Predatory Brokers – comment on NYT editorial

Today’s NYT includes an editorial entitled Predatory Brokers:

http://www.nytimes.com/2009/04/10/opinion/10fri1.html

Amazingly, I agree with much of what they say. Of course, they get some of the initial motivations wrong – such as saying that “Mortgage brokers are supposed to be impartial advocates who search out the best possible deal for prospective homeowners seeking a loan.” To anyone who ever believed that, I have a bridge in Brooklyn I’d like to sell… Mortgage brokers are like used car salesmen: you can find one every once in a while who genuinely likes cars and his customers, but most of them are in it for the quick buck and know how to get it (by having more information than the buyer).

I’ve also been saying for about a year now that three things could go a long way towards preventing the current economic crises, and loan brokers are part of the first thing on my list: make financial fraud punishable with jail time. Not just Bernie Madoff-level fraud, but all fraud. How many predatory or “liar” loans would have been made if the broker (and borrower) thought there was the chance to see the inside of a jail cell? A whole heck of a lot fewer, that’s how many.

My question for the bankers out there is, what could the banks have done better to control the problem? The article references the rate sheets which lenders distributed showing broker commissions which encouraged brokers to steer borrowers to sometimes less advantageous loans in order to earn higher commissions. This is certainly a problem for an unwitting/uneducated borrower since they wouldn’t necessarily know that they should choose a different loan product. The problem is that the reason the broker received a larger commission for, say, and ARM instead of fixed rate loan is that the banks prefer less rate risk. Therefore, it made perfect sense for banks to try to incent brokers to feed them ARMs instead of FRMs. In this situation, the lender’s and the borrower’s interests were not aligned, even though in hindsight many banks would now have preferred to have portfolios of “safer” fixed rate loans.

So, what can/should banks do to encourage the borrower to take out the best loan for them while also allowing the bank to build the best loan portfolio for themselves?

(Oh, and the other two things are regulation of derivatives such as credit default swaps, and better incentive structures for Wall Street – bonuses tied to longer term performance)