Miguel’s Thoughts on Wall Street and the Credit Crisis

February 6, 2009

I wanted to share this comment with you from Miguel that was left on my post from yesterday:

JLP,

I’m surprised to see you go for the cheap shot sound bite. I can get that in the MSM. What I would hope for from you would be a more nuanced analysis of the situation.

The problems on WS are a combination of factors, which include economic policy mistakes (on a global scale), deregulation, lax enforcement of regs, poor risk management decisions on the part of WS management, and ultimately lack of long-term accountability both at the leadership level, as well as in some case at the employee level. Throw on top of that an explosion in new products and financial technology (i.e. derivatives) to amplify the effects of the above.

Wall Street is a mixed bag when it comes to talent. True, you have some dullards (usually the eye candy sales types who are good at sweet talk and following orders) and these people are often simply carried by the tide, but for the most part, you really do have some extraordinarily talented folks. Many of them either don’t really need to work, or have enough put away to sit out this round for a few years, or have enough to go start their own business, or are extremely in demand at other firms that are not handicapped by the current crisis (and yes those do exist) or all of the above.

Additionally, there are many departments at WS firms that did make money the old fashioned way. They are the reason some of these firms didn’t lose even more money. Drive the talent away, and you might as well shut down the bailed out firms (which you might argue is what you would have preferred anyhow).

Lastly, some of the healthier firms were strong-armed into participating. Would you kill off those firms too? I guess our political establishment has done a pretty good job of redirecting attention and anger away from themselves and towards an easy populist target – those guys over there make too much money so they must be stealing it!

I just hope that in the process, we don’t throw the baby out with the bath water.

Rather than add fuel to the fire, how about some serious academic thinking about the source of our present state of affairs? And yes, if that sounded like a challenge – it was.

I like and respect Miguel very much and it was NOT my intent to take a cheap shot. Miguel has been a reader of my blog for several years now—though he is not able to comment as often as he’d like.

Miguel makes some excellent points—points that I did not consider when I wrote yesterday’s post, which was meant to be a humorous piece but went awry.

I don’t have all the answers. I’m frustrated with the situation just like everyone else.

To Miguel’s thoughts, I’d like to add a few of my own as to how I think we got into this situation. There’s plenty of blame to go around:

1. The bulk of the blame has to lie with the people who allowed themselves to get suckered into these toxic mortgages in the first place. Had there not been buyers for these mortgages, there wouldn’t have been a reason to sell them.

2. Mortgage brokers (and banks that originated mortgage loans) were huge instigators of this mess. Why? because they were on the front lines selling people on these mortgages. There was no accountability from the mortgage brokers. They simply wrote the business, got their commission, and went on to the next mortgage. A lot of them made out like bandits.

3. The rating agencies should have NEVER given securities that were backed by subprime loans high ratings. High ratings imply safety and these were not safe securities.

4. Mortgage brokers should have NEVER been paid higher commissions to sell one type of mortgage over another. Brokers were paid higher commissions to sell subprime mortgages than prime mortgages. It creates a huge conflict-of-interest. The broker should be there to help the client get the best mortgage for their needs…not to sell the mortgage that pays the highest commissions. There were prime borrowers who were sold subprime mortgages simply because there was an incentive for the broker to do so.

As far as Miguel’s thoughts on compensation for those firms receiving bailout money: I’m conflicted on this one. Surely there has to be some sort of limit. Market purists will say that the market should take care of this issue. I agree, BUT these same companies shouldn’t have been begging for government assistance either. When things were going great, they wanted the government to stay out of their business. But, as soon as things turned south, they’re at the government’s door looking for a handout.

I realize that these are big companies with lots of different business units. Is it fair for the good business units to forgo bonuses when the losses occured in one or two units? I think it is. Why? Because we are talking about the business as a whole. When the business as a whole loses money, then everyone should suffer. Of course the downside to my line of thinking is that the bonuses are structured differently for different units. Traders can makes tens of millions of dollars in one year while most average employees will make nowhere near that much. Unfortunately, a series of errors by these traders, can ruin a company. The trader of course can lose his job but he can also be the cause of innocent people losing their jobs.

So, maybe the pay structure needs to be changed.

Folks, one of the reasons I blog is so that I can learn too. Believe it or not, I appreciate points of view that don’t agree with mine. There have been numerous times when I have written something and someone will say something in the comments that will make me think, “Hmmm…I never thought of it like that before.” Miguel and Ted made me do just that with their comments.

Thoughts? Weigh-in, weigh-in.

39 responses to Miguel’s Thoughts on Wall Street and the Credit Crisis

  1. I’m curious about point 4. The point of salespeople is to sway customers into purchasing products with higher margins. Higher margins means more profit to the company and thus higher commissions for themselves.

    There’s no conflict of interest because the interest of salespeople and their customers are never aligned. IE, the local coffee shop wants you to get an extra shot of expresso, the burger joint wants you to super-size your order, your haircutter wants to convince you to get your hair washed.

    Why are the rules different for mortgage brokers? People need to realize that salespeople are not there to provide advice and guidance. They are there to convince people to spend more.

  2. Adam,

    The difference is that fries and coffee deal with dollars while mortgages deal with hundreds of thousands of dollars. There’s a big difference.

    I’m saying that one product should not pay a higher commission over another product. There is no doubt that the different commission payouts contributed to higher usage of subprime mortgages.

    Lots of brokers sold first and tried to justify later.

    Besides, what about doing what’s right? Isn’t that important?

  3. @JLP

    >> “The difference is that fries and coffee deal with dollars while mortgages deal with hundreds of thousands of dollars. There’s a big difference.”

    That may be the weakest rebuttal i’ve read in the past week. If you would like to have sales people put on the kiddy gloves and limit their earning potential, and more importantly, you think the majority of Americans would be interested in that as well, then it sounds like you’ve found an empty market space and need to open a business.

    >> “I’m saying that one product should not pay a higher commission over another product. There is no doubt that the different commission payouts contributed to higher usage of subprime mortgages.”

    There are intended purpose for each product offered. And who are you to say that private company XYZ should not be allowed to offer Zero-down mortgages?

    >> “Besides, what about doing what’s right? Isn’t that important?”

    weakkkkkkkkkkkkkkkkk. who decides what’s right?

  4. Ted,

    Are you going to tell me that when a broker has two products to sell and one product pays a larger commission than the other, that the broker isn’t going to sell the one he can make the most money on, regardless of whether or not it is right for the customer?

    The purpose of a subprime loan is to compensate the lender for the increased risk of lending to someone with less than stellar credit. WHY should the broker earn a bigger commission for selling such a product? They have nothing at risk in choosing one mortgage over the other. They are simply middlemen, orchestrating the transaction.

    I’d be interested to hear your thoughts on why we’re in this mess. What things could have been done to prevent it? Why don’t you ADD something to the conversation instead calling all my thoughts weak?

  5. My biggest problem with Wall Street compensation isn’t so much the absolute amounts, but the lack of penalties for failure. Traders made vast bets and got monster bonuses with little personal risk other than simple employment risk. If they blew a few hundred mill of other people’s money, nobody went after their bank accounts or houses. But they’d get massive, monstrous bonuses if they ended up on the right side of trades. If they are to be compensated this way, I’d prefer to see some sort of vesting for bonuses so they don’t realize their bonus until their trade has completely played out, with clawbacks for blown trades, especially if they are demonstrably dumb.

    That said, I know several Wall Street types, and from what I can see, I’d hate the work. Traders and analysts live in a truly icky world of IT-ish minutiae multiplied a hundredfold. They _are_ brilliant, but are the epitome of “always on” 24/7/365 workers with PDAs permanently “on”. I could send my Wall St. friends email at 2:30 AM NYC time and they’d reply within seconds.

    I nearly went to work there in the early 1990s, but my dad got sick and I stayed in California instead, and became a Silicon Valley techie instead of a Wall Street IT type (which is where many traders start out). I’ve often wondered how my world would be different if I’d gone there. I have little doubt I’d be far richer – although I’ve done alright here in the Valley – but I would have had to work even harder than is typical in the Valley.

  6. To all those who say that deregulation was to blame, including Miguel–you make the correct point near the end of your comment, where you mention how the healthy firms were strong-armed into participating in the subprime crapfest. The strong-arming was government intervention and regulation.

  7. As an accountant, being a Fiduciary comes w/responsibilities. Perhaps we are confusing the mortgage matter at hand w/the notion that mortgage brokers should act as fiduciaries. Obviously, they are not.

    In any event, good customer service (and ethics!) would be a welcome trait to see in a broker–i.e. match the client’s need w/the appropriate mortgage product. Oh, and consideration of “The Golden Rule” would have certainly eliminated some of the crap in the marketplace. However, “Buyer beware” or in this case “Borrower Beware” should always be the motto to protect oneself.

    I’m sensing a lot of anger out in the audience, JLP. Maybe guilty consciences do exist in some folks? Perhaps there is some hope after all…

  8. @JLP,

    I sense frustration and I perceive the problem to be with your emotions clouding your logic. For example…

    >> “The purpose of a subprime loan is to compensate the lender for the increased risk of lending to someone with less than stellar credit. WHY should the broker earn a bigger commission for selling such a product? They have nothing at risk in choosing one mortgage over the other. They are simply middlemen, orchestrating the transaction.”

    As the buyer: Why do you care that the broker earns a bigger commission? Shouldn’t you be more concerned with figuring out “what’s the best loan product for my situation?”

    As the home-office economist trying to sort through this mess we are in, why does it matter that the broker earns a bigger commission? According to the lending rules “of the bank”, the buyer qualifies for both the interest-only and 30yr fixed. so what’s the big deal?

    Do you think the car salesman is working to give you the absolute best deal for you, or for him/her???

    You are focusing on the noise with these rants about evil brokers.

    >> “Why don’t you ADD something to the conversation instead calling all my thoughts weak?”

    Why don’t you break me off some of that monthly ad revenue?

  9. Ted,

    You’re quite the jokester.

  10. Maybe the brokers should be required to be fiduciaries, instead of salesdroids. The problem is they present themselves as “loan officers” or “bankers”, not salespeople.

    In a used car lot, you’re expecting to get hustled, so you’re on your guard. When you’re getting a mortgage, you’re expecting the sort of transaction you’d get with a tax accountant – and that’s historically what you got. The rise of third-party, sales-oriented loan brokers is fairly recent – and subprime in particular was targeting poorly educated people who are more trusting of cleancut people behind desks with an authoritative air – so arguing that people knew they were getting into isn’t completely right.

  11. What ever happened to personal responsibility? Whether it be the consumer or the risk manager at the bank/investment firm.

    It seems that many were over leveraged, enjoyed a few years of high yield(risk) returns, and kept on the track. The weight got to be too much and there was a mass exodus from stocks.

    If you believe we were in a housing/credit bubble, then the stock values/home values were truly not sustainable. Consumer spending was greater than 100% of income and many markets became super saturated trying to suck up every dime.

    Is it bad that people are saving/paying debt off? The market needs to cut the fat, de-leverage some, and recalibrate their priorities. If you act like a lemming, you risk falling off the cliff.

  12. A few words about Wall Street compensation levels.

    If private companies want to over-pay people, that’s their prerogative. The company owners (the shareholders) can choose to either change that, or sell up and buy something else – like shares of a non-financial company. In the long run, over-paying will lead to company failure. (If Target chooses to pay double the wages WalMart pays, they better know how to charge much more too, or they will disappear.)

    Once the general public (via the government) becomes a shareholder, it gets to make this decision too. And I think these institutions are finding to their utter dismay that the general public has completely different ideas of what is and is not acceptable, whether it is compensation, private jets, meetings in Vegas, etc.

    Perhaps the talented managers will move to companies that pay more. But perhaps some of those highly-paid people aren’t actually all that talented. They just happen to have been employed in an industry that pays extremely well. Certainly, it didn’t take much talent to follow the herd over the cliff.

  13. Woa! This is like looking up and seeing your name in lights.

    @JLP – Thanks for the rapid response. I think the challenge in understanding what the heck happened is that there are multiple intertwined issues operating at once, and it is very hard to figure out which ones created which problems.

    I see the mortgage mess as more the symptom of a bigger problem than the cause. Though the reason most people see it as the cause is that this is what triggered the crisis – kinda like the detonator in a warehouse full of C4. Our financial system was already near derailing, it just needed something to spark the implosion.

    So, what actually caused the mortgage problem? I think this is something that had been building over a period of decades, but that started to accelerate out of control since the late 90’s.

    Where to begin… we had a long period of low interest rates, plus deregulation allowed thinly capitalized non-bank institutions to get into the mortgage lending business, plus deregulation allowed banks to essentially outsource their originaion and underwriting functions, plus political pressure caused Fannie & Freddie to lower underwriting standards, which in turn allowed lenders to do the same, plus a global liquidity glut created a hungry market for mortgage-backed securities, which in turn opened up gobst of funds for lenders to make loans with, which then incented lenders to churn out loans as fast as they could, with minimal regard for standards since somebody else would ultimately be holding the risk.

    Did I loose anybody yet? I haven’t even gotten to the role of the rating agencies in slapping AAA ratings on the mortgage securities based on poorly designed models that assumed housing prices only go up. Nor have I even spoken of the consumers of credit who barely knew what they were signing, and simply trusted what was sholved under their noses, yada, yada, yada, the list goes on.

    So, where in all of this is Wall Street to blame? There were a handful of WS firms that were the bulk packagers/distributors of the mortgage securities. And, unfortunately, some of them ate their own cooking (by keeping the hardest to place securities on their own balance sheets). Some of those firms are no longer with us, others are crippled and on govt life support.

    Where exactly is the blame for the system-wide collapse? Should they have known that some of the peanuts had samonella? In hindsight, more diligence would have made sense. But, you have to ask yourself, who were the purchasers of these securities and why didn’t they insist on better disclosure, diligence, and transparency? Why were these largely professional money managers willing to simply buy securities based on ratings without fully understanding the ingredients? That was your pension funds, investment funds, etc they are playing with.

    Ultimately, it comes down to a economic system where controls, diligence, accountability, and discipline broke down. There was a lot of money sloshing around out there, hunting for quick returns, with a blind eye to the risks. And the development of a largely unregulated derivatives market, where invisible side bets could be placed, was like adding radioactive material to the bomb.

    The blame goes well beyond Wall Street, and reaches every corner of our economy, regulatory framework, consumer culture, and political establishment. It sickens me that the MSM and the politicians can so easily divert the public’s attention from the real issues, by pandering to our baser tendencies – the need to find a bad guy and lynch somebody. Arguing about bonuses is a joke.

    We need our financial institutions and we need them to be strong. They are as much a part of America’s strategic global dominance as our military. Knocking them down and the people who keep them going will only serve to hurt ourselves in the long run.

  14. My wife was in the mortgage business. Alot of times she would tell borrowers that they could probably qualify, but they were stretching themselves way too thin. Their answer almost all the time was “I don’t care, if you don’t do this loan, I will find someone who will.” She lost alot of business that way. In my opinion, the long line of responsibility starts with Congress, who pressured Fannie and Freddie to lower lending standards. The line ends with the people who bought houses they could never afford. There are alot of folks in between.

  15. I think Miguel said it very well – thanks for a very good summary of causes of the crisis.

    A couple of things:
    @JLP: “BUT these same companies shouldn’t have been begging for government assistance either”
    As Miguel said, many of these companies – Wells Fargo, for example, – were strong-armed by the government to take bailout money. Wells Fargo CEO actually tried to object. Others like Bank of America were strong-armed into following through with buying failed investment companies with negative balance sheet and pay billions for it. What was a CEO of BofA supposed to do, refuse Paulson who told him it was his patriotic duty to complete the deal? Or was he supposed to refuse and alienate the government which could’ve caused his company problems down the line? Yet other banks with fairly good balance sheet like US Bancorp said that given that other banks take TARP money not taking the money would put them in competitive disadvantage.

    @jeff: “To all those who say that deregulation was to blame, including Miguel–you make the correct point near the end of your comment, where you mention how the healthy firms were strong-armed into participating in the subprime crapfest. The strong-arming was government intervention and regulation.”
    Miguel clearly said in his post which deregulation decisions he had in mind, for example, a) allowing thinly capitalized non-bank institutions to get into the mortgage lending business b) allowing banks to essentially outsource their originaion and underwriting functions. I would also like to add c) a 2004 SEC decision that exempted 5 major investment firms from leveraging limits essentially allowing companies like Lehmann Brothers to be leveraged 40 to 1 while buying mortgage-backed securities. What you are talking about is a completely different issue.

  16. JLP

    Quit pushing the BS notion that subprime mortgages pay higher commissions than prime loans.

    That is the biggest myth coming out of this debacle.

    As a broker you can make much much more by placing borrowers into prime loans.

    If you have a borderline borrower and you offer them a subprime loan of X percent AND THEY QUALIFY for a prime loan, doing a prime loan at that samepercentage pays 4 times as much money.

    So, the argument that people were pushed into subprimes when they should have rec’d a prime loan is complete bulls**t.

    Do some research before you start arguing what you do not know

  17. And further, you have to be completely out of your mind to think that any company isn’t trying to maximize their own profit. That is the point of all business

    This ain’t Mayberry, chief.

    If you think you have it all figured out regarding mortgage loan origination, start your own.

    Market your services as finding the best deal for the customer. “custome comes first” Yeah! Of course the best deal for the customer is for you to do the loan for free and charge them zero, and give them the lowest rate that exists so the bank makes zero, but at least your propagandic “customer comes first” mantra would still be intact. For about a month.

    Normally I find your posts fairly well informed,yet sometimes disagreeable.

    This post has to take the number one spot as the laziest assumption of what you think you know, when in fact you are so absolutely incorrect your clothes must now be on backwards.

    You really think lowly mortgage brokers have the power to topple the global economy and cause all of this? Mortgage brokers. COME ON!

  18. Kitty, you’re right, I left out extreme leverage as on of the issues (things seemed complicated enough). I think leverage became extreme in a number of ways. It’s not just that financial institutions were allowed to lever themselves out the wazu, it’s that leverage was embraced by all manner of institutions and individuals. Companies levered up to buy other companies or dividend money out to shareholders, people levered up to buy houses & cars they really couldn’t afford, the have it all now attitude, and the banks operated at leverage levels considered crazy by historic standards in the name of boosting returns. Additionally, there was a lot of leverage embedded in derivatives – these instruments allowed people to make massive bets in the capital markets without putting up much money – hence the leveraging effect.

    The multiplier effect of leverage on the global money supply was extraordinary and this of course helped drive asset prices off the charts. All manner of bubble markets formed, ranging from housing to art to securities.

    This is why I see the mortgage crisis as more symptom, than cause of our economic collapse.

    You have to ask yourself, where in all of this was the responsibility to govern the system? Who sets the rules? Who polices the system? Who’s responsibility was it to root out fraud, and reckless behavior? Each player in the system behaved somewhat rationally according to their own incentives and self-interest. But, who’s job is it to protect the system from itself? The banks are part of the system, but they don’t run the system. Would we have really allowed or even wanted them to collude together to limit competition? That would actually have been quite illegal.

    Our financial institutions use the roads, the bridges, the tunnels, of the system, but they are not responsible for maintaining them. Who’s job is it to set the speed limits, make the rules of the road, and enforce the traffic regs?

    This is why blame is so difficult to assign to any one player in the system. Sure, there was some reckless behavior, but who could have known it would bring down the entire system? There are people who should have known – those are the people we elect to protect us and keep us safe, not only from physical harm, but also from undue financial harm. Note that some of these very same people are the ones doing the loudest protesting, the most aggressive finger-pointing. They’re the ones screaming for blood and hoping you won’t notice that we got here because they were asleep at the wheel.

  19. JLP: While I agree that people who took out toxic mortgages should share some of the blame. The blame for this mess is with the banks and the mortgage brokers. For 200 years in this country poor people have gone to banks and asked for a loan and they were turned down. In the last 5 years they went to a bank and suddenly they are approved. The behavior of people without much financial knowledge is not going to change. What changed was the behavior of the banks and the mortgage broker. They found away to pass on the risk, this is where the responsibility is at for this mess, in addition they profited from it in an extremely excessive quick way that was not based on sound economic principles. The person buying a toxic loan did not profit matter of fact they lost everything.

    Fianlly, a mortgage broker is on your side that is why you are paying them in this process. Come to find out they don’t work for you, they jacked up the price of the house and then got them into a loan with a low teaser rate without much discussion. You trust people in the field and many many homeowners were led astray by their brokers.

    This is where the blame is at. Not a person with little or no knowledge and little or no money. How can people with no money damage the economy in the first place?

  20. Bob,

    Based on how angry you’re getting, I would say that you are or were a mortgage broker.

    Bob, are you saying that brokers weren’t paid higher commissions on subprime loans? That pretty much goes against what I have read in the Wall Street Journal—a newspaper that has a good reputation.

    No, I’m not blaming “lowly” mortgage brokers for toppling the global economy but they did play a part.

    The fact that you are so angry with my posts, really says a lot.

  21. I wrote on my blog that salary caps are asinine. The big reason: the are counter productive from a tax payer’s perspective. We just spent billions of our collective tax dollars to rescue these firms and are now proposing to hobble the very firms we are supporting most heavily by instituting salary caps which will cause the top talents, the stars, to pack up and leave for greener pastures. It’s like buying a business and then setting in on fire because we feel chilly. Seriously, this is a popular but asinine policy decision. If you are interested you can find my extended discussion and opinion of the subject on my blog.

  22. Bob,

    You said: “…the argument that people were pushed into subprimes when they should have rec’d a prime loan is complete bulls**t.”

    Then how do you explain this:

    “The Wall Street Journal reported in 2006 that 61 percent of all borrowers receiving subprime loans had credit scores high enough to qualify for prime conventional loans.”

    That was found on Wikipedia, which refers to the article, “Subprime Debacle Traps Even Very Credit-Worthy: As Housing Boomed, Industry Pushed Loans To a Broader Market”, Wall Street Journal, December 3, 2007, at A1.

    I thought I remembered that article. Sure enough, I blogged about it on December 4, 2007: The Mortgage Bailout Plan Stinks. In that post, I highlighted a quote from the WSJ piece:

    The subprime sales pitch sometimes was fueled with faxes and emails from lenders to brokers touting easier qualification for borrowers and attractive payouts for mortgage brokers who brought in business. One of the biggest weapons: a compensation structure that rewarded brokers for persuading borrowers to take a loan with an interest rate higher than the borrower might have qualified for.

    I’m not sure where you are getting your information.

  23. JLP

    What says alot isn’t your incorrect assumption I am angry, but your incorrect assumption regarding loan origination.

    YES. I am saying brokers were not paid higher commissions on subprime loans. This myth was propagated at the beginning of the subprime colapse by media commentary without fully undersatng the process.

    Lets look at your comments:

    “2. Mortgage brokers (and banks that originated mortgage loans) were huge instigators of this mess. Why? because they were on the front lines selling people on these mortgages. There was no accountability from the mortgage brokers. They simply wrote the business, got their commission, and went on to the next mortgage. A lot of them made out like bandits.”

    True. But you miss the main point.

    Mortgage brokers don’t get paid to provide acountability. Brokers have no fiduciary responsibility. They are not required to take the risk, and they do not get compensated to take the risk. Accountability is not part of the equation as a broker. Accountability falls on the LENDER, not the broker. The LENDER underwrites and approves the loan, not the broker. You gun is aimed at the wrong entity.

    “4. Mortgage brokers should have NEVER been paid higher commissions to sell one type of mortgage over another. Brokers were paid higher commissions to sell subprime mortgages than prime mortgages. It creates a huge conflict-of-interest. The broker should be there to help the client get the best mortgage for their needs…not to sell the mortgage that pays the highest commissions. There were prime borrowers who were sold subprime mortgages simply because there was an incentive for the broker to do so.”

    As I said earlier, you are completely wrong.

    1)Why shouldn’t brokers get paid different amounts for different products. Mortgages are bonds. Different bonds yield different amounts.
    Different loans require different amounts of work, criteria, time, expertise, licensing, etc.
    It is not a one size fits all business. There are varying degrees of difficulty just like there are in all business.

    2)This conflict of interest argument was pointed out by another poster. There is always a conflict of interest between buyer and seller. Weak argument.

    3)As I said before, the assumption that subprime paid more in commissions is bunk. For any given borrower prime rates were always lower than subprime(less risk). If the going prime rate was 6%, the going subprime rate was likely 8-9%. Both loans paid about the same commissions. About 1% on average.

    If the broker had somehow convinced some unsuspecting victim borrower that they can only qualify for a subprime loan of 8% when they really could qualify for a prime loan, every broker on the planet would put them in the prime loan. Because 8% prime would have paid about 4% commission. 8% subprime would have paid about 1% commission.

    Those greedy brokers you talk about, what do you think they would have preferred. 1% commission or 4% commission. Give that argument a rest. There was never an incentive to put qualified borrowers into subprime loans. Actually it was the other way around. Your assertion is categorically 100% false.

    As for the rest or your argument, you are correct. Brokers should look out for their clients interests and try to get them the best deal, and most do. But posts like this, filled with inaccuracies and slant paint an untue picture of what really happened.

  24. Sorry. I would have responded in the above post but weposted at the same time.

    Credit score is ONE component. The other components are equity and income/asset verification. Plus employment history

    Lots of people had great credit, but no money. Or unverifyable income. More common than you might imagine. IT takes ALL THREE to get a prime loan.

    Regarding your highlighted portion, you are confusing things. As I said before,mortgages are bonds. Of course lenders and brokers make more if you pay a higher interest rate. So do stock brokers,bond brokers and all other financial sales So do most all businesses.

    What your highlighted post does not say is that it pays more THAN PRIME. Because it doesn’t. Never has.

    I own a mortgage company. I never did subprime loans because that was never my niche and I thought they were crap. But what I am telling you is true. And I am not angry at all. I just know the myths and the truths.

    You have had acouplepeoplepoint you in the correct direction regarding resaons for our situation. I agree with your assertion of the borrower first and foremest. But there is also the issues with credit rating agencies, Credit default swap and derivitave providers, and our governments push in the mid 90’sof the CRA – Community Reinvestment Act.

    Research that.

  25. Bob,

    What you are saying goes against what this article in the Wall Street Journal says:

    For instance, according to a March 2007 “rate sheet” distributed by New Century Financial Corp., now in bankruptcy-court protection and no longer making subprime loans, brokers could earn a “yield spread premium” equal to 2% of the loan amount — or $8,000 on a $400,000 loan — if a borrower’s interest rate was an extra 1.25 percentage points higher than the Irvine, Calif., lender’s listed rates.

    Borrowers weren’t supposed to see the information. Tiny print at the bottom of the document warned: “For wholesale use only. Not for distribution to the general public.”

    On average, U.S. mortgage brokers collected 1.88% of the loan amount for originating a subprime loan, compared with 1.48% for conforming loans, according to Wholesale Access, a mortgage research firm. Payouts for subprime loans have traditionally been higher, in part because these loans sometimes took more work and the approval rate could be lower. Brokers have sometimes used the money to help the borrower complete the loan, by reducing closing costs. But there is “a lot of play in the system,” says A.W. Pickel III, a past president of the National Association of Mortgage Brokers, and president and chief executive of LeaderOne Financial Corp., a mortgage lender and broker in Overland Park, Kan. “You have to operate with an ethical basis.”

    Critics claim that yield-spread premiums encourage brokers to steer borrowers into loans that cost far more than they should and create excessive financial risk. In October, Massachusetts Attorney General Martha Coakley filed a lawsuit against subprime lender Fremont Investment & Loan and its parent, Fremont General Corp., alleging that the payments were unfair and deceptive.

    You can read the full article here.

    Sure, the WSJ could have gotten it wrong, but I doubt it.

  26. What I am saying does not go against the article.

    You are confusing information in article which says nothing refuting my post.

    I am not arguing whether someone should broker subprime vs prime. Two different types of loans, and as the article pointed out subprime typically pays a bit more (not much) than prime because the loans are much more difficult.

    My arguement is the notion that it is somehow more profitable to place a PRIME QUALIFIED BORROWER in a subprime loan. The article says nothing of the sorts, because as I have said before that is not true.

    The only reason subprime borrowers get subprime loans is because that is all they would qualify for. If they would qualify for any type of prime loan that is what they would get, because the rate is lower and it is much more profitable.

    Don’t be confused with the articles fact of average compensation with the maximum compensation available. Just because the average is 1.48% doesn’t mean that if you want or need to make more you have to switch to a subprime loan to make 1.88%

    These are averages. A lender/broker can make many times that percentage, especially on prime loans which are not subject to high cost limits that subprime loans are. There are certainly many ethical reasons for this – primarily in the instance of “no cost” loan transactions.

    The beef most “non mortgage” people have is the myth that there are legions of people who could have qualified for prime 6% fixed loans and somehow they were suckered into getting a 8% subprime loan because the broker or lender was greedy and made more money.

    That is the myth propelled by the media,propelled by your post, and propelled by your rebuttal using the WSJ article. At first glance it looks as if what you are saying is true so I don’t really blame you. But dig deeper. Listen to what I am telling you and how I explain it. Then hopefully you will see there is a difference between what you think vs. what is real

    What you are doing with your replies is typical of the media as well. You are twisting what you think you are reading into this fallacy.

    Please go re-read what I posted and then re-read the WSJ post you just put up. The WSJ didn’t get it wrong…you did.

  27. JLP

    If you can wrap your arms around what I am teaching you then you understand that it was never in a brokers interest to place a borower who qualified for prime into a subprime. It was not. You can argue it,but you are wrong.

    If you could not qualify a borrower into a prime loan, then subprime was the only option. Subprime was much more difficult. People without their ducks in a row. So it paid 20% more than prime. That statistic is only for a borrower who could not have qualified for prime in the first place. Do you understand this? Then do you understand how your WSJ article does not support your claim? I hope so.

    Forget the bogus 61% had good enough credit article as well. It takes much more than credit. It takes verifyable stable income. It takes assets or equity. Without all of those you don’t qualify for prime, even if you have an 800 credit score. That statistic is misleading, and you fell for it.

    There are thousands of people in Florida, California, Nevada, Ohio, Arizona that have perfect credit, but they cannot qualify for a prime loan. Right now. 2009. Is it still a brokers fault?

    Of couse not. It’s because they are UPSIDE down. They “gots no equity”. NO MONEY. MONEY MATTERS in a home loan.

    There are others who can’t qualify because they don’t earn enough. They too have greatcredit,and many have equity. but they still don’t qualify for a prime loan now, in 2009.

    Where is the WSJ when you need them.

    Are you starting to understand what I am telling you.

    My reason for this is when you finally get what I am telling you, then you will see brokers had zero incentive to steer QUALIFIED, not any but QUALIFIED borrowers into subprime.

    Once you accept that,you theory of brokers being bad starts to melt. We had no incentive to steer. As I said earlier, we had the opposite incentive. It was much more profitable to try and get everyone we could into a prime loan. But of couse not everyone would qualify.

    So then your disdain is based on what? accountability. I already addressed that as well. The lender,not the broker, was accountable. The broker does not underwrite or approve the loan. The lender does. The broker originates it. Thats it. Finds the client, submits the paperwork and documentation, and closes.

    So please tell me what it is about brokers you do not approve of, or how brokers played apart in this. give me your opinion,but back it up with facts.

  28. @Hogan: February 7th, 2009 at 11:44 am:
    “JLP: While I agree that people who took out toxic mortgages should share some of the blame. The blame for this mess is with the banks and the mortgage brokers.”
    Really? What about the government and its removal of regulations? What about SEC with its chairman Cox and the series of his “brilliant” decisions including allowing massive over-leveraging, complete lack of oversight, and then in 2007 the decision to apply mark-to-market to essentially illiquid securities which caused a totally inflated value of these securities in good times, but lead to their fire sale and drop in value well below their real value in terms of prospective returns in bad times. Sure, mark-to-market may have simply precipitated the collapse, but it was yet another card in the total card house collapse.

    ” For 200 years in this country poor people have gone to banks and asked for a loan and they were turned down. In the last 5 years they went to a bank and suddenly they are approved.”
    It was the government was pressuring Fanny and Freddy who then pressured banks to extend mortgages to poor.

    Yes, banks are to blame, but so is a lot of people – government, investors, banks, and people ourselves who like to lead a lifestyle they couldn’t afford.

    @Miguel – you are so right. Pretty scary though.

  29. JLP,

    Very interesting reading. Mortgage brokers have been hauled on the carpet in some quarters for supposedly being accessories to the subprime mess. Some of them have obviously operated in unethical ways, as happens in all lines of business. A vast majority of them, though, have been professional and responsible in their dealings with clients. After all, mortgage brokers didn’t invent the exotic products that were offered to them by the wholesalers; the large banks and financial institutions. The wholesalers created them and mortgage consultants merely included them in their program offerings to the consumer. Hopefully this imparts some clarity to the unfortunate misconception.

  30. Interesting. I do not think I can add much more to the preceding conversation regarding the reasons for the crisis. However, I think it is important to move away from the why and who and focus on the lessons to be learnt from the debacle.

    From a very simplistic perspective, the primary driver for the crisis is greed – plain and simple. Unfortunately, there is no way out and no way to stop it from happening again. Sure we can regulate certain aspects of the economy but people will find a way around it and try to beat the system, generally to the detriment of the rest of society.

    That just leaves us with what we can do, going forward. Simply put, invest in what you know and steer clear of anything that is too complex, even if it is the best thing since sliced bread!!

  31. there is no one group or person to blame for this mess. I think it’s foolish to point the finger solely on WS. Lots of people screwed this thing up in the beginning, during, and afterwards.

  32. @Kitty–This all started with subprime mortgage companies in
    SoCal making exotic loans to get people into expensive southern California homes that nobody could otherwise afford (Long Beach Financial and Countrywide). This process made it incredibly expensive for first time homebuyers and the loans got more and more exotic as prices went up and up and they reached for more and more. They then extended these exotic loans targeted at prime borrowers to subprime borrowers but jacked up the interest rates. The blueprint from the sourthern California experience was in place when 9/11 happened and the companies took their show on the road across the country in an explosive way. It was fueled by Greenspan keeping the interest rates too low for too long. History is full of problems when money is too cheap. So Freddy and Fannie just wanted to keep up with the competition they were not driving the truck private companies were driving the truck. There is no way Freddy and Fannie were leading the market especially with someone hostile to their existence in the White House.

  33. Personally I’ve given up trying to put a blame on anybody. Discussing it to death with friends has already started to feel like a complete waste of energy. At the same time, we’ve come to believe that right now, the market may just be correcting itself in a big way and at that there is an opportunity for people to succeed and make things right.

  34. @Hogan — spot on. If I had to lay the blame on a single person Greenspan would be it for me:

    http://www.forbes.com/2003/05/09/cx_aw_0509derivatives.html

    Greenspan convinced congress to deregulate. Without Greenspan, this mess could never have gotten so large.

    “Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.” — Alan Greenspan in 2004 on Derivatives

    “Proposals to bring even minimalist regulation were basically rebuffed by Greenspan and various people in the Treasury,” recalled Alan S. Blinder, a former Federal Reserve board member and an economist at Princeton University. “I think of him as consistently cheerleading on derivatives.”

    But, Greenspan alone can’t take the blame — as other pointed out, there are people to blame from borrowers all the way up to the highest levels of government.

  35. Too many people to assign blame to, but a single person for me would be Chris Cox. SEC ultimately made the decision to remove leveraging limits. Regardless of what Greenspan said, it is SEC’s responsibility to monitor Wall Street. Don’t forget that Lehman brothers what accelerated the credit crisis and that Lehman was leveraged almost 40 to 1. Also that 3 out of 5 companies that wanted exemption from the credit limits are no longer with us.

    If it had been just the mortgages, the crisis wouldn’t have been as huge – less than 10% of mortgages default. Banks could have easily written off these losses.

    Additionally, Cox’ decision to apply mark-to-market to the CDOs had impact too. Most of banks’ losses aren’t mortgage losses, it’s the losses in CDOs value. Imagine f you bought a house with 20% down to avoid PMI; then every quarter you have to re-appraise the house and if your house value falls, send a check to the bank so that you still have at least 20% equity. This is what banks have to do – add more and more money into reserves every quarter to account for losses in CDO value. This drives them to sell CDOs as if over 50% mortgages fail and there is no recovery.

  36. Im understand about the impact and what has happened during this time. But other then playing the blame game, lets discuss what we should do. I know I right now have been laid off and am unaware what to do during this financial crisis. Do you have any advice? should I save should I spend, invest I am at a loss. Please any advice would be miraculous.

  37. “suckers” or people just were willing to ignore common sense? I think the latter.

    lots of finger pointing, but everyone watched this thing go down. no one was willing to say, hold them horses when the rocket is already launched. Why? No one is proactive, we are always reactive. No crisis means everything is good. Hell, bush couldn’t have gotten tarp 1 if sky wasn’t falling. big 3 couldn’t have gotten bailout if sky wasn’t falling. obama can’t get stimulus and tarp 2 without saying the sky is falling. I have yet to wear a hard hat or see the sky fall. I wish more people would be tired of the sky is falling. I am. I know the dem caucus at their annual retreat (I hope they jet pooled, I know obama didn’t jet pool with any of them) sure don’t see the sky falling. for all the talk about companies taking govt bailout trimming exec comp and not having their conferences, congress sure doesn’t care considering they are asking for nearly $2 trillion in bailout from us.

    this thing has been developing since the early 90s and spanned now three administrations. it is clear that clinton’s surplus was all a bubble hype. bush didn’t help any by spending so much. now we are creating jobs for mexicans, who fled back to mexico when construction workers stopped hiring.

    here’s what we do: the economy is self correcting, so leave it alone. creating construction jobs, which is what we talk about when we say infrastructure projects, isn’t going to employ the vast majority of the 3 million unemployed who filed papers, added numbers, assembled cars, sold stuff, etc. green projects will not realize economic stimulus for years down the road, and only if oil moves and sustains at $100pb again. Even then, we saw that the green projects irrationally drove up commodity prices when there was the big push to ethynol. we all know std prevention doesn’t do anything for stimulating the economy. Maybe $100b of the current package will actually be circulatory. The rest is absolutely waste. we will lose 5-10 years, regardless. the decision is whether we add $1t-$2t more on top of our debt in the meantime.

    here’s a thought: leave the system alone. if the sky falls, then the govt can nationalize and employ everything and everyone. if the sky doesn’t fall, which is my belief, then we don’t waste another $1t-$2t.

  38. @Inna I really feel for you that you’ve been laid off. I don’t know the specifics of your situation, but my advice would be that your first priority should be to establish positive cash-flow: this means to cut all unnecessary spending completely, stop all investments, and finding a job.

    Once you have positive monthly cash-flow, then you can breathe easier and re-assess the situation. Your longer term goals should always take into account the risks of this happening to you again (or even worse things) in the short-term.

    Good luck.

  39. @Inna – I am really sorry. Save, forget investments, make the money last as long as possible.

    @Tim – I like your idea of thinking. I would understand it if they stimulated the economy Reagan’s way – lowered taxes on businesses that can actually hire those unemployed. But this package is such a waste.

    I do hope I am wrong and it works. But it’s highly unlikely.