In San Diego, CA, where Inventure Global is based, things are getting really bad in the housing market - and there are signs that we’ve still got a ways to go!
Things are so bad the Fed and Treasury are in full emergency mode to stop the bleeding. The steps they’ve taken so far are clearly necessary, but they haven’t yet addressed the issue head on about how to fix the problem in the future.
The banks are looking at their books and wondering how they can possibly avoid this fiasco in the future. Take a look at the following charts from J.P. Morgan Chase which shows the difference in loans that brokers vs. J.P. Morgan’s employees originated (the boxed area). The 2007 YTD column shows clearly that 31% of all loans the brokers’ originated had a loan to value (LTV) of over 90%! That’s quite a departure from the 4% or even 10% historically normal levels that were originated internally by the bank.
This is just one more piece of evidence that the brokers’ interests are not properly aligned with the bank’s. Default rates on mortgages paint just as damning a picture for banks not being on the same team as their investors. Given all the turmoil - is there a way to get everyone on the same side & restore order to our mortgage finance system? In a perfect world this wouldn’t require too much new expensive regulation or new departments to watch over the industry - because that’ll cost us all more later.
The mortgage industry pays brokers to originate loans - which makes perfect sense and provides a valuable service to both the mortgage industry & borrowers when done well. I think most of the problem is in how they’re paid.
These payments are large up-front dollar amounts paid upon the closing of the loan. They don’t get paid any residuals on the loan at all - so once they get this check they’ve made their money and that’s it. This is where the trouble starts. Once the guy who’s responsibility to close the deal doesn’t care whether the borrower can afford the loan, it’s only a matter of time before there’s going to be a problem. The truth is, that we already have a model for this. It’s how health insurance brokers are paid.
Pay them every month
My proposal is to change the definition of a conforming loan to include a condition that the originator is paid a percentage of the loan’s monthly payment. Perhaps a modestly larger up front payment in order to help jumpstart a person’s career in the business - but the vast majority of a broker’s income should be paid each time the borrower’s check clears every month. That way, the broker is incentivized to only originate high quality loans. If the broker thinks you can’t afford the loan, it’s not in his best interest to push you into it, it’s not worth the trouble for only a couple months of tiny fractional payments. The broker would be much better off readjusting your expectations and getting you in something you can afford. Perfect.
No new costs
The really good news is that the operational infrastructure already exists: this is how the investors are paid, it’s how some of the bond insurers are paid, and it’s how taxes are paid. One more check to cut to the broker should be a pretty easy adjustment in the system - which means it won’t introduce significant additional cost.
Someone’s always vested on both sides
Additionally, it creates an adversarial environment between existing brokers & new brokers during a refinance. If you want to refinance your mortgage and speak to a new broker about it, they may try to trick you into a new loan that’s not in your best interest. When this happens today, that’s the end of it, it’s you versus the broker. In a world where your previous broker’s paycheck depends on you staying in your current loan things are a bit different. Now you have to industry professionals fighting over your business. This is good news because they should both be better informed & equipped to slog it out on your behalf, increasing the likelihood that you’re going to get a truer picture of the situation. Now you can choose which one really is the better option. In fact, in order to change other kinds of insurance (e.g. life, disability, or long term care) you have to send in a Replacement Notice to your existing insurance provider - which they then send along to the broker to go fight for your business.
Require it for “conforming” loans
Why make it part of the definition of being conforming? Because conforming loans are the ones that Freddie Mac & Fannie Mae buy. They’re the ones that our government and our tax dollars help subsidize. These institutions drive what’s “normal” in the mortgage industry because they’re the ultimate clearinghouse for the massive amounts of capital required to keep the mortgage securities market liquid. By altering the definition of a conforming loan we can “recommend” that the market coordinate in a way that helps everyone out, without requiring too much more supervision or regulatory burden to the system. Other banks can pay brokers in alternative ways - but they just won’t have access to the large pools of money subsidized by our tax dollars. It’s up to the bank if they want to make that tradeoff on each mortgage product they underwrite. In the long run, I would hope that this model would become the norm because it really is in everyone’s best interest, but in the short run the banks & brokers could gradually move over to the new system.
Hopefully I haven’t overlooked anything critical and when the emergencies slow down we’ll see some policy changes in this direction.
July 21st, 2009 by 
Chris Harris
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