FDIC Federal Register Citations

From: charles warren

Sent: Friday, November 21, 2008 2:08 PM

To: regs.comments@occ.tres.gov; regs.comments@federalreserve.gov; Comments;

regs.comments@ots.tres.gov; regcomments@ncua.gov

Cc: sf.nancy@mail.house.gov; president

Subject: proposed interagency appraisal and evaluation guidelines - comment

Among rule based systems there are two themes. One is supervisory; rule

makers make and enforce rules. The other is adversarial. Contestants

agree on rules which may be enforced to insure fair or equal play. The

first is weak because there are almost always more players who have an

interest in evasion than there are referees to catch them. The second is

robust because there are usually about equal interests at stake.

An example of the first is arms control. Saddam Hussein exploited the

limitations of even the most stringent arms control regime. An example

of the second is the Geneva Accord. Few countries flout the Geneva

Accord because it is in their interest to see it applies to them as well

as their adversaries.

Let's take a less fraught pair of examples relating to sport. Sailboat

racing has two sets of rules. One is related to handicapping boats

depending on their different design characteristics. The second is

related to conduct on the race course. The first is supervisory and the

second adversarial.

Sailboats are faster or slower depending on a number of factors,

principal of which are waterline length, weight, power and stability.

Since I have been involved in racing boats there have been a succession

of clever rules which were devised by brilliant people with the intent

of making a formula that reliably handicapped the differences between

different boats. They have all degenerated into encouraging the

construction of rule-based boats. In other words, instead of equalizing

the scoring of a disparate fleet of boats, they have resulted in

construction of a more or less homogenous fleet optimized to the rule.

There are lots of smart naval architects and racers with the money to

encourage them to try to outsmart the rule. As the weaknesses of the

rule usually lead to odd boats, one rule succeeds another. The

International Offshore Rule was thoroughly discredited by the disastrous

losses of boats designed to it in the Fastnet Race of 1979. Hope

triumphs over experience, however, and it has had several successors.

Conduct on the race course is obviously adversarial. It is governed by

published rules which are internationally recognized. They start with

basic sorts of things. In general boats to your right have the right of

way. You must avoid collision. If you don't, beside possibly being

liable for repair costs, you will very probably be disqualified from the

race. This rule regime is pretty stable. Every five years the rule

making committee takes a look at how they've worked and makes some small

amendments. They also work pretty well in practice. Any contestant may

protest any other for an infringement. The decision is made speedily,

usually the night after the event, and locally, at the race-sponsoring

yacht club, by a committee of peers, members of a knowledgeable race

committee. The immediacy and certainty of the process as well as the

high probability of its outcome yields a high level of compliance. Even

at high profile events there are usually few protests. There is an

appeal process, too. Appeals are read carefully both by serious

competitors and by the racing rules committee in its periodic rule

revision process.

The tenet that I draw from these examples is that transparent

adversarial rules are robust. My suggestions that relate to the proposed

OCC, OTS, FDIC, etal. appraisal rules are made with that in mind.

Within the context of lending, appraisal is part of the underwriting

process. Its role as a cross-check has been degraded as the system has

had no room for cross-checks. The way to make money was to make loans.

Not making loans was not making money. In the event, because everybody

acted that way, now everybody is losing incredible amounts of money.

That was predictable.

Now, specifically, the proposed rule only "allows" the sale contract to

be shared with the appraiser. Let us suppose that the lender chooses not

to, but orally informs the appraiser of a sale price. There have been

sales in the last cycle in which as much as 15% of the nominal price was

immediately rebated to the buyer. Presumably that rebate would be in the

contract. How likely would it be that the lender would report it orally

at the same time as the nominal gross price?

The assumption here is that purchase appraisals are a large problem. Of

course they may be. But refinance and construction appraisals have

absolutely no direct reference to the market. Purchases do, the buyer

and the price. In general buyers are not stupid. Unless there is some

tangible incentive to do otherwise they will pay a fair price. In home

resales my experience is that is true over 90% of the time. Allowing

lenders to deprive appraisers of that source of information is not going

to improve the underwriting process.

It is a good idea to make appraiser independence a major goal of the

rule. There are probably two simpler ways to do that. The first is to

put appraisal in the audit department of the institution rather than

loan origination. The second is to require selection of contract

appraisers by a random or sequential process from licensed appraisers in

a geographic area.

The assumption behind the proposed rule is that taking the appraisal

quality decision to the highest level will improve the result. This is

not universally so. Had a memorable termination interview in which the

corporate head of underwriting informed me that my job as reviewer was

to rubber stamp all appraisals as acceptable. The quality control

decision was his. This interview was held in the presence of the

corporate counsel who almost apologetically confirmed that policy was

consistent with the wishes of the president-CEO. Maybe the result would

have been the same if I had been responsible to the chief auditor.

But the follow up on that internal determination is to homogenize the

contract appraisals so that none undermine the generation of fee income.

Another memorable conversation I had was with a review appraiser of an

ex-client. It turned out that I had really angered one of their

borrowers and that was why I wasn't getting any more work from them. If

appraiser selection was either sequential by license number or random in

a geographic area, that sort of homogenization would be difficult if not

imposssible.

Additional standards in excess of licensure is a dangerous concept. Yes,

achieving, for instance, senior membership in an appraisal organization

is worthy and hopefully represents an advance in knowledge and general

expertise over licensure. Similarly, course work related to specialized

topics may improve suitability for some assignments. But unless such

standards are explicit and externally verifiable, others, such as the

willingness and ability to please the client, may also weigh in the

balance to the detriment of quality.

Here's a little one. Photos of the property securing the loan are now

available from several online databases. The moment of time that these

images capture is often poorly defined. If photos are going to be any

sort of assistance to evaluating collateral, there has to be some

assurance that they represent the property at a time contemporary with

that decision.

Automated Valuation Models (AVMs) are another slippery problem. They

have proved out for property taxation. But property taxation is an

adversarial game. Using AVMs for lending is going to be a supervisorial

game. Nobody makes money by saying no. AVMs will allow the proliferation

of bad decisions faster than they can be detected let alone suppressed

by a limited number of supervisors. This assumes that the supervisors

will be as technically qualified as those who will seek to evade

supervision. Imagine pitting a GS13 with an MBA against a team of math

PhDs with bonus plans. Remember the Unibomber is a math PhD.

Assessed value is a stronger reed. Assessment is adversarial. The

assessor wants an accurate value. The property owner wants a low one.

Presumably the local jurisdiction wants a high one, but can't usually

explicitly say so. With the exception of states like California, those

interests come out with a pretty well equalized result. Yes, the

relationship of assessed value to market value will vary for many

reasons. But it may not be necessary for the lending institution to

evaluate that. It is probably evaluated at the state level to oversee

and supervise assessment generally. It may also be a matter of public

record at the local level. If the institution is to be tasked with

relating assessed value to market value, the rules better be explicit,

and the measures for doing so better be related to publicly available

information.

This is a bit outside the scope of property appraisal, but reference to

rating agencies to determine the quality and value of real estate based

securities seems a bit quaint. Perhaps verification that there is a

market maker, a liquid market and the price of the securities might be

more to the point.

Sincerely,

Charles B. Warren, ASA

urban real property

Valuation and Consultation

San Francisco

http://www.charlesbwarren.com

415.433.0959