Real Estate – the Fallacy of Government Oversight

All the forms, all the agencies, all the license requirements, lull us into a sense that someone is really watching out for us when we buy or sell real estate. But is anyone really watching out for us

Palm Coast, Florida – December 4, 2008 – Buying a home is probably the biggest single purchase most people make in their lives. Most do it several times during their lifetime of job related moves or voluntary relocations. Yet, most are unaware of the complexity of the transaction. They are typically faced with a pile of forms over one inch thick to review and sign or initial within the one hour scheduled for their closing. Only a very small handful actually read everything.

Further, the mortgage industry has become more diverse with tasks being divided along specialty lines; mortgage originator, underwriter, initial lender, subsequent owners of the mortgage and note, and Wall Street investment brokers who take subprime loans and put a new coat of primer on them before selling them to unsuspecting investors (hedge funds, mutual funds, endowments, etc.). No single state or federal agency has oversight for the entire process.

Who is supposed to be watching? Hopefully, our elected officials enact laws that protect us from fraud. Hopefully, they also enact and fund legislation setting up agencies to police the process, making sure that miscreants are quickly discovered and summarily punished. Unfortunately, hope was dashed. What Congress did was to socially engineer the mortgage system to encourage broad home ownership, a noble but unrealistic goal. Politicians from both parties pressured both Freddie Mac and Fannie Mae to create increasingly exotic mortgages. By coupling exotic loans with a lack of oversight and enforcement, congress created the perfect storm.

What is worse, however, is that we’re watching only the first act of a multi-act play. How many acts remain? I can only say that the play will continue until term limits are enacted, an unlikely event. An excellent article published by BusinessWeek on November 19th entitled "FHA-Backed Loans: The New Subprime" provides a preview of the next act. Not surprisingly, most of the actors are the same. It describes how thousands of subprime mortgage lenders and brokers have switched strategies. They’re now harvesting the same old crop from a new field; FHA insured mortgages designed to encourage homeownership for low income buyers. Here are some excerpts but I encourage you to click on the article link to read the entire story.

"For generations, these loans, backed by the Federal Housing Administration, have offered working-class families a legitimate means to purchase their own homes. But now there’s a severe danger that aggressive lenders and brokers schooled in the rash ways of the subprime industry will overwhelm the FHA with loans for people unlikely to make their payments. Exacerbating matters, FHA officials seem oblivious to what’s happening – or incapable of stopping it. They’re giving mortgge firms licenses to dole out 100%-insured loans despite lender records blotted by state sanctions, bankruptcy filings, civil lawsuits, and even criminal convictions."

"Congress and the Bush Administration are strongly encouraging lenders to apply for FHA approval and tap into the government’s loan-guarantee reservoir. In September, the agency guaranteed 140,000 new loans, up from 60,000 in January. In October, as Congress and the White House scrambled to respond to the spreading financial disaster, the FHA began to extend $300 billion in additional loan guarantees under the banner of a new program called HOPE for Homeowners. The limit on the amount buyers may borrow will rise in January to $625,000 to $362,790 in 2007."

"Some current and former federal housing officials say the agency isn’t anywhere close to being equipped to deal with the oversight of lenders seeking to cash in. Thirty-six thousand lenders now have FHA licenses, up from 16,000 in mid-2007. FHA ‘faces a tsunami’ in the form of ex-subprime lenders who favor aggressive sales tactics and sometimes engage in outright fraud, says Kenneth M. Donohue Sr., the inspector general for HUD. ‘I am very concerned that the same players who brought us problems into the subprime area are now reconstituting themselves and bringing loans into the FHA portfolio,’ he says."

The article goes on to enumerate several very bad apples who have made the switch (with government approval) from subprime to FHA-insured loan origination.
 

Click for the entire article.

Now it looks like the government will be taking a more controlling interest in the financial industry as well as the auto industry. Doesn’t that instill you with confidence?