Mr. Chairman and Members of the Committee:
I am the Managing Director of an economic research firm. I have been studying the mortgage industry for over 30 years. Since 1991 our firm has conducted much of the primary research on mortgage brokers in the U.S. Although I am a member of the MBA and NAMB, I do not represent either association at these hearings. I merely represent myself as an independent economist. I have been asked to comment on the recent Statement of Policy 2001-1 by HUD concerning yield spread premiums (YSP), and what HUD should do to prevent their abusive use. I also have some thoughts to share about markets, economics, and predatory lending.
In the early days of my professional career, I was a student of socialist systems and spent time in Russia and Eastern Europe. I saw first-hand how miserably socialism operated. It led to slow growth, few benefits to the consumer, and loss of political freedom. The first ten years of my career made me passionate about market systems as the best way to meet the economic needs of the population and preserve the most freedom. From my experience, the best solution to most economic needs is to let the market operate more freely. This will produce the most goods at the lowest cost.
Mortgage Broker Market
The mortgage market in the U.S. is highly competitiveóat least that part concerning the origination of mortgage loans. Only those firms that have low costs can compete today. No firm is earning monopoly profits at the expense of the consumer.
Mortgage brokers have evolved fairly recently to meet the needs of consumers. There were only a few operating before 1980. By 1987 they had 20% of the market. In 2001, we estimate they had around 65% of the market. That is, of the $2 trillion of residential mortgage loans originated, $1.3 trillion were made by mortgage brokers.
Mortgage brokers are the leading channel for the production of mortgages. We estimate there are 33,000 of these small, independent firms today. The median firm has five workers, including the owner. The average firm has 9 workers, for a total employment of nearly 300,000 persons. They operate throughout the U.S. The median firm is only five years old. So they are quintessentially an industry of small firms competing vigorously with one another. If they donít give the consumer good service, they go out of business. In this sense, they are similar to barber shops. No firm has any special factors with which to exact extra-normal profits from the consumer other than personal service.
Market information is widespread. Any shopper can log onto a computer and get instant market information from thousands of competing firms. Prices also are available in newspapers and television. Mortgages have become a commodity, with very little variation in price among lenders. There are firms out there, especially internet firms, that compete solely on price and offer little human interaction. Up until now, consumers have not flocked to these firms, but have stayed mainly with local brokers who can walk them through the complex process of originating a mortgage. The paperwork to complete a mortgage is highly regulated and complex and must be done correctly. If the loan is not done correctly, the consumer doesnít get the loan and the loan originator doesnít get paid.
Fifteen years ago, this industry was dominated by savings and loan associations. Since then, a vigorous secondary market has evolved that allows mortgages to be converted into securities and traded around the world. The tasks to make a mortgage have become specialized. We now have about 100 wholesale mortgage firms buying loans from 33,000 mortgage brokers. Mortgage servicing has become more centralized within the hands of a few larger wholesale firms. But brokers are the low cost producer of the origination process.
The mortgage industry is highly volatile, with periods of high refinancing. Such peak volume years occurred in 1993, 1998 and 2001, when volume nearly doubled from the prior year. It is especially in such years that brokers are needed. The existing retail firms are not equipped to grow their work forces that fast. But brokers are very agile and can grow and contract more quickly to meet the needs of the market. Without brokers, the market would have virtually collapsed last year and many consumers who wanted the opportunity to refinance their mortgage to a lower rate would have been frustrated. There would have not been enough trained workers available to meet their need.
Yield Spread Premiums
The mortgage industry serves the housing industry. It has become national policy to permit as many households as possible to own their own home. The goal is get the share of home owning households up to 70%. The main factor holding back more consumers from buying a house is the down payment. So the market has evolved several ways to solve that problemóno down payment or very low down payment mortgages. It costs about 2% of the mortgage amount or $2,800, which is needed to compensate the broker for his cost, time, and profit in originating a mortgage loan. Most buyers today either donít have that amount to pay the origination fee or prefer to finance that fee. The mortgage originator canít perform his origination function without being paid. From this has evolved the "yield spread premium," which is a way for the home buyer to retain more of his cash and yet pay the mortgage broker for his serviceópredominately saving the consumer dollars by refinancing at a lower rate and thereby lowering the consumerís cash flow. Mortgagors are saving on average about $100 per month (assuming a one percent reduction in the interest rate from 7.5% to 6.5% on a $160,000 loan) by enlisting the mortgage brokerís services. In todayís market, the consumer has the choice of paying all of the fee upfront, part of the fee upfront, or financing the entire fee. The typical homebuyer opts to pay part of the fee upfront. So the income of the mortgage broker in todayís market is 55% in fees from the consumer and 45% in the form of a payment from the wholesaler.
Yield spread premiums are really a financing tool. They became available around 1990 due to securitization. Their availability has spurred mortgage finance and had various spillover effects, including expanding the ranks of homebuyers; increasing refinance activity; growing the ranks of originators, especially brokers; and aiding the economic expansion of the 1990s. In particular, it has helped moderate the current recession by promoting the financing of homes and keeping the housing market vigorous.
If Congress outlawed yield spread premiums, the results would be: (1) fewer mortgage originations, especially among middle and low income consumers; (2) higher out-of-pocket expenses for homebuyers and homeowners; (3) fewer mortgage originators; (4) reduced national income and GDP.
Exactly how many fewer mortgage transactions would result with a ban on yield spread premiums is conjecture. We believe the reduction could be 33%. A ban would adversely affect mortgagors and broker mortgagees. There would absolutely be fewer of each group. The declines in each would be proportional. These declines would ripple through the mortgage sector, affecting Realtors, builders, appraisers, mortgage insurers, credit bureaus, escrow companies, etc. Mortgage costs would rise due to less competition.
More disclosures would add complexity and cost to a mortgage process which is already extremely confusing to the consumer. Predatory mortgage legislation is probably superfluous. Existing laws protect consumers from being bilked by swindlers and gougers. The number of predatory victims is quite small compared with the size of the mortgage industry. We estimate the number of mortgagors served with a new or refinanced loan at 60 million in the past five years. Very few have been harmed. There is no evidence to the contrary. Is it worth harming that huge market with even more laws? Enforcement of existing laws is the answer.
Reaction to HUD Clarification on YSPs
I was present in Toronto, Canada at the MBA annual meeting when Mel Martinez announced his clarification of HUDís policy on yield spread premiums. I support his clarification because it explained the earlier statement HUD made in 1999 to the judiciary and thus should stop class action law suits over the mere payment of yield spreads to brokers. The mortgage industry has been plagued by class action law suits for several years that have cost the industry tens of millions of dollars. Ultimately, these costs are paid by consumers.
Impact on Brokers of Limiting YSPs
I have been a long time supporter of mortgage brokers, who in 2001 handled about 65% of all mortgage originations in the U.S. They did so because they are the low cost providers. Our firm has studied this issue since 1991 and has been unwavering in its conclusions that brokers provide consumers with better service at a lower cost than their competitors. To restrict brokers is to hurt consumers.
Brokers get half their income in the form of yield spread premiums. I estimate that if yield spread premiums were made illegal, about one-third of all brokers would drop out of the business. The other two-thirds could survive by charging higher upfront origination fees, but it would dramatically change their customer profile. They would no longer be able to serve as many consumers with credit problems or FHA buyers. That means the market share of mortgage brokers would diminish. This would be very anti-consumer because brokers do a majority of the refinances in years such as 2001. Banks, thrifts, credit unions, and mortgage lenders use the concept of yield spread premium but do not have to report it. Any restriction on YSPs would only adversely affect brokers and have no impact on these other mortgage lenders. In addition, the retail channel (made up by banks, thrifts, etc.) just couldnít handle the volume. That means in the next refinance wave, many consumers wouldnít get the refinances they desire, certainly not compared to those who refinanced them in the past waves. You would in effect frustrate about one-third of the 7 million households that did refinances, or 2.3 million households. Do you really wish to frustrate that many people? We estimate there are 33,000 independent mortgage brokers processing and originating loans currently within the U.S. The average firm has 9 people working for them for a total of 297,000 employees across the brokerage industry. Do you wish to put 99,000 people out of work? In Maryland, there are 550 independent mortgage brokers with total employment of about 5,000 people. Do you wish to put 1,700 Maryland workers out on the street?
Maryland has lost many financial services firms over the past 30 years, including my former firm, Commercial Credit. There was MBNA, Maryland National Bank, Equitable Banks, Baltimore Federal Savings Bank. In part, the 550 mortgage broker firms in Maryland have replaced the mortgage departments of those once venerable firms. But if Congress bans YSPs, you would put one-third of these brokers out of business also and force further consolidation in the industry. Nor would the consumer be benefited. You would force consumers into the hands of larger firms, mostly based elsewhere, that might charge higher rates and fees. Shrinking the supply given fixed demand would shift supply to the left and the price would, of course, rise. Consumers would pay a higher price consequently.
Impact on Consumers of Limiting YSPs
If yield spreads are eliminated and all consumers have to pay out-of-pocket fees, a large number of lower income people would be pushed out of the market. This would fall most heavily on minorities. It would lower the portion of households that can become homeowners. Past administrations have aimed toward 70% of all households becoming homeowners. That percentage would have to fall greatly, perhaps back down to 60%. As all these transactions are taken out of the market, there are thousands of secondary market impactsóa reduction in credit agents, appraisers, escrow agents, etc. Call them unintended consequences.
What happens when government protects consumers from borrowing mortgage money? Some loans arenít made or the consumer resorts to credit cards and personal loans at 18-21% interest or to hard money lenders at even higher rates of interest. Right now the prime mortgage industry is barely profitable and subprime mortgage lending is unprofitable. There has been an exodus of capital for the past several years. Consumers will not be benefited by causing more lenders to exit.
Disclosures to Curb Abuses
If we mandate even more disclosures, make it the same for all lenders. The problem with asking brokers to estimate their YSPs at time of application is that they donít know what it will be. Until the loan application is complete, they donít know who they will be selling the loan to or what their YSP will be. They can only say that typically they earn half the cost of doing the transaction in that form. This is also true of all other retail lenders, not just brokers but loan originators at banks, thrifts, credit unions, and finance companies too. If you mandate even more disclosure, make it the same for all lenders. I would support uniform disclosures of all mortgage originator payments as a way to curb abusive uses of yield spread premiums to the extent they exist. But I donít think abuses are widespread, as consumers are increasingly sophisticated about financial matters. Doing away with yield spread premiums would not eliminate predatory lenders who thrive on cheating uneducated customers.
Rather than trying to eliminate every vestige of over pricing, Congress should foster more education about loans. Over the past three years, over half the firms in subprime lending have shut down. The remaining firms are not very profitable and are trembling not to be sued by the many new laws now on the books. I dare say, very few predatory acts (however these are defined) are taking place. Flipping has hurt Baltimore, but that has little to do with YSPs. Therefore, any new legislation beyond uniform disclosures across the entire industry would be redundant, counter-productive, and against the consumerís best interest. The normal use of a YSP is not predatory lending. It is part of doing business.
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