Every financial crisis seems to be followed by Congressional reforms and new regulations, which are designed to prevent future financial meltdowns. Within the last 25 years, financial institutions have been part of two such fiascos — the Savings & Loan Crisis in the late 1980s and the Housing Bubble and Financial Crisis of the late 2000s. In part, both of these were caused primarily by unsound real estate lending practices.

Now that the market in 2018 has recovered, changes are already taking place to allow Automated Valuation Systems AVM’s to replace an Appraisal from a licensed appraiser; which could just be the spark to another bubble…

Savings & Loan Crisis of the Late 1980s — FIRREA

The Savings and Loan Crisis (S&L Crisis) of the 1980s was a wave of savings and loan failures caused by mismanagement, failed speculation, and, in some cases, fraud. The Tax Reform Act of 1986 also caused problems when it changed the tax implications associated with many investment properties. These things, along with other economic issues at the time, combined to cause serious adverse economic consequences. When the economy declined, many property owners defaulted on their loans resulting in huge losses for lenders.

The causes and consequences of these problems have been examined, and it has been found that in a large percentage of cases, the loans that were defaulted on had been based on inflated real estate values.

All of this led to the realization that credible appraisal reports, performed by ethical and competent appraisers, are necessary to the country’s economic well-being. Since only a small portion of practicing appraisers had memberships in the generally recognized appraisal organizations at that time, most appraisers were not bound to any one set of qualifications, standards, or ethics rules. This was a deficiency in the real estate appraisal industry needed to be addressed.

Financial Institutions Reform, Recovery, and Enforcement Act of 1989

As a response to the Savings & Loan crisis, Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act (also known as FIRREA or the “S&L Bailout Bill”) in 1989.

Title XI of FIRREA requires real estate appraisals used in connection with federally related transactions to be performed in writing, in accordance with uniform standards, by appraisers whose competency has been demonstrated and whose professional conduct is subject to effective supervision. [12CFR 323.1(b)].

In addition, FIRREA requires that federally related transactions with a transaction value greater than $250,000 be performed by a licensed or certified appraiser.

Housing Bubble and Financial Crisis of the Late 2000s — Dodd-Frank Act

The rise in the housing prices since 2000 was described by The Economist magazine as the “biggest bubble in history”. The perfect storm of record low interest rates, abandonment of mortgage underwriting standards, subprime loans, and out-right mortgage fraud combined to create this housing bubble that burst in 2006.

The plunge in home sales led to a huge increase in foreclosures of subprime mortgages. By 2007, many subprime lenders filed for chapter-11 bankruptcy or closed. By the summer of 2008, the overleveraged financial institutions were in a state of chaos and reported billions of dollars in losses that caused some to fail and others to survive only with government help. The 2008 financial crisis led to the deepest recession since the 1930s.

Dodd-Frank Act

Once again, the government’s solution to the disintegration of the housing market and financial crisis was more regulation — the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). The Dodd-Frank Act made sweeping changes to financial regulatory agencies and affects almost every aspect of the nation’s financial services industry. It creates new agencies and changes others, amends the Federal Reserve Act, promotes transparency, and establishes rigorous standards and supervision to protect consumers, investors, and businesses. Its goal is to end taxpayer bailouts of financial institutions and to eliminate the loopholes that led to the economic recession. Because it is so far reaching, the legislation will certainly have unintended consequences not yet even envisioned.

The Reform Act addresses a variety of appraisal and valuation issues. For example, it requires that appraisers are independent and have no interest in the underlying transaction. It allows use of an automated valuation model (AVM) but prohibits a broker price opinion (BPO) as the primary valuation tool in connection with valuation of a primary residence. Appraisals for high-risk mortgages must include a visit to the interior of the property. The Reform Act also addresses appraisal management companies (AMC), which are widely used by financial service institutions. It may require that the fee paid to appraisers and the administration fee charged by appraisal management companies both be set forth on the new integrated closing statement.

Appraisal Changes are coming to Residential Property Appraisals

It’s no shock that technology has been rapidly changing the real estate industry. One of those rapid advancements of late has been populating automated home values instantly through sources like the Zestimate from Zillow, Redfin Estimate, ValueofProperties.com AVM and others alike.

It’s been a great source for sellers and buyers to determine a general estimate for the property, but lenders and technology companies are now trying to use the AVM model to replace residential property appraisals. This model which is coming faster than you’d expect would allow lenders to use data from an Automated Valuation system instead of requiring an independent appraisal from a licensed Appraiser.

The goal would be to speed up lending timelines and allow a buyer to close on a property faster than 30 days. Although this could help speed up the process, it seems like this could be a start to another financial crisis in the making…