Fed Gov Complains About Subprime Brokers

Gramlich indicates brokers lack underwriting incentives

January 19, 2005

By NEIL J. MORSE

During a break in a meeting of the Center for Economic and Policy Research — convened to discuss the “speculative bubble in the housing market and its implications for homeowners” — Federal Reserve Governor Edward Gramlich engaged in conversation with reporters.

According to those present, the talk turned to higher delinquency rates in the subprime market, and the higher debt leveraging among such borrowers.

“All of a sudden,” said a listener, “he [Gramlich] went after brokers, saying they were close to the ‘breaking point’, but then he backed off. The gist was that too many brokers are making loans in the subprime market, without any incentive to make sure borrowers are creditworthy,” this person recounted.

Gramlich is said to have blamed this allegedly lax attitude among brokers on the growth of the secondary market.

“All these loans are securitized today,” he is reported by those present to have commented. “Nobody holds them [anymore]. The brokers are just the ‘middleman’,” Gramlich reportedly remarked. Attempts by MortgageDaily.com to reach the federal official for comment were unsuccessful. A press aide at the Federal Reserve said Gramlich rarely does media interviews.

Recent statistics (3Q05) show subprime originations running at a white-hot pace of $640 billion annually, fully one-quarter of all mortgage loan production.

In defense of brokers, Robert Armbruster, president of the National Association of Mortgage Brokers, told MortgageDaily.com that extensive use of automated underwriting systems ensures adherence to necessary levels of due diligence. “These systems call for certain documentation and [we] have to comply,” he says.

But lenders are known to offer plenty of flexibility in pursuit of business, he acknowledges. “There’s always a desire to do [more] volume,” said the NAMB president, adding that “some programs are “unbelievable” in the amount of latitude they permit. “They’ve got ‘easy docs, no income verification’ – some of these programs can lead to problems,” Armbruster warns.

Gramlich’s remarks last week were not the first time he has addressed the issue of subprime lending.

In previous public pronouncements, the Fed governor said it has a positive social benefit, but has cautioned that such transactions must be carefully watched because increases in foreclosures, or the failure to properly control lending practices, could tip the scales in the other direction.

Gramlich’s characterization of brokers as middlemen is reference to the secondary market’s growing thirst for subprime products, especially the interest-only loan. Typically offered as an adjustable-rate mortgage, an interest-only loan may take many forms from commercial to home equity loan, but the essential concept allows payment of only the interest at regular intervals until maturity, when the entire balance is due.

The challenge for investors is in the due diligence, notes Steve Mageras, executive vice president – capital markets and product development, First Franklin Financial, San Jose, Calif. “We’re not structured to do 100% due diligence, even though Wall Street investment banks might want that,” Mageras admits.

A leading subprime lender New Century Financial Corp., Marc Loewenthal, senior vice president/corporate affairs at New Century Mortgage Corp., Irvine, Calif., says his company has tried to institute a “broker best practices.” This includes making sure that brokers “do not charge extra fees and investigating borrower complaints, taking disciplinary action when warranted.

“Because, at the end of the day, it’s not the broker who will be liable, it’s [servicers],” says Loewenthal. “It’s going to show up on the servicing side of the coin. It may show up in the form of increased delinquency and foreclosure rates that can be tracked directly back to those brokers.”

Neil J. Morse is a communications consultant and independent writer working exclusively in the mortgage finance industry. He resides in Newtown, Conn. and may be reached by e-mail at: morse@ntplx.net