I just finished reading “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street” written by William D. Cohan and published by Doubleday. It’s a fascinating read for anyone curious about the current financial mess but an absolute requirement if you were part of the mortgage business. One caveat: I was a Bear Stearns employee for almost two and half years working for their subsidiary, Bear Stearns Residential Mortgage Corporation. My review, I think is very fair and I’ve tried hard not to editorialize.
Part I of Mr. Cohan’s tale begins with the play by play demise of one of Wall Street’s most prestigious firms. It paints a vivid picture of the last week of Bear Stearns’ existence before its “shotgun wedding” to JP Morgan Chase for $2/share, later revised to $10.00/share. Mr. Cohan had unprecedented access to the players of this unfolding drama as evidenced by the abundant quotes of the key insider players. This really gives the reader an insider view of this monumental event.
In part II of “House of Cards” Mr. Cohan takes on the role of a “pathologist” tracing the firm’s legendary roots, while shedding light on Bear Stearns’ evolving culture and idiosyncrasies. He attempts to correlate this culture to Bear’s eventual downfall.
Mr. Cohan paints a colorful portrait of CEO, Jimmy Cayne. A man, according to the book, with an autocratic and bullying management style who preferred playing bridge than focusing on day to day management of the firm.
Also interesting is the connection Mr. Cohan draws between Mr. Cayne’s decision to eliminate a program known as “CAP” (deferred income as company stock). Given to some executives in the firm, CAP had the potential of making employees who participated in the program extremely wealthy, assuming the stock continued to rise (as it did in the years leading up to the fall).
Warren Spector, heir apparent to Mr. Cayne’s job, was one executive who fully participated in the program. Mr. Spector, who oversaw the mortgage business placed 100% of his compensation in CAP. Mr. Cayne, the book said, soon realized that Mr. Spector could ultimately out-earn him and gain a larger ownership stake in the firm. As a result, he eliminated the program forcing Mr. Spector to sell a huge chunk of Bear Stearns stock. With his ownership stake in the firm declining, the author postulates that this caused Mr. Spector to sour on the firm. This was dangerous for Bear Stearns because Mr. Spector figuratively had his finger on everything. He was the day-to-day manager of the firm. This, according to the author, was a deadly cocktail.
While the book provides many colorful and titillating anecdotes that may horrify some, I believe Mr. Cohan fails to answer the one question that needs to be answered definitively. Was it Bear Stearns’ management and culture that doomed it to fail? Or was it simply the coming tempest in the mortgage business that would doom them regardless? It is worth pointing out that Bear Stearns was one of the least diversified firms on Wall Street, deriving the bulk of its earnings from Fixed Income products such as Mortgage Backed Securities. Monday morning quarterbacks can have a field day debating Bear’s strengths and weaknesses. There were plenty in each category. When the complete history is written, it may come down to this: The tsunami wave that hit the mortgage business was too big for a firm that placed the majority of its bets in that industry.
Tuesday, March 31, 2009
Tuesday, March 24, 2009
WHO SHOULD WE BLAME FOR THE HOUSING BUSTS?
Watching the press trying to sort out the financial mess reminds me of my dog chasing his tail. The Press is on a mission to find the “smoking gun.” If we could only find someone to blame, someone to vilify, it would make us all feel better. I have been pondering the blame game for sometime having found myself in the middle of the hurricane working for Bear Stearns, at the time the largest issuer of what is now referred to as “toxic waste”. But like the press, I’m just chasing my own tail. The answer is elusive.
I’m reminded of the police chief in the famous movie Casablanca when he tells his subordinates to “Round up the usual suspects”. So here they are. My apologies if I have left anyone worthy of blame off the list.
CHAIRMAN GREENSPAN: The press loves to find fault with Mr. Greenspan who was the Chairman of the Federal Reserve from 1987 to 2005. His critics claim that his loose monetary policy caused the housing bubble by putting cheap money in the system.
Yet there are several problems with this theory. First, it is hard to find fault with Mr. Greenspan’s policy of releasing liquidity into the market place after the high tech bubble went bust in early 2000, and the attacks on September 11, 2001. Without the additional liquidity the economy would have fallen into a deep recession. This is particularly true in the months after September 11 when markets virtually shut down and the economy was in shock.
Second, as Mr. Greenspan points out in his Wall Street Journal Op-Ed piece earlier this month, the Federal Reserve does not regulate long term interest rates which are highly correlated to mortgage rates. In fact, long term interest rates unlike the fed funds rate are regulated by market forces; namely supply and demand. The correlation between long term rates and short term rates is no longer statistically significant.
THE CHINESE: Mr. Greenspan plainly admits the strong correlation between low mortgage rates and home price appreciation. But what caused long term rates to stay low for so long even after the Fed began to raise short term rates in early 2004? Mr. Greenspan writes: “…the presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990’s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.”
In other words, the Chinese flooded our domestic market with cheap goods and parked the resulting cash in long term treasury bonds, causing the longest bond rally in history. As bond prices run inverse to interest rates and Treasury Bonds are highly correlated to mortgage rates this fueled housing demand.
So then, should we blame the Chinese or the American Consumer?
THE CONSUMER: It was, after all, the American consumer who bought all that “made in China” stuff and in doing so helped (indirectly) pull down interest rates which propelled home prices. The home soon became a cash register as consumers piled on the home equity lines purchasing new cars, vacation homes and other trappings of material wealth. The average American soon believed that home prices would go up in perpetuity. People purchased homes they could not afford believing they could always sell later at a profit. When speculators arrived on the scene the market appreciation rates became surreal as the feeding frenzy began to take hold.
THE MORTGAGE LENDERS: Lax underwriting, poor quality control and straight up greed became epidemic as Lenders fought for market share in an ever increasingly competitive market. As one who developed business from Brokers for 25 years, I clearly saw the massive shift in the business practices of Lenders succumbing to the competitive landscape and pandering to Brokers and consumers alike. As I once told my sales force, it is as if we gave the keys to the Ferrari to a teenager. The 100% commissioned originator on the street simply had too much power.
THE MORTGAGE BROKER: Were there abuses? Of course there were. A handful of unscrupulous Brokers made the whole industry look bad. Because the Broker is a small business man without the lobbying resources of say, FNMA, he is vilified by politicians and the press. Moreover, the Broker has always been seen as an unwelcome competitor to big bank originators who, despite their resentment at having to compete with this low cost producer, dealt with him nonetheless to achieve the desired market share. It is important to point out that the Mortgage Brokers and the Mortgage Lenders did not develop the lending criteria used to make loans. These came from Wall Street.
WALL STREET: Now here is a group that the press is having fun with. Bear Stearns, Lehman Brothers, Merrill Lynch to name a few. These are truly the bad guys, right? It is not so simple. Remember we had gone through a period of unprecedented low rates as discussed earlier. The Institutional Investor was becoming frustrated with low yields on fixed income securities (aka Mortgage backed securities) and asked his favorite Investment Banker for help. “Can’t you get me something with a little better yield?” The guys at Bear Stearns were more than willing to help satisfy this demand with Mortgage Backed Securities collateralized with sub-prime loans, Collateralized Debt Obligations (CDO) and Credit default swaps, which all carried the promise of higher yield but also the associated risk.
These credit derivatives known as CDOs had the effect of putting a pile of horse dung in a big vat of rose pedals. As “The Economist” put it, It was a like the “Toddler at the pool-side syndrome.” The adults attending the pool party collectively thinks the other adult is watching. When the toddler falls in, no one is watching and the kid drowns. This is what happened to credit risk. Each party to the transaction thought it was the other guy’s job to manage risk. So then, where were the regulators? What happened to the guys like S&P who are supposed to rate these securities? It is important to point out that most of these Mortgage Backed Securities carried “AAA” ratings.
REGULATORS AND RATING AGENCIES: The horse dung hidden in the rose pedals (MBS tranches – sub-prime loans mixed in with A paper loans) were rated by the rating agencies who did not understand what they were looking at because the financial innovation and sophistication was beyond them. Much of the same goes for the regulators, SEC who regulates Investment Bankers and OCC that regulates Banks. The former should have noticed the obscene leverage ratios of the Investment Banks and the latter should have looked hard at credit risk. Mr. Greenspan mentions this in his Op-Ed piece:
“It is now very clear that the levels of complexity to which market practitioners at the height of their euphoria tried to push risk-management techniques and products were too much for even the most sophisticated market players to handle properly and prudently.”
So who do we blame for the housing crash and the resulting financial meltdown? The “usual suspects” all share some blame but still there is no definitive “smoking gun.” No one entity can take the rap for the whole debacle. It seems we were all swimming in the same pool, making lots of money and forgetting about the toddler at the pool side.
If you want to find the “smoking gun”, call it globalization: the rise of capitalism in the emerging economies, the advancement of technology and good old fashion greed. Yet I would argue that despite our recent difficulties Globalization lifts everyone’s tide. But that discussion is for another day...
Watching the press trying to sort out the financial mess reminds me of my dog chasing his tail. The Press is on a mission to find the “smoking gun.” If we could only find someone to blame, someone to vilify, it would make us all feel better. I have been pondering the blame game for sometime having found myself in the middle of the hurricane working for Bear Stearns, at the time the largest issuer of what is now referred to as “toxic waste”. But like the press, I’m just chasing my own tail. The answer is elusive.
I’m reminded of the police chief in the famous movie Casablanca when he tells his subordinates to “Round up the usual suspects”. So here they are. My apologies if I have left anyone worthy of blame off the list.
CHAIRMAN GREENSPAN: The press loves to find fault with Mr. Greenspan who was the Chairman of the Federal Reserve from 1987 to 2005. His critics claim that his loose monetary policy caused the housing bubble by putting cheap money in the system.
Yet there are several problems with this theory. First, it is hard to find fault with Mr. Greenspan’s policy of releasing liquidity into the market place after the high tech bubble went bust in early 2000, and the attacks on September 11, 2001. Without the additional liquidity the economy would have fallen into a deep recession. This is particularly true in the months after September 11 when markets virtually shut down and the economy was in shock.
Second, as Mr. Greenspan points out in his Wall Street Journal Op-Ed piece earlier this month, the Federal Reserve does not regulate long term interest rates which are highly correlated to mortgage rates. In fact, long term interest rates unlike the fed funds rate are regulated by market forces; namely supply and demand. The correlation between long term rates and short term rates is no longer statistically significant.
THE CHINESE: Mr. Greenspan plainly admits the strong correlation between low mortgage rates and home price appreciation. But what caused long term rates to stay low for so long even after the Fed began to raise short term rates in early 2004? Mr. Greenspan writes: “…the presumptive cause of the world-wide decline in long-term rates was the tectonic shift in the early 1990’s by much of the developing world from heavy emphasis on central planning to increasingly dynamic, export led market competition. The result was a surge in growth in China and a large number of other emerging market economies that led to an excess of global intended savings relative to intended capital investment. That ex ante excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005.”
In other words, the Chinese flooded our domestic market with cheap goods and parked the resulting cash in long term treasury bonds, causing the longest bond rally in history. As bond prices run inverse to interest rates and Treasury Bonds are highly correlated to mortgage rates this fueled housing demand.
So then, should we blame the Chinese or the American Consumer?
THE CONSUMER: It was, after all, the American consumer who bought all that “made in China” stuff and in doing so helped (indirectly) pull down interest rates which propelled home prices. The home soon became a cash register as consumers piled on the home equity lines purchasing new cars, vacation homes and other trappings of material wealth. The average American soon believed that home prices would go up in perpetuity. People purchased homes they could not afford believing they could always sell later at a profit. When speculators arrived on the scene the market appreciation rates became surreal as the feeding frenzy began to take hold.
THE MORTGAGE LENDERS: Lax underwriting, poor quality control and straight up greed became epidemic as Lenders fought for market share in an ever increasingly competitive market. As one who developed business from Brokers for 25 years, I clearly saw the massive shift in the business practices of Lenders succumbing to the competitive landscape and pandering to Brokers and consumers alike. As I once told my sales force, it is as if we gave the keys to the Ferrari to a teenager. The 100% commissioned originator on the street simply had too much power.
THE MORTGAGE BROKER: Were there abuses? Of course there were. A handful of unscrupulous Brokers made the whole industry look bad. Because the Broker is a small business man without the lobbying resources of say, FNMA, he is vilified by politicians and the press. Moreover, the Broker has always been seen as an unwelcome competitor to big bank originators who, despite their resentment at having to compete with this low cost producer, dealt with him nonetheless to achieve the desired market share. It is important to point out that the Mortgage Brokers and the Mortgage Lenders did not develop the lending criteria used to make loans. These came from Wall Street.
WALL STREET: Now here is a group that the press is having fun with. Bear Stearns, Lehman Brothers, Merrill Lynch to name a few. These are truly the bad guys, right? It is not so simple. Remember we had gone through a period of unprecedented low rates as discussed earlier. The Institutional Investor was becoming frustrated with low yields on fixed income securities (aka Mortgage backed securities) and asked his favorite Investment Banker for help. “Can’t you get me something with a little better yield?” The guys at Bear Stearns were more than willing to help satisfy this demand with Mortgage Backed Securities collateralized with sub-prime loans, Collateralized Debt Obligations (CDO) and Credit default swaps, which all carried the promise of higher yield but also the associated risk.
These credit derivatives known as CDOs had the effect of putting a pile of horse dung in a big vat of rose pedals. As “The Economist” put it, It was a like the “Toddler at the pool-side syndrome.” The adults attending the pool party collectively thinks the other adult is watching. When the toddler falls in, no one is watching and the kid drowns. This is what happened to credit risk. Each party to the transaction thought it was the other guy’s job to manage risk. So then, where were the regulators? What happened to the guys like S&P who are supposed to rate these securities? It is important to point out that most of these Mortgage Backed Securities carried “AAA” ratings.
REGULATORS AND RATING AGENCIES: The horse dung hidden in the rose pedals (MBS tranches – sub-prime loans mixed in with A paper loans) were rated by the rating agencies who did not understand what they were looking at because the financial innovation and sophistication was beyond them. Much of the same goes for the regulators, SEC who regulates Investment Bankers and OCC that regulates Banks. The former should have noticed the obscene leverage ratios of the Investment Banks and the latter should have looked hard at credit risk. Mr. Greenspan mentions this in his Op-Ed piece:
“It is now very clear that the levels of complexity to which market practitioners at the height of their euphoria tried to push risk-management techniques and products were too much for even the most sophisticated market players to handle properly and prudently.”
So who do we blame for the housing crash and the resulting financial meltdown? The “usual suspects” all share some blame but still there is no definitive “smoking gun.” No one entity can take the rap for the whole debacle. It seems we were all swimming in the same pool, making lots of money and forgetting about the toddler at the pool side.
If you want to find the “smoking gun”, call it globalization: the rise of capitalism in the emerging economies, the advancement of technology and good old fashion greed. Yet I would argue that despite our recent difficulties Globalization lifts everyone’s tide. But that discussion is for another day...
WHY THERE IS ROOM FOR OPTIMISM
Optimism is one of my favorite words but it is hard to find these days. I had to curtail my news consumption to avoid losing mine. Yet there is room for optimism and rays of hope are beginning to emerge.
First, so we are all on the same page, let’s define the word. According to the Webster dictionary, optimism is defined as: “A doctrine that this world is the best possible world, an inclination to anticipate the best possible outcome of actions or events.”
According to Harvey Mackay in “Swim with the Sharks”, Optimism involves “self-delusion, a belief that our own abilities are superior to the obstacles that should logically overcome us.”
Anyone in the sales profession knows that “self-delusion” is the only way to steam forward in this market mess. Yet there are clear signs that being optimistic is not just “self-delusion”.
GOVERNMENT AS THE MARKET MAKER: Last week the Federal government announced its plans to buy up to $300 billion in mortgage backed securities. The immediate effect was lower mortgage rates across the board. Mortgage rates are now at an all time low making home buying possible for a greater number of would be buyers.
AFFORDABILTY INDEX: Adding to this is the affordability index for housing which is at a 17 year high. The affordability index measures how easily someone can qualify for a home. The housing correction has made it affordable for many who were shut out in the boom years.
GOVERNMENT INTERVENTION: Within a week of announcing the purchase of Mortgage Backed Securities, Treasury Secretary, Timothy Geithner announced details of his plan to marry government intervention with the private sector to help bail out banks by getting toxic waste off their balance sheets. The immediate reaction was a nearly 500 point spike in the stock market. The fifth largest point increase in history.
IRRATIONAL FEAR: It is important to point out that perception has outstripped reality when it relates to Mortgage Backed Securities. Over 70% of mortgagors that make up the collateral are paying on time. Why then are some trading at 20 cents on the dollar? Short answer: Fear. Instead of “irrational exuberance” to coin Chairman Greenspan’s now famous comment, we have “Irrational Fear” which is why Secretary Geithner’s plan makes so much sense.
FIRST TIME HOMEBUYER CREDIT: Other rays of hope include the Government’s plan to give first time homebuyers an $8,000.00 tax credit. If I were a Realtor I would be asking everyone I came in contact with, “Do you own your own home?” I find that many first time homebuyers believe they do not qualify. Like me, they have been watching too much CNN.
LENGTH OF THE RECESSION: According to economist the recession officially started in December 2007. If you look back at the past five decades the average length of a U.S. recessions was 11 months. The current recession is 15 months old. Although this one promises to be longer than average we must be approaching the end.
THE PURGE: A market correction although painful has many positive consequences. Corrections are a necessary evil in a market economy. Much like a terrific hangover, poisons must be purged from the system: market distorting speculators, unfair lending practices and unethical lenders. The “get rich quick” crowd has left our industry and only seasoned professionals remain. Moreover, consumers have learned their lesson about overspending financed with too much debt. One’s home will no longer be used as a cash register. It is fashionable once again to save money and curtail spending which in the short run hurts the economy but in the long run ensures a higher standard of living for our citizens.
When we emerge on the other side of this mess the markets will be more efficient, consumers will be smarter, lenders more prudent and owning one’s own home will once again be the American dream. So if you are a Loan Officer or Realtor, turn off your TV and get out there and create some demand for what you are selling and shake off the pessimism. There is life after the crash.
First, so we are all on the same page, let’s define the word. According to the Webster dictionary, optimism is defined as: “A doctrine that this world is the best possible world, an inclination to anticipate the best possible outcome of actions or events.”
According to Harvey Mackay in “Swim with the Sharks”, Optimism involves “self-delusion, a belief that our own abilities are superior to the obstacles that should logically overcome us.”
Anyone in the sales profession knows that “self-delusion” is the only way to steam forward in this market mess. Yet there are clear signs that being optimistic is not just “self-delusion”.
GOVERNMENT AS THE MARKET MAKER: Last week the Federal government announced its plans to buy up to $300 billion in mortgage backed securities. The immediate effect was lower mortgage rates across the board. Mortgage rates are now at an all time low making home buying possible for a greater number of would be buyers.
AFFORDABILTY INDEX: Adding to this is the affordability index for housing which is at a 17 year high. The affordability index measures how easily someone can qualify for a home. The housing correction has made it affordable for many who were shut out in the boom years.
GOVERNMENT INTERVENTION: Within a week of announcing the purchase of Mortgage Backed Securities, Treasury Secretary, Timothy Geithner announced details of his plan to marry government intervention with the private sector to help bail out banks by getting toxic waste off their balance sheets. The immediate reaction was a nearly 500 point spike in the stock market. The fifth largest point increase in history.
IRRATIONAL FEAR: It is important to point out that perception has outstripped reality when it relates to Mortgage Backed Securities. Over 70% of mortgagors that make up the collateral are paying on time. Why then are some trading at 20 cents on the dollar? Short answer: Fear. Instead of “irrational exuberance” to coin Chairman Greenspan’s now famous comment, we have “Irrational Fear” which is why Secretary Geithner’s plan makes so much sense.
FIRST TIME HOMEBUYER CREDIT: Other rays of hope include the Government’s plan to give first time homebuyers an $8,000.00 tax credit. If I were a Realtor I would be asking everyone I came in contact with, “Do you own your own home?” I find that many first time homebuyers believe they do not qualify. Like me, they have been watching too much CNN.
LENGTH OF THE RECESSION: According to economist the recession officially started in December 2007. If you look back at the past five decades the average length of a U.S. recessions was 11 months. The current recession is 15 months old. Although this one promises to be longer than average we must be approaching the end.
THE PURGE: A market correction although painful has many positive consequences. Corrections are a necessary evil in a market economy. Much like a terrific hangover, poisons must be purged from the system: market distorting speculators, unfair lending practices and unethical lenders. The “get rich quick” crowd has left our industry and only seasoned professionals remain. Moreover, consumers have learned their lesson about overspending financed with too much debt. One’s home will no longer be used as a cash register. It is fashionable once again to save money and curtail spending which in the short run hurts the economy but in the long run ensures a higher standard of living for our citizens.
When we emerge on the other side of this mess the markets will be more efficient, consumers will be smarter, lenders more prudent and owning one’s own home will once again be the American dream. So if you are a Loan Officer or Realtor, turn off your TV and get out there and create some demand for what you are selling and shake off the pessimism. There is life after the crash.
Friday, February 20, 2009
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.
“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.
Subscribe to:
Posts (Atom)
