The Mortgage Fiasco: Why Mortgage Brokers are Getting a Bad Rap

By Keith Schemm.

As the year 2008 has come to a close and the turmoil and upheaval occurring in the mortgage and real estate markets is fully evident, I think it is worth reflecting on the last few years of the housing bubble to ask how did we get here, what have we learned and what’s coming next?

Thinking back to 2002, when I was a loan officer with Erate.com during the go-go years in real estate lending that progressed in quick succession until 2006 when I returned to corporate finance, I couldn’t help but think something had gone seriously haywire in the borrowing and lending culture. Borrowers had long resented the traditional banker sitting behind the big desk with the take-it-or-leave-it attitude and mortgage brokers offered the borrower a chance to get a competitive rate on their loan at a reasonable price with some personal service and expert advice to boot.

I cannot tell you the thousands of thankful clients I talked with over the years who appreciated the clarity and transparency that Erate’s website brought to their mortgage search experience. They really appreciated how Erate’s customer service demystified the loan process for them, we explained the 4-Cs of lending and educated them about how to integrate their loan decisions into their overall personal financial plan.

As the real estate bubble progressed, it was interesting to hear stories from borrowers as to what their financial planners were advising them about other investments and I gave them my own opinions. I once had a 55 year old woman call me about obtaining an option arm on her un-mortgaged personal residence. After talking with her about her ideas I expressed that I didn’t think that was a wise loan decision for her (see my BusinessWeek interview from 2005) and that she should really be locking in low fixed rates at that time. She then went on to say that her financial planner told her that the stock market was the place to be and she could get a better return on her equity if she paid a teaser rate and put the money into the stock market. Well her planner was obviously talking his book (commissions) and my advice didn’t go over to well and she quickly said goodbye.

I had another borrower with very sketchy credit and a lot of credit card debt who had been a longtime renter but had purchased recently and was sitting on a windfall in appreciation. He wanted to refinance and cash out to pay down the credit card balances. I said that I thought that maybe he should think outside the box and sell for a profit now and pay off his debts, build back up his credit score and rent again for a while (seeing that his lifestyle was more suited to being a renter). He said he had never thought of that as an option and thanked me. I certainly hope he got out in time.

Another mistake I saw many borrowers make was letting tax laws dictate the timing of buying and selling property. There were many who took the risk of carrying two properties to satisfy the holding period for preferential long term capital gains tax treatment on personal residences. At the end of the bubble one has to wonder how that worked out for them. Are they still holding? Did trying to save on taxes due to Uncle Sam end up bankrupting them?

By 2004 most, if not all, of the thoughtful borrowers had obtained fixed rates for long term properties. The bubbling prices were now putting the hurt on would be buyers but there was such a frenzy in the air for appreciation that no amount of down-to-earth talk about prices would get through to prospective buyers at this point. I had one young woman who was a recent Harvard Law grad who had gotten a really great job with terrific income growth potential who I just couldn’t get through too. She hadn’t yet saved a serious amount for a down payment but wanted to buy in an “up and coming market” in a shady part of the bay area selling for around $780,000. It was clearly too much money for the property. I did some back of the envelope calculations for her and said that prices had to go up a minimum of 6-7% annually for it to be in her best interest to do the deal and I advised her against it. I think she got the loan somewhere else.

During the bubble you just couldn’t get through to some people about the total lack of reality in their situation. There was always somebody else that they could find to do the loan, add a co-borrower, or bend the rules (or worse) to complete the deal. I am proud to say that we at Erate.com kept our integrity and didn’t descend into that quagmire. In fact, 98% of our loans were “A” paper the rest were special situation Alt “A” and some stated income. I don’t think we did a single sub-prime loan in the 4 years I worked there. Needless to say there were some pretty quiet stretches where interest rates trended up and we didn’t do many loans.

Finally, having 20 years of experience in accounting and finance, I think it is now clear that it was a confluence of trends and events (not due to the traditional mortgage broker) that were in place for 50 years or more in the areas of: public tax policy, societal attitudes and norms, technological capability and credit securitization and attitudes towards risk that had changed which corrupted a longstanding system of private property acquisition and financing in America that resulted in this credit crisis.

In the wake of the bursting of the Dot.com bubble, this evolved into what I term the “Property & Savings Crisis” as much as anything that gripped America and eventually the world in the first decade of the new millennium. It was the mass recognition by the average U.S. consumer that they were incapable of earning enough to adequately save for retirement and that inflation in some other asset, namely real estate, was their only hope in building wealth.

Government’s War on Savers


With the signing of the Federal Reserve Act on Christmas Eve in 1913 (see The Creature from Jekyll Island) the U.S. government began its “War on Savings’ and solidified the banking establishment’s control over the machinery of wealth creation in this country. Since Nixon’s closing of the gold window in 1971, the U.S. saver has endured a policy of government engineered inflation via issuing of Fiat currency. It is a well documented fact that a c.1910 dollar bill is now worth less than six cents today. This intentional government policy of destroying people’s savings over time by growth in the money supply and thus increasing nominal economic activity through inflation has become is so ingrained in the psyche of the population at large that no one even thinks about it anymore.

Property ownership and the favorable tax treatment of the same through the tax code (i.e. mortgage interest deduction, tax credits, and capital gains exclusions) has over time served to make real estate the primary vehicle of personal wealth creation in this country for the common man. However, it always came with the risks embedded in the economic cycle and the periodic real estate downturns along with the inherent dangers in the use of leverage by the individual compounded by the over-leveraging by U.S. corporations and the government.

The difference I see between this cycle and the ones that had preceded it in the 70’s and 80’s is the failure to recognize the moral hazards that developed within the financial industry in allowing Wall Street to effectively become the de facto regulator of itself, compounded by the scale of the securitization of mortgages and the supposed disintermediation of risk through derivatives and the changes made to the compensation scheme for the firms that rated the securities that were later sold in the secondary markets. More on this later…