The Good Elizabeth Warren Will Do For the Banking System

To listen to bank lobbyists, one would conclude that Elizabeth Warren, recently appointed an adviser on consumer protection to President Obama and Secretary of the Treasury Geithner, must be a really bad person incarnate. They were planning to pull out all the stops to prevent her confirmation by the Senate as the head of the new consumer protection bureau at the Federal Reserve. President Obama's appointment of her as an adviser does not require Senate confirmation.

What Warren and the new consumer protection bureau can, and hopefully will, do is stop the lunacy in the banking system. The baseline reason for today's economic problems isn't the federal deficit, or the tax system, or the exchange rate between the yuan and the dollar, or the Fed's printing of trillions of dollars, or the new health insurance legislation. The baseline problem is that the banking system made a shipload of really stupid, indefensibly idiotic mortgage loans. Bankers loaned money without verifying borrowers' income, assets, or employment, and paid scant heed to credit histories. All many borrowers really needed was a pulse and a signature. Bankers utterly disregarded lending standards and risk management, blithely assuming that the risks associated with the lending insanity would be passed to the investors that bought this toxic financial waste. Because of the way the mortgage market worked, higher compensation was paid to mortgage bankers and brokers for underwriting riskier loans than for 30-year fixed rate mortgages to people who had downpayments and might actually repay the loans.

The end result was the accumulation of almost incalculable amounts of systemic risk, risk that exploded and imposed trillions of dollars of losses on banks, homeowners, businesses, laid off workers, and taxpayers. Sure, some (although not all) of the borrowers who took out nutty loans had some idea of what they were getting into. But they knew of their individual risks--that the interest rate might rise, that there would be a balloon payment at some point in the future. What they didn't know--and what nailed many of them and all of the rest of us--was that the entire system was poised for a fall because the indescribably imbecilic lending had taken place on a large-scale, nationwide basis. Indeed, even the most knowledgeable federal banking regulators were either clueless, in denial, or both when it came to the systemic risk presented by the morons of mortgage lending. We're still paying the price for this disaster and will do so for years to come. The absence of consumer protection left us all without protection.

The new bureau shouldn't just impose ritualistic disclosure requirements. When borrowers arrive at the closing and find thousands of pages of documents to plow through, disclosure requirements amount to regulatory failure. The new bureau should substitute its judgment for the dysfunctional judgment of bankers (and borrowers, too, since some of them were complicit in taking out loans they realized were foolish but took anyway in order to gamble on the real estate market rising). There was a fundamental market failure in mortgage lending, and sound regulation can fix such failures. Imagine banking without federal deposit insurance if you question this notion.

Mortgage loans are already unavailable to many less creditworthy borrowers, and rightfully so. It does them--and we taxpayers--no good if the banking system accumulates a mountain of bad loans that strip defaulting homeowners of their savings, credit ratings, and pride, and taxpayers of funds badly needed for other priorities. With today's tight underwriting standards and the overall unwillingness of banks to lend, it's unlikely that the new consumer protection bureau can reduce the availability of credit a whole lot. What it may do--and this is probably what bankers fear the most--is that as the economy recovers the consumer protection bureau may prevent the banks from returning to the highly profitable insanity in which they reveled earlier this past decade. Amen, say the rest of us.

Consumer protection in this case isn't about a bunch of liberals on federal salaries singing, "If I Had A Hammer." It's about imposing and enforcing prudential consumer lending requirements on banks that protect us all. Not just borrowers with eighth grade educations, or workers whose native language isn't English, but also the most well-educated, well-read, and wealthy of Americans, because we all have a stake in the well-being of the financial system.

Shop for Your Mortgage Loan

Would you pay $30,000 for a car if you could buy it for $20,000? Of course not. But it turns out that many people have done the equivalent with their mortgage loans. On May 30, 2007, CNN.money.com reported that many subprime borrowers could have gotten a prime mortgage. See http://money.cnn.com/2007/05/29/real_estate/could_have_had_a_prime/index.htm?postversion=2007053012. That means a lot of people got stuck with a more expensive mortgage than necessary.

Subprime mortgages can have an interest rate 3% higher than a prime mortgage. As the CNNMoney article points out, that difference can increase the monthly payments on a $200,000 mortgage by $300, or $3,600 a year. Can you afford to throw away $3,600 a year? That would be almost all the money you’re entitled to contribute annually to an IRA.

Why does this happen? Because mortgage brokers are rewarded to sell subprime loans. They are paid by commission, and a subprime mortgage’s commission can be as much as 5 times greater than the commission for a prime mortgage. So, like the car salesperson who wants you to buy a model with all the options, a mortgage broker has the incentive to sell you a subprime mortgage, whether or not you need one.

Who do you think covers the cost of the high subprime mortgage commissions? You, the borrower, do, if you take out a subprime mortgage.

What can you do? If you’re already in a subprime mortgage and think you're prime quality, try to refinance into a less expensive mortgage. If you're just looking for a mortgage loan, comparison shop. Shop for a mortgage just like you would shop for a car. People routinely contact several car dealers when looking for the best deal on a car. (See our recent blog on how to get a good deal on a new car: http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.) Contact several lenders—try the bank where you have an account, or a credit union if you can join one. Then try the next few banks and credit unions down the street. Do this without going through a mortgage broker, and see what quotes you get.

If you want to use a mortgage broker, look for one who will work for a fixed fee that is set in advance, without any commissions or compensation from anyone but you. A fixed fee will reduce the incentive for the broker to put you into a high-interest rate mortgage you don’t need. An organization called Upfront Mortgage Brokers Association (www.upfrontmortgagebrokers.org) may be able to help you find a broker willing to work for a fixed fee.

Interview a mortgage broker before hiring him or her. Ask about all of his or her sources of compensation and whether the broker will be paid more if you are sold a mortgage with features that may be costly to you (like higher or increasing interest rates or a prepayment penalty). Also ask the broker how many lenders he or she deals with regularly. You want to find out if the broker will work aggressively to get you the best deal, or will simply place you with a lender with whom he or she has had a long-standing relationship. Not all mortgage brokers are crooks, but it pays to be careful.

Keep your mortgage loan simple: look for a 30-year or 15-year fixed rate mortgage. These loans are pretty straightforward, which makes comparison shopping easier. Also, your risks are lower because by definition the interest rate won’t go up. See our earlier blog about why the right mortgage loan helps you build wealth
(http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html).

Crime News: You’ve heard of cat burglars stealing jewelry. This one must have been a tiger burglar. http://www.wtop.com/?nid=456&sid=1153406.