As we’ve been discussing (1, 2, 3), new Home Valuation Code of Conduct (HVCC) rules went into effect Friday that prevent loan officers from talking to home appraisers. Our previous posts focus on getting home financing transactions done in the context of the new rules. This post is an opinion piece.
My opinion is that HVCC unjustifiably punishes ethical mortgage professionals along with the hacks it’s actually targeting. Once my frustration subsides, HVCC may prove to be a sustainable investment-bank-like ‘Chinese Wall’ policy, but it’s harder to be positive about the complacency HVCC breeds among appraisers.
Investment Bank Valuation Practices vs. HVCC
‘Objective valuation’ is an age-old battle that cuts across stocks, bonds and real estate. The last major valuation controversy peaked around 2002 when NY Attorney General Eliot Spitzer crusaded against investment banks for alleged valuation conflicts of interest during the internet stock bubble. The argument for regulation went like this: investment bank sales division wants more internet IPO business, so they influence their research division to write favorable stock valuation reports on internet sector and companies the firm does IPOs for, and the result is that IPO sales and research analyst incomes boom. Which leads to more favorable valuation reports, artificially inflated stock values, and a massive pricing bubble.
No regulation came from Spitzer’s efforts and the decades-old ‘Chinese Wall’—an ethical rather than physical boundary between research and investment banking—lived on as generally accepted securities firm valuation safeguard.
The argument for regulation on home appraisals goes like this: loan officer wants to close more deals, so he influences appraiser he works with to write favorable home appraisal reports, and the result is that loan officer sales and appraiser incomes boom. Which leads to more favorable appraisals, artificially inflated home values, and a massive pricing bubble.
It’s the exact same issue, just a different asset class. And while HVCC isn’t a government regulation, it might as well be since it’s a Fannie Mae/Freddie Mac requirement—these entities were taken over by the government last September, and they own or back 90% of U.S. home loans originated in the past year.
Holes in Appraisal Rules Nobody Is Talking About
Trick one is that HVCC doesn’t necessarily solve anything. Within mortgage or commercial banks, it just creates a Chinese Wall between loan officers (sales) and appraisal departments (research). The loan officer originates a deal and puts his appraisal request into a random request queue that the appraisal department orders and manages. The reason it doesn’t necessarily solve anything is because a Chinese Wall is an ethical wall, so if the whole firm is more motivated by sales than market relevant valuations, HVCC won’t necessarily solve anything.
Trick two is that HVCC has the potential to create even worse home appraisals. While punishing greedy loan officers, HVCC simultaneously rewards the greedy appraisers who enabled those loan officers. These appraisers, who were more concerned about getting paid than producing proper valuation research, now get paid when they turn in their report and they move onto the next one. The overwhelming majority of HVCC-approved lenders don’t have a dispute process, which breeds complacency because the appraiser’s work is never challenged. Maybe HVCC helps weed out greedy or lazy loan officers, but it generally enables appraisers with these characteristics.
As with anything finance and valuation related, it all comes down to the credibility of the firm, it’s consumer-facing advisors, and it’s research/valuation standards. The rest is politics. So while the market correction from the internet stock bust wasn’t severe enough for Eliot Spitzer to get his regulation (and perhaps a political legacy that would have outweighed his personal transgressions), the housing bust was enough.
Now it’s business almost as usual … just a bit more political intrigue. May the smartest firms and consumer advisors win.
Basis Point of Disclosure: The author of this post is a mortgage loan officer. His bank’s HVCC-compliant appraisal program allows borrowers and/or Realtors to dispute values.