Appraisal system the latest symptom of failed housing market

Over the last two years, the Obama administration and the Democrats tried desperately to keep the housing bubble’s collapse from significantly lowering overinflated home values.   Twice they extended tax credits to new-home sales, and then added resales into the effort as well.  Instead of stabilizing the market, the short-term policy gimmicks only delayed the deflation of home prices to a more rational level, while injected more uncertainty into valuation in the context of the present and near-term future.

As a result, no one seems to have a clear idea how to appraise existing homes for sale — and that has created a huge problem for the limited number of buyers in the market:

There are problems in appraisal land that transcend weak housing markets and debt-ridden borrowers, and that are causing home buyers and would-be refinancers to miss out on low rates and dream houses.

“There’s been a pendulum swing in appraisals comparable to the one we’ve seen in mortgage credit, from foolishly lax to overly restrictive,” said Walt Molony of the National Association of Realtors. He reported that as recently as October, one in 10 member agents said they’d had a contract canceled as a result of a low appraisal, 13 percent said they’d had a contract delayed, and 16 percent said they’d had a contract negotiated to a lower sales price as a result of a low appraisal.

“We haven’t seen anything like what we are facing today,” said Mark Linne of Appraisal World, a company that provides automated valuation software and services to appraisal companies and lenders.

New and proposed federal rules governing appraisals, changes in the way appraisals are conducted, and a still uncertain housing market have hit the appraisal part of the process in a way that is adding to housing market instability.

No one can blame lenders for wanting assurances that they are not loaning more than the worth of the collateral.  Unfortunately, there isn’t any clear sense of value, especially in markets with more rapidly-decreasing prices.  Plus, as the Fiscal Times reports, banks are holding a “shadow inventory” of homes that are either just going into foreclosure or close to it that has the supply side of the market glutted:

The supply-side issues are much thornier. The total number of homes expected on the market in the coming year is little more than guesswork. Banks are keeping many previously-foreclosed homes off the market, even as new foreclosures continue to mount, creating a shadow inventory that threatens to depress prices further. Hard data say that more than four million new and existing homes are on the market and unsold, but according to CoreLogic’s latest tally there are another 2.1 million homes either in foreclosure, at least 90 days past due, or taken by the lender and not yet listed for sale. That is a total potential inventory of 6.3 million homes in the coming year, which represents a 23-month supply at current sales rates, more than triple the level consistent with a healthy market.

Another way to look at the pressure on prices is the number of vacant homes for sale. The homeowner vacancy rate stood at 2.5 percent in the third quarter. Economists at UBS estimate that the rate needed to stabilize prices is between 1.7 percent and 1.8 percent, implying an excess of about 580,000 homes that are vacant and for sale. Given conservative projections for household formation, replacement demand and new construction, they gauge that the excess can be eliminated by the fourth quarter of 2011, which would stop the downward pressure on prices. But that projection doesn’t account for the shadow inventory.

Under those circumstances, with as much uncertainty that the “shadow inventory” and gimmick-driven prices created in 2010, is it any wonder that appraisers can’t agree on valuations?  Lenders only make money by issuing mortgages, but after getting burned badly over the last three years, they’re understandably more conservative about loan-to-value calculations, not just at the point of sale but in the longer term as well.  They need to know that homeowners buying houses at 2010 prices will maintain equity positions in their property after the value erosion of another 23 months of excess inventory.  Thanks to knee-jerk economic policies, that erosion is almost impossible to estimate with any confidence at all.

Nor will it improve until the economy starts creating enough jobs to put a serious dent in unemployment.  The Fiscal Times report concludes with that analysis:

One thing is clear. While housing led the economy into a recession, it will not lead it out. Until the labor markets are strong enough to start repairing the economy’s most visible and most damaged sector, the economy’s progress just won’t look like, or feel like, a recovery.

Home valuations are secondary to the ability to pay the mortgage.  It’s immaterial if one’s home is valued lower than the mortgage principal as long as the payments can be made — which means jobs have to exist for income to pay them.  The only way to do that is to adjust tax and regulatory policy on a long-term basis so that capital investments can be made which will create jobs.  As long as we’re tinkering with temporary tax and regulatory policies, we won’t solve either problem, but instead amplify the uncertainties.