Collateral Misreporting in the Residential Mortgage-Backed Security Market

Abstract

Securitized mortgage appraisals routinely target pre-specified valuations, 45% of purchase loan appraisals exactly equal purchase prices, and appraisals virtually never fall below purchase prices. As a result, appraisals exceed automated valuation model (AVM) valuations 60% of the time and are 5% higher than AVM valuations on average. High appraisals and indicators of appraisal targeting predict loan delinquency and residential mortgage-backed security (RMBS) losses and are priced at the loan level through higher interest rates, but have essentially no impact on RMBS pricing. Selection bias simulations and unfunded loan application appraisals indicate that high appraisals are intentional. The extent to which appraisals exceed AVM valuations varies across loan officers, mortgage brokers, and appraisers, and high appraisals are associated with more repeat business for appraisers, potentially incentivizing appraisers to inflate their appraisals. This paper was accepted by Tomasz Piskorski, finance.