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Off Topic: Appraisers' Role In The Residential Mortgage Meltdown

On August 18, the IBJ's online editor, Norm Heikens, posted on his blog the following:   

Some of the people most familiar with the mortgage foreclosure explosion in the Indianapolis area in recent years have privately pointed fingers at appraisers.

Appraisers too often were in cahoots with lenders to illegally inflate prices of houses, the insiders complained, usually off the record.

Most appraisers are honest, ethical people, of course. But now an Associated Press investigation says the system failed miserably.

What do you think? Have you seen evidence of appraisers’ inflating prices?

Click here for a link to the AP investigation, entitled "Weak Rules Cripple Appraiser Oversight," which telling and a good read even for commercial lenders.  While I completely agree that inflated appraisals contributed to the problem, I respectfully disagree with Mr. Heikens that appraisers were in cahoots with lenders.  It seems to me that there was little incentive for lenders to overvalue their loan collateral and leave themselves undersecured.  I concur with the comment posted by "Don" on Mr. Heikens' blog that independent, third-party mortgage brokers were the ones who stood to profit from the scheme. 

For example, My partner Dale Eikenberry has handled a number of mortgage fraud recovery cases, and I assisted him with one of his larger suits for an Indiana-based mortgage lender against an Indianapolis-based mortgage broker.  The theory of the case centered upon the broker's breach of its contractual representations and warranties concerning the truth and accuracy of the appraisals it ordered and supplied to the lender.  In our opinion, there was strong evidence that certain appraisers may have been in cahoots with the defendant broker to improperly inflate prices of houses.  We contended that our lender client had been damaged, to the tune of seven figures, by the bad appraisals, upon which the lender relied in underwriting about three dozen loans that never should've been made and ultimately went into default.   

Admittedly, the appraisal problem addressed in the AP investigation doesn't have much applicability to commercial mortgage loans, mainly because there really aren't independent, third-party brokers selling loans to commercial property owners or developers.  In the commercial setting, the lenders themselves (the funders of the loans) usually originate the loans and order the appraisals, not an independent third party who simply earns a commission if he or she closes the deal and suffers no harm if the customer (borrower) defaults on the loan. 

Certainly inflated appraisals can be a problem for commercial lenders, who are advised to scrutinize appraisal reports and utilize only trusted, experienced appraisers.  But, in my view, unlike the meltdown in the consumer industry, losses associated with commercial defaults really don't stem from appraisal-based fraud.  If others have had different experiences, please post a comment or email me, thanks.   

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