My New Blog

The War On Mortgage Brokers

In my 29 November 2007 blog, I took heated exception to the charges leveled against mortgage brokers from all corners of the media to the effect that we had been guilty of fraud. As I pointed out, one fact only is necessary to rebut this nonsense and that fact is that we do not make credit decisions. With time, it has become apparent to all that the summer 2007 subprime-related blowup was a triggering event evidencing far wider financial system vulnerabilities resident in the truly massive, unregulated derivatives markets.

There is now an important ruling by Judge Tchaikovsky in which the mortgage broker is found guilty of nothing while the lender is found effectively guilty of ignoring what should have been known, which is to say, their credit standards were deficient. As to why they were deficient, the short answer seems to be that they erroneously relied on the Bankruptcy Reform Act of 2005 to shift the burden of their knowing, bad credit decisions to the borrower.

Much of that anti-mortgage broker media sentiment was/is driven by the fact that we brokers do over half the mortgage business in this country, in my opinion. Our dominance of the mortgage market would not make sense if we were indeed the bad guys the pundits claimed that we are. It does make sense, however, in light of the fact that, according to a recent study, we save borrowers about 1/8% in rate on mortgage loans to prime borrowers. It is the mortgage bankers who have been hurt by the competition that promote this misinformation and lobby Congress to pass laws that punish the mortgage brokers. What you should know is that punishing the brokers effectively punishes you, the consumer.

Here’s the detail on the recent ruling referenced above.

Tanta writes:

This is a big deal, and will no doubt strike real fear in the hearts of stated-income lenders everywhere. Our own Uncle Festus sent me this decision, in which Judge Leslie Tchaikovsky ruled that a National City HELOC that had been "foreclosed out" would be discharged in the debtors' Chapter 7 bankruptcy. Nat City had argued that the debt should be non-dischargeable because the debtors made material false representations (namely, lying about their income) on which Nat City relied when it made the loan. The court agreed that the debtors had in fact lied to the bank, but it held that the bank did not "reasonably rely" on the misrepresentations …

Jas Jain writes:
Tanta: “I argued some time ago that the whole point of stated income lending was to make the borrower the fall guy: the lender can make a dumb loan--knowing perfectly well that it is doing so--while shifting responsibility onto the borrower, who is the one "stating" the income and--in theory, at least--therefore liable for the misrepresentation.”

CalculatedRisk: BK Judge Rules Stated Income HELOC Debt Dischargeable http://calculatedrisk.blogspot.com/2008/05/bk-judge-rules-stated-income-heloc-debt.html

Mish: Bankruptcy Reform Act Finally Blows Sky High http://globaleconomicanalysis.blogspot.com/2008/05/bankruptcy-reform-act-finally-blows-sky.html

On a 30-Year Fixed Rate mortgage loan, 1/8% in rate is roughly equivalent to ½% in Loan Fee. On a $300,000 mortgage loan, ½% in Loan Fee is equivalent to $1,500, a significant savings. And I can’t remember the last time someone used my services without first comparison shopping. I expect to continue to beat the banks and I expect to be around for quite some while yet serving you.

H. F. Pete Nelson

Senior Loan Originator

License #510-LO-34002

Normandy Mortgage, Inc.

pnelson@normandymortgage.com

(206) 890-6815

Nonlinearity

Though I have for decades read the financial pundits and even taken an econ course or two, I’ve always been underwhelmed by economics – it is dry and boring, and is appropriately called “the dismal science”. Why is that? Many are interested in money and markets, and don’t find them dismal at all. Well, first, all of economics, all of statistics actually, is governed by linear (relatively easy) math and the underlying assumptions that the Normal Curve, the Bell Curve, is reflective of reality, and that perfect information and equilibrium govern at all times. These assumptions are made to allow the economists to artificially transition what once was called “political economy” into a discipline that is math-oriented and thus more hard-science-like. Nonlinear math is hard.

The trouble is that the prominent economic tools do not pattern reality and they thus cannot be used to predict accurately. Market moves are discontinuous, often erratic and markets can stay “out of equilibrium” for many years, viewed in retrospect. Were that not so, Warren Buffet would not be very rich and Long Term Capital Management would not have failed. It should be remembered, I think, that markets are as complex as human beings, insofar as they are a human artifact. This is why they are so challenging and intriguing. And that’s why economics is boring.

The disparities between theory and actuality have become ever more apparent in recent years and a pioneer along these lines has been Nassim Nicholas Taleb (http://www.fooledbyrandomness.com/), who first wrote Fooled By Randomness, then The Black Swan. Taleb calls the Bell Curve “GIF”, meaning “Great Intellectual Fraud”. These are both excellent and very current books, and I recommend them without reservation for those interested in the markets. Here’s a recent interview:

Nassim Nicholas Taleb: the prophet of boom and doom http://business.timesonline.co.uk/tol/business/economics/article4022091.ece\

Extending the idea, Yves Smith (http://www.nakedcapitalism.com/) is one of the most thoughtful and knowledgeable bloggers “out there” today, and he had this to offer toward better understanding the impact of information on markets and their nonlinear nature.

Hoisted From Comments: Greater Liquidity Produces Instability http://www.nakedcapitalism.com/2008/05/hoisted-from-comments-greater-liquidity.html

Below is a provocative line of thought from an anonymous reader. It supports a gut feeling that I have been unable to prove, namely, that lowering of boundaries between markets (ranging from the large number of global macro hedge funds to the large number of retail currency speculators in Japan) is destabilizing. I've found the occasional supporting bit of empirical evidence (for instance, Kenneth Rogoff's and Carmen Reinhart's recent paper on financial crises, which found that greater financial integration was correlated with crises) but no theories. Conventional economic wisdom would tell you arbitrage is always and ever good (it supposedly improves price formation which leads to better allocation of capital), and inefficiencies are bad. However, complex systems theory provides a very different perspective:

Perhaps a lesson to be learned here is that liquidity acts as an efficient conductor of risk. It doesn't make risk go away, but moves it more quickly from one investment sector to another.

From a complex systems theory standpoint, this is exactly what you would do if you wanted to take a stable system and destabilize it.

One of the things that helps to enable non-linear behavior in a complex system is promiscuity of information (i.e., feedback loops but in a more generalized sense) across a wide scope of the system.

One way you can attempt to stabilize a complex system through suppressing its non-linear behavior is to divide it up into little boxes and use them to compartmentalize information so signals cannot easily propagate quickly across the entire system.

This principle has been recognized in the design of software systems for several decades now, and is also a design principle recognizable in many other systems both natural and artificial (c.f. biology, architecture) which are very robust with regard to exogenous shocks. Stable systems tend to be built from structural hierarchies which do not share much information across structural boundaries, either laterally or vertically. That is why you don't die from a heart attack when you stub your toe, your house doesn't collapse when you break a window, and if your computer crashes it doesn't take down the entire internet with it.

Glass-Steagall is a good example of this idea put into practice. If you use regulatory firewalls to define distinct investment sectors and impose significant transaction costs at their boundary that will help to reduce the speed and amplitude of signals which will propagate from one sector to another, so a collapse in one of them will be less likely casue severe problems in the others.

It worries me that we’ve torn down most of these barriers in the last several decades in the name of arbitrage, forgetting that the price we paid for them in inefficiency was a form of insurance against the risk of systemic collapse. This is exactly what I would do if I wanted to take a more or less stable, semi-complex system and drive it in the direction of greater non-linearity.

I think this was to some degree inevitable - it is a symptom of the decay and loss of trans-generational memories from our last great systemic shock in the 1930s. I suspect that something like this is bound to happen every 3-4 generations as we unlearn the lessons our grandparents and great-grandparents learned to their cost.

If the thought is correct, there are of course major implications for the role of regulators insofar as unregulated markets tend to crash. We have recent evidence of this with the March bailout of Bear Stearns, engineered by the Fed. Had they not intervened, the consequences for all of the world financial system could have been, in my opinion would have been, dire. And there is, in my opinion, more turmoil in our future.

Mortgages are, however, still available to strong borrowers and for the not-so-strong, FHA and VA still remain. Subprime is very expensive and very hard to find.

Fascinating stuff to me, but enough for now. Feel free to comment, call or e-mail me.

H. F. Pete Nelson
Senior Loan Originator
License #510-LO-34002
Cell (206) 890-6815
pnelson@normandymortgage.com