"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."
HOW CAN THIS BE?
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.
HOW COULD THIS HAVE BEEN AVOIDED?
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.
CORRELATION OF MORAL HAZARD IN MORTGAGES:
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.
WHAT CAN BE DONE TO PREVENT THIS IN THE FUTURE?
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.
SO DON'T YOU THINK THE LENDERS WILL NOW PLACE TIGHTER RESTRICTIONS ON BROKERS?
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).
BANKING GIANTS CAN ALSO CREATE A MORAL HAZARD!
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.
MAYBE THE MIDDLE GROUND IS THE BEST PLACE TO SIT?
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.
WHAT ARE YOUR THOUGHTS ON THIS SUBJECT?
*Source is Wikipedia.com search “Moral Hazard.” I encourage you to research this as well.