Why Mortgage Brokers will survive the market chaos

There is plenty being written about the extinction of Mortgage Brokers. In an open letter to President Obama, Marc Savitt, President of NAMB writes:

“Make no mistake about it; this campaign to eliminate our profession has absolutely nothing to do with consumer protection. It’s all about the market share!”

As big banks and mortgage insurance companies pull the plug on Brokers, the conspiracy theories multiply. Will Brokers become the scapegoat that Mr. Savitt worries about? In the same letter he states:

“From the moment mainstream media first used the words “mortgage meltdown” mortgage brokers were labeled as the group that inflicted the predatory practices that gave rise to record foreclosures.”

Lawmakers, the media or anyone else blaming the Meltdown on Brokers is clearly misinformed. Mortgage Brokers are opportunistic and entrepreneurial, no different from any other small business, and they took advantage of an overheated market. They were the foot soldiers for FNMA, FHLMC, FHA – the most loyal mercenaries to Wall Street.

To use an insurance analogy, let’s say that a big insurance company develops a new life insurance program and gives it to their network of independent agents. The product is a $1million life insurance policy. No age requirements, no physical required and priced at only $599 a year. It is the job of the agent to write as many of these as possible to maximize his income.

The independent agent is not the underwriter. He does not access risk. He is a salesman who works on commission just like the mortgage broker. When a salesman gets a great product he will sell it until he can sell no more. This is the essence of American enterprise and the capitalistic system we live in.

Cranking it up a notch

Mortgage Brokers were smart entrepreneurs taking advantage of the party on Wall Street, a party created by the Institutional Investor who told his friends at Bear Stearns, Lehman Brothers and Merrill Lynch that his hedge fund needed more yield. “Please crank it up a notch.” Wall Street was pleased to accommodate and Brokers were all too happy to originate the new products.

Did some Brokers cross the line from opportunistic to unethical behavior? No question about it, but all the players bear some responsibility. For instance, what about the SEC and the rating agencies? None of these organizations fully understood the risky nature of CDOs and other MBS derivatives. What about the wholesalers who were lax on quality? Or former Federal Reserve Chairman Greenspan who kept rates too low for too long fueling an asset price bubble in real estate and the stock market? The list is very long.

So while the conspiracy theories fly, there is no logical “smoking gun” to condemn the Broker industry or justify eliminating them legislatively. I still believe the facts will emerge and cool headed regulators will prevail. Brokers will face the headwinds of regulation but will not be legislated away.

There are other arguments supporting the Broker’s case for survival. One needs to ask “How did Brokers obtain such a large share of the origination market in the first place?” I will argue that the conditions allowing the Broker industry to grow in the past will be the same catalyst for their survival in the future.

My top 5 conditions for survival:

1. A mortgage broker can originate a loan for lower costs than a large retail bank. With substantially lower overhead the Broker can underbid the big guy in the long run.

2. Large Banks by definition do not empower their rank and file employees and do not achieve the same level of personal service as a Broker. The bank employee is crippled by less profit motive and a fear of being ostracized by the organization if he or she pushes too hard. The Broker has no such baggage.

3. Product and price: For a plethora of reasons any bank on any given day may have the best program, price or product. A Broker can drive real value to the consumer by shopping the deal. The bank employee is stuck with bank offerings.

4. Consolidation in mortgage servicing: In a normal market servicing runoff is around 15%. This means the servicing asset is shrinking by 15% a year. The institution that services $300 billion in mortgage loans must produce on average $45 billion a year just to stay even. It is doubtful if someone like Chase who recently pulled out of wholesale lending can produce these numbers with their retail division. Once recovery is in full swing the big guys who pulled out will be forced to return to Wholesale.

5. Entrepreneurial Spirit: This is what makes America a great place. Brokers have it. If you work for a bank you either don’t have it or you suppress it. Brokers have more incentive to close loans than the average bank employee.

It is a great time to be a Broker because those who survive this storm will face prosperity again with fewer competitors. Broken credit markets have created massive pent up demand for mortgages. Housing has corrected from its unsustainable appreciation. More importantly, the U.S. economy is more resilient than the commentators on TV would have you believe. Remember, bad news is good for ratings.

The key to survival is to stay in the field and close to realtors. Know FHA better than your competitor because that is the only thing working. Continually source for new money as it comes on the market. Many savvy investors such as Virgin are eyeing the wholesale market space. The opportunities are too great to ignore. All the big players were taken out with bad loans. New players will emerge without the baggage.

Above all, stay positive and keep a cool head. There will be good times again for the survivors.