On FRTs and Unanticipated Consequences

I’ve always been interested in the history behind our appraisal regulatory system in the United States. Like many structures, it arose from calamity – the Savings and Loan crisis of the 1980’s – and attempted to address deficiencies in how collateral value in residential real estate was established. But what I truly find interesting is how quickly our regulatory structures undid clear Congressional intent on the matter, and how that feeds into many of the conversation we have today around residential real estate appraisal.

When the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 was passed by Congress and signed into law, it created the state-led regulatory system we know today. Title XI of the act created the Appraisal Subcommittee to oversee the performance of the states in establishing and effectuating licensure, certification, and enforcement regimes; set the Uniform Standards of Professional Appraisal Practice (USPAP) as the relevant standard; and, most importantly, set forth the clear expectation that Federally-Related Transactions, or FRTs, would require the use of an appraisal.

Well, except that last part, if subsequent agency decisions are anything to go on.

Before moving forward, let’s unpack what exactly an FRT was intended to be. Per the plain text of Title XI of FIRREA:

FEDERALLY RELATED TRANSACTION.—The term "federally related transaction" means any real estate-related financial transaction which— (A) a federal financial institutions regulatory agency or the Resolution Trust Corporation engages in, contracts for, or regulates; and (B) requires the services of an appraiser.

But what, you ask, is a federal financial institutions regulatory agency? Title XI answers that for us as well:

FEDERAL FINANCIAL INSTITUTIONS REGULATORY AGENCIES.— The term "Federal financial institutions regulatory agencies" means the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporations, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the National Credit Union Administration.

We understood from Title XI of FIRREA those agencies whose regulated entities were covered by the law, and you’d guess at this point Congress would establish a firm marker on when an FRT “requires the services of an appraiser.” That, sadly, is the first domino to fall.

Congress provided some direction to the agencies listed above, saying:

FUNCTIONS OF THE FEDERAL FINANCIAL INSTITUTIONS REGULATORY AGENCIES RELATING TO APPRAISER QUALIFICATIONS. Each Federal financial institutions regulatory agency and the Resolution Trust Corporation shall prescribe, in accordance with sections 1113 and 1114 of this title, which categories of federally related transactions should be appraised by a State certified appraiser and which by a State licensed appraiser under this title.

To me, this states a clear expectation for every FRT to have an appraisal performed by either a licensed or certified appraiser, right? Not according to the federal financial institutions regulatory agencies!

When the agencies began crafting the statutorily required implementing regulations in 1990, the created the maligned de minimus threshold which exempted loans with a value up to $50,000 – soon moved to $100,000 – from complying with the requirements for FRTs. (I’ll provide an example of the regulations – from FDIC – here.) And while $100,000 might not sound like a large exemption, the median home price in 1990 was in the mid-$90,000 range and would not exceed $100,000 until August of 1992.

Bear in mind that any national home price median is inherently skewed by the highest-priced housing markets, and you can imagine large swaths of the country where the FRT appraisal requirements no longer applied. There must have been some backstop to prevent lenders from skirting appraisal altogether, right? Allow me to share this (now-incredible) statement from a 1992 GAO study:

Fannie Mae, Freddie Mac, FHA, and VA require an appraisal by a state-licensed-or-certified appraiser for real estate transactions of any amount. In its August 1992 report to Congress titled De Minimis Levels For Commercial Real Estate Appraisals, the Office of Management and Budget (OMB) stated that over 80 percent of all 1-to-4 family residential loans will be appraised by a licensed appraiser because of the high level of participation by Fannie Mae, Freddie Mac, FHA, and VA in the residential lending market. Thus, they concluded that about 17 percent of the real estate-secured loans under $100,000 in the country would not be subject to appraisal by a state-licensed or-certified appraiser. [emphasis added]

It sounds unbelievable given today’s collateral risk climate that it was the GSEs – Fannie and Freddie – who were the bellwethers against appraisal exemptions, and yet, here we were. Unfortunately, this all unraveled just two years after the GAO study.

In August of 1994, the federal financial institutions regulatory agencies released a final rule that effectively neutralized the intent of FIRREA when it came to requiring appraisals generally in connection with FRTs. This rule took two very impactful actions:

It increased the de minimus threshold from $100,000 to $250,000. In 1994, the highest the median home price reached was $106,444 in November. Using this table, we can see this new threshold far exceeded even regional median home prices in 1994, and continued to do so through 2001. It, of course, has since been increased again to $400,000; and,

It exempted from FRT requirements loans where:

(9) The transaction is wholly or partially insured or guaranteed by a United States government agency or United States government sponsored agency [GSEs – author note];

(10) The transaction either:

(i) Qualifies for sale to a United States government agency or United States government sponsored agency; or

(ii) Involves a residential real estate transaction in which the appraisal conforms to the Federal National Mortgage Association [Fannie Mae – author note] or Federal Home Loan Mortgage Corporation [Freddie Mac – author note] appraisal standards applicable to that category of real estate;

Not even the agencies themselves had control anymore over whether an appraisal was being performed – if it adhered to the GSEs requirements, it was exempt – even if the loan was merely contemplated for sale to the GSEs. This provided Fannie and Freddie with capture over the appraisal process.

In five years’ time, we went from legislating the broad requirement for appraisals in connection with FRTs, to exempting wide swaths under the de minimus threshold and deferring to the GSEs to decide how broadly appraisals should be used – a stunning reversal not long removed from the Savings and Loan crisis that gave rise to FIRREA in the first place.

While we have seen subsequent effects of the 1994 rule – the rise of the Uniform Appraisal Dataset and Uniform Collateral Data Portal, leveraging of the GSEs automated QC tools, appraisal waivers, and waivers supported by property data collection – it’s hard to overstate how much the 1994 regulations set the table for the environment we live in today when it comes to collateral risk and the excision of the appraiser from the transaction.

Certainly, those in charge at the federal financial institutions regulatory agencies could not have imagined how far the use of technology would come and its disruptive effect on how collateral risk is addressed, but I wonder if – given the benefit of hindsight – there’s anything the agencies would do differently.

By understanding the history underneath the current environment, it can help inform the steps we should be taking going forward – not just as a means of ensuring we have a sufficient appraiser population to meet the current and future needs for housing finance, but to understand that the effects of policies implemented today can take time to be fully understood.