Bum rap for mortgage brokers

When things go wrong, its human nature to place accountability for the event somewhere else, preferably at a distance. Our organized compartmental minds are not comfortable with the simple rational that “stuff happens.” It’s an unnerving thought to think that we cannot control our environment. We are more comfortable by endlessly investigating the possibilities that caused the ill occurrence and then focusing our attention in the direction of a single source that we can hold accountable. This insures that the event or occurrence will never befall us again. It’s a comforting thought.

The meltdown in the real estate market is an example. We want to know who or what was responsible, discover how and pass laws to insure that it will never happen again. One industry group that has been receiving most of the attention for their part in deflating the housing balloon is the mortgage brokers. They have been attributed for declining property values, increasing foreclosures and the worst housing recession in 20 years. Is it fair that one group of industry professionals take the blame?

The federal government has been holding hearings and conducting investigations on the mortgage mess to discover who to pin the tail on (an old children’s game, “Pin The Tail On The Donkey”, now played by members of Congress). Many large national lenders have been testifying before Congress that mortgage brokers duped them into making home loans to unqualified borrowers.

In response to the poor duped lenders, Congress is considering the passage of the Mortgage Reform and Anti-Predatory Landing Act of 2007. Mortgage brokers call the bill the anti-broker bill and if passed in its current form will severely restrict mortgage brokers from originating mortgage loans. The first thing the bill does is to exempt all federal depositories (banks or their mortgage affiliates) from the new legislation. The bill would make all easy qualifying loans to borrowers, not so easy. The legislation creates “minimum standards” which includes a provision that no residential loans will be made without documented proof of credit worthiness. Goodbye “stated income” and “easy documented” loans popular among self-employed borrowers.

The bill also requires applicants for adjustable rate or interest only loans originated by mortgage brokers (remember lenders are exempt from the legislation) must be qualified at the fully indexed rate. This eliminates the attractiveness of adjustable rates loans. Brokers must also maintain a $100,000 net worth to originate loans, be registered in a national database and any indirect compensation from a lender in the form of rebates or yield spread premiums are prohibited.


The smack-down continues. Democratic presidential frontrunner, Hillary Clinton, in a speech in Derry, New Hampshire and reported by MSNBC, called for penalties against mortgage brokers who engage in predatory lending. She said she would introduce legislation targeting “fly-by-night mortgage lenders (not having a net worth of $100,000) who make really seductive offers.” Clinton also proposed mandatory impound accounts by banning contracts that “trap borrowers in unworkable mortgage scenarios in which nothing is budgeted for taxes and insurance.” Mortgage brokers are not without some responsibility for our current correction but a little perspective is in order.

Imagine for a minute, you are the head of a large national bank in 2002. Wall Street investors are seeking higher returns than available in the stock or bond market. Interest rates are at historical low levels. There is a high demand for housing. You want to increase your loan originations and come up with some creative loan programs that include no down payments and no or easy qualifying. To implement your creative loan programs, you increase your advertising, hire telemarketers and offer financial incentives to loan brokers if they will bring their borrowers to you. Through your bank, the loans are underwritten, funded and sold off to Wall Street investors. You receive a big fat bonus at Christmas for your marketing prowess. If and when the market changes and a few borrowers or investors get hurt, you can always blame the mortgage broker.

Mortgage brokers did not think up the slick, high-risk loan programs implemented over the last few years but they are now taking all the flack for the results. These programs were conceived, promoted, underwritten and funded by large national lenders and then sold to Wall Street investors. Now some big banks see an opportunity to eliminate their competition by having Congress regulate the mortgage broker out of existence. National banks have always had a love/hate relationship with mortgage brokers who have greater success at loan originations despite their smaller size, money and influence.

Mortgage brokers are already regulated by both state and federal agencies while most national lenders are exempt from any state licensing requirements. The National Association of Mortgage Brokers maintains that mortgage brokers and bank loan originators should be treated equally. I agree, lenders came up with these goofy loan programs. It’s unfair to now say that everything would be just fine if the brokers hadn’t messed it all up.

Is the worst over?

The trauma of foreclosure or impending foreclosure has hit home for nearly 1.4 million homeowners so far this year, maintaining the nearly 91 percent year to date increase versus the last year. That’s according to the latest numbers from California-based ForeclosureS.com, which has been analyzing and publishing real estate and foreclosure data for more than 15 years.

For the month of October nationwide 54,418 REO (Real Estate Owned by lenders, newly foreclosed homes) filings were reported to ForeclosureS.com (up nearly 24 percent over the 43,941 September filings). A total of 128,019 pre-foreclosure filings were reported for October (up nearly 31 percent over 97,984 September’s filings).

These are grim numbers for the hundreds of thousands of homeowners trapped by rising mortgage payments, stagnant home prices, and tightened credit markets. “But all is not gloom,” says Alexis McGee, president of ForeclosureS.com.
“However, remember that in September nationwide both REO filings (43,941 versus 55,952) and pre-foreclosures filings (97,984 versus 117,694) were down over August (16.75 percent and 21.47 percent respectively). When you average September and October filings, you find that pre-foreclosure filings have actually leveled off (down 4 percent) since August (113,001 current versus 117,694 August) and REO’s have actually dropped significantly (down 12 percent) from the high August filings (49,179 current versus 55,952 August).”

“Although tens of thousands of other homeowners are `in foreclosure' most have not lost their home to foreclosure, as they have found solutions to their mortgage woes, ranging from workouts through lenders or other private and public organizations to rising home prices that make refinancing and home sales plausible, and growing local and national economies,” adds McGee.

Just last week, the U.S. Commerce Department reported the nation’s economy grew at a faster than expected 3.9 percent in the third quarter. Combine that with the 3.8 percent second-quarter GDP, and our economy is experiencing the strongest national growth rate in four years. And the Labor Department just reported that the economy turned out 166,000 new jobs in October vs. the 80,000 consensus forecasted. All that has happened under the cloud of the subprime mortgage industry meltdown!” No matter the hype you hear the pattern of foreclosure and pre-foreclosure filings that climb month in and month out in every state has been broken, says McGee. “Overall national foreclosure-related numbers may sound high, but the 91 percent year over year increase is in relation to historic base lows. In addition, every month there’s a bit of good news on the foreclosure front. Individual states and regions are reporting flat or dropping numbers of foreclosure and pre-foreclosure filings. That’s sometimes a tough-to-see reality amid what can be overwhelming numbers. For some areas the worst of the foreclosure crisis could be over.”

What about Larry?

I have been ordering appraisals from Larry for the last ten years. Larry is a licensed appraiser and a member of the Appraisal Institute. Last week I called him to discuss a home’s value. A former client is refinancing an existing loan and was concerned that his property may not appraise high enough to allow the refinance.

“Hi Larry, have you had a chance to review the numbers on the Jenkins property? They really need $450,000 or they can’t do the loan.” “No problem Ken, it’s a stretch but I think I can hit their number.” “Thanks Larry, I own you one. I’ll buy lunch next Friday.” Did I break the new law against influencing appraisers?

Earlier this month, Governor Schwarzenegger signed into law SB 223 making it illegal to pressure appraisers to arrive at a predetermined property value that's been set by mortgage brokers or homeowners to ensure a sale or refinance goes through. The new law makes it illegal for a licensed appraiser to engage in "any appraisal activity in connection with the purchase, sale, transfer, financing, or development of real property if his or her compensation is dependent on or affected by the value conclusion generated by the appraisal."

Some housing experts believe that inflated appraisals have significantly contributed to the mortgage-meltdown crisis. The law is supposed to deter interested parties from putting pressure on the appraiser to reach a predetermined value on the property. The new law makes violators subject to punishment of license suspension or revocation with the potential of civil action.

The state isn’t alone in passing legislation designed to safeguard an appraiser’s independence. Congress is getting into the act. Under consideration is HR 3837, entitled the Escrow, Appraisal and Mortgage Servicing Improvements Act. If enacted, the bill would prohibit interference by loan originators in appraisals. The bill will ban all forms of “compensation, coercion, extortion, collusion, instruction, inducement, bribing or intimidation for the purpose of causing the appraisal value assigned to the property to be based on any fact other than the independent judgment of the appraiser.” The bill prohibits efforts to force appraisers “to hit a targeted value.”

The new appraisal protection law puts on the books what has always been understood between ethical professionals. Current standards of practice already prohibit an appraiser from accepting compensation based upon a predetermined value. The law’s enforcement will be difficult. Unethical behavior between two consenting adults is seldom made public. I don’t think you can regulate bad people. Bad people ignore the laws and bend the rules regardless of additional regulations. Who defines the degree of pressure put upon an appraiser? If before ordering an appraisal, I discuss my opinion of the property’s value with the appraiser using persuasive language, (please, please) have I committed a crime?

Lawmakers are over simplifying the problem if they believe the current market correction is the result of widespread collusion between lenders and appraisers on property values. Although there will always be unethical behavior, over-valued appraisals were a rare occurrence even at the peak of the market in 2005. The few that have been discovered are sensationalized. The high demand for homes drove inflated property values at such an accelerated pace it was difficult to know how high was too high. It all seems surreal two years later.

An appraisal is an art not a science. It’s one individual opinion of value and therefore subject to interpretation. The appraiser’s opinion of value is reflected in the appraisal report but it is always subject to further reviews and scrutiny. The lender’s underwriter always reviews the appraisal for accuracy and many jumbo or subprime loans are further reviewed by an in-house review appraiser or outside appraisal service. The buyer and the selling agent should always request a copy of the appraisal from the lender and have no hesitancy in asking questions about how the value was determined. Recently, I acted as an expert witness in a contested property settlement. The court reviewed four appraisals all completed within the past six months. Not only were they all different but the gap between the highest and lowest was over $100,000. In that case the judge had the final say on value.

As long as the financial success of an appraiser is directly linked to the mortgage broker’s success in closing loans, there will be the potential of influence and “hitting the number.” Despite the law’s intent, an appraiser who consistently appraises property values below the negotiated purchase price, therefore derailing the deal, need not be concerned about being overworked in the future.One way of preventing undo influence on an appraiser is to rework the appraisal ordering process. Currently, most appraisals are ordered by mortgage lenders, based upon a personal relationship. Removing the personal relationship may result in more objective opinions of value. Cal-Vet has a different approach to the appraisal ordering process. The mortgage broker does not order the appraisal. Cal-Vet orders the appraisal from an approved rotating list. I suspect that some large lenders may try the clearinghouse approach to ordering an appraisal thereby removing the mortgage professional from the entire process. But why stop there? Who’s next on the list for a listing? What bank is in line for the next loan? Good appraisers don’t need additional regulations to tell them how to do their job and bad ones won’t care.

Weekly economic news

There was little to dislike about last week's tsunami of economic news. First, little of it was housing focused (which, unfortunately, is usually a good thing these days). Second, it was all generally positive.

Economic growth in the U.S. unexpectedly accelerated in the third quarter, powering ahead to an annual rate of 3.9%, the highest in a year. The rate baffled most experts, who were sure the economy was barreling toward a recession because of the tumult in the mortgage and housing markets and commercial-borrowing costs that jumped to six-year highs. I just love it when the economic experts are so wrong.

Just as important, the economic growth appears to be of the good inflation-friendly variety. Indeed, American employers added almost twice as many jobs as forecast in October. In addition hourly wages rose 0.2%, on average to $17.58 in October.
Recent good news on the inflation front allowed the Federal Reserve to lower its influential federal funds rate to 4.5% (which, to be candid, was universally expected).

Good news on inflation also translated to good news on mortgages. Prime rates are now trading at levels unseen in six months. According to Freddie Mac's weekly survey, the 30-year fixed rate loan averaged 6.26%, the 15-year fixed-rated loan averaged 5.91%, while the five-year Treasury-indexed hybrid adjustable-rate loan averaged 5.98% for the week. Points ranged between 0.4 and 0.6.

Naturally with all the good economic news, consumer confidence fell to its lowest level since October of 2005 along with a big sell-off of stocks last Thursday. Although the third quarter gain in real gross domestic product (GDP) of 3.9 percent was stronger than market forecasts, the housing market has subtracted from GDP growth over the past twenty-one months. In its most recent policy announcement, the Federal Open Market Committee noted that the rate of expansion in the economy will most likely slow in the near term, due in part to a reflection of the intensity of the housing correction.

Excess Inventory drives prices down

You have probably noticed that there is a lot of homes with a “For Sale” sign in their front yard. Homebuyers have the largest selection of locations, styles and price ranges available in years but only a few are taking advantage of our “buyers market.” What’s up with that?

It seams that the more properties for sale, the fewer sales are taking place. Excess inventory of anything will drive down prices. Buyers have no sense of urgency, believing that if they hold off, home values will drop further. They could be right? Or not.

A 6-month supply of homes fro sale is considered a normal market by housing experts. Over a 6-month supply and it is a buyers market. Less than 6-moths a sellers. In 1995 Sacramento County had a 16-month supply of homes available for sale. Today Sac. has about a year’s supply of unsold homes. In 1996 the unsold index dropped quickly to just below 8-months and kept falling to its lowest point in 2003 at under 2-months. Each month that inventory fell prices climbed. It was a quick turnaround that surprised many. This is my fourth market correction in 35 years of practice. (I received my real estate license at age 12.) If history is any indicator of future performance, no one can predict when our excess housing inventory will decline but we can rest assured that it will.

That was then......

With all of this bad news on the California real estate market, you would think that most sellers got the memo that things have changed. Apparently, there are still some sellers who think it is still 2005, and that none of these things effect them. So here are some examples about how things have changed since that 2005 market. Maybe some sellers will get a clue.

Then: Hoping for multiple offers on your home Now: Hoping for multiple showings (i.e., more than one) a month

Then: Buyers writing cute, heart wrenching letters about how badly they want the house Now: Sellers writing desperate, heart wrenching letters to potential buyers hoping they buy the house
Then: Listing agents putting a “Coming Soon” sign rider as soon as the sign goes up Now: Listing agents putting a “Price Reduced” sign rider on as soon as the sign goes up

Then: Sellers informing buyers that they will look at all offers a week from Tuesday at 4:00 PM Now: The lender informing the sellers that their home will be sold a week from Tuesday at 4:00 on the courthouse steps

Then: Smug Realtors telling someone who works at Starbucks that they don’t make enough to qualify to buy a home Now: Desperate Realtors working at Starbucks learning that they don’t make enough to refi out of their option ARM

Then: Sellers worried when their home is on the market for more than 5 days Now: Sellers relieved that their home was only on the market for 5 months

Then: 30 year old homes with green shag carpeting and harvest gold appliances are “retro cool” Now: 30 year old homes with green shag carpeting and harvest gold appliances are Expired Listings

Then: Sellers want to interview 3 top producing realtors to list their home Now: Sellers have a
hard time finding 3 top producing realtors

Then: Homeowners using their home like an ATM Now: Homeowners realizing their home is overdrawn

Then: Appraisers doing drive by appraisals, not even bothering to go inside the house since values are going up Now: Appraisers doing drive by appraisals and not going inside the house because they want to avoid getting beat up by angry, unhappy sellers

Then: Buyers buying houses “as is”, with minimal to no inspections Now: Buyers getting 27 inspections, including soil samples, air samples, written interviews with neighbors, deposition style interrogation of sellers over the disclosures, satellite images (from multiple angles at different times of day), and a comprehensive inspection from that hyper guy on Extreme Home Makeover

Then: Buyers having a minister or family priest bless the house after they close Now: Sellers having a minster or family priest perform an exorcism on the house after it has sat on the market for 8 months.