Musings on Market Collapse Disorder

Value is a personal concept. To the extent that we are ego-centric, that statement may be easy or difficult to grasp. Each person observes his world and ranks the objects and ideas within his understanding in a hierarchy; every thing and object, including life itself, has a "value" which is assigned according to perceived importance.

Further, the position in the ranking is subject to change, based on the person's perceived needs. Thus, value is merely a perception, and it is common for items which are more easily obtainable to be substituted for scarcer items whenever they are in close proximity on the hierarchy.

An example in the ethical realm would be the conflict between self-preservation and self-esteem. If a choice must be made between going hungry and stealing food, or between lying and dying, the closer together the choices are in importance to the person, the easier it is to substitute one for the other.

In the realm of currency exchange, the closer to parity two currencies are, the more equal their value appears, and the less resistance there is to trading one for the other. When real property is considered, the principle of substitution drives the appraisal process.

Whenever real property is appraised, the object of the assignment is to locate the subject within a universe of other "things" which can be substituted for it without causing cognitive distress. The "things" may be a sum of money, other real property, security, or the potential to profit in some other way via the asset. For this reason it is critical that the "value" be defined prior to any attempt to give an opinion of value (appraisal) of the property.

"Market Value" has been defined by agencies of the U.S Government (12 CFR Part 34, Office of the Comptroller of Currency) as:

34.42 (g) Market value means the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

1. Buyer and seller are typically motivated;
   
2. Both parties are well informed or well advised, and acting in what they consider their own best interests;
   
3. A reasonable time is allowed for exposure in the open market;
   
4. Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
   
5. The price represents the normal consideration for the property sold unaffected by special or creative financing or
   sales concessions granted by anyone associated with the sale.

As we go further into this discussion, it is essential to note that 12 CFR 34.44 (d) requires that for any Federally Related Transaction, i.e., a transaction as defined in 34.42 (f), the appraisal must "Be based upon the definition of market value as set forth in this subpart".

The tricky part is meeting all the requirements of 12 CFR 34.42 (g). If the predominant buyers and sellers in a market are not owner occupants, are they "typically motivated" from the standpoint of residential mortgage lending? If there is no way to judge the exposure time on the open market because the majority of sales are private transactions, can statistical data from such sales be used to describe the market for the purpose of informing the residential mortgage underwriter of "typical" market conditions?

There is no question in my mind that the reliance of many lenders on AVMs, the failure of appraisers to understand 12 CFR 34 and the characteristics of their own markets, and the willful disregard of 12 CFR 34 by the residential lenders has resulted in extension of inadequately secured credit to borrowers.

The "collapse" of many real estate markets around the country has not been due to a decline in market value of the homes. It has been due to a phony inflation of prices based on the ability to obtain undersecured financing. We are simply finding out that the emperor has no clothes.