It has long perplexed me to fully understand how a sophisticated monetary and financial system, so tightly regulated could come so unstuck as to facilitate the near collapse of the financial markets not just in the US but also globally through in part the subprime meltdown.
Sure the US had been benefiting from an unbridled run of economic growth and perpetuating the model of the classic “land of opportunity” – but to see how loans could be written to people who had no requirement to prove the status of their income or assets (more likely liabilities) always staggered most people (at least in hindsight) and then to see that these new borrowers could be offered “low start mortgages” with rates half of what the flexible lending rate was at the time only could have resulted in one possible outcome – something the world has come to better understand over the past 12 months.
Well an enlightening piece of the puzzle is very neatly exposed in this excellent blog post from Jack M. Guttentag professor of finance emeritus at the Wharton School of the University of Pennsylvania. The post on Inman News entitled “Transparency is king in U.K. mortgage system” sets out to explain for a US audience the key differences of the UK system of mortgage broking from the US approach – for NZ the model of the UK is almost exactly the same as here in process at least.
The most enlightening perspective for me is the fact that whereas here brokers earn commission by managing the process of “selling” mortgages offered by a large number of banks and financial institutions where the lender is transparent in the offer of a mortgage rate which the broker resells.
In the US by contrast the brokers effectively package up mortgages sold to them at a wholesale rate adding their margin to then offer this to buyers. This process means that truly 2 brokers could offer the same mortgage to the same borrower sourced from the same financial institution but packaged up at different rates especially as these rates may vary for each of the years of a loan. Some may well say this is facilitating a true open market, whilst other may see unscrupulous ambition driving inappropriate behaviour.
The rates offered by lending institutions to brokers are not disclosed to the public, but are the closely guarded jewel of the mortgage broking fraternity. Based on this understanding it becomes clearer as to how the gulf between those that borrowed and those that lent became a chiasm through which so much risky debt was written and then resold with those who financing the debt not having any clear idea of the circumstances of the borrowers.
Not wishing to draw simplistic generalisations, this explanation provided by Jack M. Guttentag does at least demonstrate that the risks that created the heart of the subprime debacle in the US could not have been executed in the same manner in NZ due to the fact that the fundamental process of mortgage broking is so significantly different.