This is the first post in a three part series that will discuss some key factors that are causing the Great Mortgage Correction, as well as some opinion on what can be done to alleviate some of the pressure on consumers and mortgage professionals.
Part 1. The Clone Age and Damaging Practices
'The sky is falling!'
While it certainly seems this way, the recent activities and news within the mortgage industry were not all that difficult to see coming. If you were among the 10% in the 90/10 rule of money and power, you would've rolled your money out of real estate and into the stock market when all 'this' was just starting to go down back in February. Hindsight is 20/10.
Anyone with a bit of insight and of experienced industry ilk had to know that the days of 2.75% 6-Month LIBOR, 4.125% 5-Year ARM's, and Option ARM's with Interest Only Payments that were more minimal than the Minimum Payment options, were not going to last. Neither were underwriting standards that were so loose, dead people got loans. Add enough fat to daily business operations that would clog a six lane freeway, and you’re going to get a mortgage arrhythmia, a silent then suddenly violent cease of activity.
As rates plummeted to historic lows, the mortgage industry's labor force swelled like Mecca during the Hajj. If you were looking for a job or were considering changing jobs, the mortgage industry promised unlimited income potential. There was so much business at one point that if you had a pulse and could speak clearly, you were hired. A common scenario had A+ borrowers refinancing from 7.5% down to 5.5%, and still allowed the mortgage jockey to make 2 points on the back and something similar on the front. 4-point loans, or '2 and 2's', were a baseline. Borrowers were elated with the 2-point drop in rate and never batted an eye at a GFE or the closing statement. There was no real sales involved, who wouldn't like to drop their monthly payment by $132 per $100,000. Who didn't like making $4000 per $100,000? It was the Clone Age; anyone could replicate Top Producers like fruit flies.
At the same time new 'lenders' jumped into the fray, inspired by the relatively new Mortgage Backed Securities market and the Wall Street money that came with it. Fund managers were looking for someplace to put money in light of the progressing equities 'recession' around 1999-2000. Bonds were in and entrepreneurs were frothing at the mouth. The big dogs couldn't process all the business, so shell companies were created to sell more products, and so The Conduit manifested itself as a part of the industry.
Greenpoint is a solid example here. For the most part all Greenpoint did was establish operation centers that sold CountryWide, Washington Mutual, and GMAC et. al. rates and programs under their name. They would underwrite the loans according to big brothers criteria, collect a smattering of fees at closing, bundle like loans up into packages and sell 'em to Wall Street for an additional service premium fee . GreenPoint the conduit was a broker to the brokers and the mortgage industry is/was made up of many of them.
From ~2000 to 2005 the fertile mortgage market was almost entirely turned over, many people went through with multiple refinances and purchases. Homes were akin to ATM's. Consumers were sold and gladly took short term mortgage products that barely squeezd them into qualification. Cheap rates equalled more house, greed and envy festered, while 'turn and burn' was the philosophy of most brokerages. As we've moved across the time line, loan officers compensation models graduated from ~30% to 50%-70% of gross revenues in hopes of retaining sales talent in the revolving door employment policy most brokerages dalt with. Headhunting was common, but the direct economic repercussions this sliding scale had on a businesses P & L were ignored.
The trends of decreasing loan volume, paying out over half of the gross revenue per loan, and trying to maintain the '2 and 2's' that were feasible in a market of rapidly declining rates became an exercise in futility in a sideways, not to mention uptrending market. When the clones started cutting average commissions back to 1 and 1, brokerages were essentially left trying to float on 30% of 50% of past gross revenues, or 15% adjusted gross minus expenses. It was a matter of time before many brokerages house of cards imploded. While attrition is expected in a down market, the pending carve out will be more than a pound of flesh.
Having personally dealt with conduits, they proved to be little more than inefficient red tape machines. They were made up of account executives, underwriters, processors, pricing departments, closing departments, and each 'team' had several layers of additional people assigned to a single loan. It wasn't uncommon to have a dozen people (additional layers of complexity) working on a single loan. You don't need a dozen people to work on a loan. This heavy overhead (again) created wafer thin margins based on volume, when volume drops, heads roll.
Conduits were well known for a practice called 'exceptions'. Exceptions amounted to a bumping up of the interest rate (or cutting pricing) on loans that just didn't quite fit underwriting parameters. Underwriting parameters became subject to such a high degree of interpretation (you could 'massage' underwriting rather easily), it seemed like every loan mandated some type of exception and thus a bump in rate. This was very frustrating when you had to go back to your borrower and explain that their rate was now a 1/4 point higher for reasons that made little logical sense, like cutting a certified appraisal by $6,000 for no good reason other than a Realtor drove by the house and that’s what he/she thought the real sales price would be. On the other hand, if a loan required a 660 credit score and the borrower only had a 652, exceptions were cool. I'd say that at least half the loans we sent through conduits required some sort of exception. In any case these exceptions were the first practices to go when the initial tightening of the underwriting screws (that are now sunk below flush) began.
So if half of a mortgage brokerages volume to a conduit required exceptions, and there are now no more exceptions, they lose 50% of a piece of otherwise normal volume (and so does the brokerage). Granted it may be less or more from brokerage to brokerage, regardless, they lost the capability to do business yet were flush with capacity. As stated, if you're piping $30M a month, thin margins can be maintained, when your not, doors close.
Supply and demand curves can move like a crushing Tsunamic wave, and so today we are at the end of the Clone Age.
Is this such a bad thing? Yes and no. Many will say it's all-good, flush the venom away, however, many good people will be forced to leave the industry too. Robert Ashby wrote an article comparing the mortgage correction to the airline industry, which seems highly plausible. In this case there won't be a bail out like continuing business in bankruptcy, it's a game of mergers and acquisitions. The industry is consolidating and The Man is cleaning up (on the) discounted paper.
History may not repeat itself, but it sure does rhyme...Twain
Part Two. Ideas to Pull The Mortgage Industry Out of The Quagmire...Quicker.
Money doesn't disappear, it just changes hands...My Dad