Subprime Meltdown

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?

The Subprime Meltdown

When I entered the mortgage industry in 1985, Conventional loans were only for those who could put down 10%. Most folks opted for an FHA or VA loan. There was no risk-based pricing. Everyone received the same interest rate on their mortgage loan whether they had great credit or a few late payments. Homeowners with very poor credit, lack of job stability, zero cash reserves, and unverified source of funds to close, were not approved for a mortgage. It was a very big deal to decline a loan. As a mortgage loan underwriter, I was told our job was to make loans, not decline loans. We had to try our very best to help our company figure out a way to help the homebuyer. Declining a loan was serious. We had to state rational, good reasons why a homebuyer did not qualify. That all changed with the introduction of risk-based pricing into the mortgage lending market.

20% down
10% down
5% down use to be considered very risky.
3% down buyers were directed to FHA loans
0 down use to only be available to Veterans
Then came 0 down with seller-paid closing costs
Finally we had 0 down, seller-paid closing costs combined with a variety of exotic mortgage products that were previously only offered to the most credit worthy and financially savvy borowers.

Hard money lending was re-named subprime lending and moved into the mainstream as the mortgage brokerage industry grew to originate over 50% of all mortgage loans in the U.S. Subprime started out years ago with high interest rates along with a large downpayment. As Greenspan lowered interest rates, competition heated up and we saw a relax of credit standards in the same direction. This pushed a huge amount of homebuyers into the market, and infused the industry with a tremendous amount of job growth in the lending, banking, title, escrow, appraisal, and real estate agent arena. Corporations must earn a profit (within the bounds of the law) so corporations continued to push for profit growth.  It doesn’t matter which political party holds power: Democrats or Republicans. BOTH parties push homeownership onto the American public as the dream every person in America ought to be able to achieve. Downpayment assistance homeownership programs sprung up all over the country and on a side note, it’s interesting to see FHA blasting these programs as having high default rates; high enough to possibly bring down FHA. 

With little regulatory oversight in existence for mortgage brokers and consumer loan companies, (although they argue that they are HEAVILY regulated) the mortgage brokers, consumer loan companies, and the wholesale lenders had a field day with profits during the bubble run-up years of 2002 through 2006. All the real estate agents I talk to, and I meet thousands of real estate agents every year, with regards to predatory lending considered this a problem of the mortgage lending industry, acknowledging that there “could” be effects on the real estate market, but without actually feeling any of those effects it was always someone else’s problem. It has been pointed out that real estate agents also made lots of money with the relaxation of credit standards and the resulting housing boom.

Our state regulators DO have money set aside to go after the most egregious cases of predatory lending and mortgage fraud. However, government was never intended to police every single deal written by mortgage brokers and consumer finance companies. There is just not enough government re$ources available to do this, and there never will be. 

In March of 2007, I predicted that every one of us in the industry WILL feel the effects of the subprime meltdown. Now that the subprime defaults have spilled over into Alt-A, prime ARMs, and HELOCs, we have a major national financial crisis that has resulted in an official housing recession. A full blown economic recession is underway with the FDIC preparing for bank failures and the FBI shifting its focus toward mortgage fraud. The mortgage industry will continue to see defaults rise into 2009 as more pay-option ARMs reset.  Underwriting guidelines will continue to tighten until the loans we are originating today can be proven to have lower default rates than the current vintage of Residential Mortgage Backed Securities. 

Some mortgage lenders have seen an increase in loan applications from homeowners seeking to refinance into fixed rate mortgage loans, but not all of these borrowers qualify under today’s tightening underwriting guidelines.  Mortgage companies that blatantly ripped off consumers will not see repeat business. Those customers will go elsewhere, as they should. Mortgage brokers who have ONLY done subprime will find it challenging to become approved as an FHA lender as FHA has many rules to follow including the requirement for loan originators to be W-2 employees (many brokers pay their originators as contract workers.) Consumers are sick and tired of bait and switch advertising and hopefully won’t fall for it this time around. Those companies will go down, their loan originators finding jobs scarce since their only training has been hard-core, script-memorizing, pressure-laden sales tactics. They specifically chose to be in subprime for the money and only the money. Former mortgage lending workers are reporting that they’re having trouble finding jobs in other industries and are being blackballed by recruiters.  The recruiters say employers want all candidates screened out if they were previously in the mortgage industry. 

Treating home buyers (and refinancing homeowners) only as a tool to maximize profits is one business model that is no longer growing profits at previous rates. These companies are refi machines built on marginally to blatantly deceptive direct mail, email spam, deceptive radio ads, or by purchasing leads generated off of deceptive advertising and they exist in every market in the United States. This market is now seeing a decline in profitability and in a capitalist system, profit drives morality: what’s profitable is good, what’s not profitable is bad.

Brokers, lenders, and banks that have always operated their business with a foundation of treating consumers with respect will survive and thrive. By respect, that means declining some loans because sometimes this is the most respectful thing to do.

It is way past time for a mortgage market correction and I am hopeful that the current crisis of epic proportions will lead us to a better place in the mortgage lending industry.

We should expect to see at least four more federal laws directly targeting the mortgage lending industry, similar to the wave of consumer protection legislation that swept the U.S. in the 1970s.  There have now been many laws introduced, some have passed the house but not the senate, some have passed committees, and who knows if anything at all will happen during these last few months before and after the next presidential election.  Therefore we should also expect to see many, many states jump up to enact legislation aimed at the mortgage industry. 

Watch for underwriting guidelines to continue to tighten, back to what they were like in 1985. Watch for interest rates to up, up UP! Because banks have to try and offset their foreclosure losses by…what else? Making new loans.  The industry underpriced risk for subprime borrowers, offered loan products to borrowers who did not fully understand how the product worked, and rewarded loan originators for selling the most risky products to the most credit-unworthy borrowers.  Instead of blaming everyone but themselves, the industry would do better to look within, systemically, for the solution.