Washington Mutual Is Shutting Down Its Internal Appraisal Review

Washington Mutual fired 900 employees Wednesday, 350 of them from WaMu's in-house appraisal review staff.  That effectively ends WaMu's appraisal management system for its own loans.

For the uninitiated, an "appraisal review" is an extra level of fraud protection for mortgage lenders. 

Remember that large lenders take thousands of mortgages together, average out their collective interest rate, and sell them as securities on Wall Street as Mortgage-Backed Securities -- the name is nothing clever, I know.

So, with every mortgage in the MBS bundle, there is an accompanying appraisal that says "this home on Winding Way is worth $700,000" and it represents some portion of risk to the overall portfolio.

When an appraisal is reviewed, a live person is giving it a second set of eyes, answering some basic questions that decreases the chance that fraud is occurring:

• Is the property being evaluated in a neighborhood that has other homes of the same value?
• Do the photographs of the property being evaluated match the home at the provided address?
• If the property has increased because of serious improvements, is there documentation of the before and after?

WaMu used to handle this fieldwork internally.  No longer. 

Citing "current and anticipated market conditions", WaMu cut loose the one group that can help protect the overall quality of its mortgage pools.  I understand that there is a cost for carrying employees and overhead, but there is a far bigger cost for carrying bad loans.

In June, WaMu sold of $1,000,000,000 worth of loans that were reviewed internally. 

If investors suspect that Washington Mutual's outsourced service is not providing the same level of fraud protection as in the past, they may want to see a higher average interest rate for that same $1,000,000,000 pool of loans. 

Or, investors may buy the $1 billion in loans, but will only offer to pay $990,000,000 to compensate for the extra risk -- a $10 million loss to WaMu.

The internal debate at Washington Mutual likely centers around which course of action will cause bigger losses:  keeping extra heads on payroll, or taking risk premium losses on Wall Street.  Either way, I am sorry to see that WaMu is choosing a low-cost option over a high-quality product. 

Thank you to Jonathan Miller and his Soapbox for the tip.