Bad Appraisals: Getting to the root of the subprime crisis

Attorney General Cuomo leads charge against appraisal system with lawsuits

Dec.December 05, 2007 12:32 PM

As Wall Street and state regulatory authorities peel away at the layers of the subprime loan crisis, they may want to consider what happened to the family of Edgar Reyes, a school custodian from Ossining, N.Y.

In 2005, Ameriquest Mortgage Co., one of the nation’s largest subprime lenders, offered him a deal to refinance his mortgage at 6.5 percent interest and lower his $2,990 monthly payments.

However, when the refinancing deal closed, Reyes was saddled with additional points and a higher interest rate that raised his monthly payments by several hundred dollars.

Reyes, whose wife was expecting their second child, fell six months behind on his mortgage payments. He tried to avert foreclosure with a short sale — where the mortgage lender agrees to accept the proceeds from the sale of a property, even if they don’t amount to the entire mortgage balance — through J. Philip Real Estate, one of the top brokerages in Westchester County.

An appraiser had valued the home at $363,000, but Reyes received three offers for around $260,000, and the property was forced into foreclosure.

J. Philip owner J. Philip Faranda argued that the bank had accepted the inflated value of the home, which used outdated comps and valued the property as a three-bedroom, instead of a two-bedroom with a den.

“I’m not some schlub,” said Faranda. “We knew there were problems with appraisals. These people got hosed.”

Inflated appraisals are the root of the subprime problem, experts say. The victims: Reyes and many other unsuspecting borrowers with less-than-perfect credit, who are often lured into bait-and-switch financing. The plumped-up values are now hurting homeowners who fell for exotic financing products, leaving them with mortgages that are more expensive than they expected — and with few options, since they cannot count on a quick sale in the current market. Meanwhile, banks are cranking up the pressure by raising the standards for credit, making it tougher to refinance. The result has been a spike in foreclosures, attracting national scrutiny of the lending system.

In January 2006, Ameriquest agreed to pay $325 million to settle a multistate probe into charges it inflated home values, charged excessive loan origination fees and failed to disclose terms to homebuyers. In July, New York Attorney General Andrew Cuomo said that 25,000 New Yorkers would be eligible for $22 million in restitution. In the settlement, Ameriquest neither admitted nor denied guilt.

Reyes, however, had no knowledge of the agreement and filed for bankruptcy protection.

“They set us up for failure,” said his wife, Yvette.

In the latest blow to appraisers, Cuomo filed suit last month against First American Corp., alleging its eAppraiseIT unit provided inflated home values for Seattle-based Washington Mutual. The First American unit provided more than 262,000 appraisals for Washington Mutual between April 2006 and October 2007.

He then issued subpoenas to Fannie Mae and Freddie Mac, the nation’s two largest sponsors of home mortgages.

Fannie Mae noted in a statement posted on its Web site, written by Brian Faith, its managing director of communications, that it intended to appoint an independent examiner to look at the problem as well as to cooperate fully with the attorney general. Freddie Mac issued a similar statement, noting that the corporation “has a long-standing commitment to fighting mortgage fraud.”

As a state regulator, Cuomo does not have jurisdiction over Washington Mutual, which is the nation’s third-largest provider of loans to Freddie Mac, selling $24.7 million in loans in 2007.

Washington Mutual said it has suspended its relationship with eAppraiseIT and was conducting its own investigation into the allegations. The company also said it would vigorously defend itself against unfounded allegations and lawsuits.

According to a 2003 study by October Research Corp., 55 percent of appraisers reported being pressured by mortgage lenders, brokers, consumers and real estate agents to inflate home values. A follow-up study released earlier this year shows that 90 percent of appraisers are reporting pressure to inflate home values.

“The bad appraisal is probably 90 percent of the subprime problem,” said Michael Sichenzia, chief operating officer of Dynamic Consulting Services and lead investigator for the Deerfield Beach, Fla.-based law firm of Glinn Somera & Silva.

Sichenzia, a former real estate speculator, offers an inside perspective on mortgage fraud, as he did four years in New York State prison for defrauding investors of $225,000. Between 1997 and 2000, Sichenzia purchased dozens of houses in the Newburgh, N.Y., area and resold them to family members and dummy companies that he controlled. He submitted fake documents that inflated the income and assets of the home buyers and purported down payments.

“There is a quid pro quo that exists between appraisers and brokers,” said Sichenzia. “It’s an unwritten agreement that exists in every relationship.”

Sichenzia and other experts said that appraisers depend on mortgage brokers and lenders for new business, and therefore submit fake documents, fail to actually inspect the property being appraised, or base the appraisal on outdated comps.

Lenders and brokers have been willing to overlook these inflated values, the theory goes, because the loans have been bundled up and resold to unsuspecting investors.

“The broker wasn’t the party that would have to deal with bad loans,” said Solomon Greene, research fellow at the Furman Center for Real Estate and Urban Policy in Manhattan. “They made their commission off the highest-priced loan they could sell to the borrower, which was a recipe for disaster.”

The fallout is having an impact on the New York area, as annual foreclosures are expected to surpass 14,000 by the end of the year, which would double the number of two years ago.

Earlier this year, Cuomo issued subpoenas to Mitchell Maxwell & Jackson Inc., Manhattan Mortgage Co., and Vanderbilt Appraisal in a probe to determine whether lenders were inflating home values.

Y. David Scharf, attorney for MMJ, confirmed that the company received a subpoena in May, had cooperated with the investigation and was informed that it was not a target of the probe. Vanderbilt Appraisal principal Andrew Fautley would neither confirm nor deny that his company was subpoenaed. Manhattan Mortgage officials were not immediately available for comment.

Appraisal Institute president Terry Dunkin, speaking at a November press conference with Cuomo, said that appraisal fraud has been an open secret in the mortgage industry, and much of the pressure has come directly from the banking industry.

“Appraisers were pressured to inflate the value of property, or worse, turn a blind eye to outright mortgage fraud,” Dunkin said. “It is symbolic of a problem that has plagued the appraisal industry for years.”

Fitch Ratings, Moody’s Investors Services and Standard & Poor’s were also subpoenaed by Cuomo, as the attorney general sought to examine the role of ratings agencies in evaluating mortgage-backed securities.

At the November press conference, Cuomo said the probe was expanding to look into the role of investment banks in the subprime crisis.

“I don’t believe this is just about Washington Mutual,” Cuomo said. “I believe it’s widespread.”

The crisis has forced more than 50 subprime lenders out of business, resulting in a major shift in mortgage lending to traditional lenders, who are closely scrutinizing existing deals and new mortgage applications.

Bank of America, the nation’s second-largest bank, is closing its wholesale mortgage lending unit, which offered mortgages through a network of 7,000 approved brokers. The bank reported $843 million in real estate mortgages through the first nine months of the year, and brokers accounted for 25 percent of its business.

Officials insist the move was not a reaction to appraisal concerns or subprime exposure, adding that the credit profile of its wholesale customers is similar to its retail customers.

“We’re very careful in choosing our appraisers,” said bank spokesman Terry Francisco. “Their independence and integrity is critical. It wouldn’t be in our interest in making inflated assessments.”

Otto van Hemert, assistant professor of finance at New York University, warned that the market shakeout will continue into 2008, when hybrid loans originated before the subprime crisis are scheduled to reset.

“If home prices go down further, people whose loans are resetting will have much more difficulty getting a new loan,” said van Hemert. “The most pain in the lending market is still to come.”

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