Various professionals in the mortgage industry have debated exactly what Congressman Barney Frank (D. MA) meant in his remarks in September 2009 (which can be viewed on YouTube or by logging on to Zillow.com and clicking onto the mortgage tab) when he stated that "There will be death panels enacted by this Congress, but they will be for non bank financial institutions that will not be considered too big to die."
Almost immediately after Frank made those statements, internet blogs began buzzing with interpretations of his remarks. Which non-depository institutions does he mean? Is he referring to Wall Street hedge funds? Is he referring to insurance companies who are involved in commercial and residential lending? Or does he refer to the small business owner who struggles daily to earn a living for his family? A large part of the text of Frank's new bill HR 4173, which passed the House in December and has now gone on to the Senate for debate, is devoted to dissolution. But whom does he intend to dissolve?
I would submit that the correct answer is "all of the above." To put Frank's remarks in context, it is important to understand that more than one financial reform bill passed the House of Representatives last year and went on to the Senate Banking Committee. Frank's bill, which is over 1700 pages, passed in December, but a smaller bill of only 227 pages (HR 1728) sponsored by Representative Bradley Miller (D. NC) passed last May. These bills have been sitting in the Senate Banking Committee waiting for debate to begin on the Senate's version of Financial Reform. This process was obviously held up for a while as the Senate debated Health Care Reform, but now that Health Care Reform is passed, the Senate can focus on all of the proposals and the bills dealing with financial reform.
The Miller bill is easier to navigate than Frank's bill, since it is so much smaller, and the anti-small business tone of the bill is clear. This bill has a credit risk retention clause for non-qualified mortgages, which is basically any mortgage other than a fixed rate mortgage. The originator must retain 5% of the mortgage when it is sold. The theory behind this verbage is that if the originator has "skin in the game," he will be likelier to make sure to adhere to proper underwriting standards.
The reality is quite different though. On a loan of $200,000.00, the 5% retention would be equal to $10,000.00. If the originator did 10 loans at $200,000.00, he would need to maintain a $100,000 interest in the loans. A small broker or a small correspondent lender (a broker generally sells the loan to an investor, whereas a correspondent may have a line of credit to fund the loan under his company's name and then sell it to an investor) does not have this kind of money. So this type of legislation immediately makes it impossible for the small independent to offer such loan choices.
Legislation such as this may sound good on the surface, because it restricts access to riskier loan products, but at the same time it limits consumer choice. Adjustable rate loan products are not a particularly good option for borrowers when rates are low as they have been for the past year and a half, but when rates rise as they are expected to begin doing this summer, an adjustable rate fixed for five or ten years can allow the borrower to go into a lower rate which will permit him to buy a house with a lower payment and live in it until the rates improve. Adjustable rate products are more attractive in a higher interest rate environment, and the exclusive ability to offer them gives a strong competitive advantage to larger players. Restricting access to these products limits the ability of a well-informed consumer to shop for a loan which makes sense for him.
Several years ago, I worked with a borrower from California who was buying a second home in Texas. He made all purchases on interest only ARMS (adjustable rate mortgages). I tried to get him to consider a fixed rate mortgage, but he absolutely refused. His financial advisor, whom he trusted completely, had told him that he should never own any real estate. My borrower was very wealthy--he was a successful business owner with great credit and he had chosen to manage his real estate portfolio through interest only ARMS. I complied with his wishes and financed the house on an ARM. Three years later, his ARM was about to adjust,and he called me to refinance it. This was late 2007, and fixed rates were low. This time, I really pleaded with him to do a fixed rate loan rather than an interest only arm. I pointed out that the fixed rate was 5.875%, which was the same rate as the ARM. I also pointed out that no one could predict what was going happen to fixed rates, and that if we refinanced into a thirty year fixed rate he would never need to refinance again. Once more, he adamantly refused. In the end, I once again refinanced him into an interest only ARM. I did not agree with his decision, but the final decision was HIS, not mine. This was his property, which he chose and paid for with his money, and he chose the financing he wanted. That's a big part of what free enterprise and freedom of choice is about--allowing people to make informed decisions regarding their property, their finances and their futures and respecting those decisions. Each new piece of regulation chips away at that freedom of choice.
Death Panels for Small Business Owners? Part I
Last week, Senator Richard Shelby (R. Tx) announced that the debate on financial reform would move from committee on to the full Senate. After three failed attempts to get the votes to move the bill forward, the bill could have died in a stalemate, but instead, the Republicans decided to stand down and allow the reform measure to go to the Senate floor. Of course, at this point, no one knows what the final provisions of the bill will be, but we do have Richard Shelby's warning that every small business owner should fear the provisions of the Consumer Financial Protection Act which this bill will create (which does the beg the question of why he allowed it to move forward.)
Apparently, many Americans view financial reform as an opportunity to punish those on Wall Street who squandered bailout money on lavish bonuses and vacations. The piper has now returned to be paid, and Congress is going to extract vengeance on behalf of all taxpayers everywhere (which would be amazingly ironic since many of the Congressmen and women and Senators supporting reform are the same ones who voted for the stimulus package in the first place.)
But is that really the purpose of financial reform, or is it just another excuse to consolidate more wealth into fewer hands?
Take, for instance, my profession, the mortgage broker. At the end of 2006, there were estimated to be over 50,000 independent mortgage brokerage shops in the United States, and the average shop employed approximately 7 people. According to the National Association of Mortgage Brokers, approximately 65% of residential loans in the U.S. were brokered loans. Today, according to a statistic posted on the Think Big Work Small website, mortgage brokers do about 12% of the loans in the United States. The term "mortgage broker" has almost become an obscenity, as the small independent business owners took the blame for every bad thing that happened in the real estate industry over the last five years.
While it is popular to crucify the small broker with stories of unscrupulous loan originators who put their borrowers in terrible loans, few remember that before the real estate market crashed, there were loan originators everywhere. I worked for three and a half years on a street with two other originators. I worked at the top of the street, so borrowers passed my office on their way down to the main intersection. My competitors worked closer to the intersection. So the borrower who left my office was within walking distance of two other licensed choices to receive a mortgage loan. If he did not like any of us, he could go one street over and find several more options. Additionally, Texas licensing law allowed active real estate brokers and insurance agents to obtain a license to sell mortgages. He could further choose among the mortgage departments at the banks and the credit unions, and there were always the on-line companies competing for business. This meant that after he had received his quote and even after the borrower was well into the process, he could continue to shop his loan. When he went to buy his homeowner's insurance, he might find that his agent was offering him a mortgage loan at a lower rate. And, frequently, he would come back just before closing and renegotiate for more favorable terms.
For the small business owner, this was a highly competitive environment. Service and likability were important factors in retaining the loan. So was offering a low cost mortgage with a very competitive rate. Borrowers did not live in a vacuum; they talked to their friends and family members and compared mortgage rates with their neighbors. Borrowers with good credit used their low interest rate as a bragging right.
Fast forward to May of 2010. As regulations have tightened, mortgage loans no longer abound. The one page estimate has been replaced by five pages of forms containing less information. Mortgage originators are being required to complete both state and national exams and receive both state and national licenses at very high costs, with the result that many originators are choosing not to renew their licenses. As the cost of doing business increases, the cost of getting a loan does too. A borrower with a loan approval is probably much less likely to shop his loan now because his appraisal cannot be transferred to a new company and as competition disappears, so do his choices.
In December, the House of Representatives passed HR 4173, sponsored by Barney Frank (D MA). This over 1700-page piece of legislation aims at completely remaking the financial landscape of the US. It includes a new Consumer Financial Protection Agency which will oversee all consumer lending. The bill includes oversight for all types of financial institutions and a long section detailing dissolution of firms. Which firms? In September of 2009, Frank was captured on video speaking about financial reform in front of an audience that included Treasury Secretary Tim Geithner, who is smiling during Frank's remarks. The video associated with these remarks can be viewed by logging onto www.zillow.com and also by going to YouTube. In speaking about public frustration over bailouts, Frank states that he is going to be "putting together a package...of legislation that will substantially diminish that problem. We will be providing a mechanism for putting non-bank financial institutions out of everybody's misery. There will be death panels enacted by this Congress, but they will be for non-bank financial institutions not considered too big to die. I say that because we have this euphemism that we are going to be 'resolving' these institutions. It has not been my experience that when someone says they are going to resolve something, they kill it. And we are talking about dissolution, not resolution."
Considering that approximately 500,000 jobs have been lost in the financial sector and that jobs continue to be lost as regulations become more restrictive and business tightens up, perhaps Congress should be trying to introduce regulation to grow business, not to kill it.
Apparently, many Americans view financial reform as an opportunity to punish those on Wall Street who squandered bailout money on lavish bonuses and vacations. The piper has now returned to be paid, and Congress is going to extract vengeance on behalf of all taxpayers everywhere (which would be amazingly ironic since many of the Congressmen and women and Senators supporting reform are the same ones who voted for the stimulus package in the first place.)
But is that really the purpose of financial reform, or is it just another excuse to consolidate more wealth into fewer hands?
Take, for instance, my profession, the mortgage broker. At the end of 2006, there were estimated to be over 50,000 independent mortgage brokerage shops in the United States, and the average shop employed approximately 7 people. According to the National Association of Mortgage Brokers, approximately 65% of residential loans in the U.S. were brokered loans. Today, according to a statistic posted on the Think Big Work Small website, mortgage brokers do about 12% of the loans in the United States. The term "mortgage broker" has almost become an obscenity, as the small independent business owners took the blame for every bad thing that happened in the real estate industry over the last five years.
While it is popular to crucify the small broker with stories of unscrupulous loan originators who put their borrowers in terrible loans, few remember that before the real estate market crashed, there were loan originators everywhere. I worked for three and a half years on a street with two other originators. I worked at the top of the street, so borrowers passed my office on their way down to the main intersection. My competitors worked closer to the intersection. So the borrower who left my office was within walking distance of two other licensed choices to receive a mortgage loan. If he did not like any of us, he could go one street over and find several more options. Additionally, Texas licensing law allowed active real estate brokers and insurance agents to obtain a license to sell mortgages. He could further choose among the mortgage departments at the banks and the credit unions, and there were always the on-line companies competing for business. This meant that after he had received his quote and even after the borrower was well into the process, he could continue to shop his loan. When he went to buy his homeowner's insurance, he might find that his agent was offering him a mortgage loan at a lower rate. And, frequently, he would come back just before closing and renegotiate for more favorable terms.
For the small business owner, this was a highly competitive environment. Service and likability were important factors in retaining the loan. So was offering a low cost mortgage with a very competitive rate. Borrowers did not live in a vacuum; they talked to their friends and family members and compared mortgage rates with their neighbors. Borrowers with good credit used their low interest rate as a bragging right.
Fast forward to May of 2010. As regulations have tightened, mortgage loans no longer abound. The one page estimate has been replaced by five pages of forms containing less information. Mortgage originators are being required to complete both state and national exams and receive both state and national licenses at very high costs, with the result that many originators are choosing not to renew their licenses. As the cost of doing business increases, the cost of getting a loan does too. A borrower with a loan approval is probably much less likely to shop his loan now because his appraisal cannot be transferred to a new company and as competition disappears, so do his choices.
In December, the House of Representatives passed HR 4173, sponsored by Barney Frank (D MA). This over 1700-page piece of legislation aims at completely remaking the financial landscape of the US. It includes a new Consumer Financial Protection Agency which will oversee all consumer lending. The bill includes oversight for all types of financial institutions and a long section detailing dissolution of firms. Which firms? In September of 2009, Frank was captured on video speaking about financial reform in front of an audience that included Treasury Secretary Tim Geithner, who is smiling during Frank's remarks. The video associated with these remarks can be viewed by logging onto www.zillow.com and also by going to YouTube. In speaking about public frustration over bailouts, Frank states that he is going to be "putting together a package...of legislation that will substantially diminish that problem. We will be providing a mechanism for putting non-bank financial institutions out of everybody's misery. There will be death panels enacted by this Congress, but they will be for non-bank financial institutions not considered too big to die. I say that because we have this euphemism that we are going to be 'resolving' these institutions. It has not been my experience that when someone says they are going to resolve something, they kill it. And we are talking about dissolution, not resolution."
Considering that approximately 500,000 jobs have been lost in the financial sector and that jobs continue to be lost as regulations become more restrictive and business tightens up, perhaps Congress should be trying to introduce regulation to grow business, not to kill it.
Paying for Protection: My House is Worth What?
In 2008, Andrew Cuomo, attorney general of New York, agreed to drop a investigation into Fannie Mae and Freddie Mac if both agencies would agree to sign the Home Valuation Code of Conduct (HVCC). This code of conduct would govern the way that appraisals were handled on loans which were sold to either Fannie Mae or Freddie Mac, which is estimated to be about 70% of residential mortgage loans in the United States.
The provisions of HVCC included bans on pressuring appraisers to arrive at a certain value and refusing to pay for an order which did not meet value (activities which were already illegal.) But HVCC went beyond that by requiring that neither the loan originator nor any employee of the company who would be directly compensated on the transaction have any contact with the appraiser whatsoever. In large banking institutions, this meant that the appraisers could be ordered by a separate department of the bank. However, the new regulation stated specifically that no mortgage broker or employee of a mortgage broker could order an appraisal or have any contact with the appraiser.
This piece of rulemaking by one attorney general in one state has affected the way that home buyers and home owners all over the United States receive their home values. Because of the absolute ban on personal contact between the loan originator or their staff and the appraiser, the rule made possible the explosive growth of AMCs--Appraisal Management Companies--who would act as the middle man in the transaction by placing the order and paying and compensating the appraiser.
This is one of the few cases where adding an additional middle man was touted as a cost savings measure. AMCs were certainly not new; they had been around for years, but they were not widely used because they added a lot of cost for the consumer and they were very inefficient. Cuomo's new rule gave AMCs a huge boost since they went from a cumbersome, expensive mechanism nobody really preferred to the only acceptable way of receiving an appraisal for most mortgage loans.
Interestingly, the abuses that led to this rule being adopted did not involve mortgage brokers or small independent shops at all--it was a case involving the now defunct Washington Mutual, which was taken over by JP Morgan Chase, and an AMC. Washington Mutual was apparently pressuring the AMC to pressure the appraisers who worked for it to hit certain values. It is also interesting to note that Cuomo, who is now favored to win his race for governor of New York, is rumored to sit on the board of an AMC.
The rule became effective May 1, 2009. In the old free enterprise days of appraisals, appraisers who had been in the business a long time had spent many years building their companies, participating in community events and marketing their services. The proliferation of appraisers in recent years kept costs down because they had to be competitive in pricing. And, of course, the broker and lender community knew by reputation and experience which appraisers did a good job.
With HVCC all of that disappeared. Reputation and relationships no longer matter. All appraisers have to be signed up to work for AMCs and the AMCs hire them--or don't--based on whatever rotation system they have worked out. Of course, AMCs are not charitable organizations, so they make money in only one of a few ways: 1. They raise the price of the service. 2. They pay the appraiser less. 3. They do both.
A residential appraisal in El Paso used to cost about $350.00 for a regular appraisal. An appraisal of an investment property was about $450.00. Today most appaisals run right around $400.00 and an investment property appraisal is between $530.00 and $630.00. A review that used to cost $150.00 now costs around $280.00. Lenders have a list of AMCs they use, and they assign the work to whatever AMC they want the appraisal to go to. The AMC then picks the appraiser from their list. There is no way to shop for a better price.
There is also no way to look before you buy. Before May of last year, we as the originators could talk to the appraiser about a property before we took the borrower's money. If we determined that the property was not going to appraise based on our conversation, we could advise the borrower that they were proceeding at their own risk.
But the worst and most expensive part of the new system is that there is no recourse for a bad appraisal. HVCC specifically prohibits a lender from ordering a second appraisal if the first one does not come in. The originator can submit additional comparables to the AMC, but the appraiser can reject them. I have never seen an appraiser adjust a value based on new comparables since this system went into effect. Further, since all lenders are afraid that the appraisal will not be HVCC compliant, it is very hard to transfer an appraisal, so if for any reason the loan is declined by one lender, the borrower basically has to start over and pay for a new appraisal with a new lender.
How does it work in real life? Last July I financed a home for a doctor and his wife. They had found a new home in an upscale neighborhood, and they and the seller agreed to a contract price of $360,000. The couple had strong credit and very high income and savings, and they were making a 20% down payment. We got credit approval immediately and then ordered the appraisal. About 10 days later, the appraisal came in for $270,000.00. When we reviewed it to see why, we found that the appraiser used a comparable on the same street which had been sold as a foreclosure. (Foreclosures are not supposed to be used as comparables for full price sales). I asked the seller's agent about why she priced her listing the way she did. She assured me that her listing was not overpriced, that it offered many amenities, and that sales in the area did support it. She sent me some comparables which I sent to the AMC. A few hours later, the AMC sent me the appraiser's response. The appraiser, who was actually from another city, responded that he did not work for us anymore, he did not have to change anything and did not plan to.
To make the contract price work, the seller would have had to lower the price by $90,000 (which they were not going to do) or the buyer would have had to bring in an additional $90,000 in cash on top of the $72,000 they had already planned to put down (which they were not going to do). The borrowers wanted to know if they had any other options, and I told them that the only thing I could do was start over and send the loan to a new lender who would order a new appraisal. This appraisal would cost an additional $350.00, and I had no guarantee that it would turn out any better than the one we had just received. Since the borrower really wanted the house, they agreed that this was the best course of action, with the idea that they could probably renegotiate a lower sales price with the seller if the appraised value were more reasonable.
We resubmitted the loan to a new lender and about ten days later we got our new appraisal. The value was $360,000. This appraiser did not use any foreclosures. He took great photos of the house and compared it to other houses with similar amenities. The underwriter accepted the appraisal with no revisions and the buyer and seller closed at the contract price. The difference between these two reports--the individual preparing them. Both appraisers had nothing to work with but an order and sales contract, but the first one had a mindset that the house was only worth $270,000 and that was all that he was going to appraise it for.
An appraisal is just an opinion of value. Accurate appraisals require skill, training, and a thorough knowledge of the real estate market. The new rules regarding appraisals attempt to trade seasoned professionals for anyone with a license who will work cheaply. HVCC costs consumers money in additional appraisals they would not otherwise have incurred, and it can cost homeowners thousands of dollars in equity in their homes.
Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. For more information, visit her website at http://www.frontier2000.net
The provisions of HVCC included bans on pressuring appraisers to arrive at a certain value and refusing to pay for an order which did not meet value (activities which were already illegal.) But HVCC went beyond that by requiring that neither the loan originator nor any employee of the company who would be directly compensated on the transaction have any contact with the appraiser whatsoever. In large banking institutions, this meant that the appraisers could be ordered by a separate department of the bank. However, the new regulation stated specifically that no mortgage broker or employee of a mortgage broker could order an appraisal or have any contact with the appraiser.
This piece of rulemaking by one attorney general in one state has affected the way that home buyers and home owners all over the United States receive their home values. Because of the absolute ban on personal contact between the loan originator or their staff and the appraiser, the rule made possible the explosive growth of AMCs--Appraisal Management Companies--who would act as the middle man in the transaction by placing the order and paying and compensating the appraiser.
This is one of the few cases where adding an additional middle man was touted as a cost savings measure. AMCs were certainly not new; they had been around for years, but they were not widely used because they added a lot of cost for the consumer and they were very inefficient. Cuomo's new rule gave AMCs a huge boost since they went from a cumbersome, expensive mechanism nobody really preferred to the only acceptable way of receiving an appraisal for most mortgage loans.
Interestingly, the abuses that led to this rule being adopted did not involve mortgage brokers or small independent shops at all--it was a case involving the now defunct Washington Mutual, which was taken over by JP Morgan Chase, and an AMC. Washington Mutual was apparently pressuring the AMC to pressure the appraisers who worked for it to hit certain values. It is also interesting to note that Cuomo, who is now favored to win his race for governor of New York, is rumored to sit on the board of an AMC.
The rule became effective May 1, 2009. In the old free enterprise days of appraisals, appraisers who had been in the business a long time had spent many years building their companies, participating in community events and marketing their services. The proliferation of appraisers in recent years kept costs down because they had to be competitive in pricing. And, of course, the broker and lender community knew by reputation and experience which appraisers did a good job.
With HVCC all of that disappeared. Reputation and relationships no longer matter. All appraisers have to be signed up to work for AMCs and the AMCs hire them--or don't--based on whatever rotation system they have worked out. Of course, AMCs are not charitable organizations, so they make money in only one of a few ways: 1. They raise the price of the service. 2. They pay the appraiser less. 3. They do both.
A residential appraisal in El Paso used to cost about $350.00 for a regular appraisal. An appraisal of an investment property was about $450.00. Today most appaisals run right around $400.00 and an investment property appraisal is between $530.00 and $630.00. A review that used to cost $150.00 now costs around $280.00. Lenders have a list of AMCs they use, and they assign the work to whatever AMC they want the appraisal to go to. The AMC then picks the appraiser from their list. There is no way to shop for a better price.
There is also no way to look before you buy. Before May of last year, we as the originators could talk to the appraiser about a property before we took the borrower's money. If we determined that the property was not going to appraise based on our conversation, we could advise the borrower that they were proceeding at their own risk.
But the worst and most expensive part of the new system is that there is no recourse for a bad appraisal. HVCC specifically prohibits a lender from ordering a second appraisal if the first one does not come in. The originator can submit additional comparables to the AMC, but the appraiser can reject them. I have never seen an appraiser adjust a value based on new comparables since this system went into effect. Further, since all lenders are afraid that the appraisal will not be HVCC compliant, it is very hard to transfer an appraisal, so if for any reason the loan is declined by one lender, the borrower basically has to start over and pay for a new appraisal with a new lender.
How does it work in real life? Last July I financed a home for a doctor and his wife. They had found a new home in an upscale neighborhood, and they and the seller agreed to a contract price of $360,000. The couple had strong credit and very high income and savings, and they were making a 20% down payment. We got credit approval immediately and then ordered the appraisal. About 10 days later, the appraisal came in for $270,000.00. When we reviewed it to see why, we found that the appraiser used a comparable on the same street which had been sold as a foreclosure. (Foreclosures are not supposed to be used as comparables for full price sales). I asked the seller's agent about why she priced her listing the way she did. She assured me that her listing was not overpriced, that it offered many amenities, and that sales in the area did support it. She sent me some comparables which I sent to the AMC. A few hours later, the AMC sent me the appraiser's response. The appraiser, who was actually from another city, responded that he did not work for us anymore, he did not have to change anything and did not plan to.
To make the contract price work, the seller would have had to lower the price by $90,000 (which they were not going to do) or the buyer would have had to bring in an additional $90,000 in cash on top of the $72,000 they had already planned to put down (which they were not going to do). The borrowers wanted to know if they had any other options, and I told them that the only thing I could do was start over and send the loan to a new lender who would order a new appraisal. This appraisal would cost an additional $350.00, and I had no guarantee that it would turn out any better than the one we had just received. Since the borrower really wanted the house, they agreed that this was the best course of action, with the idea that they could probably renegotiate a lower sales price with the seller if the appraised value were more reasonable.
We resubmitted the loan to a new lender and about ten days later we got our new appraisal. The value was $360,000. This appraiser did not use any foreclosures. He took great photos of the house and compared it to other houses with similar amenities. The underwriter accepted the appraisal with no revisions and the buyer and seller closed at the contract price. The difference between these two reports--the individual preparing them. Both appraisers had nothing to work with but an order and sales contract, but the first one had a mindset that the house was only worth $270,000 and that was all that he was going to appraise it for.
An appraisal is just an opinion of value. Accurate appraisals require skill, training, and a thorough knowledge of the real estate market. The new rules regarding appraisals attempt to trade seasoned professionals for anyone with a license who will work cheaply. HVCC costs consumers money in additional appraisals they would not otherwise have incurred, and it can cost homeowners thousands of dollars in equity in their homes.
Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. For more information, visit her website at http://www.frontier2000.net
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