Last modified: Wednesday, April 16, 2008 1:43 AM EDT GUEST COLUMN: Don't blame mortgage firms for subprime lending crisis BY NORMAND ROUSSEAU / In reply to a published comment from a savings bank officer that unscrupulous and unregulated mortgage companies caused the sub-prime mortgage crisis: In years past a borrower would visit their bank or credit union to obtain a mortgage. The loan officer would approve the mortgage and fund it with cash reserves from the vault. This system worked well until the bank ran out of money to lend. Borrowers came to an institution looking for a mortgage and were told to come back when a current mortgage was paid off and the bank had the funds. What the bank needed was a way to sell the loans they made, freeing the capital to lend to new borrowers. This way they could lend the same money over and over, earning an income from servicing the loans and assisting the community by offering a near-limitless pool of money. To address this issue, FNMA and GNMA were established. The goal was to provide cheap mortgage money to prospective homeowners and a high quality bond for the investment community. The bond of Mortgage Back Security takes mortgages with similar risk characteristics and pools them together. Investors in the MBS know ahead of time the return they are going to receive, much like a certificate of deposit. To ensure the performance of the bond, each mortgage is underwritten to specific guidelines. During the recent real estate boom, underwriting guidelines were relaxed, giving way to a whole new menu of mortgage products such as 100 percent financing. In addition, to streamline the influx of applications, income and asset verification took a back seat to a borrower with strong credit. With housing prices rising rapidly, the property could be sold to cover the note and foreclosure costs if this occurred. This cycle worked well until the price of houses moderated in 2006. Once the market began to cool and prices moderated, foreclosed homes were being sold for less than the notes. To add insult to injury, the loans underwritten to looser guidelines did not perform as hoped. With the value of the collateral in question (falling home prices) and the future performance of the borrowers unknown, investors' appetite for this risk waned. To attract investors in this environment rates had to increase. Unfortunately the liquidity issues associated with ALT A and subprime loans carried over to more secure AAA GNMA and FNMA loans. Sellers of AAA MBS's are finding it more difficult to find buyers. Many analysts believe the reaction has been too severe. Sanity will eventually return to the markets and AAA pricing will come in line with risk characteristics. Unfortunately it will take some time for this to occur. Mortgage companies do not establish underwriting guidelines nor do they approve loans. There also is a distinction between mortgage brokers and mortgage lenders. Mortgage brokers only arrange loans; they have nothing to do with the approval or commitment to lend procedure. Their compensation is either by them charging the borrower a fee for their services or by receiving lender compensation for arranging the loan. Mortgage lenders use their own funds (like a bank) and are capable of locking in a rate for a borrower. They can also publish rates in the media. Conforming loans generated by mortgage lenders are run through DU underwriting engine (Fannie Mae) or LP underwriting engine (Freddie Mac). The loans are reviewed by the investor (correspondent lender, i.e. the bank) and are either conditionally approved for purchase from the mortgage company or declined. Once again, the mortgage broker has nothing to do with the approval and commitment process. Mortgage companies are also regulated by the commissioner of banks. To suggest the industry is under-regulated is a statement that attacks the integrity of the commissioner. The performance of mortgage companies is heavily regulated and all complaints against them are thoroughly investigated. Mortgage companies are licensed and are periodically audited by the banking commissioner. The writer has no reservations about placing the mortgage crisis on mortgage companies, when in reality they do not make the rules. So why are they any more responsible than banks or credit unions when they operate under similar guidelines? Many larger banks have over 50 percent of their loans originated by mortgage companies in a correspondent or broker relationship to increase their servicing portfolio. The larger banks did participate in subprime lending, as did many mortgage companies. The establishment of guidelines by investors to create huge profits is what caused the mortgage crisis and not the mortgage companies. NORMAND ROUSSEAU is president of Bay State Mortgage Co., Norton.