Wednesday, May 28, 2008

Freddie Mac and Fannie Mae Agreement to Require Independent Home Appraisal Criticized

US Comptroller of the Currency John C. Dugan has joined others in criticizing an agreement between mortgage buyers Freddie Mac and Fannie Mae.

Congress created Fannie Mae during the depression to aid a faltering housing market. The company created a secondary mortgage market by purchasing mortgages from banks, pooling them, and selling them as secured bonds. The idea is that more money will be available to lend to consumers for home mortgages. Fannie Mae was converted into a private company in 1968 in an effort to balance the federal budget. Freddie Mac was added in 1970 to create competition with Fannie Mae and end its monopoly.

In the wake of the sub prime mortgage debacle and drastic home price adjustments, the companies have made an agreement that requires lenders to use independent property appraisers if they are to be eligible to sell their mortgages to Freddie Mac or Fannie Mae. The concern is that banks are somehow giving appraisers incentives to inflate the value of homes in order to pump up their profits through larger mortgages. Fannie and Freddie's contract term seems like an appropriate way to address this concern, but not to Mr. Dugan.

The Chicago Tribune reports:

In a 12-page letter to James B. Lockhart, director of OFHEO, Mr. Dugan said his office strongly endorses the principle that real estate appraisals must be conducted free from influence or coercion by any party.”
But creating a conflict-free environment is done by letting federal and state regulators enforce standards of mortgage lenders and brokers, “not by dictating the corporate and internal organizational structures of lenders,” he added.
The agreement with Fannie and Freddie could have “unintended and meaningful negative implications for the safe, sound and efficient operation of the mortgage lending industry, as well as for the cost of mortgage credit to consumers, without offsetting benefits,” Mr. Dugan wrote.

In my mind, Freddie Mac and Fannie Mae got it right. The housing bubble was inflated by greedy banks and their appraisers. Lenders have far too much influence over housing prices. They are even finding ways to profit off their foreclosures through fees. Dugan's suggestion of "letting the federal and state regulators enforce standards" was completely unsuccessful in the past as no one appeared to be watching over anyone. As appraisers artificially increased home prices, everyone patted each other on the back. The local, state and federal governments were pleased for higher returns on property taxes and would see rising prices as a sign of economic prosperity. Sellers were pleased with their profits, and even buyers could look forward to their property value climbing steadily, as long as the bank approved their mortgage application. When buyer's expectations of home ownership exceeded the economic reality of the inflated prices, the banks nor appraisers adjusted the prices. Instead, banks gave out mortgages inappropriately and with unfair terms.

Something needs to be done to attack inflated appraisals, and the regulators weren't doing and adequate job in the past, so I think that Freddie Mac and Fannie Mae should ignore this criticism and move forward with their contract.

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