Tuesday, May 4, 2010

Death Panels for Small Business Owners? Part II

Various professionals in the mortgage industry have debated exactly what Congressman Barney Frank (D. MA) meant in his remarks in September 2009 (which can be viewed on YouTube or by logging on to Zillow.com and clicking onto the mortgage tab) when he stated that "There will be death panels enacted by this Congress, but they will be for non bank financial institutions that will not be considered too big to die."

Almost immediately after Frank made those statements, internet blogs began buzzing with interpretations of his remarks. Which non-depository institutions does he mean? Is he referring to Wall Street hedge funds? Is he referring to insurance companies who are involved in commercial and residential lending? Or does he refer to the small business owner who struggles daily to earn a living for his family? A large part of the text of Frank's new bill HR 4173, which passed the House in December and has now gone on to the Senate for debate, is devoted to dissolution. But whom does he intend to dissolve?

I would submit that the correct answer is "all of the above." To put Frank's remarks in context, it is important to understand that more than one financial reform bill passed the House of Representatives last year and went on to the Senate Banking Committee. Frank's bill, which is over 1700 pages, passed in December, but a smaller bill of only 227 pages (HR 1728) sponsored by Representative Bradley Miller (D. NC) passed last May. These bills have been sitting in the Senate Banking Committee waiting for debate to begin on the Senate's version of Financial Reform. This process was obviously held up for a while as the Senate debated Health Care Reform, but now that Health Care Reform is passed, the Senate can focus on all of the proposals and the bills dealing with financial reform.

The Miller bill is easier to navigate than Frank's bill, since it is so much smaller, and the anti-small business tone of the bill is clear. This bill has a credit risk retention clause for non-qualified mortgages, which is basically any mortgage other than a fixed rate mortgage. The originator must retain 5% of the mortgage when it is sold. The theory behind this verbage is that if the originator has "skin in the game," he will be likelier to make sure to adhere to proper underwriting standards.

The reality is quite different though. On a loan of $200,000.00, the 5% retention would be equal to $10,000.00. If the originator did 10 loans at $200,000.00, he would need to maintain a $100,000 interest in the loans. A small broker or a small correspondent lender (a broker generally sells the loan to an investor, whereas a correspondent may have a line of credit to fund the loan under his company's name and then sell it to an investor) does not have this kind of money. So this type of legislation immediately makes it impossible for the small independent to offer such loan choices.

Legislation such as this may sound good on the surface, because it restricts access to riskier loan products, but at the same time it limits consumer choice. Adjustable rate loan products are not a particularly good option for borrowers when rates are low as they have been for the past year and a half, but when rates rise as they are expected to begin doing this summer, an adjustable rate fixed for five or ten years can allow the borrower to go into a lower rate which will permit him to buy a house with a lower payment and live in it until the rates improve. Adjustable rate products are more attractive in a higher interest rate environment, and the exclusive ability to offer them gives a strong competitive advantage to larger players. Restricting access to these products limits the ability of a well-informed consumer to shop for a loan which makes sense for him.

Several years ago, I worked with a borrower from California who was buying a second home in Texas. He made all purchases on interest only ARMS (adjustable rate mortgages). I tried to get him to consider a fixed rate mortgage, but he absolutely refused. His financial advisor, whom he trusted completely, had told him that he should never own any real estate. My borrower was very wealthy--he was a successful business owner with great credit and he had chosen to manage his real estate portfolio through interest only ARMS. I complied with his wishes and financed the house on an ARM. Three years later, his ARM was about to adjust,and he called me to refinance it. This was late 2007, and fixed rates were low. This time, I really pleaded with him to do a fixed rate loan rather than an interest only arm. I pointed out that the fixed rate was 5.875%, which was the same rate as the ARM. I also pointed out that no one could predict what was going happen to fixed rates, and that if we refinanced into a thirty year fixed rate he would never need to refinance again. Once more, he adamantly refused. In the end, I once again refinanced him into an interest only ARM. I did not agree with his decision, but the final decision was HIS, not mine. This was his property, which he chose and paid for with his money, and he chose the financing he wanted. That's a big part of what free enterprise and freedom of choice is about--allowing people to make informed decisions regarding their property, their finances and their futures and respecting those decisions. Each new piece of regulation chips away at that freedom of choice.

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