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I have been ranting about financial reform legislation and how it won't work and will probably have horrible unintended consequences but before today, I didn't spell out why I feel that way. Today, I decided to spell it out after I received a email from Barack Obama's people telling me to call Senator Grassley and convince him to vote for the combined bill. The email came in with the subject of Urgent and claimed the legislation is the "boldest overhaul of the financial system since the Great Depression." I like the use of the word boldest in this sentence because bold does not equate to intelligent, well designed, or effective. Once, my co-blogger after drinking for twelve hours, stole a golf cart at a NASCAR race and proceeded to drive in small circles turning left and screaming, "Guess who I am? I'm a NASCAR driver." This was a bold move, one of his boldest. It does not qualify as one of his most intelligent or positive moments and it could have landed him in jail. Sometimes bold moves, while funny as hell, are not good ideas.
What I hate most about the legislation is the creation of a Consumer Financial Protection Bureau. You might wonder why I could hate something that sounds so innocuous and the answer lies with where it will be housed: The Federal Reserve. We are supposed to be comforted by the fact that it is an autonomous bureau with a single director. Look, there is no independent agency or bureau in all of Washington D.C., I don't care what they are intended to be. Furthermore, how autonomous were you when you lived under your parents roof?
The Federal Reserve is one of the 5 major players that created the crisis we find ourselves in and they have no business being anywhere near a bureau intended to protect consumers. They fueled the crisis, failed to recognize it, and then sold consumers down the river in the bailout mess. Putting a Consumer Protection Bureau there is like assigning lions to be security detail for gazelles.
Another key element of the package is regulatory control and accountability for the ratings agencies. The problem with this is that the regulators have to understand what the agencies are doing and what the products are they are actually rating. Half the instruments Wall Street are trading are so convoluted that people within the firms trading them don't know what they are. How could a regulator possibly know what the ratings agencies are doing or what they are rating? Someone smart enough to get it isn't going to work as a regulator, nope, they will go to work on Wall Street inventing new instruments of debt and new ways to sell it. Don't even get me started on the corruption inherent in regulation anyway.
It's very simple; Consumers need to protect themselves. If we have gotten so collectively stupid that we think the government can protect us than we are totally screwed as a nation. The government couldn't protect us from September 11th, then the government created the conditions for the housing crisis, and I'm not sure if you noticed; the government can't fix the economy either. The best the government can do to help the consumer is encourage financial education in the schools and mandate more economics courses for our students. Even that won't solve the problem. When people want to do stupid things (think NASCAR story above), they will find a way to do them.
The email from Barack's people claimed that the bill would end the exploitation of the consumer by ending hidden fees and pages of small print. The pages of small print you get with a loan application are there because of regulations, trust me when I say we would have preferred to not send you fifty pages of documents to get your loan approved. If you think there is small print now, just wait.
The truth is, when I was a loan officer, my customers didn't read the disclosures I sent them. They looked at two things: their monthly payment and their closing costs. They signed fifty pages of disclosures without reading them. Most of my customers would get their loan package and call me and ask for the Cliff Notes, which I was more than happy to provide them. If you really ever read a loan package and understood everything in it, you probably would not want to get a loan. There is a clause in most loan documents that if you make any material changes to your home without notifying your mortgage company they can call the note due and demand full payoff. How many people know that? How many people know that and tell their mortgage company that they turned a bedroom into a stripper lounge?
I don't have the answers on how this gets better but I think it starts with us getting smarter, which is not too promising and quite frankly, makes me fear for the future.
Showing posts with label Regulations. Show all posts
Showing posts with label Regulations. Show all posts
Wednesday, July 14, 2010
Monday, May 24, 2010
Too Small to Succeed: The Plight of Jello Salad and Small Banks
I spent a good chunk of my weekend contemplating the future extinction of Jello salad. It started at a friend’s birthday party for her daughter when her grandmother made a pineapple Jello salad and the kids couldn’t get enough of it. I don’t make Jello salad, in fact, I don’t even make Jello, unless it is for shooters but I’m even getting too old for that. So this party had me thinking that as grandparents die off so will Jello salad, because it is only loved by the very old and the very young and very few in my generation make the stuff. I find this kind of sad, although the truth is that I don’t even like Jello salad, probably because my mom shoved it in my yapper at every kind of celebration when I was a child. If I fell off my bike I was told, “Here have some Jello salad, you will feel better. It will fix you right up!” You are probably wondering what this has to do with the mortgage and banking industry. Well at first glance, absolutely nothing but, it made me realize that Jello salad is like small banks, neither one will be probably exist in twenty years.
A glance at the FDIC bank failure list shows a number of regional and small community banks shutting their doors. I guess they are too small to succeed, while their larger national counterparts are benefitting from the notion that they are too big to fail. Our government is helping to decide who the winners and losers are and we are footing the bill.
Some of these failures are due to market forces, particularly small community banks in rural places where populations are declining and so are economic prospects. Bad investments by banks can also account for a portion of the closures, particularly those regional banks that put a considerable amount of their resources into financing home builders and commercial developers in places like Nevada, California, and Florida.
What seems odd to me is that smaller banks that didn’t take on the kind of risk that plagued the banking industry during the housing boom are failing at a much higher rate. By all accounts, they were still lending more responsibly than the rest of the industry and since many of them subjected loans to traditional underwriting by committee, they should have been more insulated than the big banks using Fannie Mae products to get nearly anyone a loan. Perhaps, a larger portion of the failures are those banks that in response to the increasing competitiveness of the banking industry and its consolidation, were encouraged to take on more risk than realistic for their asset size and local economic conditions. I still question however, that all these explanations can account for the higher failure rate. I'm sure the rest is explained by the collusion of the large banks to receive bailouts and pass on risk and exposure to the small banks.
This is on my mind because of the proposed financial regulations that will do precious little to insulate us from having another financial meltdown in the future. With the loss of small banks, we are losing tremendous information and relationships that can help foster economic growth and stability in a region. Bankers who know their customers can assess risk better than automated underwriting; tools such as credit reports, which are not always reflective of risk, cannot replace the knowledge found in a more personal banking system. The consolidation of the banking and mortgage industry which has been going on for twenty years is speeding up thanks to the housing crisis, and I’m sure the largest of the banks couldn’t be happier about it. Couple this with the melding of banking and the insurance industry and we are at more risk than ever.
So when small banks go, so does competition in the industry, leading to a cartel of banks…oh yeah, we have that already, it is called the Federal Reserve. The impact on consumers will be profound in terms of fees for everything from overdrafts, wire transfers, stop payments, and on and on. Cartels do not price competitively, they don’t have to. Will customers appreciate the convenience of large banks; of course they will. What I fear customers won’t recognize is that a less competitive banking industry can hamper our future economic growth and lead to greater risk in our financial markets.
If you haven’t read Barbarians at the Gate or Liar’s Poker I recommend you go out and get them right now. What I take from these two books is that particularly in financial markets, the consolidation of power and resources creates greater incentive for rent-seeking and collusion, leaving taxpayers more at risk to anti-competitive and harmful behavior. From junk bonds to mortgage backed securities, a very small group of players are determining behavior in financial markets and where wealth flows. Think of it this way, if you only had to answer to people just like you with the same incentives and goals you would probably behave however you wanted without fear of repercussions, there would be no reinforcement mechanism to check your asshole behavior. Ever go out drinking with a bunch of drunks? Yeah, its like that. Banks, Wall Street, the Federal Reserve, and the government agencies that are there to check them represent this giant club of assholes who have no incentive to check one another’s power.
I don’t have the answer but I know that the proposed regulations won’t work. My gut feeling is that half ass regulations will only make it worse. I want a competitive banking industry, which is impossible with the Federal Reserve and the government involved in the capacity they are working towards. This I know for sure: Clever people will always find a way around regulations and the more time goes on, the more damaging their escapes prove to be for taxpayers.
For the last twenty years, the comparative advantage of the United States has been in making debt, not creating wealth. Clever people will figure out how to make debt look like something it isn’t and it will continue to finance our economic growth much like junk bonds and mortgage backed securities have in the past. This is what we are good at as a country and the expense of it gets more burdensome every year.
Like I said, I don’t have all the solutions. Perhaps, we can save Jello salad with a few cookbooks and some help from our Grandmas, but I think small banks are on the verge of extinction. With the power of the banks and their links to Wall Street, the Federal Reserve, and the U.S. Government, there is no hope for small banks and all the Jello salad in the world won’t make it better.
A glance at the FDIC bank failure list shows a number of regional and small community banks shutting their doors. I guess they are too small to succeed, while their larger national counterparts are benefitting from the notion that they are too big to fail. Our government is helping to decide who the winners and losers are and we are footing the bill.
Some of these failures are due to market forces, particularly small community banks in rural places where populations are declining and so are economic prospects. Bad investments by banks can also account for a portion of the closures, particularly those regional banks that put a considerable amount of their resources into financing home builders and commercial developers in places like Nevada, California, and Florida.
What seems odd to me is that smaller banks that didn’t take on the kind of risk that plagued the banking industry during the housing boom are failing at a much higher rate. By all accounts, they were still lending more responsibly than the rest of the industry and since many of them subjected loans to traditional underwriting by committee, they should have been more insulated than the big banks using Fannie Mae products to get nearly anyone a loan. Perhaps, a larger portion of the failures are those banks that in response to the increasing competitiveness of the banking industry and its consolidation, were encouraged to take on more risk than realistic for their asset size and local economic conditions. I still question however, that all these explanations can account for the higher failure rate. I'm sure the rest is explained by the collusion of the large banks to receive bailouts and pass on risk and exposure to the small banks.
This is on my mind because of the proposed financial regulations that will do precious little to insulate us from having another financial meltdown in the future. With the loss of small banks, we are losing tremendous information and relationships that can help foster economic growth and stability in a region. Bankers who know their customers can assess risk better than automated underwriting; tools such as credit reports, which are not always reflective of risk, cannot replace the knowledge found in a more personal banking system. The consolidation of the banking and mortgage industry which has been going on for twenty years is speeding up thanks to the housing crisis, and I’m sure the largest of the banks couldn’t be happier about it. Couple this with the melding of banking and the insurance industry and we are at more risk than ever.
So when small banks go, so does competition in the industry, leading to a cartel of banks…oh yeah, we have that already, it is called the Federal Reserve. The impact on consumers will be profound in terms of fees for everything from overdrafts, wire transfers, stop payments, and on and on. Cartels do not price competitively, they don’t have to. Will customers appreciate the convenience of large banks; of course they will. What I fear customers won’t recognize is that a less competitive banking industry can hamper our future economic growth and lead to greater risk in our financial markets.
If you haven’t read Barbarians at the Gate or Liar’s Poker I recommend you go out and get them right now. What I take from these two books is that particularly in financial markets, the consolidation of power and resources creates greater incentive for rent-seeking and collusion, leaving taxpayers more at risk to anti-competitive and harmful behavior. From junk bonds to mortgage backed securities, a very small group of players are determining behavior in financial markets and where wealth flows. Think of it this way, if you only had to answer to people just like you with the same incentives and goals you would probably behave however you wanted without fear of repercussions, there would be no reinforcement mechanism to check your asshole behavior. Ever go out drinking with a bunch of drunks? Yeah, its like that. Banks, Wall Street, the Federal Reserve, and the government agencies that are there to check them represent this giant club of assholes who have no incentive to check one another’s power.
I don’t have the answer but I know that the proposed regulations won’t work. My gut feeling is that half ass regulations will only make it worse. I want a competitive banking industry, which is impossible with the Federal Reserve and the government involved in the capacity they are working towards. This I know for sure: Clever people will always find a way around regulations and the more time goes on, the more damaging their escapes prove to be for taxpayers.
For the last twenty years, the comparative advantage of the United States has been in making debt, not creating wealth. Clever people will figure out how to make debt look like something it isn’t and it will continue to finance our economic growth much like junk bonds and mortgage backed securities have in the past. This is what we are good at as a country and the expense of it gets more burdensome every year.
Like I said, I don’t have all the solutions. Perhaps, we can save Jello salad with a few cookbooks and some help from our Grandmas, but I think small banks are on the verge of extinction. With the power of the banks and their links to Wall Street, the Federal Reserve, and the U.S. Government, there is no hope for small banks and all the Jello salad in the world won’t make it better.
Friday, May 7, 2010
Good Luck With That....
I'm interrupting this regularly scheduled blog to insert some rant and commentary about attempts to regulate and reform the mortgage industry. I intended to blog today about the crazy loans we did but the universe has been speaking to me again and it is telling me that people still don't get it.
I work at an institution of higher learning funded by public dollars, well, at least we used to be. We probably are financed by junk bonds and mortgage backed securities these days due to the budget crisis of the state, which ironically, my former industry contributed to. I only mention this because yesterday I received an email celebrating that our business college is changing its MBA program to focus on "sustainable business practices and corporate social responsibility". This change is described as a necessary response to corporate corruption and lack of responsibility in recent years in the U.S. economy. As part of this transformation there will be a new focus on ethics in business. I have the same reaction to this that I would if you told me that you are going to take over the world today. My response, "Yeah, well good luck with that.".
Now I know that the fact that I take issue with this will make some of you react like I just announced that I like to kick puppies. It is not that I am against ethics and responsibility, I certainly don't picket businesses with signs that read, "Fuck Ethics" or "Be The Biggest Asshole You Can Be". What I have a problem with is the idea that adding courses on ethics will result in a more "socially responsible" corporate climate. It won't. It is a very well crafted public relations move by business colleges and corporations to claim they want MBA's with a social conscience, but in practice, it is not going to eliminate or reduce unethical behavior.
First, you can't truly teach ethics just like you can't teach dignity, entrepreneurship, humor, or intelligence. You can give people tools to enhance some of these innate skills but you can't teach them. Another part of the individual's personality that can't be taught is whether they are risk preferring or risk averse. If someone is highly risk averse and has an inherent system of ethics that dictates that lying and cheating are bad, they will behave ethically because they will self police and fear the repercussions for unethical behavior. Someone with flexible morality and a less rigid ethical system may not self police their behavior, particularly if they are risk preferring. In this instance, the fear of getting punished through legal channels or getting fired will not be enough incentive to keep them from behaving in an "unethical" manner.
What compounds this problem is that there will always be an incentive for people to behave unethically and in a risky fashion as long as there are gains to be realized for engaging in this behavior. Look at the jockey Calvin Borel who just won the Kentucky Derby. He was willing to take the risky path of riding the rail in an attempt to gain a competitive advantage over the field. This isn't unethical but it is risky. He succeeded in winning the race not just because he is an incredible jockey with a fast horse, but because he was willing to do what his competitors wouldn't. He was willing to risk disaster for the gains to be realized if the risk paid off.
If you are willing to do what your competitors aren't there will probably be gains to be realized by doing so. In my time in the mortgage industry nobody embodied this ability to gain at the margin like the Mortgage Devil. He revolutionized our market and created a virtual monopoly. He did this by doing what the rest of us weren't willing to do. These activities included answering customer's phone calls 24 hours a day, never taking a vacation, drinking grass water to avoid having to eat food and take a break, and volumes of unethical and fraudulent behavior. What did he get in return for this behavior? Yearly earnings between one and two million dollars and for many years there was no credible threat of punishment for this behavior.
A. Hole and I used to talk about his flexible morality. We never understood how he could get on his high horse and crucify someone for committing fraud while he was doing the same thing. Ironically, he had an MBA and took business ethics courses. They didn't work as intended. The bottom line is that there was no policing of loan officer's behavior so there was no incentive for him to behave in an ethical manner. Teaching MBA's ethical responsibility won't achieve more corporate social responsibility. The only way to encourage ethical behavior is to reward that behavior and punish those who behave unethically. Currently, those institutions are not in place in most industries, but particularly in the mortgage industry.
During the peak of the housing boom the entire mortgage industry operated under the 80/20 rule. Automated underwriting was touted as working for 80% of loans and the industry seemed to accept that if 80% of loan officers were behaving than it would more than make up for the 20% committing fraud. Turns out, the 80/20 rule doesn't always hold or perhaps, it should have been called the 20/80 rule.
This leads me to my next problem with the new regulations of the mortgage industry, the new Nationwide Mortgage Licensing System. For now, it requires mortgage originators not working for an FDIC insured financial institution to become licensed through their state. It requires that mortgage originators subject to background checks, credit reports, continuing education and a series of questions that are meant to kick out applicants who have previously been caught in fraudulent behavior.
Again, this sounds sensible. But, for now mortgage bankers only have to register with the service they don't have to be licensed, oh and there is the small problem that APPARENTLY LOAN OFFICERS CAN FRAUD THE SYSTEM AND GET LICENSED. This is more crap to make you feel like you are being protected by the government with regulations that ARE NOT BEING ENFORCED!!! A regulation that is not enforced is about as useful as a Snuggie.
You should be pissed that these regulations meant to protect you from the deviants is easily circumvented. You should be outraged that the government is passing regulations meant to help consumers even though they know they aren't going to be enforced and don't even begin to address the real problems. It's all show and no dough.
I know a loan officer who has foreclosures and judgments on their credit report, was asked to resign from another company for fraud or what they describe as a "grey area", and is involved in a lawsuit that relates to a complicated fraud scheme that included a phony loan application and the forging of a signature on settlement papers. There is not a single element of the licensing requirements that this loan officer doesn't violate and they were awarded a license last week. While were at it, why don't we bring back those guys from Enron and give them licenses too.
Regulation without credible punishments, monitoring, or enforcement mechanisms will never work. In fact, I think the more asinine regulations we pass the more fraud we create. It provides an incentive to do what your competitors won't....which is exactly what we are trying to prevent.
Regulating the mortgage industry...hmmm. Good luck with that.
I work at an institution of higher learning funded by public dollars, well, at least we used to be. We probably are financed by junk bonds and mortgage backed securities these days due to the budget crisis of the state, which ironically, my former industry contributed to. I only mention this because yesterday I received an email celebrating that our business college is changing its MBA program to focus on "sustainable business practices and corporate social responsibility". This change is described as a necessary response to corporate corruption and lack of responsibility in recent years in the U.S. economy. As part of this transformation there will be a new focus on ethics in business. I have the same reaction to this that I would if you told me that you are going to take over the world today. My response, "Yeah, well good luck with that.".
Now I know that the fact that I take issue with this will make some of you react like I just announced that I like to kick puppies. It is not that I am against ethics and responsibility, I certainly don't picket businesses with signs that read, "Fuck Ethics" or "Be The Biggest Asshole You Can Be". What I have a problem with is the idea that adding courses on ethics will result in a more "socially responsible" corporate climate. It won't. It is a very well crafted public relations move by business colleges and corporations to claim they want MBA's with a social conscience, but in practice, it is not going to eliminate or reduce unethical behavior.
First, you can't truly teach ethics just like you can't teach dignity, entrepreneurship, humor, or intelligence. You can give people tools to enhance some of these innate skills but you can't teach them. Another part of the individual's personality that can't be taught is whether they are risk preferring or risk averse. If someone is highly risk averse and has an inherent system of ethics that dictates that lying and cheating are bad, they will behave ethically because they will self police and fear the repercussions for unethical behavior. Someone with flexible morality and a less rigid ethical system may not self police their behavior, particularly if they are risk preferring. In this instance, the fear of getting punished through legal channels or getting fired will not be enough incentive to keep them from behaving in an "unethical" manner.
What compounds this problem is that there will always be an incentive for people to behave unethically and in a risky fashion as long as there are gains to be realized for engaging in this behavior. Look at the jockey Calvin Borel who just won the Kentucky Derby. He was willing to take the risky path of riding the rail in an attempt to gain a competitive advantage over the field. This isn't unethical but it is risky. He succeeded in winning the race not just because he is an incredible jockey with a fast horse, but because he was willing to do what his competitors wouldn't. He was willing to risk disaster for the gains to be realized if the risk paid off.
If you are willing to do what your competitors aren't there will probably be gains to be realized by doing so. In my time in the mortgage industry nobody embodied this ability to gain at the margin like the Mortgage Devil. He revolutionized our market and created a virtual monopoly. He did this by doing what the rest of us weren't willing to do. These activities included answering customer's phone calls 24 hours a day, never taking a vacation, drinking grass water to avoid having to eat food and take a break, and volumes of unethical and fraudulent behavior. What did he get in return for this behavior? Yearly earnings between one and two million dollars and for many years there was no credible threat of punishment for this behavior.
A. Hole and I used to talk about his flexible morality. We never understood how he could get on his high horse and crucify someone for committing fraud while he was doing the same thing. Ironically, he had an MBA and took business ethics courses. They didn't work as intended. The bottom line is that there was no policing of loan officer's behavior so there was no incentive for him to behave in an ethical manner. Teaching MBA's ethical responsibility won't achieve more corporate social responsibility. The only way to encourage ethical behavior is to reward that behavior and punish those who behave unethically. Currently, those institutions are not in place in most industries, but particularly in the mortgage industry.
During the peak of the housing boom the entire mortgage industry operated under the 80/20 rule. Automated underwriting was touted as working for 80% of loans and the industry seemed to accept that if 80% of loan officers were behaving than it would more than make up for the 20% committing fraud. Turns out, the 80/20 rule doesn't always hold or perhaps, it should have been called the 20/80 rule.
This leads me to my next problem with the new regulations of the mortgage industry, the new Nationwide Mortgage Licensing System. For now, it requires mortgage originators not working for an FDIC insured financial institution to become licensed through their state. It requires that mortgage originators subject to background checks, credit reports, continuing education and a series of questions that are meant to kick out applicants who have previously been caught in fraudulent behavior.
Again, this sounds sensible. But, for now mortgage bankers only have to register with the service they don't have to be licensed, oh and there is the small problem that APPARENTLY LOAN OFFICERS CAN FRAUD THE SYSTEM AND GET LICENSED. This is more crap to make you feel like you are being protected by the government with regulations that ARE NOT BEING ENFORCED!!! A regulation that is not enforced is about as useful as a Snuggie.
You should be pissed that these regulations meant to protect you from the deviants is easily circumvented. You should be outraged that the government is passing regulations meant to help consumers even though they know they aren't going to be enforced and don't even begin to address the real problems. It's all show and no dough.
I know a loan officer who has foreclosures and judgments on their credit report, was asked to resign from another company for fraud or what they describe as a "grey area", and is involved in a lawsuit that relates to a complicated fraud scheme that included a phony loan application and the forging of a signature on settlement papers. There is not a single element of the licensing requirements that this loan officer doesn't violate and they were awarded a license last week. While were at it, why don't we bring back those guys from Enron and give them licenses too.
Regulation without credible punishments, monitoring, or enforcement mechanisms will never work. In fact, I think the more asinine regulations we pass the more fraud we create. It provides an incentive to do what your competitors won't....which is exactly what we are trying to prevent.
Regulating the mortgage industry...hmmm. Good luck with that.
Monday, April 26, 2010
Forms and Regulations? We don't need any stinking forms and regulations!
I had been at the Bank of Hell for a few weeks when a staff meeting was held, for my benefit, to fill me in on the nuances around the local Bank of Hell branch. The Mortgage Devil had called the meeting under the guise that it was to help me but like everything he does, it really was all about giving him an hour of floor time so that we might be enlightened as to why he was God's gift to the mortgage industry and a fabulous boss.
I was still adjusting to the fact that everyone in that office seemed to hate me right off the bat and it was pretty obvious that they didn't take well to newbies. If I hadn't been so distracted by the office bitchiness and what was proving to be an interesting case study in sociology and anthropology, I would have realized that something was seriously wrong.
In the interest of full disclosure, I have to point out that at the time of this meeting I was still largely ignorant of the internal functions of the mortgage industry. Compounding this ignorance, was an unfamiliarity with the processes of working for a bank rather than a broker. As a broker, my company did not service any of its own loans and I had two outlets for lending. The first being the correspondent loan channel, where we underwrote loans internally according to the investor's guidelines and then they purchased the loan after double checking that we handled the loan according to their standards. The other channel was the broker channel, where I sent the loan to another company to be underwritten and it closed in that company's name. This didn't necessarily mean that the loan would be serviced by the company I shipped the loan to, just that it never had the appearance of being my company's loan product. Basically, I was leaving an environment where I sold other company's loan products to join an environment where I sold the Bank of Hell's loan products. This distinction is tremendously important to the incentives facing decision makers within these firms.
The meeting starts with the Mortgage Devil pontificating about how great the Bank of Hell is and how his production stacks up in the company. At this point, I am a bit in awe of him, I still think he might be a mentor and help me become more successful. So like a complete asshole, I nod and smile at all his accomplishments while ignoring the eye rolling and under the breath comments of his assistants. During staff meetings they would pass notes and call him an asshole and douchebag under their breath while sporting fake smiles to go with their fake tans, fake hair, and fake intelligence.
The meeting goes on and we are discussing a few of my loans and I ask a simple question: "Where do I get a condo questionnaire?" The Mortgage Devil says, "What the hell is a condo questionnaire?" I feel stupid because this man has been in the industry 30 years longer than me and if he doesn't know what a condo questionnaire is then perhaps, I shouldn't either. I explain that at my previous company, if I did a loan on a condominium or a loan in certain developments, we had to send out a form to the homeowner's association that would verify if it was "warrantable" and approved by Fannie Mae or Freddie Mac. The Mortgage Devil looked at me like I just suggested that that we should elect Brittney Spears president of the mortgage division. He dismissed me with, "We don't do that here, we are a bank." So I asked if all condominiums are eligible to lend money on at the Bank of Hell and he told me that indeed, there is no such thing as an ineligible condominium and that we don't worry about those matters because we don't have to sell our loans. I was confused but since I really didn't know the channels and approval processes of the bank, I figured I should take the word of the Mortgage Devil. I even remember thinking how great it was to be at a bank since there was going to be a lot less red tape and impediments to getting loans closed. Yippee, more money for me.
For those of you whom have never worked in the mortgage business, this probably seems like an incredibly innocous conversation. But make no mistake, this is an example of what was happening around the mortgage industry during the housing boom that eventually led to the demise of banks, homeowners, and millions of investors. What I didn't know at the time, was that lack of a condo questionnaire was indicative of a more pervasive problem and that ranged from cutting corners to what probably was outright mortgage fraud by the Mortgage Devil and his minions at the Bank of Hell.
The best I can figure now, with perspective and distance, is that if a loan was underwritten in our office, and not sent to corporate headquarters in Dante's Inferno, corners were cut and forms that were actually required by Fannie Mae were either filled out by processors to make the loan look compliant or were just ignored.
In later posts, I will elaborate on why the regulation of banks is so ineffective but I want to at least make a point about the incentive structure that is responsible for a lot of the ills in the mortgage business.
1. At some point, banks became more concerned about the number of loans closed than the quality of those loans. Now this was intertwined with the ability to package and ship ugly loans as mortgage backed securities but also was cemented into policies within the bank that made for fast and loose decision making and underwriting. At some point, the Bank of Hell changed the payment structure for loan processors and underwriters, such that their salary was now tied to the number of loans that they approved and closed. It basically was like putting the gate keepers on commission for the number of people they let through the gate. Ummm, turns out, that is a pretty shitty idea. When you are getting rewarded for opening the gates, you become a greeter rather than a gatekeeper.
2. The compensation structure for loan officers was incredibly lucrative. At small local banks, historically, loan officers were typically paid a salary and then rewarded for the quality of their loans in bonuses. At some point, this model was abandoned in favor of a bank not having to pay their loan officer any kind of base salary. Obviously, this reduced short term expenses for the bank by making loan officers accountable for generating their own salary in commission. The problem is, that a loan officer who doesn't get rewarded for the quality of their loans, has every incentive to go out and get every loan they can to increase their bottom line. And this is exactly what happened. The long term cost of this probably outweighed the short term savings for a lot of companies because it created an environment where everyone who should have known a loan shouldn't get made had every incentive to make that loan.
3. This doesn't even touch the surface of the perverse incentives rampant in the banking and mortgage industry. I haven't even gotten to district managers, vice presidents, and the financial market innovations that allowed risk to be distributed to those people who didn't even know they were taking it.
I don't want to give the impression that everyone in the mortgage industry was an unscrupulous douchebag, some people like A. Hole and myself behaved ethically and didn't realize what was going on around us at the time and how it played into the bigger picture. On the other hand, The Mortgage Devil was an unscrupulous douchebag and our company not only gave gave him every incentive to do so but they rewarded him handsomely for his behavior.
Two weeks in hell, seventy six to go. Stay tuned, it gets ugly quick.
I was still adjusting to the fact that everyone in that office seemed to hate me right off the bat and it was pretty obvious that they didn't take well to newbies. If I hadn't been so distracted by the office bitchiness and what was proving to be an interesting case study in sociology and anthropology, I would have realized that something was seriously wrong.
In the interest of full disclosure, I have to point out that at the time of this meeting I was still largely ignorant of the internal functions of the mortgage industry. Compounding this ignorance, was an unfamiliarity with the processes of working for a bank rather than a broker. As a broker, my company did not service any of its own loans and I had two outlets for lending. The first being the correspondent loan channel, where we underwrote loans internally according to the investor's guidelines and then they purchased the loan after double checking that we handled the loan according to their standards. The other channel was the broker channel, where I sent the loan to another company to be underwritten and it closed in that company's name. This didn't necessarily mean that the loan would be serviced by the company I shipped the loan to, just that it never had the appearance of being my company's loan product. Basically, I was leaving an environment where I sold other company's loan products to join an environment where I sold the Bank of Hell's loan products. This distinction is tremendously important to the incentives facing decision makers within these firms.
The meeting starts with the Mortgage Devil pontificating about how great the Bank of Hell is and how his production stacks up in the company. At this point, I am a bit in awe of him, I still think he might be a mentor and help me become more successful. So like a complete asshole, I nod and smile at all his accomplishments while ignoring the eye rolling and under the breath comments of his assistants. During staff meetings they would pass notes and call him an asshole and douchebag under their breath while sporting fake smiles to go with their fake tans, fake hair, and fake intelligence.
The meeting goes on and we are discussing a few of my loans and I ask a simple question: "Where do I get a condo questionnaire?" The Mortgage Devil says, "What the hell is a condo questionnaire?" I feel stupid because this man has been in the industry 30 years longer than me and if he doesn't know what a condo questionnaire is then perhaps, I shouldn't either. I explain that at my previous company, if I did a loan on a condominium or a loan in certain developments, we had to send out a form to the homeowner's association that would verify if it was "warrantable" and approved by Fannie Mae or Freddie Mac. The Mortgage Devil looked at me like I just suggested that that we should elect Brittney Spears president of the mortgage division. He dismissed me with, "We don't do that here, we are a bank." So I asked if all condominiums are eligible to lend money on at the Bank of Hell and he told me that indeed, there is no such thing as an ineligible condominium and that we don't worry about those matters because we don't have to sell our loans. I was confused but since I really didn't know the channels and approval processes of the bank, I figured I should take the word of the Mortgage Devil. I even remember thinking how great it was to be at a bank since there was going to be a lot less red tape and impediments to getting loans closed. Yippee, more money for me.
For those of you whom have never worked in the mortgage business, this probably seems like an incredibly innocous conversation. But make no mistake, this is an example of what was happening around the mortgage industry during the housing boom that eventually led to the demise of banks, homeowners, and millions of investors. What I didn't know at the time, was that lack of a condo questionnaire was indicative of a more pervasive problem and that ranged from cutting corners to what probably was outright mortgage fraud by the Mortgage Devil and his minions at the Bank of Hell.
The best I can figure now, with perspective and distance, is that if a loan was underwritten in our office, and not sent to corporate headquarters in Dante's Inferno, corners were cut and forms that were actually required by Fannie Mae were either filled out by processors to make the loan look compliant or were just ignored.
In later posts, I will elaborate on why the regulation of banks is so ineffective but I want to at least make a point about the incentive structure that is responsible for a lot of the ills in the mortgage business.
1. At some point, banks became more concerned about the number of loans closed than the quality of those loans. Now this was intertwined with the ability to package and ship ugly loans as mortgage backed securities but also was cemented into policies within the bank that made for fast and loose decision making and underwriting. At some point, the Bank of Hell changed the payment structure for loan processors and underwriters, such that their salary was now tied to the number of loans that they approved and closed. It basically was like putting the gate keepers on commission for the number of people they let through the gate. Ummm, turns out, that is a pretty shitty idea. When you are getting rewarded for opening the gates, you become a greeter rather than a gatekeeper.
2. The compensation structure for loan officers was incredibly lucrative. At small local banks, historically, loan officers were typically paid a salary and then rewarded for the quality of their loans in bonuses. At some point, this model was abandoned in favor of a bank not having to pay their loan officer any kind of base salary. Obviously, this reduced short term expenses for the bank by making loan officers accountable for generating their own salary in commission. The problem is, that a loan officer who doesn't get rewarded for the quality of their loans, has every incentive to go out and get every loan they can to increase their bottom line. And this is exactly what happened. The long term cost of this probably outweighed the short term savings for a lot of companies because it created an environment where everyone who should have known a loan shouldn't get made had every incentive to make that loan.
3. This doesn't even touch the surface of the perverse incentives rampant in the banking and mortgage industry. I haven't even gotten to district managers, vice presidents, and the financial market innovations that allowed risk to be distributed to those people who didn't even know they were taking it.
I don't want to give the impression that everyone in the mortgage industry was an unscrupulous douchebag, some people like A. Hole and myself behaved ethically and didn't realize what was going on around us at the time and how it played into the bigger picture. On the other hand, The Mortgage Devil was an unscrupulous douchebag and our company not only gave gave him every incentive to do so but they rewarded him handsomely for his behavior.
Two weeks in hell, seventy six to go. Stay tuned, it gets ugly quick.
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