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   ARTICLE   |   From Scotsman Guide Residential Edition   |   March 2006

Mortgage Brokering: A Short History

Part 1 of 2: From the early days to the 1980s, mortgage brokering evolved into a recognized market force

r_2006-03_Nackoul_spotIn part one of a two-part series, Alex Nackoul discusses the history of the mortgage-brokering industry. He looks at the roles of mortgage brokers, savings-and-loan associations, economic factors from the 1890s through the early ’80s and more. Part two will discuss the industry in the ’90s through today. This history include his personal observations.

Mortgage professionals better chart their future by understanding the history of their industry. In this examination of the history of the mortgage-brokering industry, particular attention will be paid to the industry during the early 1980s, when it began to transform into what it is today.

Brokers’ and bankers’ early days

Mortgage brokering evolved with the United States’ urbanization. One of the first mortgage brokerages was Sonnenblick-Goldman. Founded in 1893 in New York City, Sonnenblick-Goldman started by arranging debt financing for hard-to-finance real estate projects.

In the West, local real estate individuals also saw a business opportunity in the abundance of land and need for mortgage capital. They started arranging mortgage loans for people who were turned down by banks.

These “loan arrangers” brought together bank turndowns and wealthy people to create private mortgages. The number of loan arrangers grew because of a common lament: “The only time a bank will approve my loan is when I prove to the banker that I don’t need the loan.”

This financial Catch-22 helped to create a new job classification: mortgage brokers.

The Great Depression and the New Deal in the 1930s forever changed our nation’s housing policies and real estate financing. The Federal Home Loan Bank system (FHLB) was established in 1932. The U.S. Housing Act of 1934 created the Federal Housing Administration (FHA), while the U.S. Housing Act of 1937 created a public-housing program that paved the way for the U.S. Department of Housing and Urban Development. In 1944, the Veterans Administration (VA; now the U.S. Department of Veterans Affairs) loan program was created.

One purpose of these programs was to broaden borrower qualifications for home mortgages. These government programs created another job classification: mortgage bankers.

The roles of mortgage bankers and mortgage brokers were similar. Both arranged mortgage loans for borrowers who could not get traditional bank financing, and both sold their loans to investors. Brokers arranged loans to wealthy individuals, and bankers arranged loans via government agencies.

The early 1980s: Who did what?

Within a few decades, the New Deal legislation found its place. The mortgage industry’s financial markets became clearly defined at the start of the 1980s. Conventional mortgage loans were the domain of savings-and-loan associations (S&Ls), and government mortgage loans were the domain of mortgage bankers. Mortgage brokers handled everything else, including second mortgages and credit-risk first mortgages.

As the 1980s progressed, however, there were many changes to mortgage brokers’ roles in conventional home loans, government loans, second mortgages and more. Inflation and the deregulation of the lending industry in the ’80s would further impact the mortgage industry.

Institutional lenders (banks and S&Ls) operated in a highly regulated environment in 1980. The lending industry was still a “gentlemen’s domain.” “Banker’s hours” were still in place, which meant that banks and S&Ls were open from 10 a.m. to 3 p.m., Monday through Friday.

There also were no national lenders. Banks and S&Ls funded loans only in the state where they were domiciled. Further, banks made commercial loans while, S&Ls primarily funded home mortgages.

Legislation called Federal Regulation Q had a lot to do with this. Not only were lending activities regulated, but the government also regulated the amount of money that banks and S&Ls paid their depositors. In 1980, Regulation Q authorized S&Ls to pay their depositors 5.25 percent, while banks paid their depositors 5 percent.

Within this regulated environment, S&Ls continued the traditional practice of making 30-year, fixed-rate portfolio loans from 8 percent to 8.5 percent. As long as the government protected their costs of funds at 5.25 percent, it made sense. All of the large S&L lenders did this.

The S&Ls funded these 30-year fixed mortgages, which were literally kept in the vault. In other words, portfolio lending was the standard practice. These loans were typically 80-percent loan to value (LTV). Ninety-percent loans were uncommon at the time, and 95-percent loans were even rarer. One-hundred-percent conventional mortgages were nonexistent. Plus, when the LTV was greater than 80 percent, lenders required borrowers to get private mortgage insurance.

Further, to increase loan volume, S&Ls began to employ commissioned loan representatives to originate loans — in-house mortgage brokers.

Conventional lenders sometimes sold their fixed-rate, conventional mortgages, but that was not standard practice. The secondary-mortgage market was evolving; it was not the dominant force it is today. Further, Freddie Mac and Fannie Mae were just beginning to expand.

In fact, at the start of the 1980s, FHA and VA loans were still the domain of mortgage bankers. They realized that all they had to do was originate a government mortgage loan, fund it, sell it off in the secondary market for a profit and retain the servicing rights. Thus, the secondary-mortgage market began with mortgage bankers and the government.

One attraction of the mortgage-banking business was its high leverage. With little capital outlay, mortgage bankers could outfit an office and get warehouse lines to fund their government loans. The challenge was in loan origination.

David Loeb and Angelo Mozilo of Countrywide found hiring commissioned loan reps to be less than cost-effective. They pioneered the concept of mortgage-banking branch offices. They targeted paycheck borrowers with excellent mortgage pricing and low points. The borrowers could then be approved by a salaried branch manager.

Second trust deeds were a dirty word during this time. If borrowers needed a second mortgage, they were seen as financial outcasts. Mortgage brokers handled second mortgages. S&Ls did not make seconds. Third trust deeds? Forget it.

There was no organized nonprime mortgage market, though some mortgage brokers operated in this arena. The terms nonprime and subprime did not even enter the mortgage lexicon until the 1990s.

The S&Ls did conventional A-paper loans, and that was it. If borrowers did not qualify for a conventional or government mortgage, they had three options:

  1. They went to a local mortgage broker for a high-cost, short-term loan; 
  2. They asked the seller to carry the mortgage; or 
  3. Their Realtor performed creative financing.

There were no B- and C-grade mortgage loans in the early 1980s. Borrowers had to have their incomes verified. There were no FICO scores. If a borrower had many late mortgage payments, the loan was denied. Signed tax returns and pay stubs were required to have a mortgage approved. Down-payment verification was required. There were no “stated income” or “stated asset” loans.

Issues of the early ’80s: Inflation and deregulation

The appointment of Paul Volcker in 1979 as the Federal Reserve Board chairman had a significant impact throughout the decade. The nation’s No. 1 financial problem in 1980 was inflation. The federal government’s spending for the Vietnam War and President Lyndon Johnson’s Great Society social programs had caught up with the nation.

To check inflation, Volcker instituted a monetarist policy in which the amounts of dollars in circulation became the determining policy factor rather than the control of interest rates themselves. Consequently, interest rates skyrocketed.

The Wall Street Journal reported that the prime rate hit 21.5 percent in October 1980. Thirty-year fixed mortgages were written at 16.5 percent. Thirty-year U.S. government bonds were offered at 15 percent. Overnight, the financial world was turned upside down.

While the economy struggled with high interest rates, the federal government changed its policy course. It would no longer regulate industries. They would be free to compete, and thus, the spirit of competition would benefit consumers with lower prices. First, the Feds deregulated the airline industry. In 1980, they turned to the lending industry.

Out went Regulation Q; banks, and S&Ls were free to pay their depositors market rates for their deposits. Overnight, the tradition of fixed-rate portfolio loans financed by short-term deposits was gone. The importance of a secondary-mortgage market for conventional fixed-rate loans was immediately recognized.

S&Ls had to be inventive and entrepreneurial like their mortgage-banker counterparts. Wall Street types such as Charles W. Knapp saw opportunities. Starting with State Savings & Loan and then American Savings & Loan, Knapp brought a mortgage-banking attitude to the S&L industry.

This mortgage-banking attitude was in stark contrast to the traditional savings-and-loan culture. People such as Howard Ahmanson of Home Savings of America dealt with this change by funding mostly variable-interest-rate mortgages. S. Mark Taper of American Savings closed down his loan department entirely and invested depositors’ moneys in government bonds.

The conventional mortgage market started to break in the early ’80s. S&Ls closed their loan departments in response to deregulation and soaring interest rates. Commissioned loan representatives at many S&Ls were dismissed.

There was no national banking, but newly introduced legislation allowed banking subsidiaries, including bank service corporations, to cross state lines to fund mortgages. Numerous bank-service corporations moved to California. Some of the first wholesale lenders, they were subsidiaries of state banks that wanted a piece of California mortgage lending.

The service corporations were lightly financed, however, and needed a cheap sales force to feed them conventional loans that they could sell to Fannie Mae and Freddie Mac. A good portion of their sales force came from former commissioned S&L loan reps. The ranks of independent mortgage brokers were growing with this new breed, which brokered conventional, fixed-rate mortgages.

Mortgage brokers started to market their services to Realtors and borrowers as being a “one-stop loan source” for conventional, fixed-rate mortgage loans. They touted the fact that they represented lenders from all over the country. Borrowers just had to complete one loan application, and brokers would find them the best possible deal.

Consequently, the position of the mortgage brokers grew. Soon thereafter, S&Ls opened their doors to this growing group of conventional mortgage brokers. When commercial banks entered the home-mortgage market, they also went after the mortgage-brokerage business. 

•  •  •

For the mortgage industry, the 1980s started with turmoil and change and ended as a different industry. Thirty-year, fixed-rate mortgages increased to more than 16 percent in the early 1980s and steadily declined to greater than 10 percent in 1989.

Federal Reserve began winning the battle to reduce inflation at the end of the decade, but the market felt its effects.

By sheer growth in numbers, mortgage brokers created an industry that the mortgage-lending community acknowledged by the end of the 1980s. Mortgage bankers were poised to replace S&Ls.

Deregulation of the lending industry transformed it into a competitive marketplace. Those who were willing to work hard and persevere were rewarded — and mortgage brokers were more than willing.

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