The Dodd-Frank mess

The Dodd-Frank legislation, as it relates to mortgage loan originations and originator compensation, creates a quagmire of confusing and conflicting regulations that erode a borrowers' ability to shop effectively for loans. Part of the problem is that the Dodd-Frank bill is too broad, and it imposes new regulations on multiple compenents of the financial system, like banks, insurers, securities traders, mortgage bankers and mortgage brokers. I am a Mortgage Broker and I will discuss the implications of the bill as it relates to mortgage financing below.

The rule, while intended to provide consumer protection to borrowers involved in mortgage transactions, shows a lack of understanding of common (and beneficial) pricing methodologies that borrowers and their loan brokers can employ to obtain the loans they desire with favorable interest rates, loan terms, and limited fees and expenses. By working together, loan originators and borrowers can achieve mutual benefits by essentially sharing commissions paid by lenders.

Under current regulations, borrowers involved in brokered mortgage transactions receive a credit from the lender based upon the rate that they choose. This credit is known as Yield Spread Premium or YSP, and is paid to the borrower by the lender as a percentage of the loan amount. In these transactions, the borrower will receive a higher credit amount if he obtains a loan above a par rate. This YSP can be used by a borrower to pay broker origination fees, pay closing costs, pay interest, and establish impound accounts for property taxes and homeowners insurance, all without adding to the existing principal balance of the loan or paying out-of-pocket fees.

By prohibiting variable YSPs, paid based upon the interest rate of a loan, the type of loan, or other terms of the loan in favor of a uniform commission schedule based strictly upon the dollar amount of the loan; and by eliminating a loan originator's ability earn less than this predetermined commission percentage, the Dodd-Frank legislation will have the unintended effect of stifling competition and raising the overall costs of obtaining a mortgage.

The bill, which is slated to go into effect on April 1, 2011 attempts to limit a mortgage originators ability to earn excessive commissions on loans by steering borrowers into loans that have unfavorable and often misrepresented terms for the consumer. Under closer review, however, the Dodd-Frank bill fails in this regard. For one thing, gone are the days of the exotic and confusing loans that are widely acknowledged to have been a lynchpin for the financial and housing crises that we have seen in the last few years. These loans were pushed by the lenders that now stand to benefit from the Dodd-Frank legislation. Now, by attempting to establish a compensation ceiling for all loan transactions, Dodd-Frank actually creates an artificial floor that eliminates a broker's ability to charge less, and provide superior service, for the exact same programs and rates that big banks offer.

Any broker shop that has survived the last few years in the mortgage business has done so with thin margins, low overhead and high efficiency, all while offereing better rates than its Too Big To Fail counterparts. The Federal Reserve Board, which will oversee the rollout of the new compensation model, has failed to provide clear directions as to how the the rules should be implemented, which has led to multiple conflicting interpretations of the law. The only beneficiaries of the new legislation, if implemented as it is written, will be the big banks. With only a few weeks to go until Dodd-Frank is slated to be rolled out, the government needs to take a step back and examine the far reaching implications and unintended consequences of this bill.

The end result of this legislation, which is supported by the Too Big To Fails, will result in higher rates and loan costs to consumers. While I am in favor of reasonable and prudent regulations within our industry, I simply cannot understand the logic of this bill.

Many factors are keeping downward pressure on home prices and making home ownership less attractive. The obvious ones include high unemployment rates and perceptions that the real estate market has not yet bottomed out; but several underlying and less obvious factors implemented by the big banks and in Washington, DC, are cuffing the invisible hand of the housing and mortgage markets, and causing significant roadblocks on the road to economic recovery.

There is a consensus that exotic and risky loans that were peddled by big banks and resold on the secondary market in years past have had a significant impact on the today's housing market and mortgage environment, but the banks' secondary marketing campaigns for these loans has proven to have been much more damaging. In the aftermath, mortgage brokers, appraisers, and real estate agents have taken the brunt of the criticism, and are now the subjects of supposed "consumer-protection" legislation that will further erode potential borrowers'/purchasers' ability to obtain competive loan products and pricing.

In addition, banks have badly mismanaged their foreclosures and caused more apprehension in the population of potential homebuyers through the "robo-signing" scandal, their unwillingness and/or inability to offer relief to underwater homeowners, and new underwriting policies and guidelines that are keeping qualified borrowers away from the closing table.

Currently, legislators are slated to implement the Dodd-Frank Act, which will cause commissions for loan transactions that secure real property to be set by loan amount only, and not influenced by rate. If implemented, these proposed mortgage regulations will eliminate a loan originator's ability to charge less for the exact same loan products offered by the big banks, which will cause consumers to pay more for services. The banks are behind the legislation because it will shift the competitive balance of power in their favor. On its face, the Dodd-Frank Act may seem like a good idea, but when you look into what the law would require and what the actual consequences are, if implemented, its is exposed as more double-speak and smoke and mirrors.

Instead of eliminating competition, and driving the costs of obtaining financing up, the government needs to take a step back and let the housing market correct itself without artifical market restricitions.