ZAIO Chief Speaks - History Lesson is Relevant

RESOLVING THE SUB PRIME DILEMMA
Applying lessons from the S&L crisis will restore stability and market confidence

By Thomas Inserra, MAI, SRA, CEO, Zaio Inc.

History is repeating itself.
The conditions surrounding the current sub prime mortgage crisis and the 1980-95 savings and loan crisis are eerily similar: An oversupply of property for sale. A sharp drop in new home construction and mortgage lending volumes. Huge loan losses. Heightened foreclosure rates. Lenders going out of business. Turmoil in security markets, with global implications. Action from the Fed to stimulate the economy. Congressional hearings to assign blame and write new regulations.

During the S&L crisis, federally insured financial institutions with combined assets of $924 billion failed over a 15-year period. Like today’s sub prime mortgage problem, the root cause was a breakdown in credit and appraisal processes. To address the S&L issue, a government-funded corporation called the Resolution Trust Corp. (RTC) was created in 1989. The RTC managed 747 financial institutions with $402.6 billion in assets, making it one of the largest corporations in the world.

The RTC succeeded in resolving the S&L dilemma by revamping credit and appraisal processes, improving investor access to appraisal data, and revaluing mortgage assets to reflect current market values. Over time, restored confidence in credit and appraisal processes led to improved marketability and liquidity of mortgage assets.
Ironically, in 1994, at a time when the S&L crisis was still underway, lenders successfully lobbied for new regulatory loopholes, including an exemption from appraisal regulations for loans under $250,000. The $250,000 loophole, along with the failure to extend appraisal regulations to sub prime lenders, mortgage brokers and state-regulated institutions, sowed the seeds for the current sub prime crisis.

In some of the worst losses in the S&L breakdown, lenders bribed or coerced appraisers, partnerships flipped property back and forth to artificially increase value, and appraisers inflated values to help make more loans. It’s alarming to note that 90 percent of today’s appraisers have reported that lenders have attempted to influence their “independent” conclusions.

Lenders have also migrated away from appraisal reports. Some found that, instead of encouraging an appraiser to inflate values, they could avoid the appraiser altogether, and use less expensive broker price opinions (BPOs) from real estate agents or computer-generated AVMs (automated valuation models). The widespread use of BPOs and AVMs significantly increased sub prime loan losses, and represents yet another breakdown in the appraisal process.

Clearly, current issues will not be resolved until regulatory loopholes are closed and lenders take measures to improve credit and appraisal processes – essential steps in restoring market confidence, and preventing a future crisis.

Lenders and regulators need to re-engineer the appraisal process so that values cannot be manipulated, and so that pressure exerted by loan officers on appraisers is eliminated.
A very promising example of appraisal reform is a nationwide group of licensed appraisers who are beginning to draft reports in advance, prior to any transaction, and storing them in a secure database. Lenders are already benefiting from this approach, and are better able to meet the needs of borrowers because they can retrieve their pre-manufactured appraisals in seconds, instead of days or weeks.

Although regulatory loopholes have not yet been closed, many lenders have already strengthened their own credit and appraisal policies. Some have eliminated BPOs and AVMs, and reinstated mandatory appraisals on all mortgage loans. Lenders are also implementing new accounting regulations requiring assets to be based on current market value rather than historic costs. In addition, many lenders are now revaluing assets on a quarterly or even monthly basis. This improves transparency, while allowing lenders to react quickly to changing market conditions, establish appropriate loan loss reserves, and improve investor confidence.
Eventually, this mortgage dilemma, like the last one, will pass, and it will be resolved in the same manner: by restoring proven credit and appraisal procedures, by revaluating all mortgage assets to reflect realistic, current market values, and by restoring confidence.

Investors – then and now – demand proof of underlying market value before they will act. And it’s the investors, lenders and portfolio owners who have learned the lessons of the past who will lead the market recovery.