November 29, 2010

The Easiest $5-Million Job in the World

By Nemo Almen

Which industry pays loan officers up to $5 million a year? Here's a hint: these bonuses are paid through companies that have lost several hundred billion dollars, necessitating a taxpayer bailout. That's right: your tax dollars are paying for both the bailouts and these multi-million-dollar bonuses. At the risk of popularizing this racket, I will explain how and why this happens, in the hope that it inspires real reforms.

The industry is apartment finance, and the companies are Fannie Mae Delegated Underwriter & Servicers ("DUS shops") and Freddie Mac Seller-Servicers. As we know, Fannie and Freddie were founded to support affordable housing in America. To accomplish this, the companies set up single-family and apartment lending programs. To leverage their platform, they formed networks of partner companies to originate, sell, and service these apartment loans.

Briefly, here is how the system works. Fannie and Freddie publish lending guidelines. The DUS shops and Seller-Servicers solicit apartment complex owners based on these guidelines. The property owner picks a program. Then the partner companies fund the loan and sell it to Fannie or Freddie. Industry participants argue that this fills a vital need -- supporting the apartment housing market -- while other lenders (i.e., the megabanks) use their bailout proceeds to buy other banks.

Now, if this is public service work, how do people make so much money off it? To earn such sums, an individual producer must generate millions of dollars of revenue. Specifically, top producers receive about half of all up-front revenue, so to earn $5 million one would have to generate about $10 million in revenue. Each transaction earns commissions of one to two percent (on average, see S-1 p. 44), translating into loan volume of $500 million to $1 billion a year. Therefore, producers who close over $500 million a year in loans earn multi-million-dollar bonuses.

It is not wrong to earn lots of money when one generates lots of revenue. But the manner in which these moneys are earned is deeply questionable on many levels. First, the revenue is phantom income. It is not really revenue; it is your money confiscated by the government to subsidize this industry. Second, this agenda is highly suspect. Based on your taxpayer dollars, apartment owners receive about a 0.75% discount in their mortgage rates today. This inflates the value of apartment complexes.

But wait -- aren't these lending programs required to support affordable housing? Of course not. These are not construction loans; they are on only stabilized (90% occupied) properties. These programs do not create new apartment units or make living in one any more affordable; they just make the rich apartment owners richer. Industry PACs argue that your subsidy is required to make apartments appealing investments, but this argument belies the truth.

The truth is that Fannie and Freddie do not support the apartment lending market; they dominate it. Their lack of a cost of capital enables them to drive out private-sector competition, undercutting market rates by 0.75%. As John Hancock's John Monahan remarked, "As a competitor I am frustrated; as a taxpayer I am outraged!" His stance is correct. If Fannie and Freddie were truly backstops to the market, their rates would be not 0.75% lower than the private sector's, but 0.25% higher.

As it is, the much lower rates allow the partner lenders to price-gouge. They build in extra profit for themselves by selling the loans to Fannie and Freddie at a premium to par. In other words, Fannie and Freddie pay $10.1 million or $10.2 million for a $10-million loan. The difference goes to their partner lenders. So these lenders profit by screwing over their clients as well as taxpayers. A wonderful business, isn't it?

Here's the best part: odds are we can do nothing about it. For the next two years, Democrats control the Senate and Republicans the House. Neither political party has the wherewithal to further its agenda, leading to a lengthy impasse. The industry PAC (the National Multifamily Housing Council) describes this environment as a lobbyist's dream. This PAC has the time and resources (see p. 26) to lobby legislators, directing public debates and public policy to its own ends. Our only hope is a unified protest against these companies and their corruptive influence in politics. And honestly, how often does something like that happen?

Nemo Almen is the author of The Last Dodo: The Great Recession and our Modern-Day Struggle for Survival.