CHAPTER III THE INDUSTRY AND ITS VULNERABILITY -17 The abuses which have been attributed to some mortgage banks are not an aberration: they are instead a predictable consequence of the way the federal programs are structured and the way the industry operates. They therefore can be eliminated only through fundamental reforms and systematic changes, rather than through occasional policing and unsystematic regulation. This section examines basic characteristics of the business to illustrate how, in certain economic conditions, internal industry dynamics operate to the detriment of the FHA and VA, home owners, and urban neighborhoods. - The industry characteristics this section examines the ability of the industry to expand and contract its operations rapidly, the trend toward computerization, the thin capital margin are not inherently harmful. Indeed, they increase the mortgage banking industry's potential as an efficient mechanism for capital allocation. But they also concurrently increase the temptation to cut corners and neglect the sound administrative and financial practices which are needed if the interests of FHA, the homeowners, and the neighborhoods are to be protected. Rapid Expansion and Contraction of Business Current HUD regulations for mortgage banking facilitate quick geographic expansion by aggressive firms. To become authorized to issue FHA/VA mortgages, a firm only needs $100,000 in capital funds. It may then set up as many branches as it wishes in the home office state or bordering states as long as they are "staffed with experienced personnel." For each state outside this original territory in which a mortgage bank establishes one or more branch offices, it must have only $50,000 in extra capital, up to a maximum of $250,000 in additional required capitalization. -18 In other words, any firm with $350,000 in assets can open as many branch offices nationwide as it finds economically feasible. This is the extent of federal restriction on the geographic expansion of mortgage banks. This extraordinary freedom is in notable contrast to the restrictions placed on other forms of mortgage lenders. Savings and loan associations (S&Ls), for example, cannot expand beyond a single state. То establish an investor-owned savings and loan institution in a city with a population of $50,000 or more, the federal government requires that the savings institution raise over $2 million in stockholder funds which must be placed in an escrow account to act as a reserve against potential losses. The S&L organizers must also secure the over $1 million in savings subscriptions from over 1,000 savers. In addition they must conclusively demonstrate that the proposed office will meet the public's "needs and convenience" for an area. Mortgage bankers can easily open and close branch offices, depending on their profitability. Most branches are classified as "loan production offices", their sole function being to originate mortgages which are then serviced by the home office or a regional servicing office. The costs of establishing an office are relatively low. It is common practice to close one down if its intake is not covering its cost. Given the relative freedom with which mortgage bankers can open up new offices, it is easy to understand how proper market conditions can spark rapid expansionary activity. Such conditions developed during the late Sixties and grew in the early Seventies, an era which has been characterized by industry leaders as a period of "growth mania." With no effective restraints, firms went into a breakneck expansion which had devastating effects on their abilities to meet their responsibilities as mortgagees. -19 Initially, the stimulus came from the FHA/VA credit market. The Housing Act of 1968 sparked a new surge of government involvement in the housing market. As one observer noted. "Federally sponsored residential construction was in for an unprecedented five-year building spree. 16/ By the first half of 1970, FHAinsured loans accounted for 26 percent of all loans originated for 1-4 family homes. This was the highest market share in the history of FHA. The industry boomed as firms rapidly expanded their operations and responded to the increased availability of and demand for federal mortgage credit. This was a time when the phrase "out-of-towner" began to be used to describe mortgage companies which had come into new cities. One Baltimore study noted that, "In 1970, out-cf-town mortgage bankers made a serious effort to enter the local scene in the area of government-insured loans."17/ The study went on to document that these "absentee lenders" had a higher Advance Mortgage provides an example of how spreadout a single firm's operations can be. In 1975, Advance maintained 38 field production offices across the country. It employed approximately 200 workers to service over 136,000 outstanding mortgages. Of the 200, 150 worked in the central office and only 50 were maintained in the field. It was their job to contact delinquent homebuyers and care for vacated properties. With an average of one person to service each 680 mortgages, and most of them far from the homebuyers, it is easy to understand why an "out-of-towner" might have been considered "faceless and hard to contact." One MBA authority labeled this as a period during which "rapid changes led companies with limited management experience and skills into virgin lending territories without a road map." 18 In search of profitable new markets, companies overextended themselves. -20 In the words of a former MBA president, they "zealously Other basic structural problems within the industry contributed to the overexpansion of the Seventies. Thin capitalization, dependence on FHA risk-free loans, and concentration trends helped cause the growth mania and the related abuses. An MBA president viewed the relationship between the FHA scandals and the mortgage firms' overextension of operations in the following terms: ... Most of these things (FHA program abuses) This is a rather disturbing admission that the industry is understaffed because of unrestricted expansion and that there is an insufficient supply of qualified people. What is perhaps most disturbing is the comment that, even if trained people were available, firms could not afford to hire them. Does this mean that mortgage bankers will never be capable of prudently and responsibly providing mortgages? Some mortgage banking firms have outstanding records of responsible lending and servicing, but the comments do indicate a rather dangerous tendency within the industry to assume that little can or should be done to impose stringent personnel requirements as preconditions for setting up branch offices. -21 Automation An important operating characteristic of mortgage banking firms is their drive toward computerized operations. Computers reduce personnel expenditures, facilitate billing and servicing from a distance, and help meet the needs of investors for accurate, timely reporting. Despite inflationary pressure on many operational expenses, "By introducing electronic data processing systems, mortgage services have been able to maintain a relatively stable cost over a long term period. "21/ Because computers become more costeffective as volume grows, their use encourages firms to expand the size of their operations. If prudently managed, these trends can benefit the firm, investor, and consumer. If not properly watched, however, the short-term business needs of investor and firm may be met at the expense of homeowners and neighborhoods. Electronic data processing is extremely helpful in mortgage banking transactions as in any financial field requiring standardization, rapid calculations and reporting, and the continuous monitoring of a large volume of business. Far away investors who receive requests for capital require a uniform reporting system which facilitates evaluation. Electronic data systems are tailor-made to meet this need: they increase the speed with which the loan can be processed, closed, and shipped out, thus reducing costs and increasing profits. They also facilitate billing and quick intervention if a homeowner misses a payment. While computerization meets the needs of investors and mortgage bankers, it may well be used in a way which is harmful to homeowners. Computers may be seen as a substitute for personnel who, if available, could help homeowners to develop family budgets and enable them to meet their payment schedule. As the President of FNMA recently observed: "Servicing by computers alone can produce a pestilence of abandoned and boardedup properties in situations where personal contact with mortgagors and counseling with them might have salvaged the mortgage loan." 22/ |