The package of financial regulatory reforms recently proposed by the Obama administration includes a proposal for a Consumer Financial Protection Agency. According to the document, the agency would "...protect consumers across the financial sector from unfair, deceptive and abusive practices." While this proposal is likely to generate strong opposition from the financial community, the events of the past few years make some form of regulation inevitable. However, stronger regulation of the financial sector, including consumer finance, should be accomplished through the legislative process.
An example of how disruptive bad policies and regulations can be is the recently enacted Home Valuation Code of Conduct, or HVCC. It is an initiative developed by New York's Attorney General Andrew Cuomo, resulting from his investigation into questionable appraisal practices. The Code is designed to insulate appraisers from pressure to inflate the estimated value of properties on which loans are being made. HVCC prohibits any entity paid on commission (mainly brokers) and lenders' loan production staff from communicating directly with appraisers. In most cases, appraisals must be directed to independent entities ("Appraisal Management Companies" or AMCs), which effectively subcontract the work to affiliated appraisers.
While it has escaped heavy press scrutiny, there are numerous problems with the HVCC. If a broker is required to seek out a new lender after the appraisal is ordered, an entirely new appraisal must be undertaken. (In theory, lenders are allowed to accept prior appraisals. However, in many cases, lenders are either not allowing them to be transferred to the new lender, or not accepting appraisals they didn't order.) This has the dual effect of raising the costs for consumers and unfairly targeting brokers.
The HVCC-compliant appraisal process is also plagued by bizarre incentives. Appraisers assigned by the AMCs may not be competent or knowledgeable of the local real estate market. (They are, however, required to be licensed by the state.) Loan officers and realtors complain that many AMCs are awarding appraisal assignments based solely on the lowest requested fee, irrespective of market knowledge or competence, converting a highly specialized and knowledge-intensive process into a commodity. As a result, there are many reports (from lenders, realtors and home buyers) of transactions falling through due to shoddy appraisals. In fact, Lawrence Yun, the chief economist for the National Association of Realtors, cited "appraisal problems" as a reason for a disappointing May report on existing homes sales. He added that "(t)here is a danger of a delayed housing market recovery and a further rise in foreclosures if the appraisal problems are not quickly corrected."
While improving the appraisal process is a worthwhile objective, the HVCC is an extremely clumsy and poorly designed response to the problem. Despite being a product of the Office of New York State Attorney General's office, it has the effective force of law throughout the country because Fannie Mae and Freddie Mac have agreed to require it for all loans that they purchase or guarantee - which at this point is a major share of the market. (In fact, HVCC may be responsible for the recent increase in the share of loan applications taken for government-backed products, as neither the Federal Housing Administration nor the U.S. Department of Veterans Affairs require appraisals to be HVCC-compliant.)
HVCC is an important example of how not to develop and institute policies governing financial products and markets. In this light, the consumer finance agency proposed as part of the Treasury's reform package is better than a series of unworkable and disruptive initiatives. If consumer finance is to be more highly regulated, creating the framework through reform legislation is vastly preferable to having it foisted on the market by prosecutorial fiat.
Bill Berliner is a mortgage and capital markets consultant based in Southern California. His Web site is www.berlinerconsulting.net
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