For as long as anyone can remember banks have been one of the most powerful lobbies in Washington, major political contributors and the world’s biggest money machine. No less important, major banks, Wall Street brokerages, insurers and credit card companies are tied together in a web of relationships, shared interests and mutual concerns. Bump one and you bump them all, something no one in Washington has been able to do for decades.
That was then, but now the financial community is a ward of the government, dependent on friendly federal loans for survival and in business only because the outright failure of major banks is widely seen as worse than their continuation.
No less important, the mortgage meltdown has changed the political landscape.
“Probably 10 million American families will lose their home to foreclosure in the next four years, many of them falling out of the middle class and into poverty,” says Rep. Brad Miller, D-N.C. “It is shameful that the mortgages that led to the foreclosure crisis were ever made. We certainly can’t let it happen again.”
While huge banks may be too big to fail they’re no longer too big to regulate. The changing tone in Washington can be seen with the 49-21 vote by the House Financial Services Committee on Wednesday to pass HR 1728, the Mortgage Reform and Anti-Predatory Lending Act, legislation introduced by Miller that potentially spells big changes in the lending industry.
“Had the safe harbor and disclosure elements of this legislation been in place in during the past decade it’s doubtful that we ever would have faced today’s mortgage crisis,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the nation’s largest source of foreclosure listings and data. “No less important, banks, brokerages and investors would also have been protected because the value of their mortgage holdings would have been known and secure.”
Originators & Risk
The business of mortgage origination has few risks because borrowers are largely on their own when it comes to picking the right loan or finding the best rates. Mortgage brokers and mortgage bankers have repeatedly said that they simply do not represent borrowers, that they instead owe their allegiance to mortgage investors.
That allegiance, however, is remarkably limited. Mortgage originators can be forced to buy back loans from investors if the borrower defaults within the first 120 days of the loan term or if the loan was originated on the basis of fraud. In effect, the originator has no liability after 120 days unless fraud can be proven, a difficult and unlikely standard. In fiscal 2007, for example, the FBI reported that it conducted 1,204 mortgage fraud investigations while during the same period roughly 43 million first liens were outstanding.
Under HR 1728, however, the rules would be changed. Section 213 says that loan originators would be required to retain 5 percent of the risk for every “non-qualified” mortgage they originate.
The lending community argues that the 5 percent provision is unnecessary.
“Lenders,” says David Kittle, Chairman of the Mortgage Bankers Association, “already have ‘skin in the game’ by virtue of their representations and responsibilities to assignees and investors. At a time when policymakers are focusing so much of their efforts on injecting capital into the financial services sector, this provision would force an inefficient use of capital across all types of institutions, and would threaten to further impair their ability to lend at all.”
One of the key concepts of HR 1728 is to encourage the origination of dull, routine loans that borrowers can actually repay. In basic terms, “qualified loans” in the latest available version of the bill are defined as mortgages which do not “exceed the average prime offer rate” for a comparable loan by 1.5 percent for a first lien and 3.5 percent for a second lien.
In addition, to have a “qualified loan” the lender must verify the borrower’s income and financial resources, qualify the borrower on the basis of the loan’s fully indexed rate and not offer loans to borrowers with excessive monthly debts.
By making qualified loans, lenders would not have any liability under the 5 percent rule. However, lenders who use stated-income loan applications or originate mortgages with strange and exotic terms would then be responsible for such loans as long as they remained outstanding.
At first it may seem as though a 5 percent liability is not a big deal. If lender Smith originates a $100,000 option ARM loan and something goes wrong then Smith could be forced to pay $5,000 to a mortgage investor.
What makes the rule tougher than it may seem is that many mortgage brokers and mortgage bankers are thinly capitalized. They don’t have a lot of cash. While making a few non-qualified loans might be tolerable if a few borrowers fail to make their payments, a business based on such financing would represent an unsustainable risk.
Here’s why: If Smith originates 100 unqualified loans for $100,000 each — about two per week — he has created financing worth $10 million. He has also created liabilities worth $500,000 — liabilities which are likely to remain outstanding for years. If Smith keeps churning out unqualified loans at that same rate then after five years his potential liabilities will be in the range of $2.5 million, far too much for a small firm to retain the good credit needed to remain in business.
In the context of real estate, the term “steering” usually refers to discrimination and the effort to prevent individuals of different races from living in the same neighborhood. HR 1728 includes the word “steering” but with a new meaning.
“Steering,” says the committee, is used in the bill to describe a broker or bank loan officer who “is compensated for directing applicants toward more costly mortgages. H.R. 1728 would ban yield spread premiums and other abusive compensation structures that create conflicts of interest or reward originators that ‘steer’ borrowers. The bill would also require originators to disclose to consumers the compensation they receive from the transaction.”
The way the term is defined it appears possible that lenders could continue to offer “no cost” loan closings, arrangements where borrowers accept a somewhat higher interest rate in exchange for reduced settlement costs. What lenders could not do is simply price loans higher in an effort to obtain additional compensation, compensation which is generally unknown to the borrower.
During the past decade an increasing number of properties have been valued on the basis of automated appraisals, mathematical models that do not involve a physical examination of the property.
Automated appraisals make sense for large lenders because they’re cheaper than traditional appraisals and do not create much risk: If one home in a thousand is over-valued it’s not a problem in the context of a large loan portfolio.
For individual borrowers the issue is different. Appraisals are a form of buyer protection: With a purchase offer that requires a certain market value buyers can withdraw from a contract without losing their deposit if valuations come in low. This protects borrowers against paying too much for a home, a big deal in terms of monthly mortgage costs and the ability to easily sell or refinance.
Under HR 1728, full appraisals will be required for most loans, an evaluation “performed by a qualified appraiser who conducts a physical property visit of the interior of the mortgaged property.”
The Next Step
The bill must now be approved by the House and then by the Senate and the President. Along the way expect enormous pressure to amend HR 1728, especially the 5 percent and yield-spread premium provisions.
Can the bill pass through the legislative process largely intact? A few years ago it would never have gotten past the Financial Services Committee; now it’s passed with a broad majority. There are no guarantees in Washington, but in the next week or two we should have an answer from the House side of Capitol Hill.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.