Wall Street Has Not Learned The Lessons That Created FIRREA And The Debacle of the Seventies In Real Estate Lending and Investing!

By Jim MacCrate, MAI, CRE, ASA 

It is amazing that the Wall Street firms, such as Bear Stearns and Goldman Sachs, are having problems with their real estate loan portfolios and may be creating a time bomb that may create major problems in the economy. They appear to be repeating the same problems that the banking industry had in the late 1980’s and early 1990’s. I guess the accounting industry has also forgotten what happened because they should have an experienced professional real estate staff assisting the auditors in reviewing the loan packages, real estate appraisals and the like. Clearly, the auditors, such as PricewaterhouseCoopers, Deloitte & Touche, and KPMG, should be right on top of this situation with experienced real estate professional appraisers on their staffs. Investors may suffer losses because these firms may not have instituted proper safeguards, similar to FIRREA and other banking regulations to protect the investors from any losses.

Similar problems will probably occur in the commercial real estate market shortly (in a year or so). The rating agencies, such as Moody’s and Standard and Poor’s, should be right on top of this situation, along with the designated real estate appraisal professionals working at the major accounting firms.

The Federal Institutions Reform, Recovery and Enforcement Act of 1989(FIRREA) was passed to provide standards for real estate-related lending and associated activities by national banks to minimize losses from unsafe and unscrupulous lending practices. Maybe a similar law is required to regulate the Wall Street firms to protect investors from potential losses. Wall Street has an obligation to protect investors from losses due to the complex nature of many investment products and the underlying assets. The SEC and other investors, such as the state retirement systems that invest heavily in real estate, should review their current oversight procedures to insure that safeguards are in place to prevent a repeat of the debacle that occurred approximately seventeen years ago.

FIRREA is suppose to provide protection for federal financial and public policy interests in real estate-related transactions by requiring real estate appraisals performed by a State certified or licensed appraiser for all real estate-related financial transactions with few exceptions. (In fact, shouldn’t all real property appraisals for any purpose be performed by a State certified or licensed appraiser such as divorce, estate tax purposes and the like? That is not mandatory in every state, but it should be to protect the general public).

FIRREA further stated that the appraisal reports conform to generally accepted appraisal standards as evidenced by the Uniform Standards of Professional Appraisal Practice (USPAP) as promulgated by the Appraisal Standards Board of the Appraisal Foundation. Some these standards have been modified in the last several years increasing the risks to investors. The reports must written and contain sufficient information and analysis to support the institution’s decision to engage in the transaction. Appropriate deductions and discounts for proposed construction or renovation, partially leased buildings, non-market lease terms, and tract developments with unsold units must be analyzed and reported.

FIRREA further stated “if an appraisal is prepared by a staff appraiser, that appraiser must be independent of the lending, investment, and collection functions and not involved, except as an appraiser, in the federally related transaction, and have no direct or indirect interest, financial or otherwise, in the property. If the only qualified persons available to perform an appraisal are involved in the lending, investment, or collection functions of the regulated institution, the regulated institution shall take appropriate steps to ensure that the appraisers exercise independent judgment. Such steps include, but are not limited to, prohibiting an individual from performing an appraisal in connection with federally related transactions in which the appraiser is otherwise involved and prohibiting directors and officers from participating in any vote or approval involving assets on which they performed an appraisal.” Wall Street firms should have a similar procedure to insure that the real estate professionals are independent and not pressured to provide unrealistic indications of value just to make a loan package look good for resale to investors.

FIRREA specifically states that real estate loans should reflect “all relevant credit factors, including:

  • The capacity of the borrower, or income from the underlying property, to adequately service the debt.
  • The value of the mortgaged property.
  • The overall creditworthiness of the borrower.
  • The level of equity invested in the property.
  • Any secondary sources of repayment.
  • Any additional collateral or credit enhancements (such as guarantees, mortgage insurance or takeout commitments).”

Real estate markets should be monitored based on a thorough analysis of the real estate cycle, such as Glenn Mueller’s analysis from Dividend Capital so that investors can react quickly to changes in market conditions that are relevant to making investment decisions. Reappraisals may be required. Many factors that should be monitored and considered at a minimum include:

  • Deteriorating economic conditions.
  • Changes in the borrower’s financial capacity.
  • Major change in project design or configuration.
  • Construction delays resulting from cost overruns which may require renegotiation of loan terms.
  • Project target market change.
  • Demographic indicators, including population and employment trends.
  • Zoning requirements.
  • Current and projected vacancy, construction, and absorption rates.
  • Current and projected lease terms, rental rates, and sales prices, including concessions are changing.
  • Rent concessions or more discounts resulting in cash flow below the level projected in the original appraisal.
  • Current and projected operating expenses for different types of projects.
  • Economic indicators, including trends and diversification of the lending area.
  • Valuation trends, including discount and direct capitalization rates.
  • Slow leasing or lack of sustained sales activity.
  • Discovery or change in the environmental integrity of the site and surroundings.
  • The exclusion of excess land.
  • Loan renewals or extension requested.

The loan portfolios require testing to insure that the original appraisals have been prepared correctly and if it is determined to be inadequate or otherwise unacceptable, a new appraisal should be ordered. The real property interests should be reappraised annually until the risk rating improves for that particular loan. Random sample reappraisals should be conducted periodically to identify patterns of over or undervaluation by appraisers and/or firms, property type, location or market segment. These reappraisals should not be performed by the original appraiser.


These firms could improve on FIRREA by requiring a range in value reflecting the best case, most likely case and the worst case performance scenarios. Real estate appraisal is not science, but it is an unbiased, objective opinion of value based on logical reasoning supported by market information. Generally, a range in value is more meaningful because it shows the extremes that might occur and can be developed through a sensitivity analysis of the projected cash flows and valuation conclusions, possibly utilizing Crystal Ball Software. In the current environment a number of forces impact the process of determining the value of real property interests and marking assets and liabilities to market. Maybe Wall Street and their advisors should consider implementing the guidance provided by FIRREA and the banking regulators to reduce the risk exposure for investors.

This originally appeared on Soapbox.  For 2009 update on the accounting industry, see Did Accountants Mislead Us Into The Crisis? and Systemic Risk through Securitization: The Result of Deregulation and Regulatory Failure.

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About Jim MacCrate

Real estate appraiser and valuation consultant for more than 30 years specializing in reviewing real estate appraisals, risk management and quality control.
This entry was posted in Appraisal Process, Appraisal Reviews, Ethics, Real Estate Market Analysis, Real Estate Valuation Methodology, Uniform Standards of Professional Appraisal Practice and tagged , , , , , , , , . Bookmark the permalink.

5 Responses to Wall Street Has Not Learned The Lessons That Created FIRREA And The Debacle of the Seventies In Real Estate Lending and Investing!

  1. jmaccrate says:

    Follow up articles that folks should read – Signs of Risky Lending Emerge (http://online.wsj.com/article/SB10001424052748704746804575367172177309754.html)

    and

    Bond Sale? Don’t Quote Us, Request Credit Firms (http://online.wsj.com/article/SB10001424052748704723604575379650414337676.html?KEYWORDS=rating+agencies+)

  2. Yes you taught me in pre-historic times. Anyway I read your stuff on e-mail and find it worthwile but is it applicable here in the Ithaca Finger Lakes boonies. Further do you publish the stuff on real paper. I would like to read it in my leisure time (Hah!) as I still tackle some interesting commercial stuff plus and some eminent domain action.

    • jmaccrate says:

      Yes, it is applicable but you have develop local data which I am sure is more difficult to obtain. The principles of valuation have not changed for years.

      I will email you a hard copy today.

  3. jmaccrate says:

    I do consulting work for a fee and if you are interested, you may feel free to call me to discuss this topic. The question, is not easy to answer in an email. There are many issues that one must consider.

  4. I’ve been hearing about taking advantage of the down real estate market a lot lately and I was wondering if anyone knew about buying foreclosed homes cheap and re-selling them for a higher price via lease option. Is this a good idea?….Thanks,

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