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Sunday, January 25, 2009

Obama's New Mortgage Regulations: From Wholesale to Retail

The Obama administration has announced plans for sweeping new regulations that will affect much of the financial sector. The rules are vague so far and they will affect hedge funds, credit default swaps, credit rating agencies as well as mortgage brokers. Since nothing specific has yet been proposed, I won't comment on any specific regulation. Furthermore, I will stay in my sphere of knowledge and only comment on what the Obama administration plans on doing regarding mortgage BROKER regulation.

Aides said they would propose new federal standards for mortgage brokers
who issued many unsuitable loans and are largely regulated by state officials.
They are considering proposals to have the S.E.C. become more involved in
supervising the underwriting standards of securities that are backed by

The key word, the one I made in all caps, is BROKER. There are two types of niches in mortgages, wholesale and retail. Wholesale mortgages are done by banks and mortgage companies but a mortgage broker is used to bring them the borrower. The mortgage broker has the ability to choose from a universe of bank, and so the logic is that with a good mortgage broker borrowers always get the best deal.

In retail, the borrower goes through the bank directly. While this means the borrower can only choose one bank, this eliminates the need for the broker, the middleman, and thus saves on fees.

For many years, it was the broker that usually dominated the industry. Banks liked the convenience of having borrowers brought to them and thus often gave better rates wholesale than retail.

Now, in the nearly seven years in the business I have seen incremental inconveniences done to mortgage brokers. Initally, there was no barrier. I started and as soon as I had a loan, I was making money. Then, the state began charging a yearly licensing fee. Then, the state made licensing more difficult. It included testing and a background check along with a yearly fee. I also saw the state of Illinois, my home state, very disorganized in the process. Often, brokers could work for weeks and months well past when they needed to have licensing done. That's because the state had little apparatus to quickly find out if someone was operating without a proper license.

Now, the Obama administration wants to add their own licensing procedures on top of the state's procedure. The first observation is that if the state of Illinois had trouble tracking down brokers you can imagine how well the federal government will do with several million mortgage brokers nationwide. Ultimately, what all of this will eventually do is drive most business from wholesale to retail. The more difficult wholesale brokering will be, the more banks will simply focus on retail banking.

Again, the key word is BROKER. If you work for a bank, you are a mortgage BANKER. You will notice that President Obama is not talking about tightening restrictions against mortgage BANKERS. As such, what all of this new regulation will really do is give more of a competitive advantage to retail. Now, already, in the last few months, Bank of America, Chase, and WAMU, have all closed wholesale operations and they only do loans retail. If the federal restrictions will be tight enough, it will mean that wholesale won't be worth it for most banks. Many other banks will follow in the footsteps of Bank of America, Chase and WAMU.

So, what will happen? All of these mortgage brokers that President Obama wants to oversee will simply move to retail where there is no oversight. A large enough bank can have its own portfolio of loans that will rival that of a broker that can choose from a menu of banks. As such, there is often little difference between the two. If the advantage is to work in retail, that's where all of these brokers will work. As such, while the Obama administration will be touting how they provided more oversight to mortgage brokers, in reality, what they will have done is drive mortgage broker to where there is no oversight, in mortgage banking. Not only would such a move not accomplish anything as far as oversight, but it will limit competition. If retail has no wholesale competition, it's much easier to charge higher rates. A borrower would actually have to become the broker in order to shop. They would literally have to call to every bank themselves to get a rate. That's in fact why they hire a broker. Without a broker, you are liable to see all the retail shops increase their rates slightly because the competition will now be limited.

3 comments: said...

I guess that means Obama has to regulate his government being they own Fannie and Freddie. Government loans are about 90% of what’s happening right now. Mortgage brokers just folllow the guideline of the
Lender. The Lender has to OK the file. The Lender is at fault if there are problems. They have to do the due diligence to make sure the file a mortgage broker submits fit thier guidelines.

The lender created the Option Arm not the mortgage broker.
Wholesale Loan Program Portal

mike volpe said...

I believe that President Obama would say that it was mortgage brokers that steered borrowers into the wrong type of loans, however your point is well taken. Furthermore, you and I both know that now it is required that a loan show a "net tangible benefit" in order to be completed.

As such, one would ask, if there is already regulation on the book to make sure that borrowers are getting loans that are appropriate for them, why do we need more regulation. Furthermore, what does it say about the regulations already on the books that we need more.

DC said...

I think the biggest thing the government can do is ensure that there is an arms length between lender and appraiser. Value fraud causes banks and tax payers more lost money than anything.
Illinois is putting this in place and other states need to follow suit.
This site has a breakdown of every states laws- must have taken someone a while to put together