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Unintended consequences of regulating mortgage brokers

Posted by: Peter Coy on February 22, 2008

It’s understandable why people want to increase regulation of mortgage brokers, since many of them contributed to the housing bubble and bust by acting unscrupulously. But economics teaches us to beware of unintended consequences. New research indicates that at least one form of regulation of mortgage brokers could backfire.

The regulation in question is surety bonds or net worth requirements, which are intended to keep mortgage brokers honest by assuring that they have some skin in the game—real assets that can be taken from them if they screw up. But in a National Bureau of Economic Research working paper, Morris Kleiner of the University of Minnesota and Richard Todd of the Federal Reserve Bank say this:

In particular, we find that tighter bonding/net worth requirements are associated with fewer brokers, fewer subprime mortgages, higher foreclosure rates, and a greater percentage of high-interest-rate mortgages. Although we do not provide a full causal interpretation of these results, we take seriously the possibility that restrictive bonding requirements for mortgage brokers have unintended negative consequences for many consumers.

That’s kind of annoying. Especially because the authors don’t find much merit in other regulations. They say other ideas such as mandatory professional education “do not have a significant and consistent statistical association with market outcomes.” Translation: They don’t make much difference either way.

I see now that economist Tyler Cowen covered this on his blog Marginal Revolution.

Also, here’s a description from the National Assn. of Mortgage Brokers of the regulations its members face.

Reader Comments

Jim D

February 22, 2008 1:37 PM

Well, at least require them to have a fiduciary duty to the clients that purchase homes, as opposed to their current clients - the banks.

That one thing would help tremendously.

But yeah, it's hard to argue with the quote you give - do that in a vacuum, and you'll get that result. Add a fiduciary responsibility, and the outcome isn't so clear (though there would certainly be fewer brokers - but hey, we're headed down that road anyway).

Marcio - S. Florida

February 22, 2008 10:59 PM

It's incredible how academia completely ignores the very important role mortgage brokers play in setting up mortgages.

Their commission payout system and their job of advising consumers on what suits them best directly clash with each other.

Not only they should be liable for this discord. They should be punished for false information provided on a mortgage.

Also, their fees should be regulated, so this doesn't become a free for all.

I am sure that in S. Florida, mortgage brokers accounted for much of the subprime disaster that is going on here. I can recall when I started home shopping 3 years ago, that when you approached them (as I did several times to different companies) the only type of loan they pushed were ARM, option-ARM's and interest-only loans.

They fully benefited from the rise of prices and now are benefiting from the decline with the wave of refinancing that is going on. In the meantime, they have not been liable of punished for the widespread epidemic of liar loans in our market.

Jose Medina

February 25, 2008 1:41 PM

I agree with more regulations,most of the brokers who caused this mess,were more worried about making a comiision than worrying if it was the best deal for the client.The Mortgage Brokers still working are the ones who need to stay in this business hopefully all the bad ones will get out eventually.
originationg since 2001

Ken Cook

March 7, 2008 4:11 PM

Jose Medina - New Century was not a broker, they were a lender. Ameriquest was not a broker, the were a lender (check out all the really nice things THEY did to borrowers). Home Owner's was a lender, not a broker and not regulated by the states like every broker in the nation is and they may have been one of the worst of the worst. Allstate, Long Beach and Wells Fargo - were any of those brokers? Not one of them was a mortgage broker. All were subprime lenders with full approval and funding power.

While I do agree with your last sentence you need to be careful about saying "brokers who caused this mess" because you will end up sounding like the uneducated media and I see that you are not. Show me a broker with approval and funding authority and I'll show you a broker who may have "added to this mess".

Not one single broker has ever APPROVED a loan. All loans must be submitted to a LENDER and approved by their underwriters who (are supposed to) meticulously examine the borrower, appraisal and property.

Jim D. - any borrower who doesn't shop around gets exactly what they ask for. I do speak from a Georgia perspective where we have had the Georgia Fair Lending Act for 5 years and it does offer some protections for the ignorant or lazy in addition to crippling the intelligent and poor. Here in Georgia we're capped at 4.99% TOTAL closing fees (all settlement charges PFC) most of which do NOT come to the broker.

Although I detest regulation when education would be cheaper and more effective I do think this has made it better, for the most part, for those who refused to shop. Then again I'm one of the few who posts the rates daily on our front page and sticks to it when the people qualify. And I also never did many subprime loans.

By the way, if anyone's "fees" should be regulated then everyone's income, expenses, salary, where they live, where they shop and who the go to church with should also be regulated. Regulations only apply to the law abiding. And yes, any loan officer - whether they work at a bank or for a mortgage broker - should be punished if they made or were aware of and complicit with false statements on a mortgage application. Don't you insinuate for one second that only a mortgage broker is capable of doing so or that employees of the companies named above did not also engage in the same practice and in greater numbers.

Were their illicit brokers and loan officers who work for brokers? You bet and I am thankful they have been and are fleeing my industry. Probably the ones who have threatened me over the years for my stance on our fiduciary responsibility were among the first to go. But maybe you'll get your wish and there will only be mega-banks to deal with. Oh, that'll be nice for the economy and the borrower - monopolies always work out so well for the little guy.


March 9, 2008 10:47 PM

As a mortgage broker I think the new regulatory guidelines are great, one for the good guys finally. I was not caught up in this sub-prime mess, I am very proud to say and being FHA licensed in all 50 states allows me to assist & educate many people. I suggest that people shop around and ask questions. I have a special program for people who have ARMS that is the only qualification and I can get them into a new fixed rate loan. My office number 816-333-7400. This is a great business.

W. Heflin - Houston, TX

March 17, 2008 9:16 AM

Dear Peter Coy, Once again great analysis and research on the role of mortgage brokers in the lending process and the effects of current and proposed regulation. But, I'm afraid the public want an easy scapegoat and we're the easiest target. Here's why: First, we're the most visible. Brokers act as a non-salaried, sans benefit sales force. We have direct contact with borrowers. We have to explain the complex machine that delivers large sums of money from all over the world to the borrower - Wall Street to Main Street. The fact is that most borrowers don't have a clue where they get the money and most really don't care. They just shop around based on rate and adjustable rate mortgages were the cheapest. But, when the house gets foreclosed and the family is interviewed they blame it on the loan officer. I have never seen a borrower take responsibility and say, "I am responsible. I signed over 200 documents at closing that lasted almost 2 hours. I maxed out my credit cards buying materialistic possesions to fill my new home. I didn't get that raise I hoped I would. I had another child that placed added pressure on my financial responsibilities. I bought another new SUV that gets 13 miles to the gallon. I upgraded another 1000 square feet in my home that must be heated, cooled, and filled with new furniture. I invested in risky tech stocks and my 401k is worth less. I bought a 60" plasma television even though my old TV worked just fine. And, I never thought that I might lose my job." Instead, it's much easier to just say, "I was duped and tricked. Woe is to me and it's the broker's fault."

Secondly, if shady brokers and fraud were the cause of all the problems then it would be easy to verify. Here's how: Take the broker out of the equation. Analyze the the originators that did not use brokers. Look at the survival rate of banks and mortgage companies that used in house loan officers. Those companies should have been able to survive at a higher rate because they would have had more oversight and better trained loan officers with higher ethics. But, those originators are gone as well. Look at Countrywide. They were the biggest retail operation in the country and they had just as many foreclosures as anyone else.


April 22, 2008 4:42 PM

That sounds nice, Houston, but from my perspective, the easy target is the borrower. You know, if I live to be 85, I could conceivably have a dozen home loans over the course of my lifetime....maybe. CitiMortgage or CountryWide probably do more than that many mortgages in an HOUR. I'm sure that there are many honorable people in banking and brokering, but 'shady brokers and fraud' are extremely difficult to prosecute (so my attorney informs me). They know how to play the tricks. Brokerage firms like Apex Lending openly brag that their relationship with the lender is such that their brokers can successfully hide the YSP from the borrower by "[c]losing as a 'lender'--". Housing is not a frivilous option; everyone has to live somewhere. The market atmosphere shouldn't be permitted to become so 'wild west' that a borrower has to know as much about home financing as these companies and people who do it for a living just to have a place to live. Regulation is long overdue.


May 26, 2009 6:22 PM

I agree that there should be regulation. I went to BB & T Bank at the suggestion of Keller Williams. They put in an application for me to get a CHIP loan. I found a house and made an offer. I didn't know about shopping around for a mortgage, having never purchased a house. I did ask if I could pay in 15 yrs because I wanted a fifteen yr mortgage, which I can afford. I don't have a much credit history, so they only put in the application for CHIP, which I would have to pay higher interest rates on, but I was led to believe it could be paid the same as if I had a fifteen year mortgage. Chip is only available in 30 year mortgages. My agent filled out the paperwork and added contingencies regarding the sales contract. All the while I was waiting to get something from the bank with details about the loan, but I never did. They tried to push the closing up three weeks, but I said no. I had to ask several times to see the paperwork ahead of time, and finally insist upon it. I finally got it a week prior to closing and when I read the terms, it was completely unacceptable. I was then evaded when I asked what is the normal procedure when a buyer does not agree with the terms. The lawyers who drew up the closing papers (I guess, no one would say-only that they are standard for TN) finally said they could not give me legal advice! All this time I had been led to believe they were there for me-I even asked if I should get a paralegal or something, all for me, to go over the paperwork because I was afraid I wouldn't understand it. I was relieved that the paperwork was so blatantly obvious in it's unfairness. They also did not give me ALL of the documents, which I had requested-several times. What I did get was filled with mistakes. During the months leading to the closing date I'd still been looking around in case I didn't get the loan or the loan was not something I would be interested in. Because I had never seen the documents/terms I never felt that it was a done deal, which my real estate agent was aware of. At some point she should have told me that the offer I made was binding, regardless of what the loan said. That's what they are telling me. I told them I would not sign the paperwork. It's full of mistakes, blanks, AND the loan was misrepresented to me at the start. All of a sudden these people were not so helpful at all, anymore. I had never been the one rushing and in fact had expected to still be looking for a house throughout the summer. I was committed to buying the house I offered on 100%, but I didn't have my heart set on it because I had not yet gotten the details regarding the loan.
My explicit questions to the lawyers office, who my real estate agent had said were around for a long time and knew what they were doing, were giving me the runaround in email after email. (and told my agent to tell me to call them because they could 'explain it easier over the phone' and to that I said no, not if this is going to possibly end up in court.)
Finally, I re-emailed a question to the lawyers office and copied it to a lawyer I know. This is when the Lawyer's office responded with the "we can't give you legal advice, we're here first and foremost to protect the bank." I had thought they were MY lawyers! I asked if the terms were negotiable and was ignored until they told me at two minutes to closing that the terms were not negotiable. I had asked my agent nearly a month before for an extension, and then again a week before, and then all during that week. She advised me not to ask for one. Two days before closing I asked again and said I would not sign the closing documents that stripped me of all my rights, which I was supposed to waive, and granted the lender power of attorney to change, amend, ad and initial in my absence without notification. (this is the paperwork I was assured it was not necessary to read, that the lawyers would explain everything at closing.) I asked the broker if she had read the paperwork but she never answered THAT email like she did my others. She never answered the one where I asked what do I do if I won't take this loan? My agent told me, the final time I asked about an extension so that I could find a different loan, that the seller was contacting an attorney and they wanted me to forfeit my earnest money where they had added "other" as the reason: buyer is not satisfied with the loan. I said I will not sign that because it makes me look fickle. I will write every thing I had said, including the things I read from fed guidelines and from HUD to watch out for as Red Flags that were happening. No response. Saturday I get a letter form a lawyer that says my contract of sale (which I had been thinking of as an 'offer') does not allow for me to not be satisfied with the terms of the loan and the seller intends to seek damages x's 3, AND another lawyer informing me Keller Williams is going to file an interpleader.
Because no one would answer any of my questions, including one asking my agent if she ever added a 'back out' clause regarding loan terms or if it was customary to pay a fee to allow for the seller to walk away for any reason. I would gladly have paid, because I am all about protecting myself and my financial future so that my daughter, now seven, doesn't have to put up with wacky landlords like I have for 20 years. Her father died last August, so it is really important to me she be set.
I paid both inspections 500.00, and earnest money, another 500.00. It isn't like I'd have said I can't pay the walk away contingency-I took the agents advice on all the contingencies she recommended.
I'm not a stupid person, but I did rely on my agent to be aware of contingencies as I am not familiar with real estate deals. Ask me landlord-tenant law and I gauruntee I can hold me own against any lawyer in town, but I don't know property. That's why I had an agent, I thought. Should she not have informed me, while I was still asking her about other properties, that I was absolutely locked in? I still can't figure out when I was supposed to see the details of the terms of the loan. I did try to research it on my own, at home, but never found Chip info. I had been expecting a letter with details/confirmation. That's what I thought was supposed to make the deal official. How could anyone have expected me to go and sign away 30 years, hand over five grand cash, and commit to 207,000.00 without reading the paperwork? Which amounted to being worse off than renting from the genteel slumlord who owns all the giant, beautiful but rotting houses in town, acts sociopathic, and is inexplicably accountable for almost nothing. However with him I have more rights than this loan paperwork allowed for!
I had to figure out on my own that the contingency is often already in the contract of sale which allows for the buyer to walk away. If I hadn't been throughly suckered by my landlord, I'd never have known to even look for or question those documents. I'm still not sure what my rights are.

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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