Dillard Crowe $950K mortgage loan for a $500,000 house (that’s a big spread)
- Dec 2005 James Beauprez got a $400K loan to buy a $300K house from Leslie Reagan.
How many recognize the name Beauprez?
When Henry Paulson talks about “reckless lenders, investors and speculators” – I think of Dick Fuld and the Bros.
My best estimate is the US Taxpayer gave Dick Fuld and the Bros an emergency $4 billion low interest loan on a handshake and maybe some crap mortgage loans as collateral.
Don’t worry be happy. Ben Bernanke told Congress “we” (the taxpayer) got the cream of the crap.
Dick Fuld has 33 million reasons to defend the status quo.
CEO’s are going to do what CEO’s do. It’s unrealistic to think we can change the leopard’s spots. What we can do and what we need to do is develop/implement a system that is both able AND willing to value the collateral at market value. If that means fewer mortgages (i.e., houses get sold) then so be it.
The alternative is for Ben Bernanke to put $29 billion of lipstick on the next pig (Lehman) and tell the American taxpayer to bend over and pucker up – again.
Tell the Truth
Pay close attention, because nobody else (that I know of) has said this.
Tell the truth. What a concept!
It is what It ain’t
FHA, VA, Fannie, and Freddie need to immediately start telling the truth about the loan to value ratio (LTV), seller concessions, and down payment.
A recent article in the Denver Post says that Fannie requires (at least) a 3% down payment. True or spin? How would anyone know? Fannie and Freddie now account for 80% of the mortgage market. Does anyone believe 80% of mortgage loans have at least 3% down? It’s not consistent with what I see going on in Denver. Companies like Neighborhood Gold, Nehemiah, Home Ownership and Mortgage Education, exist for the sole purpose of lying about down payment and LTV.
I said this in September of 2005, and I’m still saying it. FHA and VA provide a valuable service and I want them to continue. But tell the truth. Stop manipulating the purchase price, down payment, LTV.
We Have Met the Enemy
Some of you may be thinking – if they are going to make the loan anyway – does it really matter if they call it 100% or 104%, 106%, 108%? If that’s what you were thinking please go look in the mirror because YOU are the problem.
Is it OK to make a 108% loan? Or not? Where do we draw the line? Can we all get on the same page? If it’s OK to make a 108% loan, then call it what it is and make the loan. If it’s not OK then stop doing it. Right?
Out of Control
I urge you to take a look at this example. This is not a VA loan – it’s an example of what happens when the system is out of control.
Eric Orr wanted to sell one of his many his houses – the one at 780 Sapphire Dr, Castle Rock, Colorado. As the listing history shows – in September of 2005 the house had been on the market for 200 days. The asking price was $999,000 with no takers. With the help of 2 real estate agents (Kimberly White and Richard Berst) and an outfit named Home Ownership and Mortgage Education, Ma & Pa Tieskotter were able to obtain a $1.2M mortgage loan from the good people at Countrywide. The listing agent (Berst) increased the price by $325,000 and reported a seller concession of $zero on MLS.
As I predicted – this property went into foreclosure. The REO sale closed 5/14/08 (3 weeks ago) at $675,00 – about $500,000 less than the loan balance. That’s a big spread. Somebody got screwed. Angelo Mozil0 made $200 million precisely because of all the bad loans at Countrywide. Now he’s laughing all the way to the tanning salon. I feel like I got screwed. How about you?
What’s my point? What does any of this have to do with VA?
The only difference between 78o Sapphire Dr and the ordinary 104% VA loan is the dollar amount of the lie. They both manipulate the sale price for the sole purpose of getting the loan approved. Lenders, real estate agents, and appraisers learn the system on the FHA and the VA loans. Once they’ve been properly trained, it’s just a matter of ‘fill in the blank’ with a bigger number.
These comments are from the VA Webpage titled Loan Production:
The VA allows a veteran …. to purchase a primary residence without putting money down towards the sales price, as long as the sales price does not exceed the appraised value. … VA’s appraisal is an estimate of the market value as of the date the inspection …… VA does charge an up front VA funding fee, which may be financed …. Closing costs may be paid by the seller, which is an item to consider when the sales price is being negotiated …. The seller can pay for closing costs. There is a requirement that seller concessions do not exceed 4%….
There is no mystery about how it works. 104% is pre-approved. Every VA appraiser understands how this works. It’s not coercion in the sense that there are no explicit threats. None are needed. Everyone knows what needs to get done, and everyone does their part.
The VA refers to the 104% loan as “100% financing”. They call it a benefit.
Other benefits of using VA’s program (other than the 100% financing of the sales price) include…..
Let’s look at a recent example of a VA transaction: 5184 S Jebel St., Centennial, CO 80015. Transaction date 3/7/08. Lender = Freedom Mortgage Corp. The MLS listing history shows the property had been on the market 192 days with an asking price of $229,900. Any property that has been listed for more than 90 days is (by definition) overpriced – the price is too high. Both real estate agents knew this property is not worth $229,900.
Along comes a potential buyer, Stan Kinderknecht – presumably a veteran. With the benefit of hind sight we can see that Stan obtained a $237,498 VA loan to buy this property. In theory Stan could have paid Darbara Singh (the seller) $229,900 and the VA loan would have been within the 4% limit. No problem. Right?
There is a problem. The house is not worth $229,900 and Stan (the veteran) does not want to overpay. Stan wants to pay a “fair” price. Stan wants to pay – and Darbara agrees to accept $225,525. This is a price reduction of $4,375 and now everyone is happy.
Except there is a problem with the VA loan. A $237,498 loan is 105.3% of the actual purchase price – which is outside the limit of 104%.
The buyer, seller, 2 real estate agents, mortgage broker and the lender all agree to manipulate the sale price – for the sole purpose of getting the loan approved. But the hocus pocus only works if an appraiser is willing to play along. And of course – the VA appraiser always plays along. Any idiot can see this house is not worth $229,900. And yet – the sold price is listed as $232,500. What do you suppose was the appraised value?
Does this seem convoluted? Confusing? That (of course) is the point. The confusion is built right into the process.
I don’t know who did the appraisal at 5184 S Jebel St. But I “know” that if you were to look closely at this appraiser’s last 20 VA appraisals – none of them would be below the actual sales price. Look at the last 200 VA appraisals and the result would be the same – none below the actual sales price.
This is not independent, objective, unbiased. It is the opposite. The VA appraiser started with the amount needed to make the deal work, and worked backwards to hit the magic number.
The critical first step is for the top brass at VA to tell the truth, and demand the same of the entire organization. The healing begins when the lying stops. Just like Walter Reed.
The United States of America desperately needs leadership from the VA and the FHA. Can we get some leadership?
Pardon me while I puke.
Independent / Objective / Unbiased
In theory, the mortgage appraisal is independent, objective, unbiased. This allows mortgages to be traded on Wall Street. In practice, the entire mortgage system – including the appraisal process – is out of control.
A bad appraisal is available to anyone who wants it. Think I am exaggerating? Ever wonder how hard it is to find an appraiser willing to play along with a $500,000 mortgage fraud?
Jill and Eric Orr (the sellers in the $1.2M transaction at 78o Sapphire Dr) are both appraisers. Think about that for a minute.
If you need an appraisal done you could call Jill and Eric Orr. They might be able to help you out. Or you could contact Angelo Mozilo. Angelo knows how to find a good appraiser or a bad appraiser – he could help you either way. Or you could look in the yellow pages.
What would you do?
What if someone asked you to do a $1.2M appraisal on 780 Sapphire Dr? What would you do?
If an appraiser in that position asked your advice – what would you tell them? Would you advise the appraiser to call the Countrywide mortgage fraud hot line?
Appraisal reports are not independent and it’s downright difficult to sell a mortgage on Wall Street these days. Suckers are getting harder to find. Isn’t that right Ben Bernanke?
If we want to resume/continue trading mortgages on Wall Street (and I believe we do) – we must fix the appraisal process. Mortgage appraisals must be independent, objective, unbiased. How will “we” do that?
To be clear – not every appraisal is done for a mortgage, and most of the non-mortgage appraisals do not need to be independent.
For example – if IndyMac wants to hire an appraiser to help set the price for an REO sale – my suggestions do not apply to that situation – because they are not going to use the appraisal to “sell” anything on Wall Street. IMHO – this type of appraisal (i.e., not independently ordered) should include a warning/disclaimer that it is not intended for re-sale.
With that in mind – here are my suggestions for mortgage appraisals:
Rotation
Any appraisal that will be used on Wall Street (i.e., an appraisal for a mortgage) needs to be ordered from a disinterested 3rd party. The disinterested 3rd party will assign appraisals on a rotation system modeled on the current VA process.
By disinterested 3rd party – I mean a government agency (or subcontractor) with a monopoly on all mortgage appraisal orders. I do not mean some appraisal management company with stockholders and a CEO.
If Countrywide, WaMu, Fannie, or Freddie are the “client”, it ain’t gonna work. All CEO’s get paid on commission. Dick Syron is not a good choice to control the flow of transactions because there is an inherent conflict of interest. And sadly the same is true for the head guy at HUD. Alphonso Jackson left under a cloud of suspicion. Steve Preston may be better for awhile, but the point is there is an inherent conflict of interest.
Fees & Turn Time
Fees affect appraisal quality. Turns times affect appraisal quality. There are form filler outers, and there are appraisers. For $197 you get form filler outers.
If you want a good appraisal, you must be willing to pay a reasonable fee – and you must allow a reasonable turn time. Do you want a good appraisal? Or not?
Fees and turn times must be standardized based on the scope of work. The administrative cost of the disinterested 3rd party will be funded by a portion of the fee. For example – every appraisal in the Denver Metro area will cost $400 and pay $300 to the appraiser.
Fees will be adjusted periodically (for example – once a year), with input from all sides – lenders, appraisers, and anyone else that cares to comment.
Dispute resolution is modeled on baseball arbitration. If the sides cannot agree on a standard fee, each will submit a proposed figure to an arbitrator who must pick one or the other.
Vault
On Wall Street they call it transparency. In the appraisal process there is no transparency. Everything is a secret. This means there is no accountability. This (of course) is exactly what all the bad appraisers want.
Turn on the light and watch the cock roaches scatter.
It is critically important for the disinterested 3rd party to obtain/maintain a copy of every appraisal. This “vault” would be available to the State real estate board (Erin Toll), the state attorney general, state and federal law enforcement (FBI, etc).
The cost of maintaining this data would be minimal. The savings in mortgage fraud would be huge. HUGE.
Carrot & Stick
We need to reward good appraisers and penalize bad appraisers – which will be the complete opposite of the current system.
The appraisal vault will allow us to review a random sample for technical issues and USPAP compliance.
We can/must review a non-random sample for ethical issues. This is not rocket science, and it is not mind reading. It can be done, and we must do it.
For example – look at a large group of purchase mortgage appraisals where the appraised value is not exactly the same as the actual purchase price.
If approximately half of that group of appraisals is lower than the actual purchase price – this is a powerful indication that the appraisal system is working, i.e., independent, objective, unbiased.
If something like 100% of those appraisals are higher than the actual purchase price – this is a powerful indication of appraiser bias. Right? Listen carefully – that sound you hear is every lender, real estate agent, and appraiser in America screaming – Nooooo – we can’t do that!
Do you want unbiased? Or not?
Somebody needs to get serious about appraiser discipline. For example – we need to eliminate (or repair) the administrative law judge (ALJ) from appraiser hearings. In Colorado any appraiser and any real estate agent can completely avoid discipline simply by threatening to show up at the hearing (see for example Richard Berst, pg1 and pg2). The State will always back down (settle) because the State is unwilling to risk the expense and the uncertainty of an ALJ case. Think I am exaggerating? See if you can find the case number and date of the last ruling by an ALJ in a real estate hearing in Colorado. The State always settles.
Apprentice
Under the current system, every appraiser must serve an apprenticeship to obtain a license. In theory this is a chance to learn from hands-on experience. I am in total agreement with the theory.
In practice, the current apprentice system is badly broken.
There needs to be a reasonable limit of how many apprentices can train under the same mentor at the same time – perhaps a number like 2 or 3. When one mentor is supervising six (or more) apprentices it’s called a sweat shop. Many (most?) appraisers get started this way. Mortgage brokers like these appraisers because they are well trained to hit the magic number.
All too often it’s the bad appraisers who train the next generation. Leslie Rousseau, Adam Conner, and James Esters are indicative of this problem. These 3 are gone, but their apprentices are still here. Jill Orr is an apprentice appraiser. Her husband, Eric Orr is a licensed appraiser. Who do you think Jill Orr is learning the business from? James Esters wife is an apprentice appraiser.
This needs to be fixed.
There needs to be training available for mentors – how to effectively train/supervise an apprentice. There needs to be a way to identify who the good appraisers are – and to approve them as mentors. There needs to be a reasonable financial incentive for good appraisers to take on an apprentice.
Call to Action
If the right group of people put their heads together it will happen. I’m ready to work towards a good solution. Are you with me?
So what’s it going to be?
Will we tap dance long enough to make the crisis go away – and then back to business as usual? Or will we fix the system?
This is not rocket science. It can be done. We need the backbone.
I’m not optimistic.
Sincerely,
Philip G Rice
11268 E Linvale Dr
Aurora, CO 80014
720-282-3376
phil.rice@mkgappraisal.com
ps – To all who have read this far, please take a minute and think creatively about something you can do. Make a positive difference. If you want to help but are not sure about how, call me at 720-282-3376 or send an email.
– End of Letter –
