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?