However, none of these dramatic changes were visible to the typical bank customer. It looked like the same old bank to them.
This transformation was part of a much broader transformation that was taking America by storm. This new business philosophy held that every business had a core competency and that the way to maximize your profits was to concentrate on your core, high profit skills and to farm out to other institutions your low profit, non-competency functions. It was taken for granted that the activities that were earning you the greatest profits were your core competencies and that anything that was low profit was a low competency skill that was bested farmed out to others. The flaw in this system was that in times of crisis you no longer had the in-house skills to cope with the crisis because the skills had been farmed out to others.
It has to be admitted that in normal times the new paradigm delivered on its promise of lowering costs and increasing profits. This is why today when you make a call to complain about a product or service you end up talking to a speaker who lives in Calcutta, India.
The Old Bank Model
- In-house staff real estate appraisers
- In-house mortgage originators
- In-house servicing of mortgage payments
- In-house warehousing of mortgages
The New Bank Model
- No in-house staff appraisers
- Very limited amount of in-house mortgage originating
- No in-house mortgage servicing
- Almost no warehousing of mortgages (mortgages were sold off rather than kept)
Under the old banking model when a mortgage got into trouble the bank had all the expertise needed to solve the problem in-house. Under the new banking model not only was the bank clueless but it was enshrouded in total darkness as well.
Under the old system when a mortgage problem arose the bank knew exactly what to do. Under the new system it sits around and sucks its thumb. Under the old system the first thing the bank would do was send out one of its in-house staff appraisers to do a complete inspection of the home and a complete professional appraisal. Under the new system they call up a real estate broker and ask for a BPO, a broker’s price opinion. No doubt you are wondering why they don’t hire an appraiser? The answer the bank will give you is that they are way too smart to pay the $275-$350 a complete appraisal would cost. This standard appraisal also includes a complete interior and exterior inspection of the property.
A BPO (broker’s price opinion) they craftily inform you will only cost them about $75. That’s because the broker never leaves the office. He spends fifteen minutes scanning comparable sale listings on the MLS system. Eyeballs what seems to him to be an appropriate number and another fifteen minutes writing up the one or two page BPO. As the bankers will proudly tell you they are way too smart to get the job done right. Guessing is so much cheaper.
I speak with an insider’s knowledge on this point. You see I was one of the in-house appraisers that were thrown out on the streets like a dog.
Let’s step back in time and continue our analysis. In the old days when a client asked for a mortgage The in-house appraiser and loan officer would carefully scrutinize the deal. Due diligence was taken seriously because the mortgage was going to be warehoused by the bank until maturity and not sold off. If the mortgage blew up the bank took the loss. In this case the appraiser and the loan officer give the deal a thumbs down. The appraised value is below the sale price and there are problems with the buyer’s earnings and credit. The bank turns the deal down.
A month later, an independent mortgage broker shows up at the bank with the same deal. Only this time as if by magic the appraised value hits the purchase price and the earnings and credit problems have disappeared from the mortgage application. Now you know why the banks fired all their staff appraisers and most of their in-house loan officers. Prior to this time the banks originated about 90% of all mortgages. By the bull market peak independent mortgage brokers originated over 70% of all mortgages.
Of course, if the banker has a brain in his poor,stupid head he has suspicions. However his hot, little hands are now holding an appraisal done by a licensed appraiser and a mortgage application that has been done by a licensed mortgage broker. The bank accepts the deal but there is no way he is going to warehouse this mortgage or the ever growing number of dubious mortgages that the bank is accepting from outside mortgage brokers. These mortgages are going to be pooled and securitized into various types of mortgage-backed securities ( MBS and CDO) as quickly as possible.
Let’s now return to the present. The bank now realizes that the outside appraisal was dubious and the mortgage application was even more dubious. It has probably sold off the mortgage servicing rights and kept the mortgage or it may have sold the mortgage and kept the mortgage servicing rights. Do not underestimate the importance of mortgage servicing rights. This is what gives you control of the mortgage. Others may own the mortgage but the mortgage servicers control the mortgage. There are about 8,500 banks in this country. The vast majority of which do not service their own loans. The 27 largest mortgage servicers dominate the service industry.
You now know why the banks are responding so poorly to urgent requests to modify mortgages even when it is in their overwhelming interest to do so. It is the common assumption that the reason why banks will not help out their clients is because they are just being mean or greedy. The reality is that in today’s brutal real estate market it is almost never in the bank’s interest to foreclose. Yet, the foreclosures continue because they are on automatic pilot. It is often the case today that the mortgage servicers start and often finish foreclosure proceedings without prior approval from the bank.
You see mortgage servicers are paid for foreclosing on the mortgages that they are servicing but until a recent change in federal regulations, they were never paid to modify a mortgage.
You now know why the banks and troubled mortgage payers are in such trouble. The reason why banks appear to be wandering around in a stupor, is because they are in a stupor. To a shocking extent they have lost control of the ability to manage this crisis. They are in trouble because they are as blind and dumb as a fence post. The expertise that they once had is gone with the wind.
Fred Carach is the author of “Forty Years A Speculator. His blog is fortyyearsaspeculator.blogspot.com