Fiduciary Responsibility in the Mortgage Meltdown

This article was written by Ralph Roberts and appeared in his Flippingfrenzy.com blog.

I was discussing the mortgage meltdown with a colleague the other day, when we encountered an interesting question: Who do mortgage originators (brokers and loan officers) represent? Do they represent themselves, the lenders whose products they sell, or the borrowers?

As a REALTOR, my relationship with my clients is clearly delineated. I have a fiduciary responsibility to the buyer or the seller I represent. (The term “fiduciary” simply means that I must represent my client’s best interests.) In a case of dual representation, Realtors are expected to treat both parties fairly and equitably.

A professional’s responsibility varies according to the profession and the specific role the person plays. A stock broker, for example, is supposed to sell investments to clients that are in the clients’ best interests. Someone who sells cars, however, is responsible for acting on behalf of the dealership, not the person who’s buying the car. Condemning a car salesperson for trying to sell the buyer additional optional features the buyer didn’t really need would be insane.

In real estate transactions, fiduciary responsibility is not always so clearly defined, and I believe this is at the root of many problems in the industry. For example, is an appraiser (paid by the buyer) responsible to the buyer or to the bank who uses the appraisal to deny or approve a loan? In the best of all possible worlds, the appraiser’s job is to provide an accurate appraisal of a home’s value, but in the real world, this doesn’t always happen. At the direction of a homeowner, loan officer, or real estate agent, the appraiser may inflate the appraisal, fooling the lender into approving a loan it would otherwise deny.

The fiduciary responsibility of mortgage brokers and loan officers is even fuzzier. Like a car dealer, a loan officer is merely selling a product supplied by the lender. Like an investment broker, however, the loan officer has some responsibility not to saddle the borrower with an overly risky loan. As you can see, the role that the broker or loan officer plays between the lender and borrower is clouded in ambiguity.

I believe that this ambiguity led to many of the problems leading up to the mortgage meltdown. In some cases, loan officers were overly ambitious in representing the borrower’s interests, which resulted in mortgage fraud. In other cases, loan officers who were overly eager to sell the lenders’ products pushed risky loan products (subprime mortgages) on unwary borrowers. Ironically, by acting solely on the behalf of either the borrower or the lender, these loan officers served neither party. Both lenders and borrowers got stuck with bad loans.

Some states have passed legislation that gives mortgage brokers and loan officers fiduciary responsibility to borrowers, but that addresses only one half of the equation. Brokers and loan officers also have to protect the interests of lenders.
I don’t intend to make mortgage brokers and loan officers the scapegoats in the mortgage meltdown. There’s plenty of blame to go around. Real estate agents, appraisers, title companies, Wall Street, the Federal Reserve, legislators, politicians, and homeowners all share the blame. Unfortunately, mortgage brokers and loan officers play the role of gatekeepers and are saddled with an inordinate amount of responsibility. They must serve two masters in a way that is in the best interest of both parties.

Perhaps mortgage brokers and loan officers need to stop thinking about their vendors and their clients and think in more abstract terms. Instead of selling products from lenders or representing borrowers as clients, maybe they need to be committed to making good loans. In many ways, the relationship needs to be governed by the same rules that apply to dual representation in the real estate industry — if it’s not a good deal for everyone involved, then it’s not a good deal. As an added incentive, perhaps brokers and loan officers should have their compensation tied to the success of the loan rather than receiving a commission on each sale.

My comment to this post:

Ralph:

Great topic and one that needs to be explored and defined even more.
Below is a definition from an on line dictionary but is as good as any. I hope the link works through this comment. If not, I will email it to anyone who asks.
The Free Dictionary Definition of Fiduciary Responsibility

Noun 1. fiduciary relation - the legal relation that exists when one
person justifiably places reliance on another whose aid or protection is sought in some matter.

As is noted in the above link, this comes from English law and was considered to be one of the most important laws. Since much of our law comes from English law, the same would apply here.

As we have discussed in the past, and as a mortgage broker for many years, my fiduciary responsibility was more one of ethics then fiduciary. It was fiduciary in the fact that I believe that I accept a responsibility to both the lender I may be representing at the time as well as to my client, the borrower. Saying this, I am saying that ethically, I have a fiduciary responsibility to both. I first look to my client and to do the best job I can for them. The end result of doing this will produce a loan for some lender under terms and conditions “acceptable” to the client as well as a commission for me.

This is more an ethical approach then a legal approach. Doctors adhere to a code of ethics and swear to them when accepted into the profession. Lawyers abide by a code of ethics when admitted to the Bar and Realtors, such as yourself, acknowledge and agree to abide by the Code of Ethics set forth by the Realtor Association(s). The military has a Code of Ethics every soldier acknowledges and agrees to abide by.

Ethics cannot be mandated by law. It is a voluntary performance that rests with a person’s own inner being. Each one of us must look into the mirror every morning and decide if we like what we see.

Once, realtors always represented the seller. I never thought this was right but I noticed that even though they had this so called “fiduciary” responsibility to the seller, the one’s I worked with advised me properly. They answered my questions fairly and honestly, they told me what other homes in that neighborhood sold for, they even advised me that the asking price might be a little to high. Did they violate fiduciary? No, they helped create a sale that both seller and buyer were happy with as evidenced by the “offer and acceptance”. Had there been a dissatisfied party to the transaction then there would not have been an offer or may not have been an acceptance. Once both parties agreed, their signatures attested to the fact that they were both satisfied. Now that’s a good deal when all parties to the transaction, including the realtor who got a commission, are satisfied.

We can legislate fiduciary responsibility as some states are doing but we cannot legislate morality or ethics.

I have taught many on sales, written sales training manuals and did sales training for many different industries. What I teach first and foremost is that we ARE salespersons, most working on commission. If we put our client/customer first, the supplier or product we are selling second and our commission last, we will more often then not be successful in that transaction making ALL parties satisfied. This almost sounds like a form of fiduciary responsibility.

Fiduciary responsibility is mandated in many different professions, yet abuses and violations still occur in all of them. It is up to our corporate leaders at all levels, CEO, VP, upper level Manager, Mid Level Managers and Supervisors to mandate and monitor ETHICAL performance all the way down the line.

We are all too profit driven rather then fairness driven. I speak of our large and major corporations as they are at the top of my ethics pyramid. An ethics driven business society could have prevented the ENRONs of the country from occurring as well as the current crisis we are in.
12/28/2007