"The [new appraisal] code bars lenders and their representatives from pressuring appraisers to supply inflated estimates of property values" according to the Wall St Journal. Wow. In a nutshell how the subprime mortgage mess was created. Lenders with a deathwish.
Mortgage is a simple deal. The bank lends money to buy the house. If the borrower doesn't pay it back, the bank takes the house. This simple deal breaks down if the house isn't worth the amount of the loan. When the deal breaks down, the bank looses all the money it lent and is left with a house. If the house isn't worth much, the bank takes a loss.
The bank wants to do the mortgage, in a real world it's a safe investment that pays good interest. But when the mortgage is more than the house is worth, it changes from a safe deal to a very risky deal. The home owner can walk away from the mortgage and save himself money. Any bank that isn't stuck on stupid knows this. Pressuring an appraiser to raise his appraisal is guaranteed to create an underwater mortgage, one where the house isn't worth enough to back the mortgage.
How did the banks get so stupid? Simple, they found another sucker. Fancy Wall St banks and brokerage houses began to offer "mortgage backed securities". They printed IOU's and their salesmen declared the IOU's were safe because they were "backed" by all these mortgages owned by the issuer. The Wall Streeters then went out to all the real banks and bought mortgages to "back" more IOU's. The real banks loved this deal. Make a mortgage and then sell it for cash. If the mortgage is risky, who cares, I got my cash. If the house seller wants an unreasonable price, no problem. Pressure the appraiser to appraise the house at the seller's unreasonable price and make the mortgage. Sell the mortgage quick before the borrower defaults.
The wheels came off this scam last summer when a German sucker got burned so badly he went out of business. That wised up the rest of the suckers, and now no one will touch an IOU even if it is backed with solid gold. The financial pundits call this situation "a frozen credit market".
To prevent this mess from reoccurring we ought to prohibit the sale of mortgages. The guy who makes the mortgage has to hold it, and assume the risk, because he is the only guy who really knows if the mortgage is any good. If the maker owns it, the makers will only do mortgages that are likely to get paid back.
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