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Solutions to the Mortgage Lending Crisis

The mortgage industry crisis is a gift.  Mortgage lending can emerge from this mess and transform itself. I have been co-writing about predatory lending and the ambiguous professional status of retail mortgage salespeople for over 7 years. The industry has traded consumer respect for massive profits.  It does not matter where you work: banker, broker, credit union, consumer finance company. It does not matter what you call yourselves: Loan officer, loan originator, loan consultant, mortgage planner.  The average consumer does not understand the differences. 

Solution number 1
All retail mortgage salespeople, no matter where they work: bank, broker, credit union, consumer finance company, should owe fiduciary duties to consumers, just like a doctor or a lawyer does.  The process of purchasing or refinancing a home has become more and more complex over the past 20 years. This major financial decision is no less important than a medical procedure or legal matter.

Solution number 2
Let’s stop dancing around the ambiguous behavior we call “predatory lending” and define it.  We use to call such actions “fraud.” There are now 24 states that have passed anti-predatory lending legislation.  This means multi-state brokers must deal with a patchwork of state regulations.  A federal solution is in order, but we must also make sure that funds are set aside to regulate any new federal law. An un-regulated federal law is useless.

Solution number 3
If the industry does not like paying higher costs associated with more state and federal regulations, the industry has another choice: Self-regulation.  Any industry is far better of self-regulating rather than letting the government regulate for you.  The last time the mortgage industry had to swallow government forced regulation, we ended up with RESPA and the Truth-in-Lending Act. Oh, yes, these are such fine pieces of federal legislation and so easy to understand that the industry joyfully and voluntarily steps up to the plate every day to willfully comply with these two gems.

Every time I ask mortgage brokers the following question, I get the same answer, 100% of the time: “If you accidentally messed up and violated a federal or state law, would you want one of the competitors in your marketplace to give you a call and say, for example, ‘Hey there, I think you missed the APR on that piece of advertising’ or would you rather have your competitor turn you in to your state’s regulator?”  Everyone would rather have their competitor place a direct, friendly call to them.  There’s this really cool guy named Kant who came up with one way (well he came up with many ways but we’ll just focus on one right now) to help us figure out how to act ethically. He said that if we want something for ourselves (a courtesy phone call) then we must also want it for the other person.  “But, but,” you ask, “what if that other person is our competitor?”

Self-regulation means that the industry understands that consumer respect is only as high as it’s LOWEST player.  Self-regulation is a sign that an industry is moving forward and growing up.  Yes, it will mean requiring more pre and post education, tougher exams, and higher duties owed to consumers, but moving into the realm of professional status also means more prestige, less government oversight, and the fees emerging mortgage professionals will charge for their services and knowledge will be higher because their knowledge and duties will be worth more. If you regularly argue for less government intrusion and you are pro-business, you understand the value in self-regulation.

There are now four national professional associations where retail mortgage salespeople can voluntarily choose to act with professional status, or at least pledge a higher level of honesty than the existing industry associations.  Members of NAMB must simply look like they’re honest. 

Retail mortgage salespeople who join the Mortgage Professor’s Upfront Mortgage Brokers Association will guarantee, in writing, a fixed price for their services up front.  Members also pledge to put their client’s interests above their own.

The National Association of Mortgage Professionals has a Code of Ethics that is better than NAMB, MBAA or NAPMW.

The Certified Mortgage Planners have a more detailed Code of Ethics.  However, all a person has to do is attend a 3 day class and pass a test and I’m not sure I agree with their premise: To help consumers plan how to use their home equity.  This organization has some work to do in its intentionality.  Interestingly, a regular raincityguide.com reader sent me an entire slew of articles that catch lead Mortgage Planner instructor Barry Habib with his pants down recommending consumers choose subprime products, take their equity out of their home and invest it, and other “advice.”  Looks like CNBC hasn’t asked him for advice for a couple of months.

The National Association of Mortgage Fiduciaries Code of Ethics is prescriptive and detailed. We are the only professional organization whose code of ethics prescribes fiduciary duties and we are open to all people in the mortgage lending industry.

Ameriquest and Household Finance, two consumer loan lenders were forced by way of court settlement to cease rewarding their retail mortgage salespeople for steering trusting consumers into high cost, high rate loans. In contrast, Mike Dodge recently penned an Inman Guest Perspective in which his company, Internet Brands, voluntarily adopted a twelve point, detailed, home borrower’s Bill of Rights.

Solution Number 4
Require ratings agencies to do proper due diligence on pools of mortgage backed securities and dis-allow ratings agencies to be paid by the investment bankers; a conflict of interest that certainly should have been caught long ago.

Solution Number 5
Ban downpayment assistance programs which artificially inflate sales prices and are nothing more than seller money laundering according to Tanta. 

Solution Number 6
Require that mortgage companies that purchase leads be held accountable for the advertising used to harvest those leads.  Deceptive mortgage spam, deceptive radio ads, deceptive lead generation websites only serve to circumvent an ethical mortgage company’s attempts to advertise in accordance with state and federal laws.

Some view the mortgage industry meltdown as a threat. I see it as an opportunity to put the industry back on track ethically, to help retail mortgage salespeople transform into emerging professionals, rope predatory lending back into where it came from: the fraud corral, and open a national dialogue on self-regulation. What do you see? What solutions would you add to this list?

What the Space Shuttle Challenger Disaster Can Teach Us About the Current Mortgage Lending Crisis

In this mortgage ethics article about allegiance to rule-following, I will compare the mortgage industry crisis with a classic business ethics case study.

The space shuttle Challenger accident has frequently been used as a case study in the study of engineering safety, the ethics of whistleblowing, communications, and group decision-making.  With Challenger, an O-ring eroded on earlier shuttle launches. Morton Thiokol (MT) managers believed that because it had not previously eroded by more than 30%, that this was not a hazard. During a pre-launch conference call with NASA, the MT engineer most experienced with the O-rings, Roger Boisjoly, pleaded with management repeatedly to cancel or reschedule the launch. He raised concerns that the unusually cold temperatures would stiffen the O-rings, preventing a complete seal. MT senior managers overruled him and allowed the launch to proceed. Challenger’s O-rings eroded completely as predicted by Boisjoly resulting in the disintegration of Challenger and the loss of all seven astronauts. Boisjoly concluded that the caucus called by managers who decided to launch, was an unethical decision-making forum which came about because of intense customer intimidation. “Roger Boisjoly and the Challenger Disaster: The Ethical Dimensions” from the Journal of Business Ethics 8 (April 1989).  Everyone followed the rules, and the ensuing investigation determined the accident was nobody’s fault.  Boisjoly concludes that the Challenger accident occurred because of the existing institutional system and allegiance to the rules of protocol.

In real estate and mortgage lending, we all follow state and federal laws (rules), yet some consumers ended up with a mortgage loan they did not understand and were not qualified to pay back. Pressure was applied to many people all up and down the line in mortgage lending. For example, appraisers being strong-armed to hit a value or else risk losing referrals.  Some real estate agents and mortgage brokers still apply pressure to banks and lenders to approve loans fast, now and immediately, or else risk losing referral business, and a mortgage company’s culture has a remarkable influence over corporate workers. 

Let’s follow the origination of a random mortgage loan and see if we can spot all the possibilities for system failure. 

Lead generation companies such as NextTag, Lending Tree, and lowermybills.com scoop leads off of their deceptive banner ads and sell them to hungry mortgage retail salespeople.  Leads are also generated and sold by using deceptive mortgage spam, direct mail, direct home fax, deceptive radio ads, and so forth.

A real estate agent or Realtor is not suppose to become involved in the mortgage side of the transaction because it means the agent has stepped outside his or her area of expertise.  Attorneys advise real estate agents that an agent increases liability when this line is crossed.  Some agents are comfortable taking on this liability, others are not. Many let the homebuyer’s chosen lender take the lead on explaining the structure, consequences, and results of loan products.

Homebuyers and refinancing homeowners on average know very little about mortgage lending and spend little time reading required disclosures. Mortgage retail salespeople have no mandatory ethical duties to the homebuyer or refinancing homeowner to put the client’s interests above his or her own interests to make as much money as possible off a trusting consumer. Obviously there are some mortgage retail salespeople who do look after the best interests of their clients. But how is a consumer supposed to know where to find these folks?  Relying on the referrals of trusted friends and family shifts the responsibility off the self and on to another person. 

Government disclosure forms such as the Good Faith Estimate and the Truth in Lending Reg Z forms are confusing to the consumer. Predatory lenders use these forms to deceive a refinancing homeowner or homebuyer. This is well documented in both Household Finance and Ameriquest settlements.  There never has been nor will there ever be enough government resources to police every single transaction written by every single retail mortgage salesperson.

When a loan is brokered to a bank, the bank owes no duty to the consumer to make sure that the loan was not originated using deceptive or predatory lending sales tactics, or generated by advertising that did not comply with federal Truth-in-Lending laws. A bank’s duties are to its shareholders (to follow mortgage lending laws and to make a profit.)  Wholesale lenders and banks underwrite loans to guidelines set down by investors.  Profits are made by pooling loans and selling them as mortgage backed securities.  Hypercompetition to be the biggest and best wholesale lender led to paying higher and higher incentives to mortgage brokers to sell higher and higher yield (and now morally out-of-fashion) interest only, pay option, negative-am, adjustable rate mortgage loan with and without prepayment penalties to consumers, regardless of if the consumer understood how the loan product worked.  The selling point from wholesale lender to broker was: “when the rate adjusts, you can solicit them to refinance and earn another 4 points for yourself.” An entire breed of retail mortgage salespeople knows nothing but this business model.

Consumers are given standard state and federal disclosures to read, explaining how the loan product works, and some people argue that if a consumer signs documents he or she does not understand, then it is the consumer’s fault.  Mortgage lending is complex. Here is an analogy:  A person had to undergo surgery and the doctor hands the patient a set of medical books and tells the patient to read the books and make a decision.

Appraisers owe duties of good faith to mortgage banks and lenders. Problems with the relationship between the appraiser and the retail mortgage sales people were one of the first signs of O-ring failure in the space shuttle organizational structure called mortgage lending.  To their credit, the appraisal industry made a full frontal assault against pressures levied by retail mortgage salespeople, and they are now the first to once again work on solutions.

Escrow closers are at the end of the line. When a homebuyer or a refinancing homeowner is feeling uncomfortable about rates, fees, or terms of a loan, an escrow closer must remain neutral.  Escrow closers are in a perfect position to see blatant and ongoing abusive lending practices.  However, if they file a formal, public complaint, the business consequences are grave. Most state and federal agencies will not take anonymous complaints.

When wholesale lenders sell loans to Wall Street securities dealers, the dealer’s concern begins and ends with the contract: were state and federal laws followed, and what’s the rate of return on investment.  Pension fund managers, insurance companies and other institutional investors have no way of knowing if loans in a pool of mortgage-backed securities were originated using deceptive and abusive lending practices.

The institutional and structural systems of mortgage lending are broken in many places. The subprime problems and the resulting defaults are a major O-ring failure. Now the system failure has spread to Alt-A loans and prime ARMs.  Nobody wants to look up in the sky and admit that the shuttle is disintegrating. Well, perhaps if YOUR customers aren’t defaulting, then I guess there’s not a problem.

In the Challenger case, everyone followed proper institutional protocol and adhered to existing laws. Engineers like Roger Boisjoly work inside all our institutions. They are the loan processors, escrow closers, fellow mortgage retail salespeople, and others who know exactly what’s going on but believed they were powerless to make a difference, or chose not to make an anonymous complaint due to possible grave personal and/or professional consequences.

We’re going to have more state and federal laws before this entire mortgage industry crisis is behind us. The question then becomes, will those in the trenches stay silent again?

Are Mortgage Loan Originators Professionals?

When I ask the question “Are loan originators professionals?” to a group of loan originator students in ethics classes, almost everyone says “yes.”  Anyone can do their job in a professional manner (adjective,) but not everyone is a Professional (noun.) Is your barista at Starbucks or the person who bags your groceries a professional? If you answer “yes,” what makes a barista different than a lawyer?  When we use the word Professional as a noun, there’s a classic definition that we refer to here:

A Professional:

  1. Has specialized knowledge in his or her field.  (Update: This body of knowledge is generally agreed-upon by those in the industry and is typically described within state and federal law.)  This person knows way more than the average random consumer about his or her area of expertise;
  2. Is required to complete a minimum amount of formal, academic education;
  3. Is tested for competency;
  4. Is licensed;
  5. Must maintain that license with mandatory continuing education;
  6. Subscribes to a mandatory code of ethics in an industry that is self-regulating. This is different from state or federal government regulatory oversight. The industry itself regulates ethical conduct over and above state and federal law;
  7. The self-regulating body enforces their code of ethics with sanctions for violations;
  8. Owes fiduciary duties to clients. This means the professional has the highest prescribed duty of loyalty to the client, to put the client’s interests above his or her own interests.

Here is how loan originators (LOs) measure up against the above list:

  1. LOs, there is a power imbalance between you and the consumer. You know way more about how the machine we call mortgage lending works than the average random consumer will ever know.
  2. In many states, including WA, no education is required to begin originating loans. (However, this may be changing at the federal level.)
  3. Testing LOs for competency finally began in 2007 for LOs in WA state
  4. Licensing of LOs is currently not required in all states and for originators employed by all types of lending institutions.
  5. Continuing education requirements are very low if they exist at all (WA state only requires LOs to take two classes per year.)
  6. There is no mandatory code of ethics for mortgage lenders. What codes exist at the national trade level, are voluntary and offer insufficient guidance.
  7. Currently there is no ethical oversight in mortgage lending by the industry. There may be individual company codes of ethics for employees. Were you asked to read and sign a company code of ethics before or during the hiring process?
  8. Fiduciary duties are now required for mortgage brokers and loan originators as of June 12, 2008.

One of the ways we can better understand the current crisis facing the mortgage industry is that loan officers, loan originators, mortgage planners, loan consultants, or whatever their job title, had absolutely no duty to put their client’s interests above their own. The relationship between a loan originator and the consumer was (and still is in many states) a retail relationship.  During the mortgage-lenders-gone-wild days, many consumers (based on countless interviews held by regulators, consumer advocacy groups and even the mainstream media) held a false belief that a loan originator is a “professional” and owes a duty to the consumer not to harm him or her.

Loan originators are classified as an “emerging profession.”  We are living through a historic, transformational phase. On the other side of the transformation, which could come sooner than some people think, I believe LOs, no matter where they work, will owe fiduciary duties to consumers, even with LOs who work at a bank.  If you look at the narrative history of any profession you would see, over time, a steady increase in the number of continuing education classes required, more mandatory pre-licensing education, an elevation of duties owed to clients, more expansive ethical codes, and tougher licensing exams.  Loan originators, no matter where they work, will eventually transform into professionals, though some will have to be dragged kicking and screaming.

Many brokers believe fiduciary duties means higher liability.  However, if done right, this may actually have the reverse effect by lowering the mortgage broker’s liability.

WA State Legislative Changes: SHB 2770, SB 6471, SB 6381

The Washington State Legislature has passed three new laws that will go into effect June 12, 2008. 

SHB 2770
Governor Gregoire’s legislation implementing the recommendations of the Homeownership Task Force. This legislation impacts Banks, Credit Unions, the Consumer Loan Act (CLA), and the MBPA. The bill addresses prepayment penalties, negative amortization loans, the federal guidance on nontraditional mortgage products and subprime lending, and makes mortgage fraud a class B felony.
SHB 2770 PDF
SHB 2770 Summary
SHB 2270 Final Bill Report

Interesting highlights from the Final Bill Report:

The DFI must adopt a disclosure summary understandable to the average person that includes:
• the fees and discount points on the loan;
• the interest rate of the loan;
• the broker’s yield spread premium;
• the presence of any prepayment penalties;
• the presence of a balloon payment;
• whether or not property taxes and property insurance is escrowed; and
• other key terms and conditions of the loan.

A residential mortgage loan may not be made unless the summary is provided by a financial institution to a borrower within three days of a loan application. If the terms of the loan change, a new summary must be provided to the borrower within three days of the change or at least three days before closing, whichever is earlier.

Steering
A person subject to licensing under the MBPA or the Consumer Loan Act may not steer, counsel, or direct any potential borrower to accept a residential mortgage loan with a risk grade less favorable than what the borrower would qualify for under the lender’s existing underwriting standards. The licensee must prudently apply the underwriting standards to the information provided by the borrower.

Prepayment Penalties
A financial institution may not make or facilitate the origination of a residential mortgage loan that includes a prepayment penalty that extends beyond 60 days prior to the initial reset of an adjustable rate mortgage.

Negative Amortization
A financial institution may not make or facilitate the origination of a residential mortgage loan
that is subject to the Guidance and Statement if the loan includes any provisions that result in
negative amortization for a borrower.

SB 6471
This legislation amends the CLA and MBPA. All lenders, except those making loans under chapter 63.14 RCW, must have a license under the Consumer Loan Act. Lending is no longer allowed under the MBPA. Read the FINAL BILL REPORT link below. There is a lot of concern and confusion over this change.  More info is forthcoming at the next Mortgage Broker Commission meeting on May 13, 2008.

SB 6471 PDF
SB 6471 Summary
SB 6471 Final Bill Report

SB 6381
Establishes a fiduciary duty relationship between a mortgage broker and his or her client.

SB 6381 PDF
SB 6381 Summary
SB 6381 Final Bill Report

Other links:
Here’s a quick overview from the Wash State Housing Finance Commission.