Friday, May 14, 2010

Killing Small Business

The past few days have seen the passage of two important amendments to Senate Bill 3217, the Restoring American Financial Security Act, which is currently being debated in the Senate. Both amendments have implications as they relate to small business and the availability of credit for mortgage lending.

The first amendment, the Landrieu (D LA)/Isakson (R GA) amendment, directs financial regulators to create a "qualified" category of mortgage loans which will not be subject to the 5% risk retention requirement of the bill. This is critically important because without the ability to sell mortgage loans into the secondary market, it is not possible to maintain liquidity to originate new mortgages. In simple terms, selling the loans allows the lender to free up cash to make new loans.

The second amendment is not such good news. Jeff Merkley (D OR) sponsored an amendment which was introduced after hours on Tuesday and voted through on Wednesday morning (a maneuver which was obviously intended to stymie industry lobbying efforts.) This amendment effectively caps loan originator compensation at 3% to include all lender fees and up to 1% of the insurance charged by State and Federal Entities (for example the FHA premium to which we devoted our last two posts). This is also significant, because the federal government, rather than competition and free market conditions, are regulating the compensation of individuals who work in lending. No longer will it be legal for loan originators to receive compensation based on the interest rate of the loan, unless the consumer is charged no other fees whatsoever except for third party fees such as appraisal and title insurance.

The loan does allow bonus and incentive payments to loan originators who produce volume loans.

Interestingly the wording of the amendment specifically states that nothing in the bill shall limit the compensation that the lender can make when they sell the closed loan on the secondary market. This compensation is also based on the interest rate. This is one sure and quick way for banks to shore up their reserves. The spread on interest is a function of the market, and for virtually any interest rate there is some cost or some gain. So a law which makes it illegal to share the gain with the originator allows the bank to keep the money which it can apply directly to its bottom line.

This idea of limiting compensation may sound good to many people who have heard horror stories of greedy lenders who devoured helpless victims' equity from their home loans, but in reality it is just another federal intrusion into the market place. As an active originator for the last twelve years, I can speak to the fact that competition is a better tool for getting consumers into good loans than government supervision. A good example is what has been going on this past year and a half. With interest rates at historic lows ranging from 4.5% to 5.25% on thirty year fixed rate loans, borrowers have watched the market carefully. They have looked at the internet and watched the news, so when the rates go down in a day, they hear about it. Before the new RESPA reforms went into effect, we were able to offer no origination fee loans because we got paid on the spread of the money. (We cannot do that under the new rules because all lender fees including any lender compensation through the rate must be included in the origination fee). Competition kept the costs and the interest rates reasonable for most borrowers, because they were able to shop for a lower rate. And competition forced originators to keep the interest rates they offered and the fees they charged in line with the local market. After all, who is going to take a 5.125% interest rate if all of their friends got a 4.75% and they find out they could qualify for a 4.75% as well. And while the government bemoans loan originators who overcharged, the truth is that originators who overcharged too much lost the transaction and didn't get paid at all.

Small businesses are not charitable organizations. They have high overhead, employee expenses etc. With recent rulings determining that all loan originators must be W2'd by their employers and stating that loan originators are legally entitled to overtime pay, it is increasingly difficult for the small business owner to compete. Merkley's newest amendment basically means that an originator will be able to make about 1% on a loan, if he is lucky, after he pays the lender fees and the title escrow fee, the attorney's fees and up to 1% of any federally mandated insurance. By the time he splits his portion with his employer, he will barely have the money to pay his own mortgage. All of which spells fewer people working in the industry, fewer choices for consumers, and ultimately higher prices as a multi-trillion dollar industry becomes concentrated into fewer and fewer hands.

Senate Bill 3217 is expected to pass next week, and then the House bill 4317 and the Senate version will have to be reconciled. The House version does not contain the qualified loan exemption to risk retention, so it is going to be very interesting to see how this shakes out in the end. In the meantime, those of us who heard Barney Frank's warning that he would have death panels for non-depository lenders are getting our blindfolds ready to face the firing squad.

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