NY AG's Lawsuit May Shed Light Into Consumer Ripoffs When Obtaining Home Mortgages

A recently filed civil lawsuit by the New York State Attorney General's Office against First American Corporation and its real estate appraisal subsidiary, eAppraiseIt, charges them with allegedly allowing national mortgage lender Washington Mutual Inc. into strong-arming them into knowingly issuing inflated residential real estate appraisals in connection with home mortgage loans.

The following excerpt from the lawsuit may shed light for some into how so many consumers looking for home financing to either purchase or refinance a home were blatantly ripped off by the bad actors in the home mortgage and related industries.

• Most people interested in purchasing or refinancing a home (“borrowers”) seek a financial institution (a “lender”) to lend them money on the most favorable repayment terms available. Traditionally the lender, as part of agreeing to loan the funds, wanted to ensure that the borrower was able to repay the loan and that the loan was adequately collateralized in case the borrower defaulted. The borrower and the lender had a common interest in accurately valuing the underlying collateral because both wanted to be sure the borrower was not paying too much for the property and would be able to meet the repayment terms, or that – in the event of default and foreclosure – the property value could support the loan.

• Today, the landscape of the mortgage industry is quite different from this traditional model. Rather than holding the mortgage loans, lenders now regularly sell these mortgages in the financial markets, either directly or to investment banks or Government Sponsored Enterprises (“GSEs”), such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”). The loans are then pooled together, securitized, and sold to the general public as mortgage backed securities. The money that the lender receives for the sale of the mortgage loans or bonds is then used to finance new mortgages, increasing the lender’s profits and aiding its stock price. Today, the vast majority of mortgage loans are sold to investment banks or GSEs, leaving the original lender holding far fewer mortgages in its portfolio.

• This reconfiguration of the way that mortgages are held has transformed the incentives in the industry. Specifically, it has the effect of making the lender less vigilant against risky loans since any risk is quickly transferred to the purchasers of the loans. Moreover, as the lender does not hold many of its loans in its portfolio, the lender’s interest in ensuring the accuracy of the appraisal backing the loan is severely diminished. Even worse, because lenders’ profits are determined by the quantity of loans they successfully close, and not the quality of those loans, there is an incentive for a lender to pressure appraisers to reach values that will allow the loan to close, whether or not the appraisal accurately reflects the home value.

• Further jeopardizing the process, mortgage brokers and the lenders’ loan production staff (also known as “loan origination staff”) are almost always paid on commission. Thus, the income of these individuals depends on whether a loan closes and on the size of the loan. Accordingly, brokers and loan production staff have strong personal incentives to pressure appraisers to value a home at the maximum possible amount, so that loans will close and generate maximum commissions. For these reasons, mortgage brokers and lenders frequently subject real estate appraisers to intense pressure to change values in appraisal reports.

• The investment banks and GSEs also have an interest in inflating (or at least in not questioning) the value of the pooled loans. The values of these loans serve as a basis for the value of their securities. As such, the higher the value of the loans closed, the greater the value for which the securities are sold on the secondary market.

• Thus, the only parties under the current system who want an accurate appraisal are the borrowers and the investors in the asset-backed securities market. Neither of these parties, however, has any contact with, or control over, the appraisal process.

(from the New York AG's lawsuit, Cuomo vs. First American Corporation and First American eAppraiseIT, paragraphs 12-17).

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As has been observed by others, it appears that the current foreclosure mess revolves around the fact that the home lending business, which was once dominated by "bankers" (with a focus on "loan quality") appears to be now dominated by "salespeople" (with little concern about anything other than "loan quantity").

For a recent story on inflated appraisals, see Banks bullying appraisers to boost values bad news (Kenneth Harney syndicated article). Cuomo OFHEO Fannie Mae Freddie Mac