_September 23, 2008
_An appraiser weighs in. The ‘nut’ in all the mess: “Fair Market Value.”
Seven hundred billion dollars is not chump change, not least of all to the American taxpayer-chumps who will be expected to hand it over to Wall Street players on little more than a wing and a prayer.
The “mess” is the collection of junk the finance industry took as collateral backing the paper that entitled the top tiers to rake in fortunes that would have made Midas blush. No one knows what that junk is worth, and anyone trying to tell you that he or she has even a whiff of a “smells-like” guess is doing two things: lying to you, and expecting you, as the chump, will believe the lie.
For most of two decades I had one of the larger real estate appraisal firms in the San Francisco Bay area. I absolutely refused to deal with mortgage brokers because it was dishonest work. They were not interested in an honest appraisal, only one that would enable them to secure a nice commission when the loan package was sold to an institutional — read as bank — investor.
The estimate of fair market value was only one element on the standard FNMA-FHLMC form that determined whether the loan package would be approved and purchased. Others included “good”-“average”-“fair”-“poor” check-box ratings concerning the subject property’s overall neighborhood, its conformance to the neighborhood on a variety of factors, the condition of the property, and so on. Any “fair” or “poor” ratings required narrative analysis and explanation. Irrespective of all other factors, generally, a “fair” or “poor” rating would doom the loan.
But the nut of it all inheres in the estimate of fair market value. Seems like that should be easy enough. It is anything but that. For starters, FMV is defined as: “The highest price in terms of money for which a property will sell, as of a given date, in an open and competitive market between a willing seller and a willing buyer, with both buyer and seller acting with full knowledge of all the uses to which the property may be adapted and for which it can be legally used, with neither buyer nor seller acting under duress.”
Each phrase is key. First of all, the estimate is precisely that, an estimate. The more knowledgeable and experienced the appraiser, the better his or her judgment, and the more abundant and recent the sale data, and the greater the conformity of the subject realty with that data, the more reliable will be the estimate. Next, it’s as of a given date. Say, like today, September 23, 2008. Tomorrow, all bets are off. Anything can happen overnight, which is exactly the reason that in more prudent times lenders wanted one of two things: either a 20% cushion, or a 10% cushion backed by borrower purchased PMI (private mortgage insurance).
Before he or she has been at the craft an extended period, the appraiser will notice properties while traveling that will elicit the private prayer, “Please, I do not want to have to appraise that property.” It’s weird, does in no way conform to anything in the area. The 100-year-old 4,000 sq foot farm home with a barn on two acres that, for miles in either direction, is surrounded by more recently constructed 1,200 square foot tract homes on 6,000 square foot lots. Whatever the appraiser states as an estimate of value will at best be a WAG; wild-ass guess. That’s because “land loans” do not qualify. In other words, for the property to be accepted as security for the “conventional” (80% LTV – loan-to-value) loan, the value must be land plus improvements; tear-downs and spec development not accepted.
Far and away the greatest factor severely impacting the bailout today, however owes to those parts of the FMV definition that are absolutely missing today. We do not have either “fair market” conditions, nor do we have actors operating free of duress. No property has a market value higher than the lowest price for which a comparable property is currently available for purchase. And when the market is in free-fall those lowest prices are changing moment to moment, depending on the level of duress the seller is experiencing.
Picture it this way. The owner of a property is shoved out of an airplane at 35,000 feet, without a parachute. He will exchange the property for a parachute at different exchange prices depending on the altitude at which the parachute is offered; one price at 30,000 feet, an entirely different price at 1,000 feet. Indeed, at 1,000 feet he may give you the property in direct exchange for the life-saving apparatus!
Now insert an appraiser into the picture. What will the exchange price be at 5,000 feet intervals? You tell me, because, in all honesty, I’m going to make it up. I’m going to make it up, because in all honesty, with the earth racing closer and closer, and with the certainty that the earth is a very hard surface, neither I nor any human can tell you.
But that is the environment today. The government is proposing to buy several tons of paper, the underlying values of which no one on earth can put a value on. Not Secretary Paulson. Not Chairman Bernanke. Not Senator McCain, and not Senator Obama. Not no one, no how! The $700,000,000,000 figure is nothing but a WAG!