Compensation Structures in Mortgage Industry
Interesting piece on how mortgage workers were comped during the heyday by John Quigley, titled Compensation and Incentives in the Mortgage Business.
It goes a long way to explaining why so many people did such silly things during the boom: They were well paid to do so!
A quick excerpt:
The incentive structure that arose for firms in this specialized industry set the stage for
the collapse. The incomes and fees generated are all transactions-based, that is, payments are made at the time the transaction is recorded. The originator of the loan, typically a mortgage broker, is paid at the time the contract is signed. Brokerage fees have varied between 0.5 and 3.0 percent. The mortgage lender earns a fee, between 0.5 and 2.5 percent, upon sale of the mortgage. The bond issuer is paid a fee, typically between 0.2 and 1.5 percent, when the bond is issued. On top of this, the rating agency is paid its fee by the bond issuer at the time the security is issued. All these fees are earned and paid in full within six to eight months after the mortgage contract is signed by the borrower.Thus, no party to the mortgage transaction has any economic stake in the performance of
the underlying loan. In fact the mortgage broker is paid a larger percentage, termed a “yield spread premium,” if he convinces his clients to accept a higher and more default-prone interest rate. With this structure of incentives, it is not hard to understand why any risky loans were originated, financed, sold, and securitized, especially during the period of rapidly rising house prices from 1999 through 2006. With expectations of rising house prices, it is also not hard to understand why pools of these loans received the imprimatur of a credit rating agency when offered for sale.One does not need to invoke the menace of unscrupulous and imprudent lenders or of equally predatory borrowers to explain the rapid collapse of the mortgage market as house price increases slowed in 2006, before ultimately declining. There were certainly enough unscrupulous lenders and predatory borrowers in the market, but the incentives faced by decent people—mortgagors and mortgagees—made their behavior much less sensitive to the underlying risks. The only actor with a stake in the ultimate performance of the loan was the mortgagee. Everyone else had been paid in full—way before the homeowner had made more than a couple of payments on the loan.
The full list of foolishness is maintained at mortgage implode . . .
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Source:
Compensation and Incentives in the Mortgage Business
John M. Quigley
The Economists’ Voice: Vol. 5: Iss. 6, Article 2.
http://www.bepress.com/ev/vol5/iss6/art2
October 31st, 2008 at 1:16 pm
I know my broker got paid $5000 from WaMu for getting me a $250k loan. I know that because WaMu showed me the documents. This makes me sick. This industry completely lacks transparency. Does anyone know if the gov is going to regulate this industry in anyway?
btw, the closing costs in this country is just nuts. The closing costs are usually thousands for just doing paper work. I’ve gotten a mortgage in Canada and all I paid was roughly $900 CDN. The real estate industry is really screwed up here.
October 31st, 2008 at 1:36 pm
Where are all the comments today. Anyone have any feeling where this market is going? I think Monday will be bad, possibly the ugliest day ever seen in the markets. The day of the Led Zepplin. Pension and Mutual funds that have been forced to buy (to re-balance funds due to stock value losses) the last few days of this month will no longer be buying. Couple this with a little pre-election sell off in anticipation of an Obama win, and the Democrats seizing 60 seats and it could be the fugly. The real trick this Halloween is that the market is up the last three days based purely on I don’t know what.
October 31st, 2008 at 1:49 pm
Barry,
This means people respond to incentives?!? What a concept!
October 31st, 2008 at 1:49 pm
Yes, why are the comments dropping off so precipitously? I find half the value of this site to be the forum of comments.
October 31st, 2008 at 2:02 pm
Comments dropping off = inflection point? Market bottom? you make the call!
Also, normal temporary side effect of transition to new format.
October 31st, 2008 at 2:44 pm
This sell it and pass the buck must be the “flaw” that Greenspan found in his markets hypothesis.
October 31st, 2008 at 2:48 pm
No, the comments are from needing to register to comment.
BTW, the spacing is all f-d up. Need smaller font and less space in both the posts and comments.
Chuck
October 31st, 2008 at 2:52 pm
We’ve “incentivised” the behavior we’ve received…shocking indeed. Perhaps a plan for the future might be to consider building incentive plans that reward the behavior that keeps the business solvent???
October 31st, 2008 at 4:49 pm
We saw this movie ten years ago. I did a posting on it, under the green tree.
November 1st, 2008 at 12:07 am
And they aren’t done yet. I just read this on Bloomberg about the “new” wall street PR on self regulation.:
“I don’t call it self-regulation anymore,” said Harvey Pitt, a former SEC chairman who is a lawyer at Kalorama Partners LLC in Washington. “Private-sector regulation” is Pitt’s new term.
Government can spell out what’s legal or illegal, Pitt explained to the audience, but “private-sector regulation can tell you what’s ethical.”
In your dreams it can. Beware the retrofitted regulatory structure that leaves a smile on your broker’s face.
(Susan Antilla is a Bloomberg News columnist. The opinions expressed are her own.)
To contact the writer of this column: Susan Antilla in New York at santilla@bloomberg.net
WHY ISN’T PITT IN PRISON? THE MAN IS A TEXTBOOK CARDBOARD HOODLUM. HIS VENALITY MAKES COMIC BOOK VILLANS LOOK NUANCED.
November 1st, 2008 at 4:25 am
ya know, with all the ink spilled, and pixels fluoresced, over this “Mortgage Crisis”, isn’t it time for a post on the actual Mechanics of a Mortgage?
towit: What, exactly, is being lent? Who funds the transaction? Where does the ‘bank’ get the ‘money’? and so forth..
to those, at the minimum, that are excited about Yield Spread Premiums (YSPs), you should wonder about the answers to those Q: s ..