How About a Score to Rate Mortgage Lenders?

By Randy Johnson for Credit.com

01.20.10

We have gotten used to the idea of a FICO scoring system in credit evaluation. It is the standard model that is widely used throughout the industry. But it is 100% directed to the evaluation of the individual consumer’s credit. How about a scoring system that borrowers could use in evaluating potential lenders?

Wouldn’t it be nice if lenders had to post some sort of score or rating on their premises, stationery letterheads, e-mails, websites, and all of their advertising? In this way, a consumer could tell if he was dealing with a 600-lender or a 700-lender or an 800-lender.

Most average borrowers simply are not able to evaluate lenders, mostly because when it comes to financial matters, consumers are often either ill-informed or ill-equipped. Either through lack of experience, education, or training, American consumers are not always able to make good financial judgments. Many people make major and expensive mistakes when it comes to saving, investing, or financing real estate. Credit.com helps consumers fill in the gaps so that consumers can become more astute in their financial decision-making.

Many people did a terrible job of picking where to get a mortgage. For example, the consensus among those in the mortgage industry is that at least 40 percent of those who got a toxic subprime loan would have qualified for an A-paper loan. But they made a serious mistake and chose poorly. They went to subprime lenders and ended up with toxic loans. Perhaps one-third of those borrowers, around a million people, ended up in foreclosure.

Of course, theoretically there are systems for evaluating companies. In corporate America, Dun & Bradstreet evaluates the creditworthiness of businesses. In addition, Moody’s and Standard & Poor evaluate the quality of securities offered by public companies. We now know that they did a horrendous job of rating mortgage-backed securities. In fact, their track record was so bad that you would have to wonder about the very concept of rating securities.

Then you have all the Wall Street analysts who study companies and make buy-sell stock recommendations. They all made serious errors and lost billions in the process. And then you have the regulators including the Federal Reserve; the Office of the Comptroller of the Currency; the Federal Deposit Insurance Corporation (FDIC); the Officer of Thrift Supervision; the Office of Federal Housing Enterprise Oversight that is now the Federal Housing Finance Agency; the Federal Trade Commission (FTC); the Department of Housing and Urban Development (HUD); and a few more that I am sure I missed.

The problem with these systems is that they look at the overall performance of a bank or other company. But mortgage lending or credit card lending may just be a small portion of the bank’s activities. A bad company might have a terrific mortgage division and an otherwise good company might have a terrible mortgage operation. I have seen both of these.

Fannie Mae, Freddie Mac, and Countrywide were not multi-industry companies. They were mortgage-only companies, so while it might not have been easy to figure out their finances, it wasn’t as complex as the bank that was in 129 different businesses. The world was shocked to find out – too late – that these entities have now suffered capital losses of $1 trillion from what the market said were worth a few years ago compared with what they are worth today. This figure includes the billions of dollars in federal stimulus funds injected to keep them afloat.

Finally, you have similar agencies in almost every state. In some states, notably in California, the Department of Corporations was responsible under the 1996 California Residential Mortgage Lending Act for supervising mortgage bankers – but that sure changed when subprime lending increased dramatically.

Outfits like Ameriquest, New Century, Countrywide, Option One, and a host of smaller lenders sprang up. The biggest one of all, Countrywide, was subject to supervision by the California Department of Corporations. Arguably the reason these lenders set up shop in California was because of the lax regulatory environment in which they could operate without much interference from regulators. These firms prospered by using crooked selling practices to foist toxic mortgages onto unwary and gullible consumers.

Everyone thought we had a sophisticated system of investigation and regulation but, in fact, the entire system was broken. At both federal and state levels it was a sham.

In the immediate aftermath of the economic meltdown in September 2008, I can remember the FBI announcing with some fanfare that they were investigating 17 different subprime lenders to see if there had been any criminal wrongdoing. We have not heard a peep out of them in the two years since that announcement. The only visible action occurred recently by the Securities and Exchange Commission, which indicated that New Century Financial was under investigation.

So if lenders did all these bad things without breaking any laws, some people conclude that we didn’t have the right laws in place. To that end, we are about to get a complete overhaul of the regulation of the financial industry when the Consumer Financial Protection Agency Act of 2009 is passed and signed by President Obama, which seems likely.

Will it protect consumers? Not likely. We actually have enough laws already, just poor execution and regulation. So do not expect some government agency to protect you. And as cute as it might sound, it probably won’t be possible to come up with a score/rating for lenders either. If these people couldn’t even tell that the industry was imploding, how do you suppose they could possibly rate lenders and give them a performance score that would be meaningful and helpful to borrowers?

As a consumer you need to protect yourself. You can do that by getting an education. There are ample resources here in the mortgage section of the Credit.com website. Consider spending some serious time becoming a shrewd consumer, especially in the homebuying process. You also ought to consider buying a book about the process. When you make good decisions, you will potentially save tens of thousands of dollars over the life of the loan. Is that reward enough for your efforts?