Submitted by George Wuenschel, Missoula, Montana.
I am a retired California real estate broker living in Montana. I am not an appraiser but I went beyond mere brokerage and was an expert witness for many law firms and have been trusted as an expert on valuation in several cases in state and federal trials. I was active in the support of California’s Prop 13 to limit property tax.
Recently I have found a serious nationwide injustice in the determination of assessed value for property taxation. There was a time when price and value could, in most cases, be considered synonymous. Those days are long gone.
There exists a balancing effect between price and financing terms which is precisely determinable mathematically. If an unusually low interest rate is available to a particular home (i.e. seller financing, assumable loan) a buyer can and will pay more for the property.
Property tax appraisers are required to make a “cash value” appraisal for real estate. They must make adjustments to value for every influence upon price that is not really part of the value of the real estate itself. An example would be a $700K sale price that included a Ferrari in the garage. The home’s cash value is less than its stated sale price. Cash equivalency adjustments must also be made for any influence upon price caused by financing to the extent such financing has a positive or negative annuity value.
In order to determine the value of favorable financing, it must be contrasted against some other financing package as a benchmark. Tax assessors have always presumed that no cash equivalency adjustments were necessary for financing if the terms a buyer received were substantially the same as those terms quoted by common financial institutions, or “street terms”. That was plausible as long as street terms resulted from free and open competition between borrowers and savers, as it was when real estate taxes were implemented.
That was the purpose of Fannie Mae. Investors would purchase FNMA bonds and that competitive market influenced interest rates on current loans. Interest rates are now merely set by the same entity that creates money; the Federal Reserve Bank.
Borrowers are no longer borrowing from savers using banks and marketplaces as an intermediary. The Federal Reserve Bank actually creates the money for borrowers, then the note executed by the borrower, through a circuitous route, eventually winds up on the Fed’s balance sheet as ‘backing’ for the money created. This is the only way that home mortgages could be made available today at 3.5% in a 10% inflationary environment. Consequently, the price of a home is considerably higher than its cash value.
This artificially-low interest rate loan has a current cash value that adds to the price of every real estate transaction in the US, but that added value doesn’t come from the property itself. It is akin to the Ferrari in the garage. In those rare cases where a buyer actually pays cash for a home, that buyer must compete with borrowing buyers. The seller wants the financial benefit of getting the highest price, so there is no discount for the cash buyer who declines this contribution to price from the FRB. Consequently, it is the mere availability of an artificially-low interest rate loan that adds to the price paid for real estate, but does not add to its true value. Should anyone doubt this dynamic, just remove the artificially-low interest rate and watch what happens to the price.
In order to determine the value of an artificially-low interest rate loan, it must be contrasted against a true market-based loan. That requires speculation about what the interest rates would be if based upon free and open competition between borrowers and savers. Since nobody can possibly make such loans in competition with the FRB's member banks, there is no lending operations to obtain such figures. All we can determine is the floor or minimum interest rate required just to break even by starting with the real inflation rate that affects the US dollar.
The well-respected Chapwood index (chapwoodindex.com) and economist John Williams index (shadowstats.com) both show a loss of purchasing power in the US Dollar of about 10% annually. Lenders will always compute a real rate of return (note rate minus inflation). The first 10% interest they receive is really not a profit at all. It only offsets the decline in purchasing power of the dollars the lender has tied up in the loan. Since lenders will be taxed on interest income from nominal dollars, the lender additionally needs to recover those taxes from the interest rate. Then there are loan servicing costs, loan origination costs, and finally, profit.
There is no way interest rates could be less than 12% today if such rates had to be determined by free and open competition between borrowers and savers unless we expect such lenders to systematically lose wealth in order to make loans. They only way to circumvent that reality is to have the entity that creates money also be the ultimate funding source behind the loans. The injustice here is that appraisers contrast the street interest rate against the actual rate the borrower received resulting in no needed equivalency adjustment to arrive at the cash value of the real estate.
I contend they should be contrasting that artificially-low rate loan against the rate that would be required if determined from free and open competition between borrowers and savers. Remember, the purpose of the adjustment is to separate the value of the home from the value of extraneous elements of price that do not come from the home itself.
Why doesn’t a proposed real estate lender’s appraiser make such adjustments? All appraisals have a purpose. The purpose of a proposed lender’s appraisal is to protect their security interest so they don’t get over-extended. They must be confident that, if they need to foreclose, the property will sell for enough to satisfy the lender’s loan. A lender is unconcerned about the components that make up price. They are only concerned about price itself because that is what will protect their loan. But tax appraisers must determine cash value, which is very different than price in this artificial environment. And why do savers and bond purchasers routinely accept less than a 2% risk-adjusted yield on their investments in a 10% inflationary environment? Certainly not in pursuit of profit. They do it to mitigate the losses of staying liquid in cash because its the best that can be done in an artificial environment where the free market and price discovery is totally corrupted.
For property tax purposes, all real estate is overvalued by 30% to 35% for ad valorem taxation (tax based upon value) because of this valuation scam. About 2/3 of a typical property tax bill is based upon the value of the property while the remaining 1/3 is a tax on the value of an annuity injected into every sale transaction by the Federal Reserve system. All sale transactions become a historic comparable sale used to determine the value of all other homes for tax purposes. Each and every one of those comparable sales reflect an erroneous inflated value unless they are adjusted to cash equivalency – and they are never adjusted.
One way to understand the need for cash-equivalency adjustments is to consider the effect on price if home mortgage interest rates go negative, as they did in Denmark. A negative interest rate loan is actually an income instrument to the borrower. A negative interest rate loan will eventually amortize to a $0 balance without any payments ever being made. In such a case, the price of the secured real estate should go to infinity because price doesn’t matter. If cash equivalency adjustments were still not made for such financing, the property tax bill must likewise go to infinity. Can rates go negative in the US? Measuring from 12% rates, we have traversed three quarters of that distance. We are already deep into artificially high real estate valuations and very close to infinite valuations.
Having spoken informally to two lawyers about this matter, including a former US Assistant Prosecutor, they recommended a 42 US Code Section 1983 Civil Rights case. However, there are several prevailing facts that increase the severity of this tax injustice.
There are multiple government entities involved in the conspiracy: state appraisers, county tax assessors, county tax collectors, county recorder’s office, and sometimes even the state court when they induce a forced tax sale. There is an ever-present threat that if the inflated tax bill isn’t paid, the property will be involuntarily sold out from under the owner. There are government officials operating under the color of doing their job. So why isn’t this a violation of The Racketeer Influenced and Corrupt Organizations Act, 18 US Code Chapter 96 (RICO)?
It is RICO, but a nightmare of a case. Nonetheless, I have made a RICO complaint to the US Department of Justice. In my state of Montana, a state appraiser admitted they are not making such cash-equivalency adjustments and the Governor’s office will not respond. Its time for homeowners to get vocal.