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Appraisers May Be Holding Back The Housing Market, And That Might Be Okay

July 12th, 2017 5:37 AM by Jackie A. Graves, President

I want to warn you from the top, this is a highly speculative post in multiple directions at once. I have a theory as to what is holding back the housing market, and another theory as to why that might be a good thing. There isn’t a lot of data to back up either claim, and I wouldn’t elevate other above conjecture at this point. But stick with me anyway.

A 'For Sale' sign is seen in front of a house in the Georgetown neighborhood of Washington, DC, on December 13, 2016. / AFP / NICHOLAS KAMM (Photo credit should read NICHOLAS KAMM/AFP/Getty Images)

To start with, single-family housing remains in a sluggish recovery from the housing bubble bust. New houses are being built slowly, and prices in most places are gradually and only somewhat recently moving above the housing bubble peaks on a nominal basis. In the top 100 metro areas, Trulia found that only 34.2% of home values are above the pre-recession peaks. Yet at the same time, it’s really hard to buy a house right now because inventories are extremely low, meaning few houses are for sale.

So what gives? If housing demand is strong enough to quickly absorb supply, why aren’t prices rising faster and luring more sellers and new construction into the market? Why is supply low and price growth slow? Here is my first conjecture: appraisers are very conservative in the wake of the housing bubble, and are effectively keeping prices below their market levels.

In the wake of the housing bubble, regulations including Dodd-Frank have forced more independence into the appraisal process. As a result of these rules, banks are more likely now to outsource the process of hiring independent appraisers to so-called appraisal management companies. As Ding and Nakamura argue, there is a risk of bias in the non-arms length appraisal process:


“Buyers, sellers, and real estate agents, as well as lenders who do not bear the risk of originated loans, all have a vested interest in getting an appraisal that is not less than the contract price and completing the sale.

The way to ensure the deal is for the appraisers to assess slightly higher than (or equal to) contract prices. Much anecdotal evidence suggests that such bias exists

And indeed, empirical evidence from before the new regulations suggested over-valuations happen relatively frequently, and undervaluations were quite rare. So this is why regulators have targeted the relationship with more rules since the housing bubble.

My conjecture is that with less incentive to just rubber stamp, appraisers are now constraining house price appreciation. In addition to the new independent rules, appraisers who lived through the housing bubble may be more conservative about what kind of price movement is reasonable. Anecdotally, I am hearing examples of sales where buyer and seller agreed on a price and appraisers shot it down. If buyers and sellers are constrained to below market prices, this would give you the conditions we are seeing in reality: low days on market, underwhelming house price growth, and scarce inventory.

So if appraisers are excessively conservative and that is holding back house price growth, is that a bad thing? On the one hand, since there is little hope that appraisers on average will better know the what the “right price” is than home buyers who have skin in the game. And banks who are making the loans seem like the best party to determine if the cost-benefit of conservative appraisers is worth it.

However, if you think about this policy from a macro standpoint, it begins to make more sense. Consider the following claims: 1) as Ed Leamer argued, housing is the business cycle, 2) the Fed will likely be near the zero lower bound going forward, 3) we appear to be much slower at recovering from recessions than we used to be, and 4) the political will for fiscal policy is weak at best. It is easy to look at these claims, which I think it is fair to say are each at least partly true, and conclude that we need more macroprudential policy.

Raising interest rates is one tool for tamping down a housing bubble, but there are problems here. First, housing bubbles do not equally affect all areas but raising interest rates does. Some parts of the country may be experiencing a huge housing bubble with rapid price appreciation, while others are not. Raising interest rates holds back every place, and not just those getting ahead of themselves. Preventing house price growth from reaching it’s full potential is going to be a more binding constraint in places where it is growing fast, and will be less likely to hold back places just experiencing modest or slow growth. In that sense, it is more targeted. It is also more targeted in that it addresses the housing market specifically, while there are many channels through which interest rates effect the economy, some of which may not be experiencing bubbles at all.

The second problem with using interest rates to tamp down a housing bubble is that the Fed targets inflation and unemployment, not the housing market. So this would require changing their mandate.

So if claims 1), 2), 3), and 4) are all true, and if conservative appraisers are constraining house price growth, then maybe that is a good thing. Like I said, all of this is highly speculative and I haven’t proven it even to myself. But it’s worth considering. Micro macroprudential policy in general seems under-discussed. Maybe a policy that effectively prevents the government from adding fuel to the fire in housing markets where prices are rising by, say, 10% a year would be worth the cost.

By Adam Ozimek - To view the original article click here

Posted by Jackie A. Graves, President on July 12th, 2017 5:37 AM


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