Sunday, April 11, 2010

Mortgage Meltdown

It amazes me that everyone is trying to figure out what went wrong in the mortgage industry. I can tell you in a heart beat. Bad management.

Management means directing others to accomplish goals. If the goals are not accomplished the management is to blame. Management may have taken on a task that could not be accomplished with available resources. Management may have mis-managed those resources. It does not matter which, the problem is always bad management.

Management defines and directs the actions of the workers. Period.

The mortgage meltdown can be easily explained. People in the mortgage industry are rewarded based on the amount of money that they lend out. Mortgage Brokers receive a “commission” on each mortgage. Realtors receive a commission based on the sale price of a home. This provides an incentive to sell homes for more money, as much as they can possibly be sold for.

Every house that is sold is appraised by a real estate appraiser. Appraisers who do not appraise properties for what the real estate agent and mortgage broker think the property should be sold for will be complained about and fired or laid off.

The VA mortgage system is slightly different. VA appraisers work for the VA and answer only to the VA.

FHA, Fannie Mae, Freddie Mac, Banks, etc, appraisers typically work for appraisal companies, mortgage brokers or they freelance. They are answerable to their customers, mortgage brokers who are paid based on how much the house sells for.

Essentially Mortgage Management built a financial system that depended on the capabilities of the real estate appraisal system and then created a reward system to ensure that the real estate appraisal system would appraise houses for the maximum possible value.

So what happened?

As long as homes were appraising upward nothing happened.

When homes were appraising downward there was a HUGE response time lag based on the reluctance of the people involved to reduce their income.

W. Edward Demming used to say that a failure in quality was always a failure in management. This is true again in this situation. Management failed to properly manage the people actually doing the work that their system of checks and balances rested on.

Is the problem the fault of the appraisers, the real estate agents and the mortgage brokers? NO.

These people did not break the rules. These people learned how to maximize their incomes within the rules and ethics of the mortgage system.

It is not the place of the person doing the actual labor to determine the actions of their labor. It is the job of management to define and direct the actions of workers. Period.

Pure and simple the mortgage industry melt down was caused by a failure of management.

Congress mis-managed the situation by changing the mortgage laws in the 1990's without considering how those changes were going to influence the way the work was being done.

Financial Institution managers mis-managed the situation by not effectively identifying and managing the risks caused by the changes in mortgage rules.

President Clinton lobbied for mortgage reform. It was one of his major accomplishments during his presidency. Both houses were controlled by Republicans at the time.

How could the system have prevented the melt down?

Because the entire mortgage system is predicated on the value of the mortgaged property and the value of that mortgaged property is determined by a real estate appraiser all real estate appraisers should work for the government and be answerable only to government authority.

This will not fully solve the problem because there is a huge emphasis on increasing tax values when property taxes are based on the value of the property.

Property tax laws need to be re-written so that taxes are not based on the value of a property. This way appraisers are not influenced by the need of a community to increase taxes. The other potential solution is to have all property appraisers employees of the Federal Government, however, that creates a situation where the appraisal department has effective control over the entire real estate industry.

With absolute power comes absolute corruption. The best way to limit corruption is to limit power.

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