I'm going to have to start paying Janet Guilbault a royalty.  This is the second post in a roll that was inspired by one of hers!  If you haven't checked her blog out, you really should! 

Anyway, yesterday she wrote a blog called, "Breaking News, WAMU Is Exiting The Wholesale Mortgage Business" that talked, as the title suggests, about Washington Mutual exiting the wholesale mortgage business.  In the comments sections Janet raised an important question about the future of wholesale originations.  This post is my take on that question.

The History of Mortgage Brokerage

In order to understand where we're at now and where our industry might be heading, you have to understand where we, as an industry, have been and what the factors were that lead to our birth.

Basically our industry came into being during the early 1980's.  Prior to this if you wanted to finance the purchase of a home you only had a few choices.  If you wanted to utilize a government loan program (FHA or VA), you went to a Mortgage Banking company and if you wanted to buy a home utilizing conventional financing, you went to a Bank or a Savings and Loan. 

With any of these institutions you set an appointment with the lender and during business hours you went to that institution and made application.  

Then in the early 1980's a few entrepreneurial people realized that it could be done better and that it could be done less expensively than what the banks, mortgage banking companies and savings and loans were doing.  Arrangements were made with some of these institutions to allow for these entrepreneurs to "originate" the mortgage and then to sell that mortgage to the lending institution. 

It was a classic "win/win" situation.  Whereas the institution had certain cost structures that they couldn't avoid such as various regulations, as well as other overhead issues, these entrepreneurs weren't encumbered with these costs and could originate that mortgage less expensively than what it would have cost the institution to have originated that mortgage themselves.  Plus, by buying mortgages from "brokers" an institution could greatly expand it's market place without taking on a bunch of additional overhead.

I'll use Knutson Mortgage Corporation (a company that I used to work for) as an example of this.  Knutson Mortgage was a Minneapolis based mortgage banking company that was owned by a Boston based Savings and Loan.  They at one point had 60 "branch" officers located throughout the country. 

At a sales meeting one of our many vice-presidents explained our cost structure to us loan officers.  He told us that by the time Knutson paid for it's office building, all of the various branch offices, several layers of management, as well as the costs of maintaining the corporate jet, that it "cost" Knutson 2.25% to originate the "average" mortgage.

Shortly after this meeting I went to work for a buddy of mine who had started a small mortgage brokerage where our overhead consisted of the rent on a 600 square foot office space, wages for a processor/closer and the lease on a copy machine and one computer. Even paying a loan officer a .05% commission on the loan amount, we were able to undercut Knutson by around a full point.  In essence, if they had so desired, Knutson could have purchased the mortgages that we originated for less money than they could originate the mortgages for themselves.  Many financial institutions did the math and figured this out.  An industry was born!

Real Estate Becomes The Hip/Happening Thing

As time went on Mortgage Brokers grew their market share to where it is estimated that over 60% of all mortgage origination in the United States is done by mortgage brokers.  As with any market where substantial amounts of money are being made, new competitors entered the market.  

In the early 90's interest rates dropped substantially which fueled a wave of refinances that was unprecedented.  The number of mortgage brokers and wholesale mortgage lenders ballooned.  The invention of the sub prime mortgage market, combined with historically low interest rates led to a boom in the US housing market.  The number of lenders, as well as the number of new lending programs sky rocketed.  Many of these programs were of dubious nature. 

Wall Street had taken into account the fact that some of these mortgages were going to default, but were confident that real estate values would continue to appreciate enough to make these defaults tolerable.  They created investment vehicles such as Collateralized Debt Obligations (CDO's) in an effort to shied investors from the riskier  loans that were packaged with better quality loans.  These new investment vehicles were rated as investment quality products by the various Wall Street Ratings Agencies (such as Standard and Poors and Moody's) and marketed to institutions and people who wanted a "secure" investment that still provided an attractive rate of return. 

The hunger for these investment vehicles led to the creation of even risker loan programs. At one point it was possible to obtain a mortgage even if you had bad credit and were not able to substantiate your income. 

All of these factors increased the size of the US mortgage market and therefore allowed the number of lenders, both wholesale and retail, to grow to a level never seen before. 

The Party Ends

Then, a couple of years ago, interest rates rose and many of these mortgages that were originated started to default when they came due to adjust to what some consider to be usury levels.  In addition, real estate values started to stagnate and even go down in many markets.  

This increase in defaults combined with declining real estate values has led to upheaval in the mortgage markets.  According to one web site that keeps track of major lenders that have imploded, "ml-implode.com" 249 major US mortgage lenders have ceased doing business.  This doesn't count the hundreds of other lenders that have substantially curtained operations or the thousands of smaller lenders who have gone out of business.

As Janet's post points out, Washington Mutual is just the latest of these lenders.

What Does The Future Hold?

While no one, myself included, has access to an accurate crystal ball in order to gaze into the future, I think that I have a pretty good idea of what is going to happen.  The current consolidation that is happening in our industry will continue.  Even if the powers that be see fit to address the credit crises directly and create a program to rescue home owners in danger of foreclosure, consolidation in our industry is going to be a fact for some time to come.

Eventually, borrower bail outs or not, the real estate and credit markets will weather this storm, but the number of lenders (both wholesale and retail) will be substantially smaller.  Interest rates are going to rise because they will have no choice and while some of the non-conforming programs may eventually return, sub prime will never be the same as it was.  

All in all, real estate will return to what it has been for hundreds of years in this country; a roof over your head, a hedge against inflation and an investment that (if held for a fairly long term) will provide an attractive enough return to justify it being part of most people's investment portfolios.

As far as wholesale mortgage lending goes?  It's hear to stay.  The economic forces that spawned it's creation will still be there.  Even with legislation that will raise the cost of production for brokers, banks and other institutional lenders will still have a problem competing with us on a cost basis.  Brokers will remain an agile and quick, as well as flexible alternative to bank financing.  Institutional lenders will come back to seeing the advantages of dealing with brokers and eventually, we will return to a "normal" market.

R.B. "Bob" Mitchell

ValueList Real Estate Services, Inc.

Bob Mitchell is president of ValueList Real Estate Services,  St. Louis' largest discount/full-service real estate and mortgage company.  If you would like to find out more about Bob, ValueList or our flat-fee listing program, please feel free to visit our web site at valuelistre.com