Moral Hazard: The Demise of the Mortgage Industry

Mortgage and Lending with PS Financial Services 305-791-4874 or 888-845-6630

"Moral Hazard occurs when a party insulated from risk behaves differently than it would behave if it were fully exposed to the risk."*  It can be said that the reason Mortgage "Brokers" are being pushed out of the market by regulation is because of Moral Hazard and the fact that they are unregulatable.

I was watching the movie "Wall Street: Money Never Sleeps" this weekend, and a lady asked Michael Douglas what Moral Hazard means.  He defined as Wikipedia did above, but slightly differently.  He stated its when you give someone money who is not responsible for what happens to that money.  I immediately turned to my wife and said, "that is what has happened to the Mortgage Brokers in our industry."


Here is my disclaimer, first and foremost.  I do not believe that all Mortgage Brokers are or were unscrupulous the same way not all stock brokers are like Gordon Gecko, Michael Douglas' character in both Wall Street movies.  The fact remains nevertheless that many Mortgage Brokerage offices that are out of business today were able to escape the danger of regulation by simply going under and/or filing for Bankruptcy.  They simply passed the buck.  Many of them put together many bad or fraudulent loans and then skipped town when the proverbial stuff hit the fan. 


If the Mortgage Broker Companies would have been forced to have a certain net worth, put money in a bond, have been regulatable, and been directly liable for the origination of the loan, then we probably would not have seen so much fraud and MORAL HAZARD as we did during the boom.  Granted, there are many factors at play and it’s not completely the Brokers' fault.  But we still must understand why the government is taking this approach and why brokers are being come down on with such force.


Moral Hazard is when you act on behalf of another party and may have incentive to act inappropriately.  A direct example was Mortgage Professionals putting clients into Negative Amortized loans and qualifying them on the minimum payment without explaining the ramifications.  In the movie Wall Street, Moral Hazard was taking money from a client as a Stock Broker and investing in a way that the Broker knew could harm the client.  Well, when a broker took a client and forged documents to get them in a home, or didn't properly disclosure the ARMs or Neg Am loans it was essentially the same thing.  The Broker made larger commissions by placing the client in a toxic program without their knowledge or consent.  This was not the case with my specialization, Reverse Mortgages.


First off, it wasn't only Mortgage Brokers doing this.  Countrywide was one of the biggest fraud brokers around, but the difference is that Countrywide was highly regulated and therefore ultimately responsible for their toxic loans.  So the government is tightening the reins and making the lenders have higher net worth and bond requirements.  They are also placing the full responsibility on the lenders if anything goes wrong. 


They already have, and have been doing so since about 2007!  Some examples are stricter underwriting, tougher correspondent or broker approval guidelines, and the mandatory use of the least ineffective type of appraisal system AMCs (Appraisal Management Companies).


Keep in mind that Mortgage Brokers are not the only ones responsible, as it seems that the risk was moved on down the chain and the last one holding the hot potato got burned.  Economist Paul Krugman states that the lending giants can take on the risky loans at the expense of the tax payer* (source Wikipedia).  This is something we have seen with the bail outs.  The giant banks took the risky loan and then when they all went down the government bailed them out of it.  So why isn't the government pushing out the giant lenders also?  This may be because the government is NOW the large lenders after the bailout.


There may be some bias behind this statement because I am now part of a small lender, but we have many benefits that brokers and lending giants do not.  We can still essentially broker while not being subject to the rules of the lending giants.  We are regulatable while not being strangled by crazy guidelines from other lenders or their AMCs and Underwriters.


So in watching the movie this weekend I was inspired to write about this subject yet again (see my blog THE END OF THE MORTGAGE BROKER).  I continue to see evidence of the broker being pushed out of the market.  Some may stay, but not many.  If I were to change to another company, I would not go to a broker rather I would look for a small lender as opposed to a large depository lending institution because of the benefits.



*Source is search “Moral Hazard.”  I encourage you to research this as well.


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PS Financial Services

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Alison Swain
3rd Generation Appraisal Services - Orlando, FL

Kudos to you for an excellent post!  You are absolutely correct about how people act when they have "no skin in the game."  I cannot begin to tell you how frustrating it was dealing with mortgage brokers who expected me to bump up a valuation or overlook glaring physical deficiencies so that that they could get their commisions.  If I didn't play ball, I never received another order from them.  Some of them were bold eough to come right out and tell you in advance.  Let's just say I got "fired" a lot!  

Given the standards agents and appraisers are held to and the resulting threats to our licenses, can you imagine that behavior being the rule (rather than the exception) among us???  I know so many mortgage brokers who made 5 figues a month "back in the day."  Of all the brokers who ordered appraisals, there were only two I felt were honest and competent enough for me to feel comfortable referring my family and friends.

Here's the dirty little secret about AMCs: most of the large ones are owned by the lenders/banks themselves.  In some cases, small AMCs are owned by ex-appraisers who had their licenses yanked away for their awful ethics and/or incompetence.  The lenders are still in the driver's seat, manipulating the process, going through the motions to appease the gov't regulators and maximizing their profits from fees (in the case of AMCs, carving out north of 50% of the "customary and reasonal" appraisal fee from the actual appaiser's side while charging a "premium" to the client for the buffer fee).  As a result, agents are often left to meet an inexperienced appraiser from 100 miles outside the market who is just that desperate for work.


Hopefully, the changes that are currently being discussed will prove to truly reform our industry. Some things which must be done are to regulating, managing and disciplining mortgage brokers, loan officers and lending institutions to the same or greater degree as we agents and appraisers have always been.

Oct 04, 2010 02:29 PM #1
Phil Stevenson, CRMP
PS Financial Services 305-791-4874 or 888-845-6630 - Miami, FL
Reverse Mortgage Expert in Miami and Florida

Alison, that is very true about AMCs.  I even wrote blogs about AMCs and how they are NOT part of the HVCC.  Everyone is taught that you must use AMCs because of HVCC, but as you said its simply a way for the lenders to make an extra buck at the clients' expense.

Oct 04, 2010 02:45 PM #2
Donne Knudsen
Los Angeles & Ventura Counties in CA - Simi Valley, CA
CalState Realty Services

Phil  - LMAO!!!  I just started to post this really long comment but then decided to delete it.  You and I have had this discussion before and suffice it to say, "you know how I feel about this topic and where I stand".  I've made no secret of my opinions, observations, practices and philosophies.

Oct 04, 2010 03:59 PM #3
Donne Knudsen
Los Angeles & Ventura Counties in CA - Simi Valley, CA
CalState Realty Services

On another note, in my eight year mortgage career, I have never originated a neg am loan.  Furthermore, I disliked the first Wall Street film so much that I have absolutely zero interest in seeing the sequel.  JMHO

Oct 04, 2010 04:01 PM #4
Phil Stevenson, CRMP
PS Financial Services 305-791-4874 or 888-845-6630 - Miami, FL
Reverse Mortgage Expert in Miami and Florida

Donne, I do know how you feel, and respect that.  Part 2 was pretty good.  I liked it because it showed a lot fo what was happening in the markets in 2008. 

The truth is, a lot of people were at fault and moral hazard ranged from the broker to the largest banks.

Oct 04, 2010 04:06 PM #5
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Phil Stevenson, CRMP

Reverse Mortgage Expert in Miami and Florida