The elephant in the living room - commissioned sales people

I regularly watch for news concerning mortgage fraud. The justice department is "aggressively" pursuing the situation according to an article in the New York Times (login required, but free):

Mr. Mukasey made clear that he saw the mortgage fraud problem at the root of the nation’s housing crisis as a serious one. But he said he was confident that the Justice Department’s current approach — using local prosecutors’ offices around the country to oversee separate F.B.I. investigations — was adequate.

Since he took over as attorney general last November, Mr. Mukasey has grappled with how best to deal with the law enforcement side of the growing housing crisis. He said in March, for instance, that the Justice Department was still struggling to determine whether there was a “larger criminal story” behind the housing crisis.

What this suggests is that there is originator-level fraud at the root of the housing crisis. What is seriously lacking in this article is an examination of why. It is clear to anyone currently paying attention that credit was too easy. It is also apparent that the entire mortgage industry was predicated idea that home values would continue to rise for ever. The article does mention part of the problem:

Christopher J. Dodd, the Connecticut Democrat who leads the Senate banking committee, said Mr. Mukasey’s comments suggested that the administration “vastly underestimates the scope of this problem.”

Mr. Dodd said in a statement that “millions of borrowers were lured into mortgages they could not afford by unscrupulous lenders and brokers, resulting in a housing crisis that has affected neighborhoods across America. The administration ought to be aggressively pursuing the perpetrators of these abusive practices.”

But we are still dancing around why brokers and lenders would lure people into these products. He takes a step in the right direction by pointing out that it is not just brokers, but also lenders. The real problem is that most loan officers ( brokers and bankers alike) are commissioned sales-people. When a lender provides a loan officer with a commission incentive to do something, they are going to do it. That is what incentives are for.

Let's take the example of Washington Mutual (WaMu). When I began in this business it was with a small local bank. We were a correspondent lender, which is essentially the same as a mortgage broker. A couple of times a month our WaMu rep would come in and explain their products to us. On a typical product/rate sheet, the most common loan programs are featured on the front, and the more arcane ones are featured on the latter pages. One day our rep came in and started to tell us about Option ARMs. By now we know that these loans can be disastrous for the average home owner. It is easy to fall behind (because the minimum payment is less than the monthly interest accrued), and the payment can quickly become unmanageable. In any case, our rep came in one day and the Option ARMs had moved to the front of the rate sheet. The Option ARM was never designed for the average consumer. But it was obvious that WaMu wanted us to sell these, and to sell a lot of them. My rep kept talking about how you could earn up to 3 points, twice as much as we usually made on a loan, if we added a prepayment penalty.

Here we had banks giving huge incentives to brokers (and other bankers!) to sell these Option ARMs to everyone. Of course at the end of the pitch my rep always amended, "for the right borrower, of course." As if that would deflect the anger that was surely to come when these loans started to adjust waaay up.

In an earlier post I said the time for finger pointing was over. I believe it is. I am really making a point about banks here, as much as anything else. Banks are currently trying to translate the enmity towards mortgage brokers into an increase in market share. But banks (as we have seen) are not any more ethical than brokers. If your loan officer is commissioned, and incentivized, then they have a conflict of interest. The only way to eliminate that conflict of interest is get force them to be up front about the terms and conditions of their loan offerings, including how they are incentivized. Remember, in Michigan, they are required to do this by law. If they can't (or won't) disclose, it is time to move onto the next loan officer. One who is willing to conduct business transparently.