Morality and Mortgages

A few years ago, a number of mutual fund companies were accused of engaging in the unlawful practice of "late trading." Normal customers like you and me can place orders to buy or sell shares at any time, but the price will be the closing price at the end of the next trading day.

If information that develops after the close of trading results in the market going up or down the next day, the "late traders," typically a favored customer, can buy or sell after the market price is established. This allows late traders to lock in a guaranteed profit by trading at today's price instead of the tomorrow's closing price. That's illegal.

Elliot Spitzer, then N.Y. Attorney General, went after the industry after being tipped by insiders. The companies that were charged did not admit guilt but paid severe fines and agreed not to do what they never admitted to doing in the first place.

It was clear that in some companies the chief knew what the tribe was doing, but in other cases it was being done by underlings without top management's knowledge. The only case that went to trial did not result in convictions. That dampened Spitzer's zeal and he moved on to other arenas (and we all know how that ended!).

This practice hurt normal customers because, in effect, the profit that the favored customers made came out of the pockets of the normal customers. Most owners of the mutual funds shares didn't know about this. But others were outraged at being treated as second-class citizens. Research demonstrated that the loss to the normal shareholders was almost 4% in international funds and about 1% on domestic funds.

The effect would be that if you had a $500,000 pension plan invested 50% in international and 50% in domestic mutual funds that engaged in these practices you would have received $12,500 less, every year. Apply this rule over a long time period and you can see how much it would affect your retirement plans.

As a result of this, outraged mutual fund customers sold billions of dollars worth of their shares and moved the money to other mutual fund companies where they were assured of more ethical treatment.

We seldom get a chance to make buying decisions based upon the ethics. We just don't have enough information about ethical lapses to have them enter into buying decisions.

Not so with the mortgage business. We now know that many people and many companies in the mortgage industry have engaged in deceptive practices that defrauded millions of customers. We will find how much was illegal when the FBI finishes looking at the practices of the seventeen companies that are currently under investigation. But even if they were illegal, these practices were certainly unethical. The bottom line is that many companies made a ton of money by deceiving and taking advantage of their customers. They still do.

Some 250 of these companies are now out of business, according to the Implode-O-Meter that tracks this. Some have been absorbed into other companies but are still doing business with the public.

Here's what I can't figure out. Why do borrowers want to do business with these companies? Where is the sense of outrage that the mutual fund shareowners felt? What if the Mafia owned a mortgage company? Would you do business with them if they offered you a lower rate than a legitimate lender?

This is now affecting borrowers who have ARMs that are resetting. I have gotten calls from people who wanted to compare what I could offer in the current market with what their current lender was offering. I can assure you that these offers ALL appear attractive, although just for the short term. Remember that these aren't really lenders; they sold that loan years ago, but they want to keep the servicing a profitable business. What they are trying to do is keep your loan on their books so they can continue to profit from you.

I know enough about human nature to know that no one wants to admit that he has been cheated. Frankly, it isn't just the money. They just don't want to admit that they were so ignorant that someone could take advantage of their ignorance. Or, more likely, they don't think that THEY were the victims of deceptive practices even though they know that millions of others were. That's called denial.

I think that these customers ought to be saying, "I'm not sure if you cheated me on the initial transaction. I'm not sure if you are going to cheat me on this transaction. I'm not smart enough about this to tell. But I would rather not do business with a company that cheats its customers when it thinks it can get away with it. I would rather do business with a company I know won't cheat me."

There is a difference between ignorance and stupidity. Ignorance can mean being UNAWARE of something. That can be corrected by education. The other interpretation of ignorance is knowing something but IGNORING it. To me, the latter is more like stupidity -- for example, thinking the stove won't burn you this time if you touch it.

There are plenty of ethical companies and plenty of ethical loan officers whom you can trust. They won't cheat you; they will help explain the options, and they will help you make the best decisions for your family. Why not deal with one of them, even if it might appear to cost a little more?