Despite bitter opposition from appraisers, federal housing officials last week inaugurated a controversial new electronic monitoring system called Appraiser Watch that's designed to spot appraisers who inflate valuations on FHA-insured home mortgages. Appraisers cited by the system face termination from the agency's roster of approved appraisers -- effectively putting them out of the FHA loan business -- and civil penalties.

The new system relies heavily on statistical reviews of defaulting loans, plus what the agency calls "historical risk factors": individual appraisers' association with disproportionate numbers of loans that go into default; and individual appraisers' involvement with types of loan programs that frequently have high default and fraud rates, including rehabilitation loans, mortgages on REO (real estate owned) properties sold by banks; and loans on multi-unit properties.

A spokesman for the appraisal industry's largest professional association, the Appraisal Institute, called the new FHA initiative "bad news."

"It just doesn't make sense," said the Institute's Washington-based vice president for public affairs, Don Kelly. "(HUD) Secretary Martinez needs to focus on the real culprits behind" fraudulent mortgage lending -- "unscrupulous lenders," rather than appraisers.

Kelly said, "I have never heard about an appraiser going into a bank and saying, hey, do you need a fraudulent (inflated) appraisal today?" Instead, he said, lenders themselves "drive the process" by putting pressure on appraisers to "hit the number" needed to close a loan or sell a house.

But Martinez and other federal officials argue that's not the full story. They say that test-runs of Appraiser Watch's statistical methods have been highly efficient in identifying individual appraisers who inflate property values illegally.

Under an earlier appraiser quality review approach used by FHA from 1997 through the fall of 2001, 30,000 appraisals were targeted for review, but only 30 appraisers -- just .01 percent -- were terminated from the FHA roster for poor performance, according to the agency.

By contrast, it said last week, a recent test of Appraiser Watch turned up just 1,900 appraisals for manual review, but led to the termination of 97 appraisers for poor performance. The new statistical methodology, in other words, is more efficient in homing in on greater numbers of bad appraisers based on analysis of far smaller samples of all FHA loans made during a specific time period, according to the agency.

HUD officials concede that pressure and intimidation by lenders and mortgage brokers play potentially large roles in fraudulent and inflated appraisals. To fight that problem, the agency has proposed or initiated a series of lender-oriented new reviews:

Published: November 3, 2003

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consumer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.