The stupidity of free-market chic ... in real estate.

The Stupidity of Free-Market Chic . . . . . . in Real Estate

Ralph Colburn has been selling a certain commodity in Idaho for decades. Until recently, he had a bustling office in Boise. Like any sharp businessman, he looked around for a piece of the market overlooked by his competitors. Seizing upon the opportunity he saw, he advertised that something new had come to Ada County. Ralph hit upon something the market was eager for--something that saved his customers money. Business was good. But Ralph's competitors weren't so happy. They pulled him in, tired him before their private tribunal, and drove him out of business. That left Ralph bankrupt at age 73.

Ralph was selling (pick one):

a) new cars

b) stocks and bonds

c) potatoes

d) houses

Unfortunately for hapless Ralph, the answer is d)--he was selling residential real estate, an industry controlled at almost every level by the National Association of Realtors (NAR) and its thousands of local boards. So great is the control that the NAR tries to exert that it treats the term for its members as a registered trademark requiring capitalization: Realtor. Part of that control is a stipulation in the NAR code of ethics that in essence prohibits Realtors from competing with each otehr, a condition that by definition makes the NAR a cartel.

In 1988, after nearly a decade as a Realtor, Ralph broke from the Realtors' mandated practices and started advertising as a "buyer's broker." Almost all Realtors represent the seller--even those who drive the house-hunting buyer around to look for a home. The agent who helps the buyer find a home then splits a commission--usually 6 or 7 percent of the selling price--with the agent who worked with the seller from the beginning and listed the house for sale.

When both agents in the transaction represent the seller, both are legally bound to do everything in their power to see that the seller gets the highest price. Splitting the commission obviously leads to this result as well. But Ralph didn't want to represent the seller--he thought it unfair, misleading, and probably illegal.

"There are more than 700 Realtors in Ada County," Ralph's ad read, with a photo. "Here's part of them--all nice folks. All dedicated and obligated to sellers! How many are dedicated to the best interest of the buyer? Ralph Colburn."

Pretty tame stuff, right? But the "nice folks" in Boise didn't much like Ralph telling customers that most Realtors represent the seller. A 1983 Federal Trade Commission (FTC) study found that nearly 75 percent of buyers and sellers didn't understand that the broker who helped the buyer find a home wasn't representing the buyer. So in millions of deals, year after year, buyers have been confiding financial information to the broker--even disclosing their highest bidding price--not knowing that the broker is obligated by law to relay that intention to the seller and make sure the seller gets the highest price possible.

Monopoly money

The local Realtor board "hearing" that hurled Ralph into bankruptcy court faulted him for seeking "unfair advantage over other Realtors" and failing to "avoid controversies with other Realtors." The Boise Board of Realtors also found that Ralph broke the rule that read, "The Realtor shall not publicly disparage the business practice of a competitor nor volunteer an opinion of a competitor's transaction."

Imagine the glee of big automative manufacturers, large Wall Street firms, and potato barons if they were told they could quash the pesky competitive threats of upstarts, unfettered by any significant market force or government intervention.

But the National Association of Realtors is unique. The linchpin holding the whole organization together is the network of thousands of Realtor-run multiple listing services (MLSs), which catalog properties for sale.

"If you're going to be in residential housing sales, you have to be a member of some kind of MLS," explains Colburn in his Idaho twang. Membership in the NAR is compulsory if a broker wants access to an MLS. That rule has made the NAR the largest trade association in the world, with about 820,000 members.

The NAR's control over the country's MLSs--which handle about 80 percent of all home sales--has been picked at halfheartedly by various agencies for years, but with little real change, and with no lessening of the Realtors' stranglehold on the industry.

During the Carter administration, Paul Roark, now staff attorney with the FTC's regional office in Los Angeles, led a team of FTC investigators that began looking into the Realtors' influence over the real estate industry. When the voluminous study was finished, the Reagan administration stalled its release for years, then failed to take any real action on the study's findings. "The primary issue for Realtors is the maintenance and control of the MLSs," Roark explains.

To get access to an MLS a broker must join and pay dues to the NAR, its state association, and a local Realtor board. The NAR's share of those dues totaled $57.8 million in 1989 alone. The NAR's total revenues that year were $106.8 million, according to Dale Stinton, the NAR's comptroller.

Those revenue figures don't include what the Realtors' aggressive political action committee, RPAC, brings in every year. Between January 1, 1989, and March 31, 1990, RPAC reported receipts of $3.2 million; for the 1987-1988 election cycle, RPAC raised $6.2 million.

And what does all that money buy? In just the past couple years, the Realtors have:

* Ambushed an Office of Management and Budget (OMB) option that could have netted $604 million a year for the Treasury.

* Declared war on any politician who dares support an interpretation of the Real Estate Settlement Procedures Act (RESPA) that would prohibit Realtors from collecting mortgage-origination fees from buyers. Detractors say that the Realtors' handling loan originations add $2 billion to $7 billion annually to the costs of financing homes.

* Helped four federal agencies come to the conclusion that residential properties selling for less than $100,000 need no appraisal and that certified appraisers aren't required for properties selling for less than $1 million when the home is financed by a federally insured lender. Many Realtors have a sideline appraising business, but do not meet the educational standards of any professional appraisal group.

* Terrorized a member of the House Ways and Means Committee who obliquely suggested a cap on the deductibility of mortgage interest. The NAR was so effective that the congressman will not even discuss the episode. Mortgage-interest deductibility cost the Treasury $34.2 billion in 1989.

Twisted ARMs

The NAR is so successful at the federal level because it couples its political contributions with hard-core lobbying from the moment it gets wind of any initiative it doesn't like.

That was the case with the OMB's consideration this spring of a new transfer tax on real estate sales. The 0.1 percent tax on the $604 billion in single-family home sales last year would have been used to protect environmentally threatened areas. The NAR, working in concert with the National Association of Home Builders and the Mortgage Bankers Association (MBA), contacted policymakers at the White House and the Treasury, and the initiative was dropped in a matter of days, according to Sharon Canavan, deputy legislative counsel with the MBA.

The NAR goes to great lengths to train its hundreds of thousands of members in "grass-roots" political persuasion techniques that the Realtors can apply to representatives from their home states. Last April, at its midyear conference in Washington, the NAR told its members that the MBA (usually the NAR's political ally) was waging a "war" against the Realtors' "right" to charge fees for helping a buyer find a mortgage. The NAR called on all Realtors to lobby against any revisions to the 1974 RESPA that would ban Realtors from charging fees for computer-originated mortgages, a relatively new but lucrative development in the industry.

Part of the program was a skit by the "Realtor Prime Time Players," intended to show Realtors how to influence their elected officials. The skit was distributed to Realtors on cassette tapes marked "Restricted."

The scene: Senator Batsen D. BElfry from teh State of Confusion is visited by Roger and Roberta Realtor from the state's Realtor association. Also present is Belfry's legislative aide, Snidely Scribe.

First, Belfry, venal and money-grubbing, thanks the Realtors for their "gift" to his campaign. Then Roger Realtor quotes a recent Belfry speech in which the senator swore to introduce a bill that would prohibit real estate brokers from charging "exorbitant fees for helping home-buyers in getting a mortgage."

"I'm afraid you've been victimized by the use of a buzzword," Roger Realtor tells Belfry. Roberta Realtor then asks Belfry if he doesn't think people should be paid for their time.

"I think it only right to charge people for time," Belfry responds in a Southern drawl. "I couldn't very well make a living if I couldn't charge people for talking to them. There's no such thing as a free lunch. Unless of course therehs some honorarium attached. Folks want to get paid once they make the deal. Anybody who makes a deal with me better be able to pay. Don't worry about that bill, folks. I'll see that it doesn't get past my committee. Now, about that fundraiser coming up...."

About 75 percent of all buyers ask the real estate broker for help in finding financing, according to the NAR. One way brokers find financing is through computer loan origination, which will probably become standard in the next decade. RESPA prohibits real estate brokers from taking fees for referring buyers to lenders, but the question is whether computer loan origination is a "referral" within the meaning of RESPA.

Today about 100,000 Realtors are pulling in hefty fees for computerized mortgage-origination services, and the MBA and some consumer advocates are warning that this violates RESPA. In September, the Department of Housing and Urban Development (HUD) disagreed. In testimony before the House Banking Subcommittee on Housing and Community Development, HUD declared that it would interpret RESPA as allowing real estate brokers to take fees for originating mortgages if they don't restrict the mortgages offered to just one lender.

The most prominent of the loan origination systems is Citicorp's MortgagePower. Citicorp charges users $2,500 a year for access to the computerized listings of the mortgages it offers, and the brokers charge buyers anywhere from $200 to a full percentage point of the loan's value to file an application. The NAR says that a Realtor's innate concern for a buyer's well-being will deter him from steering the borrower to Citicorp (and recouping his $2,500 investment) unless it's also a good deal for the buyer. Citicorp was so wedded to its mortgage strategy that it quit its major trade association, the MBA, in September because the MBA objected to real estate broker's originating mortgages.

The MBA took a survey of MortgagePower loans in the spring of 1989, and claims that loans originated by real estate brokers have interest rates 1/8 to 3/8 of a point higher than otherwise available, which would mean home-buyers are spending $2 billion to $7 billion more a year than necessary on interest payments.

Since MortgagePower was rolled out nationally in 1986, Citicorp has increased its market share from 2.9 percent in 1985 to become the industry leader at 4.1 percent in 1989, when it lent $12.3 billion in mortgages.

HUD General Counsel Francis A. Keating told the banking subcommittee that HUD's inaction on the issue in the past several years had created confusion in both the real estate and mortgage industries, and that Citicorp had been allowed to establish a "monopoly." HUD gave Citicorp two years to open up its system to other lenders.

Left unaddressed were the problems inherent in a real estate broker's arranging for complex mortgage financing when his primary motive is to close a sale and move on. Keating said HUD envisioned the nation's mortgage-origination system resembling the airline-ticketing systems that list the fares and routes of most major carriers. But what with points, balloon payments, and other mortgage twists and turns, finding a "good" loan isn't quite as easy as booking a customer through to Duluth.

A. Love's labor lost

Mortgage origination isn't the only lucrative sideline some Realtors try to milk in a single deal. For instance, brokers are allowed to refer buyers to title insurance companies in which the broker has an ownership interest. Another example is the NAR's position on requiring appraisals of residential property. About 100,000 NAR members do appraisals on the side.

Rep. Doug Barnard was convinced years ago that faulty and fraudulent appraisals lay at the root of the S&L debacle and many bank failures. He spearheaded a part of the S&L bailout bill in 1989 that required certified appraisals for homes selling for more than a certain amount. Barnard favored a $15,000 threshold.

By the time the Federal Reserve Bank, one of the five federal agencies charged with overseeing the country's financial institutions, issued regulations in June, that $15,000 threshold had been changed at the urging of the banking industry and the NAR.

The new limit: $100,000. Homes selling for less than $100,000 would need no appraisal to qualify for loans from federally regulated lenders. In 1989, 54 percent of all homes on the market sold for less than $1000,000. For houses selling in the $100,000 to $1 million range, the law stipulated that the appraisal could be performed by a licensed appraiser, rather than a more qualified, more educated, and more experienced certified appraiser. To be certified, an appraiser must pass stringent educational and work-ex-experience requirements imposed by appraisers' professional organizations.

The NAR spearheaded the move to the $100,000 threshold, arguing that otherwise there would be an appraiser shortage that would force consumers to pay more for appraisal services. But A. Scruggs Love says he knows better. Love is president of the American Institute of Real Estate Appraisers, which fell under the cloak of the NAR until last June.

"The NAR wants their brokers and salesmen to be able to do an occasional appraisal," said Love from his office in San Antonio. "We agree, but think they should have the education to meet the minimum requirements to do a competent job." Love charges that many of these occasional appraisers do a "windshield" appraisal--a simple drive-by of a house, with no real research or inspection.

For the past year, as the NAR was lobbying hard--first against any change in appraisal standards, then for raising the limit of $100,000--the 22,000 certified appraisers who were members of the NAR had to sit by in horrified silence. That's because in 1988 the NAR created a rule that forbade its 10 affiliated organizations from communicating with any government body without the NAR's prior approval. Not surprisingly, the NAR never gave Love's group the go-ahead for anything. Love's frustration at being gagged for two years by the NAR was evident months after the appraisers voted themselves out of the organization, breaking an affiliation that dated back to 1932.

Leaving the NAR over this issue was no easy decision for the appraisers, because those who left the NAR cannot have access to the MLSs. "It's extremely difficult to do single-family residential [appraisal] work if you don't have access to MLS," Love said. "I personally don't believe the NAR has the right to insist [someone must] be a Realtor before joining an MLS."

Barnard, the congressman who advocated the $15,000 threshold, said that from the legislation's passing in August 1989 until June 1990, he had no indication from the Federal Reserve or other regulators that his reforms would be thwarted. "I was shocked," Barnard said. "They were trying to dilute the legislation we had been working on so long. Appraisals have been known as one of the main reasons for the failures we've had as far as savings and loans are converned." Faulty or fraudulent residential appraisals are officially blamed for about 10 percent of the S&L mess.

Legislators keep in mind the kind of pressure the Realtors can apply at almost a moment's notice. Take, for instance, the case of Long Island Rep. Thomas J. Downey, who had a Kafka-esque run-in with Realtors in 1988. Despite repeated requests for an interview, Downey will not discuss the episode, so the following synopsis is drawn from a 1989 Newsday story by Stephanie Saul.

In an April 1988 speech, Downey, a member of the House Ways and Means Committee, mentioned that a cap on mortgage-interest deductibility might be one of the many ways Congress could generate revenue. Mortgage-interest deductibility cost the Treasury $34.2 billion in 1989.

Come June, 23 organizations, including Citibank and the American Bankers Association and led by the NAR, demanded a meeting with Downey. Downey, who never said he was going to actually propose a cap, discussed the possibility of creating a cap of $50,000, the approximate annual interest on a $500,000 mortgage.

But the NAR and the Long Island Board of Realtors still weren't satisfied. A member of Downey's staff told Newsday that the Realtors threatened to withhold RPAC contributions to Downey's campaign. Downey received $8,000 from RPAC during the 1987-1988 election cycle, according to the Federal Election Commission.

At a subsequent meeting of the 23 groups, the NAR pledged to alert its affiliated boards to the danger posed by Downey. An entirely new 34,000-member lobbying group, Alliance of America's Home-owners, was formed specifically to battle Downey's never-proposed interest-deductibility cap. A widely distributed report by the National Association of Home Builders put Downey on an "alert" list of politicians who had designs on mortgage-interest deductibility.

By August, Downey met with the Long Island Realtor association to recant and promised to leave mortgage-interest deductibility untouched. Then Downey got two $3,000 contributions from RPAC. Finally, Downey wrote an article for the Long Island Realtor, pledging vigilance in protecting the current level of mortgage-interest deductibility, which is $100,000.

Deadly double agents

But nothing the NAR has managed to pull off in Washington can compare with the legal legerdemain it uses to control access to MLSs. In 1989 alone, 3.44 million homes changed hands through MLSs. And almost all of the those deals are rescindable.

Just think about it. You've changed jobs, taken the kids out of school, hauled everything you own in the world 3,000 miles, and settled into your new home. And somewhere out there, the guy who used to own your new house decided he wants it back. He can dissolve the sale if he feels like it. Now multiple that disastrous scenario a couple million times, and the perils of the nation's current real estate industry become quite vivid.

The problem lies in something called "subagency." All Realtor MLSs outside of California require that the Realtor helping the buyer look for a house be a subagent. A subagent is required by law to represent his agent and his principal--in this case, the seller's Realtor and the seller. This means that all the Realtors who belong to the MLS represent the seller in any transaction, either as agent or as subagent. These sales are rescindable if the subagent left any impression in the buyer's mind that somehow his interests were being represented. And remember, the FTC found in 1983 that nearly 75 percent of all buyers and sellers believed that the broker who helped the buyer actually represented the buyer--and they were surveyed by the FTC after their deals closed. Ralph, the renegade Realtor from Boise, got into torouble because he refused to act as a subagent.

Paul Roark, the FTC attorney, said that most subagents in truth act as a quasi-agent for the buyer, because such a relationship is natural, though prohibited by the NAR. This reality makes the subagent something illegal: a dual agent. Dual agency is illegal in every state if not everybody involved in the transaction knows about the dual agency and consents to it.

"Subagency causes undisclosed dual agencies," Roark says. "It's almost always undisclosed and [that's] grounds for rescission in all states, without showing of injury."

Forcing all Realtors to be subagents "is a biased supposition of the NAR," Roark continues. "The sub-agency is a ridiculous position that serves the purpose of the association and almost no one else. It's really about money and revenues." The NAR, which must be aware of the lurking danger of millions of rescindable contracts, persists in mandating subagency because that is the only way it can hang onto its mainstay--the MLSs.

In 1976, when the NAR defined the MLS as a "means of disseminating information," and California Supreme Court ruled that the Realtors couldn't restrict MLS access to Realtors. "[A]ccess to the multiple listing service is so essential to nonmembers if they are to compete effectively that such access must be granted to all licensed salesmen and brokers who choose to use the service," the court ruled in Marin County Board of Realtors v. Palsson.

After it was clear California was lost, the REaltors had to do something, or risk losing copycat cases in other states and subsequently their control over the industry. So the NAR changed the definition of the MLS in 1980 to "a blanket unilateral offer of subagency." The sudden embracing of subagency was a piece of rhetorical gymnastics for the NAR, whose executive director, William North, had warned of the perils of subagency when he was the NAR's general counsel in 1976.

"They altered the definition of an MLS to include and mandate subagency," said Roark, who added that the system also endangered sellers, who are liable for the subagent's misrepresentations and misdeds. "If the seller knew the vicarious liabilities that went along with it," he would refuse to list on an MLS, regardless of the system's marketing benefits.

But the NAR must cling to the subagency requirement if it wants to maintain control of the MLSs. How does this work? Well, the NAR argues that sub-agency is so dangerous, because of its liability problems, that all members of an MLS must be bound by the NAR's Code of Ehtics, which means they must join the NAR.

That defense has prevailed in a couple of state court challenges. But the NAR may have a nasty surprise ahead. Though Roark and the FTC will neither confirm nor deny that the agency is examining the NAR for antitrust abuses, investigators have been canvassing the country, talking to people like Ralph Colburn. While Roark won't discuss the existence of an investigation, he did say that one area of persistent FTC interest in the Realtors' commission rates of 6 or 7 percent.

Though the commission rates must be negotiable by law, most sellers don't know this. In 1989, brokers raked in $40 billion in commission alone. In many European countries, the commission rates are set by law; in Australia, the rate is set at 2 percent. Roark suggests that home-sellers in this country are paying $26 billion more each year on commissions than they would if the NAR did not control the marketplace.

Those huge transaction costs of buying or selling a home make homeownership one of the worst financial deals around, unless the buyer holds on to the house for a long time.

The hefty broker fees are supposedly justified because the agent should be acting as a fiduciary for his client. But as the industry has evolved, real estate agents have become less fiduciaries and more mediators and dealmakers. Consumers are bound to start asking themselves whether such limited services are worth an average brokerage fee of about $7,000. "A broker is just not a lawyer-type advocate," Roark says. "Should people be paying 6 to 7 percent for what they get now?"

Roark recalls a conversation he had with a former president of the California Board of Realtors, who told him that "2 percent is closer to what a competitive rate wold be if there were not these artificial structures in the real estate industry."

Elizabeth Lesly is a business writer for the Albany , New York Times Union.