Say Goodnight to The Bad Guy
The mortgage and real estate meltdown is becoming apocalyptic in size and influence. An annihilation of the U.S. economy is a very real possibility. The pain is spreading globally as well. As bad as it is and it is very bad, the worst is yet to come. If you doubt me, just think about this. Congress has mobilized to “fix” the problem.
When faced with a dilemma as foreboding as this one, placing blame is a must. Even if you blame the wrong guy, that’s okay as you must blame someone; anyone. Of course this task accomplishes nothing and wastes valuable time and resources. None the less, it feels good and gives the appearance the problem is being dealt with.
True to form, our political leaders and the media have taken up the blame task. Congress and the media are well on their way to effectively dealing with the problem as they have designated their “bad guy”. It’s the mortgage broker.
Warning: There is very offensive language in the clip.
Say Goodnight to the Bad Guy
In an industry cast with many players, from the borrower to the investors buying mortgage paper, the political and media elite would have you believe the bad guy is one of the middle men in the industry. A middle man who is responsible for roughly half of all mortgage originations.
It matters not that this middle man has nothing to do with the flawed design of the products or their final disposition in some investment fund. The mortgage broker is the culprit. After all the media says so and Congress has them in their cross-hairs.
What is obvious to me is that Congress and the media is wrong, dead wrong. Sure brokers share some responsibility for the current economic dilemma. However it’s not to the extent the political and media elite would like you to believe. So let’s take a look at all of the players and try to determine who bears the most blame.
Here is the cast of players in the mortgage industry…
- The Borrowers
- The Originators (both brokers and lenders)
- The Lenders (in the roll of underwriting and pooling mortgages)
- The Investment Firms (responsible for converting mortgages into investment securities)
- The Investors
- The Ratings Agencies (responsible for rating the risk of securities)
How it all works…
Here is how the industry operates in a nutshell. Borrowers seek to borrow money, they contact an originator which can be a broker or lender. The originator will make a loan offering based upon the borrowers characteristics and the lenders guidelines or rules. The lender ultimately decides if the borrower gets the loan. The lender makes the rules that borrowers and originators must follow.
The lender’s rules or guidelines are based upon the requirements set forth by the investment firms. In order for lenders to operate efficiently, they must be able to sell their loans to investment firms to free up money to lend yet again.
Lenders do not lend if the investment firms aren’t buying the mortgage paper. In essence, final loan decisions by the lender are based upon the investment firm’s rules and guidelines. Yes lenders have a higher source to answer to.
The investment firms set their rules for buying the mortgage paper. They must assess the risk characteristics of the loans involved. They categorize and pool up the mortgages based upon the risk factors of the loans. After assessing and bundling up the mortgages, they sell the final investment vehicle to investors usually consisting of large institutions.
Investors rely on the ratings agencies to properly assess the risk elements of these mortgage securities. Additionally, both the institutional investors and selling investment firms alike, have risk management departments whose job it is to determine the risk aspects and suitability of the mortgage investments.
They are the watch dogs. Their job is too make sure the investments in question do not have excessive risk characteristics.
Fast forward to the mortgage meltdown of 2007
Due to an unprecedented number of loan defaults, investment firms are no longer buying any mortgages except those of the highest credit quality. The defaults are due to borrowers agreeing to mortgages with escalating payments they can no longer meet.
Lenders gave these loans to borrowers without the borrower having strong credit histories and in many cases, the proof of the capacity to repay the loan. The lenders also didn’t require that the borrower have capital at stake in these transactions. The lenders financed 100% of the purchases. All the while, the investment firms and ratings agencies were giving the lenders their blessings.
The end result of the loan defaults is a historic number of foreclosures pushing down the price of real estate to dangerous levels. Furthermore, now that investment firms aren’t buying but the best of paper, the lenders have drastically scaled back their loan offerings.
Borrowers needing to refinance out of mortgages they no longer can afford cannot do so because their home values are less than their loan balances and lenders are not offering the necessary products. This just causes the meltdown to get worse, in essence feeding upon itself.
Adding to the downward spiral is the fact many of these troublesome mortgages are yet to upwardly adjust their payments. Meaning there will be even more borrowers faced with not be able to afford their payments and ultimately defaulting. Of course these future defaults will lead to more decreases in the value of real estate and the personal wealth of millions of Americans.
With all of this unfolding, it is plain to see that without investment firms buying and trusting the integrity of mortgage securities, the mortgage industry doesn’t exist.
Unless the system of turning mortgages into investment securities is fixed, we are looking at years of financial and economic pain. Perhaps the total destruction of the American economy.
All right already, who is to blame?
The problem is that borrowers were given improper loans for their circumstances and are unable to repay these loans. Originators could not offer these loans unless lenders were willing to make them. Lenders would not make these loans unless investment firms were willing to buy them. The investment firms and their clients, the buyers of the investments, would not be involved with the mortgage investments unless the rating agencies and risk departments gave these mortgages their stamp of approval.
It’s rather plain to see who is not to take the most blame. That being the borrower, the broker and the lender. They are merely middle men operating according to rules that are ultimately set by the investment firms. The investment firms ultimately make decisions based upon the rating agencies and risk management departments.
That being so, the sleeping sentinels turn out to be the rating agencies and risk departments. Based on their erroneous stamp of approval, investment firms made seriously deficient decisions that effected every player in the industry including the consumer.
The mortgage securities causing all of the woes of today are exactly the same as they were two, three and four years ago. Now it’s come to light just how wrong these self policing entities were and we are just beginning to pay the price for their mistakes.
The bad guys are the rating agencies and the risk management departments.
Having a basic knowledge of the workings of the mortgage industry, it’s plain to see that the political and media elite are wrong in blaming the mortgage brokerage community for the current economic crisis.
Instead of directly addressing the most important and primary problem, which is mortgage securitization, Congress is focusing on the middleman, the broker. They stand ready to legislate more laws and regulations on an already overly regulated industry. The end result will be mortgage brokers going out of business leaving consumers with less choices and more expensive ones at that.
Meanwhile the mortgage securitization machine is broken and no one is paying attention. As long as the machine is broken, the mortgage and real estate industries cannot be repaired. The pain and the crisis will continue while our political, media and business elite are focused on minutia.
So say goodnight to this bad guy. There’s a bad guy coming through, you better get outta the way…
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