Guest Post: Fed Aims At Mortgage Fraud, Shoots Housing Market In The Gut

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

Fed Aims At Mortgage Fraud, Shoots Housing Market In The Gut

The problem with mortgage fraud wasn't broker compensation: it was the ease of the fraud and the incentives throughout the food chain for collusion. New Fed rules simply wipe out competitors to the "too big to fail" mortgage banks.

Why are we not surprised that the Fed took aim at mortgage fraud and ended up shooting the housing market in the gut. Here's a simple guide to what's good and bad for housing:

Things which makes it easier and cheaper to borrow money: good.

Things which make it harder and more expensive to borrow money: bad.

And that's the fundamental problem with the Federal Reserve's new regulations crimping mortgage broker compensation. Unless we expect mortgage brokers to take vows of poverty, then the system has to allow legitimate brokers to get paid in accordance with the amount of work the loan requires to get funded.

By severely limiting compensation, the Fed has basically wiped out small brokerages and lenders, reducing the availability of mortgages to a handful of--you guessed it--too big to fail banks, who already control the majority of mortgage origination.

the Fed's ill-advised "reforms" simply act to further consolidate an already concentrated market, creating what amounts to a mortgage cartel by snuffing out smaller competitors in the mortgage market.

The goal of limiting mortgage fraud is necessary and laudable--the point here is that limiting compensation is like chopping off a toe to fix a tooth ache: the problem was lax underwriting rules, inadequate/zero oversight, fraudulent appraisals and ratings of mortgage-backed securities, etc. etc.

The Federal Reserve Board says that its regulatory goal is to “protect mortgage borrowers from unfair, abusive, or deceptive lending practices that can arise from loan originator compensation practices.” The basic idea is to prevent loan officers from steering borrowers into riskier types of loans or a higher than average interest rate to make a higher commission.

Officially titled “Loan Originator Compensation amendment to Regulation Z,” The new rules apply to mortgage brokers and the companies that employ them, as well as mortgage loan officers employed by banks and other lenders.

Since most of us only deal with mortgage loan origination fees when we buy a home or refinance a mortgage, the average citizen will have a tough time sorting out the often-arcane issues at stake. But the bottom line is straightforward: the already-limited mortgage market is about to become more limited, as small mortgage brokers are being shoved out of business. Call it “unintended consequences” or a cloaked plan to channel more of the mortgage business to the “too big to fail” big banks, but regardless of the motivations, the rules end up limiting consumer choice and making it harder for home buyers to get a loan.

That's bad for housing in two ways: limited competition drives costs up, and marginal buyers will find nobody wants their business because it's simply not worth the compensation allowed by the Fed's new rules.

One size does not fit all--except in a Centrally Managed Economy (TM, Federal Reserve).

This is yet another case of closing the barn door after the horses have already left: the riskiest subprime-type mortgages that were the root cause of the problem have largely vanished from the mortgage market.

Since the rules largely apply to small lenders and brokers who must sell the mortgages they originate to larger banks--most banks and other direct lenders, including big mortgage companies that function like banks, are exempt from the new regs—then the limits will weigh entirely on smaller independent players.

Critics, including U.S. senators David Vitter and John Tester, observe that this will further concentrate a market which is already dominated by mega-large banks. According to the senators, two banks already originate 43% of the nation’s mortgages. (Can you spell "cartel"?)

What the regulations do is set some ground rules--consumers must be offered the lowest possible interest rate and fees for which they qualify, for example--and limit loan officer and broker compensation in several key ways.

“The loan originator may not receive compensation that is based on the interest rate or other loan terms.” In other words, a lender can no longer pay a loan broker a yield-spread premium, which is tied to the rate or terms of the mortgage. Currently, the brokerage firm and the loan officer typically split this rebate, which is typically stated in “points,” where each point equals 1% of the loan amount. Thus a loan origination might earn an $8,000 fee, $4,000 of which goes to the loan officer and $4,000 to the mortgage broker.

Under the new rules, the mortgage broker cannot pass on a part of the commission to the loan officer, who must now be paid an hourly wage or salary. The idea is to remove the incentive of the loan officer to push the consumer into a more lucrative loan, but the result is to remove the incentive to remain in the independent mortgage business.

Mark Helling, a licensed loan officer based in Ohio, summed up the view from inside the industry: “After April 1st, a Loan Officer will have to be paid the same rate whether it is an easy loan that takes two weeks to close or a foreclosed property in need of rehabbing for marginal borrowers that takes three months of work to close. Just when the country needs the most experienced and knowledgeable mortgage professionals to help liquidate the flood of foreclosed homes, the Fed is making it unprofitable for loan officers to accept these deals."

From the point of view of those in the mortgage industry trenches, what the rules do is increase the regulatory expenses of being in sales but eliminates the commissions that are the lifeblood of any sales enterprise.

“Prohibits a loan originator that receives compensation directly from the consumer from also receiving compensation from the lender or another party.” In other words a loan originator cannot collect payments from both the consumer and the lender in a single transaction. If a broker is paid a commission by the lender based on the loan amount, then the broker is barred from charge the borrower “points” or fees for the loan processing.

This prohibits loan officers from paying borrowers’ fees or issuing them a credit from their own commission. This has been a common practice within the industry, and from the inside perspective, it that has offered a flexible way to lower borrower’s costs.

These major regulatory changes are being made in the service of fair lending practices, but to those seeing their livelihoods threatened, it looks like a sledgehammer is being used where a flyswatter would have sufficed.

“As far as trying to protect consumers from those seeking to charge a higher interest rate, with all of the competition out there for mortgage loans,” Helling observes, “all a consumer has to do is check one or two other banks and they can quickly find out if they are getting a fair deal or not.”

The rules will also interact in potentially harmful ways with the massive Dodd–Frank Wall Street Reform and Consumer Protection Act, the most sweeping financial regulation since the Great Depression.

At issue is section 1413 of the Dodd-Frank Act, which states that any violation of the loan originator compensation rules will offer the borrower a “defense to foreclosure” for the life of the loan.

In other words, if a delinquent borrower can go back and find some violation of the compensation rules in his/her mortgage origination, the lender is effectively barred from foreclosing on the borrower’s loan.

Given the risks this presents to banks, many observers, including the two senators, expect the large banks which typically buy mortgages from independent brokers and small lenders will shun these mortgages. Why buy a mortgage which could go sour via default that could preclude foreclosure as a remedy? Talk about putting a bullet in the housing market when it's already down: the new rules create huge disincentives for banks, too big to fail or otherwise, to buy independently originated mortgages.

These rules will poison the housing market in several ways. If mortgage brokers can no longer make enough in commissions to stay in business, then the mortgage options for home buyers will shrink. The most productive loan officers will find reduced incentives to risk remaining independent, and so there will be less competition offered to the big banks which already dominate the industry.

What happens as mortgage sources and competition dry up? Mortgage costs rise, and marginal buyers will be shunted aside as unprofitable customers.

The need for carefully thought out regulation has been made painfully apparent by the excesses of the credit and housing bubbles, but squashing legitimate independent loan originators and further concentrating the mortgage industry into the hands of the “too big to fail” banks does nothing but hurt the housing market and eliminate the healthy competition to big banks offered by smaller lenders and legitimate mortgage brokers.

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Bearster's picture

What?!?  A new government action sold on the claim that it will help the little guy actually ends up protecting large incumbents?!?

Quick, let's enact more regulation to protect the little guy!  These guys need more power and the little guy, er, I mean TBTF need more protections!

redpill's picture

All this achieves is crushing small brokers, and it can't possibly be a mystery to them that it does so.  For brokers who are large enough to get a warehouse line and become a correspondant lender, many of these hurdles disappear.

For those not familiar with how the process works, a broker is a third party that simply organizes the transaction, and charges a fee for matching borrowers to lenders and doing the paperwork.  These new regulations make it very difficult for brokers to make money because of absurd restrictions on what they are able to charge one borrower versus another.  It is essentially price fixing.  It would be akin to the government going to your local car dealer and telling them they have to make exactly the same amount of money on every single car they sell.  Well congrats, you just killed the jobs of every salesman on the lot.

Correspondant lending is when a loan agent has sufficient financial standing (read: a warehouse line) that they actually fund the loan themselves and immediately sell it to a bank.  From the borrower's perspective, there is no difference, apart from the fact that if the agent is a correspondant lender, they don't have to disclose nearly as many things as a broker would, and they don't have to adhere to the rigid price fixing called for in the recent legislation.

In the end, the borrower's loan is still provided by the same bank, the only difference is how the process plays out.  Small brokers get cut out of the sales loop and are forced to follow ridiculous rules, while correspondant lenders (or direct lender banks) don't have to.  Plays right into the hands of the large financials, AGAIN.

spelledwrong's picture

This sums it up well!

This esp:

 "It would be akin to the government going to your local car dealer and telling them they have to make exactly the same amount of money on every single car they sell.  Well congrats, you just killed the jobs of every salesman on the lot."

No matter what you think of a mortgage broker, the fact that the FED has come in and told us how we can get paid and that we have to make the same on every loan no matter what the amount of effort is absurd...but that is what has happened. This after disclosing every last penny (gross) we make per loan.

nufio's picture

i think it works out well... mortgage rates should be higher than 5% for a 30 year loan.

if this makes it so and a bunch of salesmen lose their jobs... its worth it.

the big banks make their money anyway. and they stil have to compete with each other.



redpill's picture

You think a cartel = competition?

spelledwrong's picture

Not much on capitalism, eh nufio?

nufio's picture

i dont think mortgage brokers should exist. I think anyone who gains out of the mortgage transaction in a % basis of transaction should hold a % of the risk.

I think this should also hold for real estate agents.. but their business model is dying with competition from companies like redfin.. hoooray!!!!


the govt should close down fannie and freddie and stop buying home loans.  If fannie and freddie did not exist i would support zero regulation for mortgage brokers or banks. this is the best case scenario. I doubt many mortgage brokers would want this scenario either.


Just carifying that I do support deregulation, but only if govt money is out of the picture in the first place.

FreedomGuy's picture

Good post, Red Pill. I enjoy knowledgeable posts like yours. I truly believe that as government encroaches on every industry that all of us in every industry could write similar posts about government interference in our industries. I have come to the belief that regulation overall is a large net loss, especially when you add in the costs of the monitoring and documenting.

Zero Govt's picture

usual monopolist rot which is Govts very purpose

D1eeeeeNAHHHHH's picture

redpill, I know it sounds that simple regarding old brokers transitions, but it's not.  The people I know who own their own companies are forced to work under bank charters or were forced to essentially becaome a bank. 

The banks eliminated nearly 100% of the competition in one swoop and got paid by the fed and the us government in the process.

According to them, all loan volume is waaay down, even for the loan companies that did survive.  When nearly everyone requires 20% or go FHA, there are only refinancing (near ly everyone already has done this) or purchases (most don't qualify and are afraid.)

TruthInSunshine's picture

The truly scary thing is that only by allowing fraud can Ponzi-nomics in the U.S. & Europe delay (for how long, who knows) a depression, as housing is beyond burnt toast. This analysis is an admission of that.

 Bring back the NINJA loans!

And one just has to love that all these so called competent economists keep talking about housing as a cause of our economic pain, when it is jobs (or joblessness - unemployment and underemployment).

Jobs drives housing and all other consumption, not the other way around!

As we all know, the solution for high structural unemploment, underemployment and wage destruction is an easy fix....   /sarc

riphowardkatz's picture

And it is all about consumption. That is how we get more wealth by consuming more. 

TruthInSunshine's picture

A society can begin consuming less, and even considerably less, than it has in past decades and generations. Hell, one doesn't even need to study Empire Fail to understand this, as lesser sovereigns succumb to this trend with enough time and expansion built on debt. We've just begun a great cycle of consumer deleveraging in the U.S. & Europe (we're probably in inning 2).

Savings coupled with sound fiscal policy leads to true long term wealth and higher SUSTAINABLE consumption.

Jobs are always first and foremost as the foundation for sustainable economic growth. Consumption based on central bank drugs is a fleeting high that leads the user more susceptible to debt illness and death.

duo's picture

How many people were talked into NINJA loans with cherry-picked appraisals by mortgage brokers?  Too many.

Village Idiot's picture

"How many people were talked into NINJA loans with cherry-picked appraisals by mortgage brokers?  Too many."

How many people -

  • had agents who knew prices were inflated;
  • worked directly with banks who were just as complicit as "brokers" by offering "NINJA" loans and "cherry picked appraisals";
  • had those products securitized by knowingly complicit markets;
  • etc, etc, etc,

Everyone was complicit, including the prospective homeowner.  This site promotes truth.  Look for "advisors" who are willing to put your success ahead of their's. Hard to get shafted when people are telling you the truth.


dark pools of soros's picture

just outsource the job for pennies.. like the rest

apberusdisvet's picture

What this means is that the median home price will eventually fall below $100K; real estate/mortgage brokers need to learn a new trade; nominal wealth goes poof for the middle class, if it will exist at all in the next 5 years.

WonderDawg's picture

I don't think there is any doubt the median home price will fall below $100K, before it snaps back to the long term trend. If you can wait until the overcorrection plays out, you'll be able to buy your favorite McMansion for pennies on the dollar.

FreedomGuy's picture

This is a perfect example of the law of unintended consequences. In an effort to write enough rules and laws to make/force all of us to be "good" you actually end up doing more harm. I see it all the time in my profession.

For those who always believe every problem is a lack of regulation/rules and rule enforcement: How many laws will it take before all human interactions are perfected? Can we know them all? The companion question is: How many regulations will it take until we are all miserable and depressed as it becomes impossible to do anything? I think you know that the answer is that the second will occur long before the first.

When you are a non-socialist/collectivist as am I, the question of any product is so much easier. I simply have to ask myself, "Is the price and hassle of the product worth it?" If the answer is "Yes." then I buy it. I can research the fees and reasons and how something is made or done but I don't have to know it all. Entrepreneurs can capture a market, including home loans with better, simpler, clearer, more reliable and less expensive methods. However, they have to have the ability to innovate. Regulation removes innovation and the ability to tell the better players from the poorer players. Let laws about fraud and negligence more widely applied give pause to the shady operators. BTW, how many have been prosecuted under our current plethora of regulations? Hmmmm?

As a libertarian let me ask the final question, too. Under what Constitutional provision does the Federal government set the fees and procedures specifically of the housing market? Where is the right to make loan originators hourly wage earners instead of commission? Can they do that to you and I, as well? Are we then free if we cannot agree to our own wages and terms of employment?

Birddog's picture

Sounds like we are becoming serfs.  Or maybe we are already.

dark pools of soros's picture

since you are what you are you won't be able to see anything besides things directly interacting with you;  but you will still be slammed by all the indirect nonsense like everyone else.  How about we just bring back monopolies completely and then you can have a great choice right?


OldTrooper's picture

Seems that in this case it is the government that is actively encouraging monopolies.  And I couldn't help but notice that you avoided the question of where the government derives its alleged power in this area.

dark pools of soros's picture

I was replying to his slant in the beginning of his message..  when someone rambles it isn't the listener's responsibility to remark on every tangent.


You do know that the 'hourly wage' can be loop holed away right? Or will this be the first time ever in history that the intent will be followed with no gaming of the system?

FreedomGuy's picture

There is no rambling Soros. There's a consistent set of challenges that you don't seem to understand. I understand very clearly the loop-holes of hourly wages. I am in a class action lawsuit over that issue. That doesnt' change a thing about this article or my point. I submit to you that if you are free you own yourself and therefore you and your employer negotiate how you will be paid. Government has no standing in those negotiations. They do not own you and they do not own the business, so you are free to make whatever agreements you wish.

The Constitutional part suggests that the government actually has no legal authority to even regulate these things as an added challenge. Make more sense, now?

FreedomGuy's picture

Hard to make sense of what you write about indirect nonsense. You missed the point of the article and my comments. This will become a state monopoly. They are the worst of all monopolies. These rules LEAD to a monopoly of state favored and larger institutions. Look at the earlier comments of someone who actually knows the broker business and you see how the little guy is put out of business. BTW, that is a part of how large business eliminates and prevents competition. You get regulatory and cost hurdles, even favorable legislation that makes the bar too high for smaller competitors and new entries.

Perhaps you favor state monopolies or even nationalizing industries? How has that worked out historically? Maybe the Constitution doesn't matter either. There is no authority for these types of regulations. Even if you think there is then you have to conclude we are all in fact servants of the State as it will set our wages, terms of employment, abrogate all contracts and voluntary interactions and essentially run all industry at will. That's not a plan or idea I signed up for.

A state monopoly can never be defeated. All monopolies historically have been through the state and/or protected by the State.  Private monopolies have never really existed and are theoretical problems that have never happened. In reality they cannot exist long without government protection.

StychoKiller's picture

No worries!  Because:

"Dreams Come Due, Government and Economics as if Freedom Mattered", ISBN: 0-671-61159-3, by John Galt
The book is dated, but many of the things it talks about are still valid today.

What do you give the Govt that's taken everything?

Vertical Drop's picture

My only quibble is the idea that TBTF's consolidating an ever greater percentage of the market is "unintended".

FreedomGuy's picture

Lol! Well, I may grant you that possibility given the crony-capitalism or fascism we are experiencing now. It is not unthinkable the bigger players lobbied for these exact changes. However, my general point remains about regulation and the "good" it does us.

Piranhanoia's picture

can you say, monopoly?  As long as they get a free ride from the cities they will buy the little local tics, wipe out the small business and eventually become the only one stop spot. Empty, but your one stop spot all the same!

ghostfaceinvestah's picture

The Fed is actually doing the country a favor by putting brokers out of business.

Mercury's picture

Right, and when borrowing directly from the government remains the only legal way to get a loan we will have achieved a state of maximum financial liberty and fairness.

ghostfaceinvestah's picture

Hate to tell you but brokers are only originating loans that are ultimately owned by the government.  By definition brokers don't put any private capital into the mortgage financing market.

But they do a great job putting unqualified borrowers into government loans using fraudulent loan application information.

redpill's picture

Correspondant lenders and many banks do the exact same thing.  And claiming all of them are frauds is ignorant.  There's less fraud in the mortgage business than there is on Wall Street, imho (if you can find a way to separate the two anymore).

spelledwrong's picture

"But they do a great job putting unqualified borrowers into government loans using fraudulent loan application information."

I know that is still out there and probably always will be, bank LOs are as guilty.

With all the checks and balances and background checks now I really don't see how anyone can get away with loan fraud. I'm sure it happens but now the bank does a verbal verification of employment the day before closing, which has to be a publicly listed phone number, the credit is re-ordered within a week of closing, the tax trancripts (4506) are ordered on EVERY file to make sure the income submitted matches the income submitted to the IRS, the lender now orders the appraisal from an appraisal management company who then randomly selects the apprasier and we are not allowed any communication with them, all deposits over $1,000 need to be documented (which sometimes leads to a papertrail nightmare) and on and on.

On the GFE we are now married to the charges for not only the our fees but the transfer taxes that are quoted.


I think most of these are good esp the GFE, but IMO, most of the problems with fraud and unethical LOs are gone (but will never be gone completely just like any any business).

StychoKiller's picture

...but now the bank does a verbal verification of employment the day before closing, which has to be a publicly listed phone number, the credit is re-ordered within a week of closing, the tax trancripts (4506) are ordered on EVERY file to make sure the income submitted matches the income submitted to the IRS, the lender now orders the appraisal from an appraisal management company who then randomly selects the apprasier and we are not allowed any communication with them, all deposits over $1,000 need to be documented (which sometimes leads to a papertrail nightmare) and on and on.

After all that, the bank then trashes the note and makes an entry into the MERS database -- go figure!

waylon153's picture

Not entirely correct.  Lenders have an underwriting department to review the borrower qualifications and an Appraisal Review department to review the property.  If there is fraud it is the job of the lender's employees to find this -  and they do, all the time.  The underwriters call everyone on the application and verify addresses, call creditors, call banks/401k accounts, etc.  


If there is fraud then the lender has not done their job. Why?  They look the other way because they want/need the fees.  Or, the loan qualifications (from the government) are not clear and are open to interpretation.  The loan standards are about 30 pages long even for a "simple" 30 year fixed loan. 


The lender loans the money and gets it back in about 30-60 days from the investor (basically the US government now).   The lender gives the money to the borrower not the broker.  If you were giving money to a stranger, wouldn't you do a thorough job with due diligence?

SwingForce's picture

 Everything Obama, Geithner, & Bernanke do, they do it all for The Banksters. EVERYTHING!


Many people have lost their homes. Many more are paying inflated rates on inflated properties which the banks refuse to refinance. Savers are getting lousy rates on CDs, but are charged 10%-24% on a credit card. From the top of the credit menuboard to the bottom, The Banksters have FREE REIN to suck as much blood out of the middle class as they possibly can. It’s a criminal plan that TARP was paid for by The Taxpayers to save the banks from extinction, only for them to revive and viciously attack the hands that feed them. Henry Paulson should be charged with Treason for using The Taxpayers' Money to re-arm The Banks of Mass Destruction. Everybody is a victim, even the homeowner without a mortgage, his equity is dropping in its entirety; he's  losing more than the guy with a mortgage. Condos sit empty because banks don’t want to pay associations’ maintenance fees, while those fees rise for the rest of unit-owners to make up the shortfall. The Banking Cartel is waging a war against every American Citizen, and it won’t be happy until every savings account is drained, every homeowner is broke & evicted, every credit card holder is “paying” 24.9% + $88/ mo. in overlimit and late fees, and every house is in their possession. Even the foreclosure process is financially draining for the owner, with insurance and electric payments continuing until property is taken out of owners’ name, an average of 2-3 years. (Upon repossession, the bank doesn’t book the loss until resale, artificially covering-up insolvency issues). Wake up people, its not us against each other, its Us vs. The Banksters who run their operation with impunity.


Further details of the covert TARP program, “Where the Bailout Went Wrong”, by Neil Barofsky:

AldousHuxley's picture
Lower Real Estate Values is great news!
Stuck on Zero's picture

We should eliminate mortgage tax deductions and government guaranteed mortgages.  The result will a drop in home prices and an increase in home affordability and ownership. 

FreedomGuy's picture

Not sure if you are being humorous/sarcastic but you are correct. Housing and property in general should have its own natural market value which would have been much cheaper over time. I would support this with a concurrent reduction in income taxes so the tax burden does not increase.

Dr. No's picture

Ive stated this before.  Just look at housing prices in countries without subsidized 30-year mortgages.  Homes which are bought from the owner for cash or on owner finacing terms.  I have seen builders offer condo units a large discount in the early phases of construction in order to presell the homes.  Terms such as 50% down and the rest over 5 years.  Whats wrong with this?  Gone is the corruption from GSE's. mortgage brokers, TBTF.

robobbob's picture

That would be great. With jobs being outsourced, remaining wages stagnate and being destroyed by government sponsored inflation, growing taxation, how does the average person come up with a 50% deposit before the age of fifty? and what happens to all of those construction and RE related jobs?

know where that ends up in statistville? justification for unlimited public housing. which I guess solves the problem of what the gov plans to do with all of those toxic loans they bought up. a regular win/win........... for statists

nufio's picture

you are assuming that the re prices will remain the same.. in that scenario prices will drop to a point where the sheeple can afford houses at an earlier age.

Dr. No's picture

a 50% deposit before the age of fifty


If the house cost $20-$50k, its doable.  How is it statist for housing not to be propped up by federally subsidized 30-year mortgages?  The current system is statist:  It lets people to pay for a house on a 30-year plan. Therefore people bid up the price of the home based upon monthly cash flow.  If there was no 30-year mortgage, home prices would be bid much lower.

FreedomGuy's picture

The statist part is the tax deductability of the mortgage interest. The State is favoring one asset class over another. They could do the same for auto's, HDTV's or anything else if they chose. A 30yr mortgage is not statist but you are right in that the availability of these does indirectly drive up the prices of houses by making more money available. Cars would cost more if they had 30yr or 10yr loans as the amount of money to finance them increased.

Missiondweller's picture

It alaways amazed me that to sell securities you had to be licensed, get fingerprinted and pass background checks as well as consider "suitability" for the client.


The mortgage broker is not encumbered by any of these things (in the US) and can/could recommend any type of financial scheme/mortgage irregardless of whether its suitable for a potential homeowner.


After three years, have there been any reforms? No.

OldTrooper's picture

No doubt the regulators for the mortgage industry would be just as effective at sniffing out fraud and malfeasance and bringing perpetrators to justice as the SEC is.