Heavy traffic may mean your overpriced home is a ‘pinball’

By Ken Harney 06/15/2012

WASHINGTON — In the real estate brokerage field they’re known as “setups” or “pinball” homes, and this spring’s improving conditions in some markets could be stimulating more of them.

A setup or pinball property is a house listed with an unrealistically high asking price that pulls in lots of visits by agents and shoppers, but no offers. The problem is this: Real estate agents, including even the listing agent, are using the overpriced house as a negative example to sell other, similar homes nearby that carry lower asking prices.

“It’s like a pinball machine,” says Debbie Cook, an agent with Long & Foster Real Estate in Silver Spring, Md. The “setup” is the foil — the house that agents show clients in order to make other more realistically priced listings look better. Maybe the sellers — encouraged by reports of rising sales and low mortgage rates — insisted on the aggressive asking price and wouldn’t list for anything less. Or maybe the sellers’ agent didn’t fully brief them about what the house could command in today’s conditions rather than lose the listing.

Whatever the specifics, pinball houses tend to see heavy “traffic” but go nowhere until the sellers drop the asking price, usually by significant amounts. Before then, however, they may be used without the sellers’ knowledge to market other houses. Since no one seriously expects them to sell at their original asking price, agents are happy to exploit the overpricing to facilitate other sales.

“We’re definitely seeing it,” said Sandy Nichols Acevedo, an agent at Prudential California Realty in Oxnard, Calif. “Some people think they can go higher now because the market seems to be doing better.”

Joe Manausa, owner-broker at Century 21 First Realty in Tallahassee, Fla., who wrote about the phenomenon on Active Rain, a Seattle-based industry blog with more than 220,000 members, offers this hypothetical example: “If two very similar homes are near each other, with one priced at $250,000, and the other at $280,000, the higher-priced home is often shown first. Then the real estate agent says, ‘If you like this home at $280,000, you are going to love the home down the street at $250,000!’ ”

Bill Gillhespy, an agent in Fort Myers Beach, Fla., has a real life example: He currently has a listing on the 14th floor of a luxury condominium project overlooking the Gulf of Mexico. The asking price is $450,000. There’s a unit on the same floor with similar views, similar square footage and layout, but with a more updated décor, that is listed for nearly $150,000 more. When Gillhespy is asked by another agent or a prospective buyer to see his unit, he often says, “Let me first show you a unit just down the hall. It’s one of the nicest in the entire building.” The higher-priced model shows well, but shoppers immediately remark on the $150,000 difference “and they can’t see how it’s justified.”

Perrin Cornell, a broker at Century 21 Exclusively in Wenatchee, Wash., says some sellers in the mid-to-upper price brackets in his area “are exuberant that we’re finally out of it (the recession) now,” and are tempted to disregard agents’ more sobering recommendations on pricing.

What happens to such listings? “Unless we’re using it for a setup,” Cornell said in an interview, “we stop showing it” until the seller agrees to re-price to a sensible number.

But as a matter of principle and ethics, should realty agents accept listings from homeowners who refuse to listen to reason? Manausa is adamant that they should not. “If you list a property at a price you know will not sell,” he says, “you are misleading the seller. Effectively you are saying, ‘I don’t think it will sell, but I’ll put my name on anything hoping to get paid.’ ”

Acevedo agrees agents have a fiduciary duty to educate even the most headstrong owners about sobering market realities, but has a compromise solution: Take the listing but require the seller to sign a contractual agreement requiring an automatic price reduction to a specified level if the house doesn’t sell in the first two to three weeks.

Bottom line here for owners thinking about selling in modestly improving markets: Get as much accurate information as you can about closed sale prices of comparable houses in your immediate area. Talk to multiple realty agents before listing. Sure, you can try pushing a little on price, but if you go overboard, you seriously risk becoming the unwitting setup, the pinball, and the out-of-touch competition everybody else loves to visit.

FICO, by the numbers

By KENNETH R. HARNEY Jun 8, 2012

In a marketplace where lenders are demanding record-high FICO credit scores – Fannie Mae and Freddie Mac are averaging around 760 on approved mortgages this year – are you a little fuzzy about what can push your scores up or down?

Take “inquiries,” which Fair Isaac Corp., the developer of the iconic score methodology dominant in the mortgage field, says are among the most widely misunderstood components of its system. Do multiple inquiries – requests by lenders and others to pull your national credit bureau reports – knock your score down? Do you know whether your lender is entering the correct code to minimize damage to your score when you’re shopping for a mortgage and generating lots of inquiries? If you’re young or otherwise new to the world of credit, could multiple inquiries do enough damage to prevent you from getting approved for a home purchase?

Given the importance of maintaining high scores, FICO senior scientist Frederic Huynh agreed to run through the key rules governing how inquiries affect homebuyers and mortgage applicants in an interview with me and a post on Fair Isaac’s Banking Analytics blog.

Start with the basics: Yes, racking up large numbers of inquiries can lower your score. The FICO models consider them significant because extensive behavioral research has shown that “consumers who are seeking new credit accounts are riskier,” more prone to defaults, according to Huynh. “Statistically people with six or more inquiries on their credit reports can be up to eight times more likely to declare bankruptcy than people with no inquiries on their reports,” he said. So inquiries do matter.

But this doesn’t mean that if you’re shopping for a home loan or refinancing, and six lenders pull your credit reports, that you’re going to be hit with six separate inquiries and have your score lowered. The FICO models, says Huynh, ignore all mortgage-related inquiries during the 30 days immediately preceding the computation of the score. All mortgage inquiries during the 45 days preceding your loan application only count as no more than a single inquiry. The same buffer zones cover shopping for auto loans and student loans – but no other forms of credit.

In any event, says Huynh, a single inquiry usually is not a big deal, knocking less than five points off your score per pop. But experts in the credit-reporting field say that despite FICO’s good intentions, bad things can happen on inquiries. This is especially true for people with “thin” credit files, such as young, first-time homebuyers and others without extensive credit histories. Larry Nelson, owner of KCB Information Services in Pekin, Ill., a credit reporting agency active in the mortgage field, says a recent applicant lost her pre-approved home loan at closing because five new inquiries for an auto loan suddenly appeared on her credit reports. This deflated her FICO score to 610 – a loss of 30 points and put her below the minimum score required for the mortgage.

How could this happen, since auto loans are one of the three protected classes of credit where multiple inquiries within a short time period are OK? According to Nelson, unless loan officers properly code the purpose of the inquiry when they report it to the national credit bureaus – an auto loan in this case – it won’t necessarily be identified in credit files that way. Nelson’s homebuyer had double bad luck: None of the inquiries that should have been covered by the 30-day buffer carried the correct purpose identification. Plus Fannie Mae and Freddie Mac have begun requiring lenders to pull a second set of credit reports immediately before closing to ensure that applicants’ FICO scores haven’t changed significantly. In this case, there was a sudden spike of score-injuring inquiries in the bureaus’ files and the buyer couldn’t close on the loan.

Nelson says glitches like this “are becoming more commonplace” and can hurt unwary consumers. He strongly urges mortgage applicants to avoid all credit-related shopping – for credit cards, furniture, home improvements, you name it – in the weeks before their closing because a string of inquiries can mount up and knock the home purchase off track or delay it.

Of course not all inquiries indicate active credit seeking, says Huynh, even though your files are accessed. For example, if you’re checking on your credit before applying for a mortgage – either through www.annualcreditreport.com, where they are free once a year – or by simply buying them from Equifax, Experian or TransUnion, your FICO score goes untouched.

Investors Cry Foul Over Their Treatment in Mortgage Settlement

By Kevin Wack

JUN 7, 2012 4:44pm ET

WASHINGTON – Mortgage investors, who have been complaining for months about the costs they will bear under the national servicing settlement, presented a list of proposed remedies at a congressional hearing Thursday.

The settlement between 49 state attorneys general, the federal government, and the nation’s five largest servicers requires the servicers to dedicate at least $20 billion to mortgage relief, including principal reductions. It resolves allegations of robo-signing and other servicing abuses.

But the terms allow the servicers – Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM), Citigroup Inc. (C), Wells Fargo & Co. (WFC) and Ally Financial Inc. – to get partial credit for principal reductions on mortgages owned by bond investors.

“In the AG settlement, the government is allowing banks to use investor funds to pay for their own wrongdoings,” Laurie Goodman, a senior managing director at Amherst Securities, said in written testimony before the House Financial Services subcommittee on capital markets.

The hearing illustrated that in the five years since the foreclosure crisis began, mortgage investors have developed a deep distrust of the servicing industry.

Under the settlement, the five large banks get credit for modifications of investor-owned mortgages that they were already allowed to make under the contractual agreements that define their relationship with the investors.

But the investor groups argued Thursday that there is potential for abuse by the banks. Under one scenario, banks might grant larger modifications in order to get more credit under the settlement when smaller modifications would make more economic sense to the investors who own the loans.

Another scenario raised by the investors involved banks hiding from investors the size of various fees charged to borrowers, including fees for force-placed insurance.

“Shouldn’t investors, who ultimately pay these fees through a lower recovery on their loans, have the right to disclosure about these costs?” Goodman said in her written testimony.

Another gripe from groups representing investors is that they were excluded from the settlement’s negotiations.

“Our clients and the general public are important stakeholders in this settlement,” Vincent Fiorillo, of Doubleline Capital, LP, said in written testimony on behalf of the Association of Mortgage Investors. “Yet we were excluded from the negotiations over its 15-month process.”

The investors’ specific requests included that the settlement be amended to consider investors’ concerns. But they also proposed more targeted solutions.

Among the ideas they proposed were a monetary cap on the amount that specific investors will have to pay; detailed monthly public reporting on the modifications made under the settlement; and that banks be barred from getting credit for write-downs of investor-owned loans in any future settlements with smaller servicers.

The hearing was convened by GOP Rep. Scott Garrett, R-N.J., who last month sponsored legislation to bar the Justice Department from engaging in mortgage settlement talks with additional servicers without giving bond investors a seat at the negotiating table.

Garrett, who chairs the capital markets subcommittee, echoed the investors’ complaints.

“So, in this case, we actually have the administration advocating policies that directly take money from investors that committed no wrongdoing in order to pay, at least partially, for the problems admitted by the banks,” he said at the hearing.

But it was not just Republicans who expressed concern about the settlement. Democratic Rep. Maxine Waters made remarks similar to those of Garrett.

And another witness, Adam Levitin, a Georgetown University law professor who has frequently defended the Obama administration, also criticized the government’s decision to exclude investors from the negotiations.

“Regardless of how one believes that the cost of principal reduction – and thus ultimately responsibility for the housing bubble – should be allocated, if at all, the process of allocating the costs must be done fairly,” he said in written testimony.

Federal Preemption on Appraisal Laws Not a Sure Thing

Nathan Brown JUN 6, 2012 2:08pm ET

Ignoring state appraisal laws may subject bank employees or third-party service providers to fines or even criminal penalties. National banks relying on federal preemption for appraisal laws should take another look at that assumption in light of Dodd-Frank.

The primary federal regulatory agencies recognize that financial institutions appreciate the flexibility in the revised Interagency Appraisal and Evaluation Guidelines permitting the use of less-formal real-estate evaluations in lieu of more-costly appraisals in certain low-risk transactions. Those guidelines do not require that an evaluation be prepared by a licensed or certified appraiser. But the appraisal acts in many states – passed in the wake of the savings and loan crisis in response to a mandate in the Financial Institutions Reform, Recovery and Enforcement Act – do not provide that flexibility.

Many states created “mandatory” licensing regimes that purport to prohibit any person from attaching any opinion of value to real property without an appraiser license. Some recognized the need for banks to perform evaluations and enacted exceptions that specifically allow banks to perform and obtain evaluations using qualified but unlicensed internal staff or agents of third-party providers.

However, the exemptions in some mandatory states – including Alabama, Arkansas, Kansas, Louisiana, Minnesota, Mississippi, and North Carolina – extend only to full-time, salaried employees. Under that structure, community banks may be at a significant disadvantage against large banks with substantial in-house collateral valuation staff.

Some “mandatory” licensing states – Michigan, Connecticut, Florida, Pennsylvania and South Carolina for example – appear to make no exception for evaluations, whether performed internally by bank employees or externally by a third party. In those states, any person preparing an evaluation without a license could be subject to criminal penalties, fines, and even jail time.

Licensed appraisers are presumably the most qualified – why not offer evaluation assignments to them? Reporting requirements and scope of work rules in the uniform appraisal standards (USPAP), which most states require all licensed appraisers to follow, make it more difficult, especially since the Appraisal Standards Board removed the departure rule and the concept of the limited scope appraisal from USPAP. The ASB has promised additional guidance by 2014, but it’s a gray area for now.

And what about federal preemption? FIRREA itself does not preempt state laws that regulate appraisers. To the contrary, FIRREA generally recognizes the ability of states to regulate appraisers and supervise appraisal-related activities.

So the general rule is that federal law will preempt state laws for a federally-chartered bank if the state laws “prevent or significantly interfere with” the bank’s exercise of its powers. A good argument could be made that a state law which says “a lender may order XYZ type of valuation only from a state-licensed appraiser who follows USPAP” is preempted. (That said, one court has held that a law that requires a national bank to use a state-licensed appraiser does not “prevent or significantly interfere with” a national bank’s exercise of its powers). However, most state laws that require state-licensed appraisers do not target the lender directly – they target the person who would perform the valuation.

Enter Dodd-Frank. Section 25(b) provides in general that neither the National Bank Act nor the Home Owners Loan Act will preempt state law for an agent of a federally-chartered bank. And Section 1465(a) applied national bank preemption standards to federal savings banks.

The thought that NBA and HOLA would not protect the agent of the national bank from prosecution under a state law, even assuming the state law is preempted for the bank, seems like a peculiar result. But courts have not yet had the opportunity to interpret the agent preemption provision in Dodd-Frank, so banks should anticipate that states might argue that there no longer is any preemption for agents.

An employee of a bank who performs a valuation for the bank in contravention of state law would appear to have an especially strong claim to be protected by the bank’s “preemption umbrella.” But in reality, banks might have difficulty finding people willing to risk severe personal consequences based on an abstract preemption argument. And of course, regardless of the ultimate resolution of issues surrounding preemption for federally-chartered banks, state-chartered banks will still be forced to face the issue.

Nathan Brown is the chief legal officer of MountainSeed Advisors, which provides valuation-related products and services to financial institutions.

‘Disparate Impact’: Regulators Need a Lesson in Statistics

James P. Scanlan JUN 5, 2012 3:19pm ET

In April the Consumer Financial Protection Bureau issued a statement that it was adopting the “disparate impact” concept in its enforcement of the anti-discrimination provisions of the Equal Credit Opportunity Act. It is doing so in a manner consistent with an Interagency Policy Statement issued in 1994 by the Department of Justice and other federal agencies involved with the enforcement of fair lending laws.

This is one new chapter in a remarkably perverse episode of federal law enforcement. The problem is that federal agencies’ failure to recognize a fundamental statistical concept results in encouraging lenders to take actions that make them more likely targets for litigation.

The disparate impact concept has its origin in employment discrimination cases going back to the late 1960s, where plaintiffs challenged tests and educational requirements that disproportionately disadvantaged black applicants or employees. The concept was formally legitimized for employment cases in the Civil Rights Act of 1991.

In the employment setting, disparate impact doctrine essentially holds that, even though an employer does not intend to discriminate against a protected group, it cannot use a device or practice that disproportionately disadvantages such group unless the device or practice serves a sound business interest. Further, there must be no less discriminatory alternative that equally serves that interest.

Beginning in 1989, lenders were required to keep records reflecting the race of applicants for home mortgages. Studies immediately appeared showing large differences between rates at which minorities and whites were denied mortgages. Often rejection rates for minorities were several times those of whites. Initially, these rejection rate differences were attributed to willful discrimination by lenders. But in the early 1990s, there emerged a recognition that differences in rejection rates resulted in significant part from that fact that minorities were less able to meet standard lending criteria just as minorities were often less able to meet certain employment criteria.

In March 1994, that recognition led ten federal agencies involved with monitoring or enforcing fair lending laws to issue an Interagency Policy Statement citing the disparate impact lenders’ policies may have on minorities and stating that the agencies regarded unjustified disparate impacts to violate federal lending laws. The statement cited minimum loan amounts as an example of a practice that might have greater adverse impact on minorities than whites, and it generally called into question all unnecessarily stringent lending criteria.

The discouragement of unnecessarily stringent lending criteria accorded with thinking in the employment testing context where one universally recognized way of reducing a test’s disparate impact on a protected group was to lower cutoff scores. That worked like this. Suppose that at a particular cutoff point pass rates are 80% for an advantaged group and 63% for a disadvantaged group. At this cutoff the advantaged group’s pass rate is 27% higher than the disadvantaged group’s pass rate. If the cutoff is lowered to the point where 95% of the advantaged group passes the test, assuming normal test score distributions, the disadvantaged group’s pass rate would be about 87%. Thus, with the lower cutoff, the advantaged group’s pass rate would be only 9.2% higher than the disadvantaged group’s pass rate.

Lending criteria operate just like test cutoffs, and, as with the lowering of test cutoffs, relaxing those criteria tends to reduce relative differences in meeting them. The extent to which lenders relaxed their criteria in response to the Interagency Policy Statement or other discouragements of unduly stringent lending criteria is unknown. But assuming some lenders did so, one can also assume that relative differences between rates at which whites and minorities secured mortgages decreased.

Simple enough so far. But, while lowering the cutoff tends to reduce relative differences in passing rates, it also tends to increase relative differences in non-passing rates.

In the situation just described, the disadvantaged group’s non-passing rate was initially 1.85 times the advantaged group’s non-passing rate (37%/20%). With the lower cutoff, the disadvantaged group’s non-passing rate would be 2.6 times the advantaged group’s non-passing rate (13%/5%).

This pattern is not peculiar to test score data or the numbers I chose to illustrate it. Lowering a credit score requirement will reduce relative differences in meeting the requirement but increase relative differences in not meeting it.

Nevertheless, regulators and others concerned about disparities in lending outcomes continued to measure the size of those disparities in terms of relative differences in mortgage rejection rates. Thus, lenders that were most responsive to the encouragement to relax criteria – hence, more so than other lenders, tending to reduce relative differences in approval rates while increasing relative differences in rejection rates – were regarded as the most discriminatory lenders. The actions of the DOJ and other regulators were akin to pressuring employers to lower test cutoffs and then singling out for litigation the employers who lower their test cutoffs the most.

One would think a perverse situation where, in enforcing fair lending laws, the federal government encourages lenders to engage in conduct that makes them more likely to be sued for discrimination could not persist for long. But the situation has existed for 18 years with no sign of abating.

The DOJ’s complaint filed in conjunction with the record $335 million settlement of lending discrimination claims against Bank of America’s Countrywide Financial Corporation last December sent lenders one clear message: once aware that their practices lead to racial differences in adverse lending outcomes, lenders must seek out less discriminatory alternatives.

And the complaint specifically criticized the defendant for practices that increased the frequency of such things as assignment to subprime loans. As indicated above, however, measures that reduce adverse outcome rates, while reducing differences in favorable outcome rates, tend to increase differences in adverse outcome rates on which lenders are judged.

There exist many situations where the failure to understand fundamental statistical concepts leads to distorted interpretations of data on group differences. But, as reflected by the size of the Countrywide settlement, it is in the lending industry that the financial consequences of the failure may be the most severe.

James P. Scanlan is a lawyer in Washington, D.C. He specializes in the use of statistics in litigation.