Appraisal Reform

Making Appraisal Reform Part of Housing Finance Reform

(Editor’s Note: This article originally appeared in the Spring 2017 issue of Appraisal Buzz Magazine)

A new administration and Congress took office in January, renewing the hope for long-awaited housing finance reform. Such reform is the unfinished business from the financial crisis that began before the Obama administration took office. Today, Fannie Mae and Freddie Mac remain in government conservatorships and American taxpayers remain the equity support for more than half of the U.S. mortgage market.

Reduced to its essence, housing finance reform’s primary component involves shifting to private investors some $5 trillion of mortgage credit risk currently on the balance sheets of Fannie Mae and Freddie Mac. Every significant legislative proposal for reform would shift (at least) all but the tail risk to such investors.

This raises an issue for the investment community that directly affects appraisers.  Since reform would create a new asset class in mortgage credit risk, investors in this asset class should care a lot about collateral risk. What is the value proposition for appraisers in assessing and communicating information about collateral risk to investors?

The liquidity and stability of this new credit market will be strengthened the more that uncertainty can be reduced.  Collateral risk is one source of uncertainty that could be reduced if we can answer the following:

  1. What data and analytics should appraisers produce as part of developing their opinion of value that would enhance investors understanding of collateral risk?
  2. What changes to the appraisal report would capture this new information and how can it be conveyed to credit investors?
  3. How could appraisers update certain key information on collateral risk over the life of the loan so investors can be informed of changes in collateral risk? How would appraisers be compensated for such work?

The last question might be best answered on a market-by-market basis not loan-by-loan. But the first two speak directly to conveying more information from appraisers to investors than simply a point value estimate of current market price.  Indeed, the first two questions get to the original purpose of an independent appraisal — an opinion of underlying value, not just an assessment of current market price.

Credit investors are continually making risk assessments.  A simple snapshot of market price is insufficient to tell investors how sustainable, or stable, today’s market price is.  Investors want to know something about the house value should the borrower default and they need to foreclose on the property.  As one example, some estimate of the range of possible value, or of a confidence interval around the value estimate, could be useful.  So, we need to ask better questions of appraisers to get those answers.  And we need to better equip appraisers, whether with data, analytics, training, or compensation, to produce that kind of value for investors.

Housing finance reform also involves rethinking our regulatory infrastructure and legal framework.  Certainly, the appraisal arena is in need of modernization in those areas. Instead of a subcommittee of the Federal Financial Institutions Examination Council (FFIEC) co-managing oversight responsibility, there needs to be a single regulator in charge and empowered. My personal preference is for the Federal Housing Finance Agency to be charged with establishing a Chief National Appraiser position and the FHFA assuming responsibility from the FFIEC.  Whatever the particular solution, the lack of clear federal leadership in this area should be addressed as part of housing finance reform.

Recognizing that the current state of affairs creates many pain points for the appraisal community, I believe that opportunity exists for appraisers to be part of a constructive dialogue of how the industry can serve the needs of a reformed housing finance system.

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About Ed DeMarco

Ed DeMarco
Ed DeMarco is a senior fellow in residence at the Milken Institute Center for Financial Markets, where he researches issues involving housing finance, housing policy and financial institution regulation. He is a widely sought expert and frequent public speaker on housing finance. In 2015 he was a visiting professor at the Owen Graduate School of Management at Vanderbilt University. From 2009 to 2014, DeMarco served as acting director of the Federal Housing Finance Agency (FHFA), the conservator for Fannie Mae and Freddie Mac and regulator of those companies and the Federal Home Loan Banks. He was named HousingWire magazine’s Person of the Year in 2012 for his impact on housing finance. Previously, DeMarco was chief operating officer and senior deputy director of the FHFA and its predecessor agency from 2006 to 2009. DeMarco’s federal service also included the Social Security Administration (2003 to 2006), where he was assistant deputy commissioner for policy; the Treasury Department (1994 to 2003), where he was director of the Office of Financial Institutions Policy; and the General Accounting Office (1986 to 1994). He received a B.A. in economics from the University of Notre Dame and a Ph.D. in economics from the University of Maryland.

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