While many factors are contributing to the current state of the housing market in the United States, a key component in the collapse is a lack of trust in the U.S. residential mortgage market by the secondary market. But how can we restore trust when incomes are stated inaccurately, secondary or income producing properties are listed as primary residences, additional incomes are nothing more then a myth, erroneous appraisals, lending to borrowers clearly unable to repay, and unsupported speculation? While I may never know who would win in a fight Mike Ditka or Bill Brasky; I do have the answer to the little lending conundrum…
**DISCLAIMER: Before I proceed I want to be clear that I don’t believe that the blame lies solely on one side of the problem.
In my opinion the housing market is merely enduring a two sided problem; we have bad originators and bad borrowers. However in our current system, the originator is free of risk. There simply is not enough “ownership” for the loans given out; this however does not excuse borrowers that misrepresent themselves and the purpose of the property. People were able to get to comfortable with scamming originators because lenders were did the bare minimum. While we can develop systems that will not fall pray to the smoke and mirrors of borrowers, these deceitful individuals most absorb all the blame when “jig is up!”
But what about the borrowers who were clearly loaned more money then they should have been? Well this is where the idea of ownership needs to come into play. Lenders must endure penalties if they qualify people that should not be qualified. A borrower simply using refinancing as a tool to keep the “boat afloat” is clear instance where their freedom from penalty is exhibited… If someone was told that they can afford X amount, and they act responsibly it should be the duty of the originator bear the consequences if that loan amount was clearly too much.
Robert E. Barnett, over at American Banker has a proposed solution in its least complex translation breaks down, pay mortgage originators only for good loans, not bad ones. This proposed solution would encourage originators to be very thorough during the application process ensuring that the borrower's income is verified, that the property is denominated correctly as a primary residence or something else, that appraisals are accurate, and that the borrower truly can afford to repay the loan. The flip side this is that borrowers will no longer be able to just skate by with fraudulent applications (obviously their will always be scammers, but this will weed out the “casual” liar).
It need not be too complicated. For example, the start-up problem could be addressed by letting brokers borrow against their expected income over the five years; perhaps a market would develop. Or the payment setup for originators could be loaded with payments after the first year — starting with, say, 5% of the amount due and then increasing the rate of payment through the years (10%, then 15%, then 20%) until 50% of the compensation would be paid after the fifth year. Or lenders could advance some small salary to start-up originators, as could large brokerage companies that employed many brokers. That is not uncommon in the insurance industry.
Because it almost seems impossible that originators will allow a system where they need to wait it out for their compensation, an alternative proposal to the current system is monetary penalties accompanied with a point system… So if you have a loan that goes into default, the borrowers will be fined a certain amount of money. Next, some sort of governing body then needs to establish whether or not the originator did not do their job properly, if so to what degree and assign points to the violations. If you get X amount of points, then you can no longer originate loans for a certain period of time and repeat offenders should lose their ability to originate loans all together. (Very much like a getting points assigned to your driver’s license)
No matter how it is done an objective system with checks and balances would keep lenders on their toes and weed out the nonchalant ones…
Image Credit: Taber Andrew Bain on Flickr.com