Who is to blame for the current sub-prime loan fiasco?
Seen any recent news stories or blog posts about sub-prime loans and alleged mortgage fraud? Seems to be a hot topic. It’s also been a topic of discussion with some of my own past and prospective clients.
The recent uproar about sub-prime loans and mortgage misrepresentation could have been predicted and foreseen by many of the real estate industry leaders.
During the past five years, prices for residential real estate soared and interest rates dropped to historical lows creating an environment for emotional rather than logical buying. In turn, this spawned unparalleled growth of real estate professionals in all aspects of real estate from sales, lending, appraisal, and title/escrow. The cause for the growth was the ease of making large sums of money from the various real estate disciplines. Along with the growth came the untrained, undereducated, inexperienced, and of course, unscrupulous persons looking to make the “quick buck.”
But this is not the only cause of today’s environment – it was also the concept of one-stop shopping – hey it works for the super stores such as Wal-Mart and Target. Real estate franchises and companies also saw the advantages for marketing to the real estate consumer one stop shopping. Hey, don’t we all like convenience in today’s hectic world? Finally, large developers and builders also saw this aspect.
This convenience can best be called “vertical integration” – not a new concept, it’s been used for many years in other industries to control a market. An example would be the petroleum industry – drilling, refining, distribution, and retail sales.
The stage is now completed for sub-prime loans and mortgage misrepresentation in both the resale and new construction arenas.
During the not too recent “feeding frenzy” days – “for sale by owners” could put a sign up and quickly sell their property. Real estate agents worked with an ample supply of buyers. Developers and builders had buyers standing in line to purchase. Unfortunately, many of the buyers were not well informed in the terms for the loans which they qualified and the impact that the programs could have on their personal finances. Everybody was happy buying, selling, and making money.
So what went wrong?
1. Foremost, emotion ruled rather than logic.
2. Buyers did not do sufficient research nor consult with knowledgeable and reputable professionals.
3. When a buyer heard “unacceptable” information, they looked for another method to achieve their goal, regardless of potential consequences.
4. The proliferation of loan programs that did not require the buyer to have any vested interest in their purchase – 100% financing, paid closing costs, etc.
5. Stated income loan programs – maybe better referred to as “inflated income” or “liar loans” – as well as limited documentation, no documentation, etc.
6. Vertical integration – too much control by one entity with profits and a strong balance sheet at stake.
7. Too much information passed between parties during a real estate transaction.
8. Weak requirements for entering the various disciplines within the real estate profession.
9. Lack of information on appraisals.
10. Lack of an effective system of checks and balances by independent entities.
What can be done?
1. As Realtors, we cannot change others, but we can change ourselves – as real estate professionals, we need to expend more efforts to inform and educate prospective buyers through all the avenues available to us.
2. Establish trust; be honest with prospective buyers, even if we do lose a few transactions.
3. More loan programs that require the buyer of real estate to have some vested interest in the property.
4. Greater independent verification of information supplied on a loan application. Why have the individual with the monetary motive required to supply verification of information or substantiation as now?
5. Disallow incentives for using related companies – it is required that companies disclose if they are related (in other words, profit from each other). But, does a consumer truly know the associated costs of a real estate transaction?
6. Less information passed between parties to a real estate transaction. A good example is when an appraisal is ordered, why does the appraiser need a copy of the contract with the stated sales price? Or why does the mortgage broker or real estate agent need to disclose this information to the appraiser?
7. Stronger requirements for entering the various disciplines of the real estate profession, raising the standards, and the possibility of increasing fees by national and state associations. Implementation of competency testing at the national, state, and local level on a continuing basis.
8. More information on the appraisal. Recently, I saw an appraisal where the subject property, a condominium, was located in a community with a mechanical gate which was closed only during the evening and night hours. One comparable was actually from the subdivision. The other two comparables were taken from a community more than one mile from the subject. This is fine, however, the community is manned and gated 24 hours 7 days a week; in addition, it is a bundled golf course community where the buyer receives “deeded rights” to both the golf course and country club. There is a value associated with such a purchase. Yet, there were no adjustments to the two comps for this added value or even a comment regarding this fact! The subject property appraised in the mid $350’s, while similar units in the same subdivision sold over the past year from $302k to $339k. How could the property appraise in the mid $350’s, especially when the current market values for condominiums have been stable or declining? I should mention that the appraisal was done for refinancing purposes, so I have to wonder if the mortgage broker furnished the appraiser with the amount needed for refinancing?
9. Any good financial transaction has a system of checks and balances (internal controls) with no one person controlling the transaction. Is there insufficient or lack of adequate controls in the real estate transaction flow?
Some of us may remember the days of adjustable rate mortgages that did not have annual or lifetime caps. We know that it helped in the short term, but in the long term as interest rates rose, people were placed in a financial bind.
Does this sound familiar to today’s environment?
As real estate professionals, we should put our client’s interests first. That includes informing buyers of the pros and cons with certain mortgages – ultimately, it is their decision (and we all know clients who will make bad decisions). And we may lose a commission in the short run, but in the long run, we will gain respect and maintain our professionalism. And that reputation alone could lead to referrals by folks who know you are honest and truly care about your clients.
Today’s situation of increasing foreclosures, sub-prime loans, and mortgage misrepresentations requires an overhaul in our industry. So, maybe it’s not such a bad thing that many of these lenders are now going out of business because the buyers they “helped” now can’t pay back their loans…
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About the Author: Glenn Ginsburg, REALTOR, e-PRO is a licensed real estate broker and mortgage broker serving the Naples, Florida area. Glenn has twice won the FIVE STAR - Best in Client Satisfaction Real Estate Agent from Gulfshore Life Magazine and is frequently interviewed about the Naples real estate market by the local ABC and NBC television affiliates. Glenn’s website is Naples Real Estate and blogs about the Naples real estate market on Naples Florida Real Estate Homes.
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March 22nd, 2007 at 10:40 amGreat post, Glenn!
March 22nd, 2007 at 12:15 pmThat was a very comprehensive explanation, and one that makes a great deal of sense. I also think another contributing factor to our current state of affairs is GREED. Investors were chasing higher returns and as a result, they created the market for sub-prime loans. Rather than the 5-6% they could get by investing in conventional mortgage-backed securities, there was significantly more money to be had by buying risker loans. Because there was a secondary market for these loans, lenders were able to offer them.
The rising real estate market masked the underlying problems with the sub-prime loans. Since the real estate market has flattened, it is harder to sell or refi out of a bad loan. Now it seems it is virtually impossible to sell a sub-prime loan - no one wants to buy them on the secondary market. As a result, lenders aren’t offering them. Hopefully lessons will be learned.
March 22nd, 2007 at 12:28 pmGlenn, great post. I especially agree with your suggestion of raising the standards - and the fees - for those entering the real estate profession.
March 22nd, 2007 at 9:30 pmKristina and Andrea - thank you for the compliments.
Andy, I agree with you that GREED played a role in this fiasco - the GREED factor was always there just that it was ignored.
There is a business saying “the higher the risk, the higher returns.” Maybe some people forgot about this when making their business decisions to get involved in the purchase of the high risk loans on the secondary market.
Now, they are upset by their decisions and are looking to blame someone for their own bad judgement.
Also, who says any investment should turn out to be profitable. It is like the stock market - you buy a stock it can stay the same value, go up or go down. You have a decision to make - make the wrong decision and you just my lose.
The question remains is who is going to ultimately pay for another person’s poor business decisions?
March 23rd, 2007 at 5:56 am“As real estate professionals, we should put our client’s interests first.”
I don’t know about the other 49 states, but in California, ’should’ is replaced by “are required to’. It’s called fiduciary duty and its the law.
March 24th, 2007 at 8:31 pmYou are correct that we should put our client’s interests first.
I believe that the law of agency according to the Uniform Commercial Code (UCC), which has been adopted in most states defines the fiduciary relationship and duties just as you stated.
The problem is getting the minority of agents out there to recognize this fact.
Frankly, I don’t know if it is ignorance or greed for some.
March 25th, 2007 at 6:00 amIts both.
March 25th, 2007 at 7:08 amI think the image on this post sums up the motivation for some…
March 25th, 2007 at 12:23 pm
Bob,
You are 100% correct. Putting our clients interests first is a “requirement”, not a “suggestion”.
March 25th, 2007 at 12:29 pmJim, the image really summed it well for the motivation of some.
March 26th, 2007 at 4:45 pmI think the requirements to be a mortgage broker/lender should be raised to a much higher standard. Great article
March 26th, 2007 at 9:26 pmI agree about the image, that every-finger-pointed-for-itself attitude is exactly what is making the situation worse.
March 27th, 2007 at 10:34 amHi Gary,
I believe you are referring to the image actually used for this post. And I agree with you, that also is a good illustration of the problem.
The image Glenn was referencing was one I mentioned in a comment above. That image can be found at this link.
March 27th, 2007 at 11:20 amI think there are so many new real estate agents and mortgage people in the business over the last 5 years, who do not know what they are doing, and the requirements and standards should be much higher.
March 27th, 2007 at 8:18 pmThe clients are trusting you to lead them in the right direction. They are depending on you to educate them so they can make the right decision. The client’s needs and interests should always come first!
March 27th, 2007 at 8:22 pmGlenn great post!!
The subprime industry over the past few years didn’t make sense. The rules got to a point that anyone could get a mortgage. You are asking for problems when you are giving someone a loan that just had a foreclosure or bankruptcy, or giving someone that can’t pay their current bills on time a mortgage for 107% of the property value so they can pay off credit card debt at closing (Like they aren’t going to go max out the CC’s again?).
March 28th, 2007 at 4:48 pmGlenn,
Couldnt of said it better-
GC
March 30th, 2007 at 2:41 pmJamie - I totally agree with you regarding upgrading the requirements for mortgage brokers.
April 1st, 2007 at 6:53 amGary - the present system is weak as a transaction process and one that allows individuals that are greedy and not ethical to take advantage of the system.
April 1st, 2007 at 6:55 amShelley - requirements do need to stricter for entry, but also stronger training methods in place or possibly an apprentice period.
April 1st, 2007 at 6:57 amShelley - you are right the clients are looking to the professionals for guidance and education. However, there is an old saying “you can lead a horse to water but you can’t make them drink.” The emotional aspect of owning their own home, is what will drive an educated person to look towards an undesirable solution.
In most fraud situations, the thrill of “beating the system” causes small fraud to become big fraud situations. What most people don’t realize is that eventually the pyramid crumbles around them and then they are caught.
April 1st, 2007 at 7:01 amKen - what you are talking about is habits - habits are hard to change. Does make much sense if someone has bad money management skills and then on the day of closing they are changed.
For some loan programs the borrowers do need to take a course in order to get the loan.
But I have always wondered what is exactly accomplished by a short course (hours) rather than one that is over a given number of weeks.
April 1st, 2007 at 7:04 amThanks Giorgio
April 1st, 2007 at 7:05 amHey Ken,
The game of paying off creit cards at the clsoing table and fog-up this mirror type home loans are gone.
107% is a dinosaur in my neck of the woods- this is the dawning area of “seasoned” funds and 90-95% CLTV’s. Our lending guide lines have rapidly increased thus making it even more difficult for those “tweeny” prime borrowers with a so-so financial picture to get funding for.
On stated or “liars loans, as I like to call them,” the minimum credit score for these at 95%er’s is 700;
If you are under “700″ and are w-2ed, you better be showing “proof of income” & sunstantial reserves. If you are over 700 and are w-2ed, then your in a better position to fog-up the mirror and skate on liquidity.
The secondary market is just starting to see damaged borrowers float to the surface in this sea of bad debt.
April 1st, 2007 at 6:45 pmJaime,
If your desire to sell money is great, and your greed is greater, then you can, by determination, pass the current examination that’s in place to ba a liscenced mortgage banker/ broker in Illinois. I suspect that those laws are similar in most states.
However, should you mess up (it only takes a few times in my neck of the woods) and get reported, you could face serious charges and/or suspension of lending privledges and your business will come to a screeching halt.
April 1st, 2007 at 6:55 pmGlenn,
Great analysis of the causes for the subprime meltdown, but let me really pound one of your points home.
Most folks when discussing this topic (especially headline hungry politicians) are laying the cause at the doorstep of “bad” mortgage brokers.
Now we all know there are greedy mortgage brokers selling subprime, stated income, and other questionable loan products, but their loan volume compared to the “big banks” loan volume is truly incomparable.
The new home builders with their wholly owned mortgage subsidiaries and the named banks are the true culprits here, but with their political clout both at the state and federal level; you’ll here nothing about it from politicians or mainstream media.
As a matter of fact, this will be the perfect opportunity for the big banks (Wamu, Countrywide, Wells Fargo) in conjunction with the builder mortgage banks ( Pulte Mortgage, CTX, etc.) to get legislation passed regulating the small mortgage broker virtually out of existence.
They tried to do it back in 1999 with RESPA reform making mortgage brokers show yield spread premium on the HUD when the banks were left exempt from the very same disclosure. The banks thought customers would notice this “extra” cost and flock back to the banks not realizing the bank loan was equally “expensive”.
It didn’t work. The clients did not see it and still to this day many consumers and I dare say many real estate agents still don’t understand yield spread premiums. If you need a refresher course on this multi-billion dollar rip-off no one is talking about go to:
http://themortgageinsider.net/yield-spread-premium.html
My point is the banks will stop at nothing to pull market share away from mortgage brokers and if they can’t get it with better service and pricing, then they get with their huge coffer of PAC money and media spin machine.
Who is really to blame?
Just ask yourself,
Can a mortgage broker “create” an idiotic loan program?
Can all the mortgage brokers in the country sell as many “bad loans” as all the new home builders, the big banks’ subprime retail offices (e.g. Countrywide’s Full Spectrum Lending), and the big TV advertising banks (eg. Ameriquest - before they went under)?
Not in a million years!
April 3rd, 2007 at 1:43 amRob, Thank you for the nice compliment. We can not put the full blame for the events on the new home builders. It is my understanding, that the loans they generate are sold into the secondary market or to some larger lender. So it equates to loan programs from the lenders. This is what you are saying when you refer to mortgage brokers can not create an loan program.
The idea of the Truth-in-Lending form is supposed to be the consumers guide to which loan program is the best one from a cost standpoint. However, the calculation of the APR is so complex that the average person can not understand it. What the average person does understand is the monthly payment.
The yield spread premium from most of the closings, if not all my closings shows as a POC - therefore, the borrower does not see this item as coming out of their pockets.
Yes, the loan programs that were made available to high-risk borrowers is part of the cause. The system is flawed and its weaknesses were usurped during the past few years and now that flawed model is coming apart at the seams.
April 9th, 2007 at 5:06 amOk- I see your point. However, even after apr, reg z, TIL, if I sat you down @ closing (alongside your attorney) and told you that your monthly payments would be “x” and you agreed to “x,” then it is YOUR fiscal responsability to pay “x.”
You miss the payments on “x” and now everyone is blaming the lender- that, in my opinion, is a simple game of blame shifting that should not be tolerated by anyone that holds a license to sell money.
Here are my steps to being fiscally on top of the borrowing game:
Step 1: Be careful who lends you money.
April 9th, 2007 at 6:06 amWork with a CMPS (certified mortgage planning specialist) be blunt, ask about this coveted designation, it will save your borrower tons of money @ closing.
Step 2: Read, ask good questions, be alert.
3. Don’t sign @ closing with out your attorney explaining and consenting to the lenders terms.
Giorgio,
You mention sitting down at closing and tell the buyer the monthly payments. Shouldn’t a prospective buyer be told what the payments will be at the time they are shopping for a loan?
Of course, the monthly payments are subject to the time that the prospective buyer “locks” their interest rate.
So, it would be appropriate for prospective borrowers to be fully informed about the monthly payments and locking an interest rate, prior to the closing.
My concern lies in the fact that at the time of closing, if the payments are not what the buyer expects and does not sign the paperwork - the buyer is in default on the purchase contract and may lose their deposit.
April 23rd, 2007 at 5:10 amGlenn:
Good point- hopefully, you as a consumer, again, have done your due dilligence prior to “going into closing.”
Your Banker, should have provided you quite accurate figures before closing and this problem should not rear its ugly head at closing.
However, as a professional, and also someone who is not keen on re-buying a loan because of default on payment, I strongly recommend walking away from the table should the numbers be far off from where you expected them to be; even if it means risking the down-payment monies.
CAVEAT EMPTOR (buyer beware)- this should give you all the more reason to work with an “upfront banker,” whose systems are in place to protect the borrowers interests at all times. If you as a buyer are ever in doubt, consult the attorney and never sign off on anything you feel even the slightest uncomfortable about. Even if its at closing.
Remember, would you rather risk $1,000-$10,000 in one feld swoop or get stuck with default, foreclosure and upside down credit for the next 7-10 years? That is he real question.
April 23rd, 2007 at 5:24 amGiorgio - as a REALTOR and real estate broker, I don’t want my clients forfeiting their deposit - maybe I take a paternalistic view - but so far none of my clients have had any problems with their financing or monthly payments.
April 23rd, 2007 at 1:30 pmLike I said Glenn- I am with you here; worst case scenario, I mean the worst case…you should NEVER lose money on a project.
However, the reality of it is, as you can see clearly with the foreclosure rates escalating to unprecedented levels as of late, people have been signing off on lots of bad things; and it is getting “worse.”
I am happy to hear that your clients have never had any problems with their financing or payments for that matter!
Let’s keep it that way.
April 23rd, 2007 at 3:34 pmGiorgio - I think the reason why I don’t issues is because I have a “big mouth” and sometimes lack tact. LOL
In one case the escrow for real estate taxes was double what is should be. After discussions with lender, reference to the sales contract, and comparative properties’ real estate taxes - the lender changed the escrow and new papers were signed the next day.
In another situation - I had the buyer call his mortgage broker, who called the lender and got the terms of the loan changed. We signed the closing documents the next day.
April 24th, 2007 at 7:23 amThere were several lenders that closed their doors here in Las Vegas for making too many questionable loans. Several were huge companies too. Perhaps this will lead to a reform. At the least, its weeded out some bad companies.
May 7th, 2007 at 7:31 pmboy this has really been an eye opener.my friend ask me what i knew about a sub prime loan.now im truly informed.thanks
May 28th, 2007 at 4:01 pmCharles - Yes, some very large lenders have either closed or closed their doors as a result of the questionable loans. You also might be seeing some mortgage brokers closing down, because, when loans goes into foreclosure the lender monitor what company or mortgage brokerage originated the loan.
Also the MBA has a meeting coming up with an agenda item to address some of the issues related to originators that are not doing what they should be doing.
May 30th, 2007 at 7:59 amGreat article, could not have been better said. I have been in the business for quite some time and was impacted by my company going out of business. I think change is needed in order for us to turn this market back around.
August 3rd, 2007 at 11:02 amI like the fact that you did point out that some of the blame falls on consumers. They don’t like what you tell them, so they go to someone else who will tell them what they want to here. Happened to Jacqui. She had a couple that wanted to buy, but didn’t like what they could afford. So they found a less reputable agent and loan officer. They are now falling behind on their payments..
August 5th, 2007 at 1:57 pm