Friday, April 18, 2008

How It Was Is Not How It Will Be

Picture an old grand-father's clock in your mind, with it's pendulum swinging back and forth. That's how the residential real estate mortgage lending industry trends have historically performed. The pendulum swings in one direction for a time; then it reverses itself and goes back the other direction. With each 'correction,' the newly changed course brings fresh and innovative ways to operate; many new concepts develop that were not a part of the former path.

After the last correction that started during the Fall 1998, several original concepts evolved. As we think about that period, we need to remember through the 7 years of that pendulum swing, home values soared nationally and interest rates plunged to historical lows, inspiring mortgage brokers and LO's to think 'short-cut' and 'easy money' was the way to go (and thus keeping them from growing in business knowledge and realizing they should have been learning their trade - but the Greed was intoxicating). With property values and rates acting like they had never done before, it encouraged the scheme of refinancing customers 2, 3 or even four times over a short period - stuffing large YSP's and raising loan balances each time, effective burying many of them in their homes; all the while persuading every Tom, Dick & Harry to jump into our industry so they could make Big Bucks! Unlike the more traditional way of thinking, Integrity and Ethics seemed out of place during that cycle. Also among the more startling ones that grew, included the idea of paying LO's and AE's commissions (six plus figure incomes!) vs. previously customary salaries bonus - which made them transaction and commission check focused and it took away from a fiduciary duty to place the customers interests ahead of their own; the notion of permitting unsupervised and unqualified LO's operate as independent contractors working out of their home; wholesale funding sources, overcome by greed, offering one irresponsible loan program after another chasing production; the net branch biz plan often utilizing unlicensed and always poorly trained loan officer/agents to uncontrollably operate nationwide ... I could go on and on about all the changes that came to pass during the 98-05 pendulum swing. This was a most regrettable period for our industry, thankfully, most of the careless concepts are disappearing as we speak.

Let's not forget, the Aug '98 - Dec '05 swing brought us astronomical production numbers all up and down the line - however, those were not true loan volume numbers, but really GIFT stats, as most transactions were a present/gift to the borrowers as there was very little resemblance to real lending being done, given the major deterioration of the vital checks and balances from LO to broker to processor to underwriter to lender and up stream from there. I have never seen the amount of total industry destruction these and others ridiculous practices have caused.

Since the current 'correction' began during the Winter 2005, at the moment we're just over 2 years into the current pendulum swing; on this new path you've already seen a great many changes - there's more to come ... don't look backward for what's now gone, instead look forward to up-to-the-minute ways of doing things(*).

A great many new State and Federal laws are being enacted to protect the public from the Wild West 'out of control' attitudes of the mortgage industry recently, with regulators looking at those they license more closely and enforcement of existing laws being stepped up. By and large, the barriers of entry into the industry should return. A return to previous foolish programs being offered by wholesale lenders is not likely; neither is the business model of permitting unsupervised LO's to be our 'front-line' with the public; optimistically the general idea of avoiding industry education and training should disappear since the 'big easy money' has stopped at last. Wholesalers accepting new business from mortgage brokers without performing appropriate due diligence first, should vanish. Traditional/ conservative underwriting standards (some of you vets I'm sure remember the old 28/36) will resume (including across the board LTV reductions); and along with hundreds of other important areas to consider, the upstream warehouse funding sources, the wall street conduit developers, pool & bond insurers, etc. all should return to the previous checks and balances each were designed for and must perform, to maintain a viable secondary market.

To be expected during this swing, would be rates increasing and property values declining, the beginning of things returning to a more normal and balanced way of doing business. Today however, since the Fed is artificially pushing rate lower in an effort to boost the American economy, that variation in this correction will have an unknown effect on business in the long run. We'll therefore, likely see a rush into the conforming arena by most, with subprime/non-conforming taking a bit longer to transform itself into what it will look like, during the rest of this present day cycle the next seven to 10 years. And when it does, it won't look at all like it did during the 98-05 period; probably more like it did preceding the '98 correction. They'll be all new players, novel hot loan products, etc. Thankfully, long gone are the Low score high LTV Stated GIFTS!

I have seen in previous 'corrections,' nearly all of the formerly weakest areas tend to come to recognize how they contributed to problems and then they make adjustments and improve! Adapting to the changes, is the key to any long-term success in this business. Those 'good old days' of fast & easy money are gone.

PS: (*) loans will stay on the books longer than they had been during the 98-05 swing (where many borrowers refinanced regularly, frequently traded up on home purchases, etc.) to the more historical 5 to 7 year loan durations. Therefore one example would be that due to the changes in loan life, if you have been churning your former customers for new loans or trying to survive on referrals from them, you'll discover in this new climate, the number of loans you'll be able to get funded will be significantly reduced.


Article by Peter Samuel Cugno, Chairman & CEO of Secret! University, the educational division of Americas Money Center, Inc. with 40 years experience in the subprime industry niche. Questions or comments may be directed to Peter 310-833-4068 or online at: http://www.americasmoneycenter.com

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