Amidst all the breaking news today, you could be forgiven for not having time to notice the big WSJ article on kickbacks from property sellers to buyers – kickbacks which serve to overstate house-price indices and severely damage the balance sheets of mortgage lenders who end up lending on the basis of inflated valuations.
Lenders are being a bit more responsible these days when it comes to LTV ratios: they won’t lend more than the property is worth. As a result, it seems that sellers and buyers are conspiring to pull the wool over the lenders’ eyes by agreeing to a purchase price well above market. Here’s the final anecdote from the WSJ story:
Another transaction that shows signs of price distortion is the sale of a home on Olen Mattingly Road in Avenue, Md. The two-story, 2,158-square-foot home, built within the past two years, was originally listed for sale in February 2005 for $635,000 but languished on the market for more than a year, according to local real-estate agents. The owner, builder Bennett Homes LLC, gradually reduced the price to $469,000 by March 2007. In May, however, the home sold for $600,000, far above the recent asking price. Vangie Williams, a real-estate agent who represented the buyers, says the sale involved a payment by the builder to an organization that collected fees for finding buyers. Officials of Bennett didn’t respond to requests to comment.
A unit of Wells Fargo & Co. provided two loans to finance the purchase, the first for $479,800 and the second for up to $120,000, for a total of just under $600,000. That is about 28% more than the asking price for the home two months before the sale. A spokesman for Wells says the property was appraised at $615,000. He adds that Wells relies on “objective third-party appraisals in making all lending decisions. While we expect that appraised value [will] be close to market value, that may not always be the case.”
The house recently was back on the market. The latest asking price: $499,000.
The problem here is that the entire mortgage industry is already overwhelmed with delinquencies and defaults. Everybody knows that a lender should do lots of due diligence on the valuation front before lending any money – the key is to lend not up to a maximum percentage of the purchase price, but rather up to a maximum percentage of the house’s value. But during the property boom lenders were quite happy using purchase price as a proxy for valuation, and now they simply don’t have the resources to switch back.