September 11, 2008: At the October, 2001 national convention of the Association of Appraiser Regulatory Officials (AARO) the group's past president Sam E. Blackburn decried conditions in the property appraisal industry saying “the present system is not working.” Why? Because “lenders have added a new twist to the old law of supply and demand: if appraisers don't supply the numbers they need, they demand another appraiser.”
Blackburn wasn't alone in his observations. For several years professional publications and online discussion groups had featured articles and comments by appraisers about lenders pressing for inflated estimates of value and retaliating against those who refused. Appraisers voicing these complaints took pride in their work and were saddened by what was happening to their profession. Some spoke of getting out of the appraisal business. Not all could afford to do so.
In October, 2002, Business Week published The Housing Boom's Dark Side about the rising tide of mortgage fraud and over-extended buyers. The article quoted the FBI: “mortgage and housing related swindles have risen 25% in the last year.” (Six years later the FBI is still sounding warning bells.) James Croft, director of the Mortgage Asset Research Institute (MARI) also weighed in: “people have figured out that robbing banks is too hard. The real money is in real estate.” MARI, a non-government entity, collects data on mortgage fraud from private and public sources including federal and state agencies. In reports issued in 2000 and 2001, MARI identified various states, counties, and cities as mortgage fraud hot spots. Most still rank high with the FBI.
According to Business Week, factors contributing to the housing boom's “Dark Side” included the post tech-bubble migration of securities salespeople into the mortgage broker business (do the bubble hop, hop hop hop) and the migration of professional criminals into a range of real estate industries. Connie Wilson, an investigator from AppIntell put it this way: “You've got money laundering operations in Miami involving real estate and rings of thugs in California doing house-flipping scams.” Also at play: EZ mortgage transactions over the Internet and a mortgage securitization process that uploaded shoddy loans into the investment ether. From sea to shining sea, real estate was becoming increasingly unreal.
In the growth years of the housing bubble the majority of securitized mortgages flowed through Fannie Mae and Freddie Mac. At one point Fannie and Freddie controlled roughly three quarters of the mortgage market. After investment banks put a hurt on their business (largely through subprime) Fan and Fred got into the subprime game-- despite the fact that their government charter restricts the GSE's sphere of activity to mortgages deemed “conforming”. Though this may be splitting hairs. As lending and securitization standards deteriorated so did the lines between grades of mortgages.
As we all know now, Fannie Mae and Freddie Mac are not just “mortgage giants” (the info-free term the press often used when covering Fan and Fred's myriad scandals) but Government Sponsored Enterprises. Aka GSEs. Neither straight-up businesses nor flat-out government agencies, Fannie and Freddie have enjoyed the best of both worlds. With their privatized profits pumped by the implicit guarantee of socialized losses-- in case of disaster break glass and soak taxpayer. That implicit guarantee has now become an explicit government takeover by the U.S. Treasury. The ultimate cost is unknown. Estimates run from billions to trillions. The Congressional Budget Office believes the bill should appear on the federal budget. According to the September 9th Financial Times (Cost of US-loans bail-out emerging) President Bush may not have realized the GSE surge would go on the federal books.
Taxpayers who fear toting the Fannie/Freddie load may find hope in the words of Treasury Secretary Henry Paulson as quoted by Reuters on September 8th (US's Paulson: Fannie, Freddie costs difficult to know). “Many of us believe that this housing correction will stabilize in the months ahead..in that scenario, it's very possible for not only the taxpayer not to be hurt or to make money, but for the shareholders to have some value restored to them.” Paulson didn't mention how large the possible profits from the possible scenario might possibly be; it's difficult to calculate possible returns without knowing the ultimate size of the forced investment.
More comfort for taxpayers: the Bank of China approves the takeover. As do other central banks in Asia. Where most of Fannie and Freddie's debt is held. A September 8th article at Bloomberg.Com (Zhou, Trichet Endorse U.S. Rescue of Fannie, Freddie) describes the go go reactions of a gaggle of big money boys. “This is positive” glowed People's Bank of China Governor Zhou Xiaochuan. “It should have a useful tranquilizing effect on the very stressful market” intoned Joseph Yam, chief exec of the Hong Kong Monetary Authority. “Japan welcomes the U.S. action” said Japanese Finance Minister Bunmei Ibuki. European Central Bank President Jean-Claude Trichet dittoed the welcome mat. But Polish central bank President Slawomir Skrzypek was a tad wet blanket. What if the takeover encouraged investors to take on more risk knowing government would bail out failures?
At the beginning of this decade the moral hazard question was raised by appraisers in their comments re lenders pressing for inflated values. Some appraisers thought that lending standards were deteriorating because lenders no longer held mortgages but profited upfront by selling them to Fannie Mae and Freddie Mac. And some suggested Fan and Fred were lax about the quality of the mortgages they bought since they made huge profits via securitization and that investors were equally sloppy because of implicit taxpayer backing. Which is now writ large in explicit stone.
Carola Von Hoffmannstahl-Solomonoff
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