Monday, November 10, 2008

How Will the Bailout Affect Claims Against Appraisers?

The number of legal claims against appraisers – both residential and commercial – has increased about 100% in the last two years. This increase results largely from high foreclosure rates relating to loans made in 2005-2007 combined with lender and borrower decisions to blame appraisers for their losses and to seek compensation by filing claims. For the record: we believe that the vast majority of the claims we see against appraisers arising out of the mortgage crisis are without merit – typically, the claims are filed by lenders who ignored responsible lending criteria or by parties who were not clients of the appraiser and the subject appraisal is usually defensible as of the time it was performed. However, even though most claims can be defended, appraisers are still left with the problem of too many claims and lawsuits. Just defending them consumes enormous time and expense and, of course, causes stress and anxiety for appraisers.

The federal bailout will have an important impact on whether claims against appraisers increase or decrease. Our simple hope is that the bailout will decrease foreclosures and defaults and thus spare appraisers from some of the claims that would otherwise have been filed. Our fear, however, is that parts of the bailout could involve organized/institutionalized efforts to recover loan losses from appraisers and other professionals (as occurred under the RTC during the S&L crisis). It is too early to tell what will happen. Our current observations are discussed below.

TARP. The Treasury Department’s $700 billion Troubled Assets Relief Program (TARP) became law October 3, 2008. Prior to enactment, TARP was sold to the public and Congress on the basis that it would be a mechanism for the Treasury to purchase troubled mortgages and mortgage backed securities to rescue financial institutions and bring relief to struggling borrowers. The Treasury Department, however, immediately took TARP in a different direction after enactment by allotting the first $250 billion dollars of the program to purchase equity interests in banks. While these investments may stabilize the chosen lenders, they will do nothing to prevent foreclosures or have the effect of decreasing claims against appraisers.

The Treasury Department states that it is still working on planned programs to actually purchase troubled mortgage debt and that it is still in the process of selecting the asset managers who will oversee the management of the debt it purchases. As this process occurs we, are reading through documents that become available to discern if the organized pursuit of legal claims will be part of the direction given to the asset managers. Our obvious hope is that there will be no such direction in the program and that the emphasis will be on simply taking the debt off the books of lenders and trying to work with borrowers to prevent foreclosures and defaults.

FDIC. We have seen the FDIC take over a number of banks in recent months. The most notable of these seizures were the FDIC’s takeover over of Washington Mutual and its seizure of Indymac. Thus far, we have not seen any overt sign that the FDIC is intent on pursuing organized litigation against appraisers or other third parties relating to loan losses by these lenders. However, the backdrop for such an effort (which, at its worst, would resemble what the RTC tried to do) does exist. For example, in the case of WaMu, when the FDIC sold WaMu’s banking/mortgage assets to JP Morgan, the FDIC retained – as receiver for WaMu – all rights, actions and claims against third parties “whose action or inaction may be related to any loss . . . incurred by the Failed Bank.” This provision appears to be standard in the FDIC’s agreements when it sells loan assets from failed banks and means that the FDIC is retaining the right to pursue claims against professionals like appraisers. At the same time, the FDIC is currently seeking bids from law firms desiring to provide legal services to the FDIC for, among many other things, the purpose of pursuing these types of claims. We will, of course, be monitoring such movements for any sign that the FDIC has begun to pursue coordinated legal actions designed to recover losses from appraisers. We are hopeful that what the FDIC is really trying to carve out and pursue here are claims against bigger players who actually caused harm to banks (such as their former officers and directors, their legal and accounting advisors, and rating agencies).