Monday, March 17, 2008

Credit Crunch Characters (2) - Mortgage Brokers

Once upon a time when you wanted to borrow money through a mortgage on your house, you went to a bank, but things have changed. Over the last couple of decades mortgage brokers have sprung up. Borrowers liked them because they took away the formidable task of dealing with the bank. In fact they go round all the banks and get the best deal for you.

The banks like the brokers because they took over the task of completing all the paperwork and assessing the creditworthiness of borrowers. Soon most of this work was outsourced to the mortgage brokers. Countrywide Financial became largest mortgage broker in the United States.

The problem with this model is that mortgage brokers work on commission. They get a fee for every mortgage they sell, but they carry no risk if the mortgage goes wrong. This gave them an incentive to organize mortgages for people who could not afford them. The mortgage broker got their fee and someone else would have to deal with the mess when the mortgage turned sour. They were not accountable for their actions. Soon the Ninja loan emerged, lending large amounts to people with no income, no assets and not jobs, in the hope that their mortgage would be taken care of by rising house prices. Applications in which people lied about their income also slipped through.

Mortgage brokers were irresponsible.

We have mortgage brokers here too; Mike Pero Mortgages and Wizard Loans, for example. They have not been as rash as those in the United States, but I suspect that they have organized huge mortgages for many people who cannot afford them. The consequences will only come to light, if houses prices fall significantly or unemployment increases. As Warren Buffet said. You only find out who has been swimming naked, when the tide goes out."


Gene Redlin said...

Ron, This is really interesting.

Just yesterday i discovered that Mortgage Brokers could earn thousands on one mortage. I thought they probably pocketed the origionation fees.

Follow the money I guess.

This is very educational stuff.

RonMcK said...

The reason brokers get so much is that they are not just broking. Countrywide et al are also involved in securisation and some of the other activities that I will talk about in the next couple of days. The origination fee probably does cover the broking part. They earn more by doing other parts of the process.