Bloomberg | January 17, 2008
By Sharon L. Lynch and Bob Ivry

Home appraiser Julian ``Tony'' Perez conjured $7.5 million out of thin air in the first six months of 2001 by overvaluing 33 condominiums in the Atlanta area.

Perez valued eight unfinished properties at the Deere Lofts development on April 2. Some were missing ceilings, cabinets or sinks. Each had been bought the previous week for $90,000 to $167,000. Perez said they were worth $177,000 to $330,000, according to the U.S. Attorney's Office in Atlanta.

``These are the worst condos ever,'' Perez said last January during testimony at the federal trial in Atlanta of developer Phillip Hill, who used the appraisals to resell the properties. ``Those values are super over-inflated, probably double what the amount of that property is probably worth.''

Perez and appraisers like him helped exaggerate U.S. mortgage values by as much as 10 percent, or $135 billion, in 2006, according to Susan Wachter, a real estate professor at the University of Pennsylvania's Wharton School in Philadelphia. Such appraisals artificially inflated the value of collateral supporting mortgage-backed securities and are contributing to record foreclosures because borrowers end up owing more than their houses are worth.

Lenders and investors in mortgage-backed securities depend on independent appraisals to value their collateral. Buyers use them to make sure they aren't overpaying.

`Blesses the Loan'

Mortgage lenders, eager to make bigger loans and win market share during the five-year housing boom, relied on both higher appraisals and the proliferation of subprime and adjustable-rate mortgages, said Wachter, who has consulted for mortgage buyer Freddie Mac and General Electric Co.'s U.S. home loan unit.

``There has to be an appraiser who basically blesses the loan,'' she said. ``There are lenders who are deciding what terms to extend and then there are appraisers indicating it is appropriate or isn't appropriate.''

Lenders and mortgage brokers routinely pressured appraisers to boost values, said Jonathan Miller, a New York property appraiser for more than two decades who writes a blog about the problem.

Protections established by the Washington-based Appraisal Foundation, a non-profit that sets industry qualifications and standards, came under attack in the 1990s as banks cut their appraisal departments to save money, Miller said. The system was further corrupted when lenders began moving mortgage applications to third-party brokers who only got paid if a loan closed, he said.

Market Mentality

``There just became less and less emphasis on quality,'' Miller said. ``You started to see more and more loan products that would keep payments low, and I see that as correlating with appraisal pressure because those products only work in a rising market.''

Ninety percent of appraisers surveyed in a study published last year by Richfield, Ohio-based October Research Corp. said they felt pressure to make bogus valuations. Five years ago, that figure was 55 percent.

Almost three-quarters of the appraisers said that mortgage brokers asked them to bend the rules.

Perez said in court that he did it because it ensured steady work from brokers connected to Hill's properties. In some cases, he valued condos that needed substantial work as if they were complete. He also used the sale prices of more expensive apartments nearby to justify inflated values.

The decision cost both Hill and Perez. Hill landed a 28- year prison sentence for using the appraisals to defraud lenders out of $112 million and Perez pleaded guilty to conspiracy to commit wire and mail fraud and is awaiting sentencing. He declined to comment.

Appraisers who resist pressure to inflate values said they may be blacklisted.

`Squeeze Another $20-$25,000'

Paul Bodeving saw his business dry up after he was hired by an appraisal management company to evaluate a four-bedroom, 3,500-square-foot house in Grants Pass, Oregon, last February.

After examining the value of comparable homes, Bodeving determined the property was worth $837,000. The appraisal management firm asked him to ``squeeze another $20-$25,000'' in value so the lender could close the loan, Bodeving said. He refused and rarely gets work from the company anymore.

``It's absolutely horrible,'' he said. ``We've never had the pressure we have now.''

Debbie Huber, a Las Vegas home appraiser, says a third of the mortgage lenders who want to hire her are looking for a guaranteed value before she appraises the property.

Pistol-Packing Appraiser

``We get calls like that every hour of every day,'' said Huber, past president of the Nevada Appraisal Commission, the state agency that oversees appraisers.

The problem became so severe in Florida that appraiser Pamela Crowley said she started an e-mail distribution list in 2003 for real estate appraisers to report suspicious sales and refinancing deals.

Crowley said she was forced out of the appraisal business because she refused to report property values that were higher than the actual worth. She has turned the e-mail list into a Web site, and says she now works with a snub-nosed .38-caliber pistol at hand because she's afraid of retribution.

``There are a lot of people who made a lot of money on this whole game and I was hurting them,'' Crowley said.

Appraisers also are being pressured to overlook imperfections in homes or ignore housing trends in a community that might bring a property's value down, said John Oakvik of Tozzer, Oakvik & Associates Inc. in Fort Lauderdale, Florida.

Oakvik said he got a call in October from a mortgage broker who asked him if he'd made a mistake when he checked a box on an appraisal report that said home prices were falling in the area.

`No Red Flags'

``She asked me to change the box from `declining market' to `stable market,''' Oakvik said. ``Mortgage brokers just want a generic report, no red flags.''

Appraisal practices are drawing the scrutiny of prosecutors. At least seven states have opened investigations into the mortgage industry, including ties between appraisers, lenders and brokers.

In New York, Attorney General Andrew Cuomo subpoenaed Fannie Mae and Freddie Mac, the two biggest buyers of U.S. mortgages. He also sued First American Corp.'s eAppraiseIT LLC for allegedly caving to pressure from Washington Mutual Inc., its biggest customer and the largest U.S. thrift, to inflate values.

Cuomo said in November he uncovered a ``pattern of collusion'' between lenders and appraisers to bolster home values.

$4.7 Trillion Market

The investigations call into question $4.7 trillion worth of mortgage securities guaranteed by Fannie Mae and Freddie Mac, and may limit the availability of home loans to borrowers with good credit, CreditSights Inc. analysts Frank Lee and Sarah Rowin said in a Nov. 8 report.

``If there is a disruption in Fannie and Freddie trying to buy conventional loans, that would be very, very bad right now,'' Lee said.

The valuation crisis in the credit markets may cost banks and investors $400 billion, according to November estimates by Deutsche Bank AG analysts.

Lenders including Lehman Brothers Holdings Inc., the biggest underwriter of mortgage-backed bonds in 2007, say they too have been victimized by fraudulent appraisals.

New York-based Lehman sued 14 people and five companies including Passarelli & Potts Appraisal Service and appraiser Fred Passarelli in federal court in Tampa, Florida, alleging ``grossly inaccurate'' appraisals that valued residences in the Sunset Bay development at about $733,000 when they were only worth $73,000.

Inaccurate Appraisals

Jurors ruled Dec. 13 that Equitable Title of Florida Inc., based in Clermont, breached its contract with Lehman in handling closings and that Passarelli & Potts of Winter Park, Florida, was negligent in its appraisals. Jurors said both actions led Lehman Brothers' Bancorp unit to fund millions of dollars in mortgage loans secured by properties worth a fraction of their sales price.

Passarelli's contract was with Interlachen Residential Mortgage Co., a defunct Florida company, which passed the appraisals on to Lehman, said Eric Lanigan, Passarelli's attorney.

Legal Ruling

``Our position is that Lehman Brothers had no right to rely on Passarelli's appraisals,'' Lanigan said in an interview. ``If you had no right to rely on it, and you knew you had no right to rely on it, then you rely on it at your own risk.''

Equitable Title was ordered to pay $2.8 million. Passarelli & Potts Appraisal was ordered to pay $4.5 million. The jury originally said Passarelli & Potts was liable for $6.9 million, then reduced the amount by 35 percent, saying Lehman was responsible for that portion.

Lenders made about $2.7 trillion in new mortgages and home refinancing deals in 2006, according to the Washington-based Mortgage Bankers Association.

For some appraisers, including Perez in Georgia, going along was the key to staying in business.

The Georgia case in which Perez testified hinged on 300 inflated appraisals, according to Assistant U.S. Attorney Barbara Nelan. Hill and companies he controlled bought 50 houses and 250 condominiums and made money by recruiting straw buyers to repurchase the properties at inflated prices.

Even before Perez pleaded guilty, he paid for bucking the system, said his lawyer, Page Pate.

``He liked the steady stream of business,'' said Pate. ``My client refused to inflate a few appraisals and they cut him off for a long time.''