Fed Wants To Limit Compensation On Difficult Loans

Albeit, sub-prime and Alt-A lending appear to be dead for the time being, both product pools are extremely valuable for the mortgage borrowing community. Yes, there have been abuses, but that does not mean we effectively "throw the baby out with the bathwater". This proposal by Bernanke and Co. simply insures the demise of the sub-prime lending industry. Thus, eliminating a huge pool of potential borrowers and destroying a sector that, until recently, was an extremely important part of lending, "sub-prime". We need sub-prime lending, ironically, to help get us out of this mess.

Yes, abuses have taken place in sub-prime lending over the past several years. The fact is, however, that sub-prime lending (to encapsulate all sub-prime and Alt-A loans) has been a successful part of the lending world going back decades. Remember HFC (NSE:HFC/PB), Beneficial, Norwest, Associates, Avco, etc.? All the aforesaid were vital companies serving borrowers' needs. The key differences in the "old" style of sub-prime lending and the style which helped get us into this mess, are that the old-style maintained higher underwriting standards and priced according to risk.

Obviously, underwriting standards need to be raised. I remember when HFC was considered insane for going to 85% CLTV! Assuming we can re-establish sound sub-prime underwriting standards, we need to price accordingly.

This brings us to risk-based pricing. Higher borrowing costs for sub-par borrowers will achieve two things: 1) It will limit borrowers to those who are willing to pay the price for their inferior credit circumstance(s), and 2) the higher costs and rates to the borrowers will help the offset losses for the lenders due to higher charge-off. Some may argue that this will stifle lending. What lending? Nobody is lending in the sub-prime arena these days anyway. Perhaps we can attract lenders back by allowing them to make profits based on risk?

So how does this relate to Mr. Bernanke, et al? If we limit the compensation for lending to higher risk borrowers, you will simply see loan professionals walk away from that business altogether. The work it takes to get a sub-prime borrower approved is FAR more than the work to get an "A" paper borrower approved, historically speaking. If I were to spend three months working a difficult file, I want to be paid for it. Borrowers understand this as does anyone who charges for their labors.

We need to get back to good underwriting, appropriate pricing, and compensation that make sense. I am not arguing that abuses were committed. I am arguing that we cannot eliminate, by regulation, policies, or compensation structures, the much-needed area of lending called sub-prime. To limit compensation to that of "A" paper compensation is just another nail in the coffin.

Joseph Chatham