Four states are considering legislation that would prohibit or restrict appraisers from using distressed sales, such as those of foreclosed properties, as comparable sales when assessing the value of a home.
The rationale for the bills in Illinois, Nevada, Missouri and Maryland is that the prevalence of foreclosures and short sales — almost four out of 10 sales in the country are distressed — is distorting the markets.
But lenders are worried that excluding these transactions from appraisals will lead to the kind of inflated valuations that contributed to the housing crash four years ago.
"The notion that you are going to excuse foreclosures from the calculation of value means that as much as you would like it to be higher, the value you are assigning the house will be overstated," said Bill Uffelman, the president and chief executive of the Nevada Bankers Association. "It will be contributing to a new bubble."
Even for lenders who are comfortable with appraisals that ignore distressed sales near their collateral, selling the resulting loans into the secondary market could be a problem.
"There is the very, very real possibility that if one of these bills were enacted into law that Fannie Mae, Freddie Mac and the [Federal Housing Administration (FHA)] would stop accepting appraisals from those states," said Scott Dibiasio, the manager of state and industry affairs at the Appraisal Institute, a trade group.
The Federal Housing Finance Agency, the conservator for Fannie and Freddie, and the Department of Housing and Urban Development, the parent agency for the FHA, didn't return late calls Friday by press time.
At the very least, lenders would have to start pricing in uncertainties in states that adopt legislation restricting appraisals from taking into account distressed properties, Uffelman said.
"What will happen is that in effect we will have a foggy appraisal," he said, "so the interest rate will be higher."
Appraisers are worried the bills would put them into a legal Catch-22 in which they would have to violate federal standards in order to comply with state ones.
The Uniform Standards of Professional Appraisal Practice (USPAP), which apply to all loans sold to or insured by federal entities such as Fannie, Freddie or the FHA, says appraisers "must analyze such comparable sales as are available."
"If any of these bills were enacted into law appraisers would be in the awkward position of having to choose whether to violate the law that prohibits the use of distressed sales or whether to violate USPAP," Dibiasio said.
Proponents of the bills, many of them real estate agents and home builders, argue that using distressed sales as comparables in appraisals creates a self-perpetuating cycle.
"You are going to get more foreclosures if people cannot refinance their house," said LaShawn Ford, an Illinois state representative, who introduced a bill that would amend the state's Real Estate Appraiser's Licensing Act so that appraisers could not use as comparables any foreclosure that had sold 12 months before the appraisal. "Everyone should be able to refinance out of their high interest rates but they cannot do it because their properties are appraising out because of the current values."
Ford, who is also a real estate agent, framed the issue as a consumer one.
"A lot of people are paying 6 and 7% percent rates," on their mortgages, "so what people need to do is find ways to cut costs," he said. "If you can refinance at 4% you could save yourself $300 a month."
Housing prices have now fallen more from their peak in 2006 than they did in the Depression. Some economists are predicting a further drop in prices on the order of 5% or more.
"Banks sell properties at fire-sale prices and it doesn't give the regular homeowner a chance because prices are being driven down," Ford said.
However, Dibiasio said removing distressed properties from appraisals will result in inaccurate assessments.
"I understand the predicament they [home sellers] are in," he said.
"But right now in many locations, distressed sales are the market, so appraisers have the obligation to consider them as comparables; they have to at least consider them for comparables."
Uffelman also acknowledged that the growing inventory of foreclosures is killing housing prices. He said that when he was set to refinance his house for $300,000, an appraiser that his lender hired found a foreclosure in the neighborhood that cut the value of Uffelman's house to $240,000 and resulted in his having to bring an extra $60,000 to the table.
During the bubble years, appraisers complained about pressure from volume-hungry lenders — as well as from mortgage brokers, real estate agents and consumers — to inflate valuations. Stories abounded of lenders threatening to withhold future business from appraisers unless they came through with higher numbers.
"Part of the problem in creating the false housing economy was shaky appraisals," Uffelman said, "and now we want to sanction a new round of shaky appraisals?"