Home -> Law Blog Directory -> Legal Journals Blogs -> The Journal of the Business Law Society

Legal Journals

: The Journal of the Business Law Society

Have Brokers been Blowing the Housing Bubble?: Improper Ties between Brokers and Appraisers

By Scott Hockenberry

I. Introduction

     Amidst all the recent talk of a housing bubble,[1] allegations have been leveled that mortgage providers have been encouraging the overvaluation of homes. The charge is that lenders have coerced appraisers to overprice properties in order to justify larger loans and correspondently larger profits. Such sharp practices put borrowers, and the market as a whole, in obvious danger. This article will explore a recent example of such practices and the implications which they could have on the individual consumers and the economy as a whole.

II. Background

     On November 1, 2007, New York Attorney General Andrew M. Cuomo announced at a press conference that he was bringing charges against First American Corporation and its wholly owned subsidiary eAppraiseIT for conspiring to inflate home appraisals in order to issue more profitable loans.[2] The Complaint alleged Fraudulent or Illegal Business Practices, Deceptive Acts or Practices, and Unjust Enrichment.[3]
     The factual allegation is that First American required eAppraiseIT to use appraisers from a ?preferred list? who were known to be willing to inflate prices.[4] By so doing, the company assured an increase in loan amounts and a corresponding increase in profits.[5]
     Concerns about tainted appraiser incentives are not new. ?[C]ritics of the appraisal business . . . have warned for years about the growing pressure on appraisers to inflate home values.?[6] Empirical evidence also supports suspicions of undue influence on appraisers. 90% of appraisers reported in a recent survey that they had been ?pressured by real-estate agents, lenders, mortgage brokers and consumers to adjust property values.?[7]

III. Discussion

      A spokesperson for Washington Mutual[8] stated that brokers ?have absolutely no incentive to have appraisers inflate home values.?[9] This is blatantly untrue.[10] Individual mortgage brokers are paid on commission and thus have ?strong personal incentives to pressure appraisers to value a home at the maximum possible amount.?[11] The employers who pay these commissions do so because they too realize higher profits from larger loans.
     The risk of default on these loans, which is higher when the initial appraisal is inaccurate, is not a deterrent because lenders seldom retain their own mortgages.[12] Rather, mortgage companies sell their interests in loans to the market[13] as mortgaged backed securities.[14] ?This reconfiguration of the way that mortgages are held has transformed the incentives in the industry? by insulating lenders from loss in the case of default.[15]
     In light of this incentive structure, it is not surprising that undue influence has been asserted. Nor does it seem that the problem has been an isolated one.[16] Rather, the case of First American is ??indicative of an industry wide problem.??[17] Additionally, it has ??probably been going on forever.??[18]
     Despite the tempting advantages such practices offer those in the mortgage industry, inflating mortgage loans is devastating to homeowners.[19] In the first place they are scammed into initially paying more than the property they are purchasing is worth. Perhaps even more harmful, the systemic use of such tactics contributes to the emergence of a housing bubble, such as that the country is now experiencing. 

IV. Conclusion

     Businesspeople seem prepared to seize every opportunity for profit, however insidious.[20] Extensive legal regulations have been enacted to preempt such activities, yet some businesses seem to have no qualms about evading these rules.[21] Given the lack of compliance with regulation, a stronger deterrence strategy seems necessary.
     Perhaps such a strategy could be found in enhanced punishments. White collar criminals tend to be sentenced fairly leniently. Additionally, at least on an individual level, only a small percentage of those entangled in such schemes are ever held to account. The existing punishments do not seem enough to tip the scale of incentives away from violation. Perhaps stricter sentencing practices (and possibly targeting a greater number of individuals) would tip the scales towards compliance.

Sources:

[1] A housing bubble occurs when housing prices rise faster than actual housing value.

[2] Associated Press, N.Y. Accuses Real Estate Appraiser, Nov. 2, 2007, available at http://www.baltimoresun.com/business/realestate/bal-bz.appraise02nov02,0,7080584.story.

[3] Complaint at 29-30, New York v. First American Co., available at http://www.oag.state.ny.us/press/2007/nov/EA%20Complaint.pdf.

[4] See Dan Harris & Richard Esposito, N.Y. Attorney General: Leading Bank Profits at Homeowners' Expense, Nov. 1, 2007, ABC News Blotter, http://blogs.abcnews.com/theblotter/2007/11/ny-attorney-ag-.html; see also, Complaint, supra note 3, at 7-10

[5] See id. at 6

[6] Amir Efrati, New York Sues First American Unit in Probe of Home-Loan Appraisals, Wall Street Journal, Nov. 2, 2007, A4

[7] Id.

[8] Loan originators at Washington Mutual were implicated in the First American scandal. The company was not named in the New York charges because of jurisdictional issues.

[9] Harris, supra note 4 (quoting Libby Hutchinson, senior vice president and public relations manager of Washington Mutual).

[10] Complaint, supra note 3, at 6

[11] Id.

[12] See Complaint, supra note 3, at 13

[13] Most are bought by investment banks or Government Sponsored Enterprises. Id.

[14] Id.

[15] Id.

[16] Associated Press, supra note 2.

[17] Id. (quoting New York Attorney General Andrew Cuomo)

[18] Id. (quoting New York Attorney General Andrew Cuomo)

[19] See complaint, supra note 3, at 2-3 (discussing the importance of independent appraisers to homeowners).

[20] The most obvious recent example is that of the Enron scandal. See Lynn Brewer, Is there a little bit of Enron in all of us?, 30.1 The Journal for Quality and Participation 26 (2007) (discussing the Enron scandal and the broader issue of employee ethics).

[21] The Sarbanes-Oxley Act is the most significant piece of recent piece of regulation attempting to curve sharp business practices. See generally, A Guide To The Sarbanes-Oxley Act, http://www.soxlaw.com.

Full post as published by The Journal of the Business Law Society on November 16, 2007 (boomark / email).