Let's Raise the Hood on Mortgage Lending

[almost_there]

Let's Raise the Hood on Mortgage Lending

By David Lee Smith December 10, 2007

Like it or not, we've become a nation fixated on investigations. Congress in particular, taking its oversight role perhaps a little too seriously, has all manner of inquiries going at any given time. The most recent -- and perhaps the most questionable -- involves a look-see by a Senate committee into potentially self-serving activities by a group of half a dozen televangelists.

Fine, investigate the TV preachers if you must -- although targeting that group in hopes of unconvering some sort of income-tax or truth-in-sermonizing violations appears a little absurd for members of this purportedly august group. But what about mortgage brokers and lenders? This crew is appearing more culpable by the day for the subprime mortgage wounds that have bled over too much of our economy. That, it seems to me, is where the senators might better expend their efforts.

Another idea

Until recently, my conclusion was that the subprime infestation was simply a circumstance of cyclicality: The system had been working as it should -- that is, until home prices stopped increasing linearly, catching all manner of borrowers in bad positions when the music stopped. But a Wall Street Journal article published last week has led me to believe that there really are identifiable culprits in the subprime rot.

At this juncture, I'd be hard-pressed to state precisely where the bodies are buried in this mess. But I think we should start with an analysis of the practices of the major lenders, including, of course, Countrywide (NYSE: CFC), Washington Mutual (NYSE: WM), Wells Fargo (NYSE: WFC), and JPMorgan Chase (NYSE: JPM). And let's not forget that army of brokers who worked with the individual mortgagees. Beyond that, we should clearly take a gander at those who securitized the mortgages, including the likes of Goldman Sachs (NYSE: GS), Merrill Lynch (NYSE: MER), etc.

According to the Journal, in 2005, fully 55% of subprime mortgages that were ultimately packaged into securities to feed the voracious appetites of investors went to borrowers with scores that could have qualified them for cheaper conventional loans. In 2006, that proportion moved to 61%, nearly half again higher than it had been in the first year of the decade.

Bad form

Further, the article also contains a number of other sobering revelations:

Brokers frequently operated under compensation schemes that rewarded them for pushing borrowers toward loans carrying higher interest rates than they should have been charged.

An analysis by Fitch Ratings of 45 subprime loans that lurched into default, despite the borrowers' having credit scores that theoretically should have put them into conforming loans, indicated a prevalence of misrepresentation in the origination process.

A New Century rate sheet from last March (that was not intended for public disclosure) promised brokers a "yield spread premium" for putting borrowers into loans with interest rates above the lender's listed rates.

In an era when we're prone to regulate almost any transaction of any type between two or more parties, in most states, mortgage brokers or lenders have no obligation to steer lenders toward the mortgage that's most appropriate for them.

So, I'm admittedly in a quandary, Fools. On the one hand, I'm opposed to regulatory oversight of almost any industry. My experience has been that, when government at any level begins meddling in an area of commerce, that area is soon on the way to higher prices, lower quality, or both.

Control tower to lender

But in this case, I believe that the various sectors of the mortgage business have demonstrated in spades that they're generally unsuited for flying without control-tower supervision. Of course, although it's been conveniently forgotten, the industry was pushed by members of the administration and the preacher-investigating Congress to participate in raising home ownership toward what was considered a magic 70% level.

Beyond that, the system of subprime adjustable-rate mortgages, with the down payment often tied to piggyback loans -- such that borrowers frequently waltzed into their new homes with nary a dime of their own cash forked over -- worked well as long as home prices headed steadily higher. But as they say, all good things must come to an end, and they've clearly done so for housing.

With the idea that the system must be fixed, we first have to establish who or what went wrong. We will clearly be able to do that best by raising the investigative hood on all segments of the mortgage industry and attempting to repair what's broken. But until that's accomplished, I'd recommend that Fools give a wide berth to investments in the lenders, the homebuilders, and perhaps most areas of financial services that haven't been thoroughly fumigated.

[brokeinok]

Has anyone contacted an attorney to pursue litigation on this?

[almost_there]

Oh yes. People are lining up for litigation as we speak. As for me, my BK attorney thought he could handle my claims until I met with him and we went over the overall scope of our case. He said it was too big for him to take on and has us working through some referrals. I have yet to secure a lawyer, but I'm certainly working on it.

In a situation that is set to "make Enron look like a parking ticket" I wonder if there will be enough capable lawyers to handle all of the claims of violations Time will tell I guess.

[brokeinok]

Would the naca.net be a good place to start on this? I know that I was given sub-prime at a higher rate when I could have qualified for fixed and much lower (after learning about my CR and CIC).... wish I'd known what I know now back then, maybe then I wouldn't be scrambling to make payments on everything.

[brokeinok]

Another question, my refi was through American Equity Mortgage. Do you have any information on them in this mess?

[merkurfan]

hey OP have you spoken with Jack Prescotts office? I know your in MN just not sure where. Prescott and his son have been doing BK's for ever. Jacks a really nice guy in person. I use to service their cars

[almost_there]

No I have not, but thank you very kindly for the info. Oh, and I am located near St. Cloud.

[merkurfan]

Seems to me Prescott might have a office of there too. Jack himself does not do much any more in the firm, I think it's in his mid 80's. But his office handles most any BK situation. Also he has or at least had, a payment plan.

Update..

http://www.prescottpearson.com/

They offer free consults too

[jq26]

Has anyone contacted an attorney to pursue litigation on this?

Litigation on what? Under what cause of action? Unless your state imposes a fiduciary duty on your lender or mortgage broker, I'm not sure there is anything to be done, or rather, should be done. Every other transaction is fulfilled with one party getting the highest price they can and the purchaser getting the lowest price they can. The lender's were trying to make money for their company. And a broker is just that- they make money by middling the transaction and extracting spread.

Housing goes up 50% over 5 years and everyone is all smiles, especially those that built equity with none of their own money but the banks. Housing goes down 5% and the floodgates of litigation open. What a country.

Keep in mind, fraud is a different animal. If your broker sold you a fixed rate loan and all of a sudden it has adjustments, then they are and should be liable. If your servicer is refusing to accept payments so they can foreclose, then sue the servicer. But this wholesale blame game is ridiculous. The information is all there. The underlying premise that the system is broken is false.

[merkurfan]

I *think* our state AG and our elected idiots passed such a law in MN. I know a broker won't touch a sub prime with a 10 foot pole now that they passed some laws about mortgages in Minnesota.

[almost_there]

Another question, my refi was through American Equity Mortgage. Do you have any information on them in this mess?

I checked msfraud.org's list of "baddies" and American Equity Mortgage was NOT on the list, but just to cover your bases, I would check them out at the BBB, ripoffreport.com, and the FTC. If there are more than a handful of serious complaints I might be concerned. But otherwise, hopefully you're with a servicer that won't take advantage of you. Best of luck!

[brokeinok]

Litigation on what? Under what cause of action? Unless your state imposes a fiduciary duty on your lender or mortgage broker, I'm not sure there is anything to be done, or rather, should be done. Every other transaction is fulfilled with one party getting the highest price they can and the purchaser getting the lowest price they can. The lender's were trying to make money for their company. And a broker is just that- they make money by middling the transaction and extracting spread.

Housing goes up 50% over 5 years and everyone is all smiles, especially those that built equity with none of their own money but the banks. Housing goes down 5% and the floodgates of litigation open. What a country.

Keep in mind, fraud is a different animal. If your broker sold you a fixed rate loan and all of a sudden it has adjustments, then they are and should be liable. If your servicer is refusing to accept payments so they can foreclose, then sue the servicer. But this wholesale blame game is ridiculous. The information is all there. The underlying premise that the system is broken is false.

Litigation of fraud, for selling me a sub prime mortgage when I was qualified for your good old-fashioned fixed. For telling me that I didn't qualify when now that I've researched it, I did. That's fraud, it's deceptive trade practices and I've checked my state statutes and they do apply to this or any other type of commercial transaction.

I don't appreciate the implication that I'm asking just because I'm out to find someone to sue and get some of the "free cash" floating around. I was harmed in many ways by this.

Just a few of the things:

All I wanted was a second mortgage or an equity loan to pay some bills and do some remodeling. I was current on every other bill I had, my CC utilization was less than 40% across the board and I had over 15 years of perfect payment history, no judgements, no collections, no nothing. But at the time I didn't understand or even know about FICO scores or anything else so when they said I didn't qualify, I believed them.

They also convinced me to refi my first mortgage, get a second and get cash out rather than what I contacted them to do for me. Again, it made sense what they were saying and I believed them.

During all this, I still believed I was getting a fixed rate loan and I specifically told them I didn't want an ARM. When I got to closing, what do we have? A first with an ARM and a fixed second mortgage with a time-barred clause for refinancing. I was told it was just a temporary loan and in two years, I could do this again, get more cash out and move both mortgages to a single fixed.

Being somewhat naive and trusting that they knew what they were talking about, I went ahead and signed it. Now I have a mortgage that has adjusted twice beyond what I can afford without working two full time jobs, I'm behind on almost every bill I have and I'm locked into this because there is a monstrous penalty if I refi before the time is up.

So please, do not make assumptions about my situation or motivation when you haven't been walking around in my shoes.

[jq26]

This is my point. There are two things going on here:

Litigation of fraud, for selling me a sub prime mortgage when I was qualified for your good old-fashioned fixed.

...is totally different than:

During all this, I still believed I was getting a fixed rate loan and I specifically told them I didn't want an ARM. When I got to closing, what do we have? A first with an ARM and a fixed second mortgage with a time-barred clause for refinancing.

Claim #1 is you getting a bad bargain. You may have been harmed but people get bad bargains all the time and they're not actionable. What if you bought stock for your retirement account in 1999? Sue your broker in 2001 when it dropped by 50%? You were clearly harmed and your broker could have sold you bonds instead of stock that gained in value. I don't think so. What about when a car salesman sells you a Lexus when you have a Toyota salary and you default. Actionable because you were financially harmed? No. You signed for it and he has no duty to babysit your finances. Do we really want the sellers of products to become nannies of our finances?

Claim #2 is a bait and switch. Totally different situation as I posted before.

The larger point was there is this presumption that people are looking out for you. They are not. They work for themselves (brokers who add to par rate to extract cash) or they are loan officers who work for shareholders NOT for borrowers. They owe a duty to shareholders to get a return on their money and not to you by putting you in the best loan they can. That is, unless your state has created this duty artificially by statute.