Don't regulate lending, regulate how lenders get paid
Among the most remarkable (I know, because I've already remarked upon it, and I'm not the only one) of the new rules on home mortgage lending finalized Monday by the Federal Reserve is the one that aims to:
Prohibit a lender from making a loan without regard to borrowers' ability to repay the loan from income and assets other than the home's value.
Lenders need the government to tell them not to make mortgage loans to people who can't pay them back? Actually, they probably won't for the next 10 or 15 years. But there will come a time when the bulk of bankers, mortgage brokers, mortgage securitizers and mortgage investors will have no memory of the Housing Debacle of '07 and '08 (and '09 and '10?), and somebody will need to rein them if a rerun is to be prevented.
Will the Fed rule actually do that? It sounds both breathtakingly obvious and dangerously vague, although it does subsequently get into specifics:
A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this prohibition, a borrower does not need to demonstrate that it is part of a "pattern or practice."
When I talked the other day to Louis Pizante, CEO of Mavent, "the mortgage industry's foremost provider of automated regulatory compliance solutions," and himself a former mortgage investment banker, he wondered if maybe the Fed wasn't taking the wrong approach. "The regulators are encroaching more and more on the actual underwriting of the loans and they're getting more and more subjective in their requirements," he said--a recipe for confusion, legal wrangling, and poor compliance.
What Pizante would like to see instead are government rules on how mortgage brokers are paid. "To me it would seem that it would be much easier to regulate broker compensation," he said. For example: "You're not going to get a lump-sum fee, you're going to get a percentage of the cash flows from that loan."
There's been an awful lot of talk over the past year about changing compensation both on Wall Street and in the mortgage business to better reflect the risks inherent in transactions that deliver a big up-front payday. But the standard retort is that any firm that tries to enforce such pay arrangements would quickly lose its best producers to competitors. Which, in Pizante's view, is exactly why government needs to step in.
"That's where regulation is supposed to come in," he says. "You don't want to stifle innovation, but you do want to insure that there's a level playing field."
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1
I'm not sure you've thought this through. If I were getting a small amount from each loan, I would be inclined to generate as many loans as possible and if any particular customer stopped paying, it would have little material affect.
Perhaps a better solution would be:
1. You get 50% of your commission at time of signing.
1. If it is a fixed rate, you get 50% of your commission after 3 years.
2. if it is an adjustable rate, you get 25% after two years and 25% after 5 years.
3. If you have a temporary fixed followed by adjustable, you get 25% after two years and 25% two years after the switch to adjustable.Nick
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2
This is supposed to be one of those "tax the rat farms" solutions, isn't it?
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3
This is in response to Nick's prior comment.
Brokers and loan officers are currently given incentive to generate as many loans as possible, but no incentive is provided to the quality of those loans. Brokers receive a lump sum fee that is based on the loan amount, and in some cases that fee is increased (through yield-spread-premiums) based on loan terms that are not always in borrower's best interest.
What I suggest is that compensation should be tied to loan performance, not merely production. The measure of loan performance should include not only losses from defaults but also from regulatory fines and borrower litigation. Your proposal is a hybrid approach, providing the broker/seller a portion as an upfront fee and tying the remainder to performance.
The record spike in foreclosure rates and enormous write-downs in financial services is in some part related to poor credit, collateral and consumer protection compliance decisions. Rather than introduce new regulations are paternalistic to borrowers and risk stifling innovation, I believe the market would be better served if compensation was more directly tied to sound underwriting and responsible lending.
Of course, this sort of proposal introduces uncertaintly and time-value-of-money costs to brokers and loan officers. For this reason, it is no surprise that it will prompt much criticism. But the current regulatory trends are far more likely to risk negatively impacting broker compensation and the market for consumer credit.
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4
Thanks, Lou!
And for those puzzled by SpotWeld's "tax the rat farms" comment, it apparently comes from one of Terry Pratchett's Discworld novels. Here's an elucidation swiped from Daniel Barlow:
[T]he city is having such great trouble with a plague of rats it has resorted to offering a bounty for each rat tail brought to the Palace, and even this has not staunched the tide. The Patrician, on being told about the problem, simply said "tax the rat farms"
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5
It's not clear to me that it's in the best interest of loan applicant, lender, servicer, securitizer, bond holder, or society at large to have the mortgage broker be a commissioned salesperson.
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6
Curmudgeon,
However, what is clear is that permitting the mortgage broker to engage in full speed ahead - damn the loan quality tactics - is a large part of what got us into this mess in the first place.
Anything that could have cooled off the wheels would have kept this train from leaping the tracks....I believe that due to the sheer volume in size and proportional terms of what our real estate market means to the U.S. we should engage in every means available to maintain long-term relative stability in the market.
When the government is forced into considering backstopping $5 trillion worth of GSE's, it is time to put the kids to bed, take away the toys and bring some sanity to the house. Anything else is just asking for stuff to get set on fire. Regulation may stifle some loans but better some questionable loans sit on the sidelines than watch the air get deflated out of the ball. In this scenario, nobody gets to play and that makes no sense.
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7
We should not regular adding but should pay attention on get paid the interest in the form of tax. Consumer securities and compliance decision making. I believe the better served compensation would be more directly tied to sound underwriting and responsible adding.
______________________________________
bush
Addiction Recovery Maine
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