This is a guest column from Ned Bushong is a business broker and commercial real estate agent in Ohio. His website is www.bushongbusiness.com.
For two years, person after person has told us who or what caused the mortgage crisis. The latest entry being a book by Michael Lewis and reported by Courtney Comstock, right here. Problem is, none of these really hit the bullseye. They’ve all missed the target. So, right here and now, I’m going to tell you who single-handedly caused the mortgage crisis: It was the appraisers. Let’s say you want to buy a piece of real estate, a house. If there is a bank involved, you will most likely be asked to get an appraisal done. It’s your responsibility to pay for it. Here’s the good part: when that appraiser accepts your check, he/she is now bound by a “fiduciary responsibility” to give the you an accurate appraisal. Even if the appraiser isn’t highly trained and licensed, he still has to follow National guidelines known as Uniform Standards of Professional Appraisal Practice. The appraisal report consists of three specific tests: 1)Market data: the property is compared to prices paid for similar properties, in a similar time frame, and in the same location. 2)Replacement value: the property is compared to the cost of building it, new, minus a rate of depreciation. Structures are depreciating assets and will someday be worth nothing. Only the land maintains value forever. 3)Income: the property is compared to similar properties that have been rented and are bringing in a decent return on the investment. Once the appraisal report is complete, all three of these tests must be very close to each other in value. If they are not, then something is wrong and it must be addressed and corrected. Next, the bank will loan according to the appraisal. Even if the bank lends 100% they are only on the hook for 80%, because a mortgage insurance company will guarantee the other 20%. At this point the system is working great. If the appraiser has done his job, correctly, there is no way the bank can get hurt. There is no speculative bubble and there is no way the value can fall more than 20%. Enter the real estate market of recent: Appraisers, knowingly, breached their fiduciary responsibility by lying about values. The most common thing they did was to use the market data method, only, and ignored the other two tests. By ignoring fundamental values, prices simply leap-frogged sale after sale. Up and up and up, into a speculative bubble. In the end, had the system of checks and balances been supervised, everyone would have done their job to the best of their ability. But that wasn’t the case, it was a financial orgy, and everyone was having a blast. Every one turned their head when something had to be fudged, none of the players felt any pressure to do the right thing. So, there’s plenty of blame to go around. But only the appraisers had a fiduciary responsibility, a sworn duty, a legal obligation, to perform to the best of their ability. Given this information, you simply have to point your finger at them and say, “Right there is the main culprit in the crisis”. (Background: Ned read this story on Michael Lewis’ guide to the people behind the mortgage crisis and wrote an email saying it’s actually the appraisers fault. We asked him to explain in a guest column.)
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