I have some nitpicks with Jeffrey Dorfman’s op-ed at RealClearMarkets but I think the basic message is on target. Let me summarize it in one sentence. The “mortgage meltdown” of 2008 was caused by all parties acting in a way consistent with the incentives they had.
Unfortunately, the incentives in the mortgage market are designed in such a way as to create exactly the type of mortgage market meltdown we recently experienced.
When you apply for a mortgage you deal with a mortgage broker. Even at most banks, the person you deal with has multiple sources of funds. Each source has provided the mortgage broker with an amount of money to lend, a set of rules to qualify for a mortgage, and interest rates to charge based on credit worthiness. The mortgage broker hopefully pairs you with the best mortgage deal given your circumstances. When the loan is approved and closes, the mortgage broker gets paid a commission.
That means the broker’s incentive is to close the deal and collect the commission. Whether the borrower makes payments on the mortgage is irrelevant to the mortgage broker. This was not lost on the mortgage brokers who stretched and bent rules in some cases in order to get deals done.
It wasn’t just the mortgage brokers. It was the ratings agencies, the banks, the mortgage bankers, the buyers, the sellers, the borrowers, the lenders, the local, state, and federal governments. Everyone was doing the prudent thing based on the incentives that were in place.
The incentives haven’t changed. That’s been my gripe for the last five years. I think that at the very least one of the ratings companies needed to be executed to encourage the others. Why we have private rating agencies at all is something that eludes me.