Monday, November 8, 2010

Death by A Thousand Cuts

My brother, Stefan, who works here in my office, came in today telling me about the SAW VI movie that he rented this weekend.  He wanted to see it in advance of seeing the final SAW movie--as a young single man in his twenties he still has the stomach for the kind of blood and gore that have made the SAW franchise a hit.  He tells me that in each movie the psychotic--and yet oddly self-righteous--serial killer Jigsaw tortures and punishes a particularly evil segment of society who preys upon the weak.  Stefan tells me that SAW VI opens with a man and a woman trapped by the killer who is about to extract vengeance for their crimes against society.  This time, however, they are not violent criminals, or drug dealers; instead they are mortgage brokers who put people into houses they could not afford and then foreclosed on them when they did not make their payments.  It seems that Jigsaw turned all of his attentions to the business community in SAW VI--he also hunts down and tortures an insurance agent whose "crime" was that he denied a claim because the claimant had lied on his application for insurance. (I would be willing to bet that there will never be a SAW movie in which the killer traps and murders preachy movie producers and overpayed actors for making millions turning out low quality slasher movies, but that is another subject for another blog.)

In real life, Jigsaw would not need to waste his efforts murdering mortgage brokers--Barney Frank beat him to it.  Frank had famously promised death panels for non depository lenders, but instead he and all of his cohorts sentenced the whole industry to death by a thousand cuts, and even though the GOP won the House of Representatives last week, there is no reason to believe that the sentence will be commuted.

Cut # 1 came in the form of the Safe Act (Secure and Fair Enforcement) which required licensing and testing for mortgage brokers and loan officers working for institutions that did not take deposits. In my office we had finished all of the requirements except the credit report ordering process, which became available last week.  As I went on line to order and pay for the individual credit reports, I was once again confronted with the fundamental unfairness of the SAFE act.  Registrants (employees of banks, credit unions and other institutions which receive deposits) do not have to have a credit check, just as they did not have to take a state test and a federal test or complete 20 hours of CE.  The sad irony of the law is that many of the small business people who are left in the industry have had a lot of credit problems resulting from the steady drop in income we have all experienced the last three years.  So if a broker has filed bankruptcy, or had his credit cards charged off, he may not be able to get a license, but if an employee at a bank has had the same experience no one will ever know.

Cut # 2 was the new RESPA rule which is designed to favor banking institutions in the way that fees are disclosed.  A former client of mine came to see me last week to ask me about refinancing his house.  He had brought with him his estimate from his current servicer, along with the estimate that I had emailed him.  The bank's interest rate was .375% higher than I had quoted and the fees were almost exactly the same.  But he was confused about which was the best deal because the bank had told him that they were giving him a special "discount" for being an existing customer.  Not being in the industry, he did not understand that "discount" is just bank speak for "I am charging you a 1% fee to give you an interest rate which was too high to begin with."    The three page good faith estimate was designed to make it hard for brokers to win deals, but fortunately it is so confusing that very few borrowers can actually understand what it says, so we have a chance to defend our numbers in person.

The other 998 cuts are going to come in the form of the Federal Reserve's new rule which was published August 16 and which will become effective April 1, 2011 regarding broker compensation.  I believed from the beginning, and wrote in my post entitled "The Broker," that this rule was going to be the final death blow for what is left of our industry.  After attending a webinar last week, however, I find that this is not just one solid blow, but a series of cuts which will drain the last of the life out of the brokers who are left.

As explained to us by the law firm of Black, Mann and Graham last week, the new rule is going to effectively require that brokers have written compensation agreements with their wholesale lenders.  These agreements can be renegotiated with the consent of both parties, but they cannot vary from loan to loan.  Further, the rule absolutely prohibits the loan officers from collecting fees from both the consumer and the lender.  (The exception would be that a salaried employee of a bank could collect a commission from the consumer as well as his salary.)  In the world of the broker, the lender is ultimately responsible for whether the loan is compliant with federal laws and regulations, so if the broker sneaks out and collects a processing fee from the consumer without properly disclosing that information and then collects a fee from the lender also, the lender has funded an illegal loan.  For this reason, I believe that starting April 1, few or no wholesalers will pay the brokers any compensation for their loans.  By requiring brokers to receive all of their compensation directly from the consumers, the lenders will protect themselves, but they will also put the brokers at a significant competitive disadvantage against the large banks who can offer lower upfront closing costs since their loan officers are salaried.

The broker industry has only two real advantages over the retail banking industry--the ability to offer overall better pricing and the ability to transfer loans between lenders in the case that one lender does not accept a loan application package for a consumer.  But the new rule requires that the broker guarantee the lowest rate and lowest costs to the consumer by offering loan options containing  1. the lowest rate, 2. the lowest fees and costs.  If the broker has three lenders, he needs to present pricing options from lender A, lender B, and lender C.  If lender A has the lowest interest rate, and the lowest over all costs, and the borrower chooses that option, then presumably the broker would prepare a good faith estimate, which is now a binding contract, and send it to the borrower within three days of loan application.  But what if lender A denies the loan?  In the old days, if lender A denied the loan because the underwriter did not like it, the broker could send it to lender B, who would probably like the loan package.  If the interest rate were the same, the borrower was usually fine with the switch.  But what about under the new rules?  Under RESPA reform, changing wholesale lenders is not an acceptable reason to issue a revised good faith estimate, so if the broker cannot honor the lowest rates and or lowest fees he has guaranteed the borrower, he is going to have to deny the loan.  Now both competitive advantages--pricing and flexibility--have been wiped out.  Add to that the reputational damage that the industry has suffered, and death is soon to follow.

I researched "death by a thousand cuts" this afternoon.  Used in Imperial China from about 900 A.D. until 1905 A.D. this form of torture and execution appears to have been administered primarily to enemies of the state.  While the victim died long before the cuts reached thousands, the dismemberment of the prisoners meant that they could not be resurrected in the afterlife.  As a form of execution it symbolized permanent death and extinction--both in this world and in the next.   Even Jigsaw could not do better than that.

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