The FDIC's Big Appraisal Fraud Suit: Why It Smells Fishy

Property appraisers are all-important watchdogs in the real estate and mortgage market. They are the trained professionals, sworn to follow strict standards, who are supposed to provide an objective analysis of the value of properties before banks make loans. If appraisers are corrupted, the whole system is at risk.

And that is exactly what happened during the boom.

In 2005, I wrote a report for Demos on how widespread appraisal fraud imperiled both homeowners and the real estate market. Appraisers were giving the thumbs up to inflated property values and banks were loaning out billions based on these estimates. We know how that story ended.

Since the bust, there have been several efforts to hold appraisers responsible for their misleading valuations. Most notably, Attorney General Andrew Cuomo took on this issue and ultimately imposed a controversial new set of appraisal rules on loans backed by Freddie and Fannie.

Now comes a suit by the FDIC, in its role as the receiver of the bankrupt Washington Mutual, against the appraisal firm LSI and some of its partners.

You can read the full suit yourself, but here's the gist: The FDIC wants LSI to cough up $154 million for doing shoddy and inflated appraisals for WaMu, leading the bank to make millions in bad loans to properties that were overvalued.

The suit clearly frames WaMu as the victim here. It says that WaMu took specific steps when it began working with LSI to insulate appraisers from any pressure coming from WaMu employees and suggests that LSI cooked up the inflated appraisals all by itself. Specifically, the suit alleges that WaMu's appraisals were conducted in a grossly negligent fashion, flouting any number of standards, and that inflated valuations were the result.

Okay, so what is wrong with this picture?

Basically this: It contradicts much of what we know about appraisal fraud, as well as WaMu's own sorry record in this area.

As I documented in my report, appraisers were seldom the bad guys when it came to jacking up real estate values. Rather, the pressures to hit higher numbers typically came from brokers or lenders who had a financial stake in getting deals to close.

Now, it's perfectly plausible that LSI was doing sloppy work for WaMu during the boom and hiring any warm body they could find to keep up with the avalanche of deals. Just about everyone was cutting corners during those heady times when it came to dotting the i's and crossing the t's on loans.

But what doesn't compute is why LSI's incompetence would necessarily lead to inflated valuations, as opposed to some mix of over and under valuations? I do see the motive for a greedy appraisal firm to cut corners to save money, all the while telling its deep pocketed client (WaMu paid LSI $127 million in fees) that it was doing all the proper homework. But I don't the motive for individual appraisers to inflate values all by themselves.

Another reason this smells fishy is that WaMu is now well known to have been one of the shadiest outfits in the mortgage business, right up there with Countrywide. More specifically, it's been accused of complicity in appraisal fraud. In 2007, when Cuomo went after First American Corp. and its eAppraiseIT (EA) subsidiary, he accused WaMu of being part of the deceptive practices.

Cuomo's complaint explained what happened as follows:

 In April 2006, EA began providing appraisal services for WaMu, which became EA’s biggest client.  Within weeks, WaMu began complaining to EA that its appraisals were not high enough. 

WaMu pressured EA to employ exclusively a new panel of appraisers that WaMu hand-selected as “Proven Appraisers.” This set of appraisers was chosen by WaMu specifically because they inflated property appraisals. 

WaMu profited from these higher appraisals because they could close more home loans, at greater values. Over the course of their relationship, between April 2006 and October 2007, EA provided approximately 262,000 appraisals for WaMu.

In the old days, a bank wouldn't have had a financial interest in making loans based on inflated values. But those days were long gone by the time the boom rolled around. Like other lenders, WaMu was closing crappy loans and lying about their underwriting practices as they sold these loans into the secondary mortgage market where they were turned into securities.

In other words, while LSI didn't have a freestanding motive for inflating values, the company that paid its fees, WaMu, did. So who logically would have been driving the appraisal fraud train here? The most plausible hypothesis is that WaMu leaned on LSI, just as it had leaned on EA.

Finally, there is Jennifer Wertz's suit against WaMu, filed in 2007. Wertz, a California appraiser, claims that she was blackballed by WaMU from doing further work after she failed to go along with inflated property valuations. Wertz worked as an independent contractor for LSI, but was directly contacted by a WaMU employee trying to influence her appraisal work. She was subsequently told by LSI that she wouldn't get any more work from WaMu, which had accounted for $100,000 a year in income for her.

The FDIC is supposed to recoup as much money as possible that taxpayers lose when banks go belly up. But in this case, the agency is acting more like an apologist for WaMu than a federal agency. It's case against LSI is an embarrassment.

That is not to say that LSI didn't behave badly or shouldn't be held to judgment. If it went along with pressures from WaMu to inflate loans, it should be punished. But the correct story needs to be told here -- not some nonsense about incompetence that lets WaMu off the hook.

Did the attorneys for the FDIC -- Steven Jay Katzman, Steven Hoard, John Mozola, Greg Dimmick, Sarah Pelley, and Leonard DePasquale -- do  their homework on appraisal fraud before filing this suit? One has to wonder.

Comments

[TedWa]

Good article. You nailed important problems that have yet to be addressed by anyone. Just lately B of A paid a $1 billion fine to stop the investigation of them and Countrywide of inflating home values from 2003 to 2009. All the banks were doing it. As an appraiser for the last 21 years, honest and ethical, who lost work because I would not inflate values, the ignorance of this specific cause of the bubble and bust is truly egregious. Now, thanks to Cuomo and his HVCC, banks own AMC's like Eappraiseit and totally control the appraisers while skimming their fees at 50%. By raising the least experienced and ethical among us they are planning to get rid of appraisers as protectors of the public trust by using AVM's and other assorted sundry models. Fxing the results to their desired goals. It took a lot of fraud for the banks to grow as large and bloated as they are, and it will take much more crimes for them to stay this bloated and to grow even larger.

Thank you for pointing out bank controlled appraisers and valuations causing the bubble.