The home-loan pyramid
Any one who doubts the housing bubble inflated from the ground up, who thinks all the attendant greed and deception resided on Wall Street rather than Main Street, hasn't been listening to my brother-in-law the appraiser. Long before Washington Mutual and Wachovia and Lehman Brothers bit the dust, he complained, the whole system was corrupt. This was how he explained it:
A bank loan officer is paid on commission. No loan, no commission. So when somebody comes in to finance a house purchase, he wants to make the loan. But first he needs an appraisal. If the appraiser says the house isn't worth what the buyer wants to pay, he can't make that loan.
So he calls an appraiser and specifies that he wants an appraisal of, say, $400,000. The house may or may not be worth that much. If the appraiser says it's not, he knows he'll get no more business from that loan officer. If he says it is worth that much, he can be pretty sure that business will keep rolling in.
Some people refuse to play that game. But some give the loan officer exactly what he wants. The loan officer gets his commission. The appraiser gets his fee. The real estate agent gets his sale. The consumer gets his house. Everybody's happy.
But that loan was based on an inflated number. So although the financial services industry packaged the loan with many others, its "value" was illusory. The base of the pyramid is every bit as shaky as the top.
Comments:
Posted Thu, Oct 2, 6:26 p.m. inappropriate
Yes, But: Thirty or forty years ago commissioned loan officers were common at mortgage companies, but very rare at commercial banks and savings and loans.
That changed in the early 1980's as management of these institutions, often coming from the sales side of the institution (Kerry Killinger for example) rather that the loan side, started emphasizing rapid growth and put in place commission or bonus arrangements for loan officers. Situations like the Seafirst Oil Patch loans, the S&L; Crisis of the late 1980's early '90's and the current sub prime mess can indeed be attributed in part to the commissioned loan officer. While it is true that the loan officer, appraiser, buyer and real estate agent all benefited from this scenario, none benefited anywhere near as much as those at the top who started getting multimillion dollar bonuses and left with fat golden parachutes. The loan officers and appraisers did not create this system.
The commission/bonus system should be done away with, or alternatively paid out over a period of several years and be subject to reduction or elimination if the loans become non-performing. The Feds could do that now if they wanted to.
Posted Thu, Oct 2, 7:53 p.m. inappropriate
Home Economics: Scientists speak up, architects speak up, even lawyers speak up. Don't economists have any interest in educating people that it is not in our best interests to be artificially inflating housing prices. Is the best that can be done the former Fed chair who gave stern warnings, winked and went right on encouraging more of the same?
If events cause any soul searching, I'd suggest they get started on the next economy, how to grow more mature, more complex, instead of just bigger and bigger, more and more and more. No one says it's going to be easy, just necessary.
Posted Fri, Oct 3, 10:51 a.m. inappropriate
supply and demand: Normally, the process of making a loan would be constrained by the availability of money, so the increase in house prices would have been moderated. But the problem is the Federal Reserve was fighting the threat of a slowdown brought about by Japan's recession/sluggish economy in the 1990's, and so Greenspan kept a lot of money in the system. So the brakes were off, and housing took off.
There is plenty of blame to go around here. Yes, the system was corrupt from the bottom to the top. Buyers could and did like about their income to qualify for loans they couldn't pay. Loan officers looked the other way knowing the documents were fraudulent. Appraisers went along with overpricing houses. Banks really didn't care because they could sell off the loans on a securities market that was more than willing to buy them.
What is needed is integrity to be put back into the system. Unfortunately, we now have to pay for the breakdown all along the line -- and we will pay big time, believe me.