In 1995 Joe Garrett penned a gloomy commentary for American Banker in which he argued that for many mortgage companies, the answer to declining profits was to get out of the business.

The previous year, rising interest rates had killed off the early-'90s refinancing boom, prompting massive layoffs and a vicious price war. Mr. Garrett sold American Liberty Bank, the Oakland, Calif., thrift he had headed.

This year history seems to be repeating itself. Rising rates have ended the biggest lending boom to date, some companies have laid off employees, and lenders have recently reported intense price competition. But Mr. Garrett, now a consultant to Xpede, an Oakland Internet company, is more optimistic than he was four years ago about the prospects for mortgage bankers.

In a recent interview he spoke of how to avoid cutthroat pricing and told why he thinks lenders should be wary of Internet mortgage brokers.

How is the mortgage business today different from the way it was in previous rising-interest-rate environments?

GARRETT: In the wake of the refinance booms of 1986 and 1993 you had more players, so there were more companies that could go under and exit the industry. It's been narrowed down.

Back in 1994 it was an appropriate response for a board of directors to say, "You know, maybe we just need to exit this business entirely. We're a weak sister, we can't go up against the big guys like Countrywide and Norwest. We're fooling ourselves if we think we're going to be able to outlast them in price competition."

Today the people who are left, generally speaking, are the stronger ones who survived the 1994 crunch, and I don't think the appropriate answer necessarily is, as it was a few years back, just to get out of the business.

What should lenders do in a rising-rate environment like this one?

GARRETT: They've got to stop fighting the price war. When somebody is trying to get business from customers who have nearly perfect knowledge, the only way you win is by losing.

And it's come a long way, even since 1993 or 1994, in terms of the Internet. It's not just "I've got 20 rate sheets in front of me, I'll scan them to see who has the best price."

Somebody can go to any one of dozens of (on-line) services. So if you're a broker or a correspondent, you're going to sell to whoever has the highest price.

If you're a buyer of loans, do you really want to only get loans when you have the price that is best for the customer and therefore worst for you?

What's the alternative?

GARRETT: The point I've been trying to make to management these days is that what they have to do now is really develop and grow and protect their brand.

I've seen too many of these companies decide, "Let's go to LendingTree or, let's be one of the 25 lenders on E-Loan." You're only exacerbating the problem. You're putting yourselves out there in an auction situation, in a zero-sum game. The mortgage broker's gain is your loss.

Any lender that goes on any of those services, in my mind, is giving up his own brand identity. If (a consumer) gets a loan through E-Loan, whose customer is that really, when it comes time to cross-sell him other products, other services, or maybe just a refinance?

Next time around, is he going to say, "Gee, I got a loan at BofA"? Or is he going to say, "I got that loan by shopping on E-Loan"?

But surely the lender that services the loan maintains the relationship with the customer?

GARRETT: For some number of people, they'll just say, "Yup, here's the '800' number on my coupon." But for this whole new generation of people who do their shopping on-line, some percentage of them are going to say, "I got a good loan from Norwest, not because I found Norwest but because I went on-line to E-Loan. Now that rates have come down, I might come back to E- Loan. I got a great loan by going to E-Loan the last time."

Banks have not yet been widely successful in cross-selling and holding on to their customers.

The more they have interacted directly with the customer from beginning to end, the more revenues they get out of that customer, and the less attrition.

But when the (lender) gets a customer from an electronic posting service, (the lender is) just renting the customer until the next time he needs a financial service.

So what can a lender do to improve its brand?

GARRETT: Be proactive. Don't wait for (the customer) to contact you when rates come down. Have a system set up to e-mail him.

Why couldn't a bank program its computers to do this:

"This is Joe Garrett. We've had him for three years. Perfect pay history.

"We made the loan at 73% (loan-to-value). Now let's go into our appraisal data bases, get a sense of what's happened in his ZIP code. There's been 10% appreciation, so what was what was 73% may now be 68%.

"Now let's get his Fico score. ? It's a high score.

"Now we know it's a lower LTV, he's got a perfect payment history ... maybe he has his paycheck automatically deposited into his bank account, so we know his income. We can figure out his qualifying ratios."

Why doesn't the lender e-mail this guy and say, "Guess what? You're approved. We'd like to invite you to come down to our local branch and lower your rate."

Using data mining, you can identify those people who can be refinanced.

The banks that figure that out will be able to deliver such an amazing level of service to that borrower that the borrower won't care about shopping around for price.

Say you've got an 8% mortgage and your bank calls up and says, "We'd like to lower you to 6.5%. You're approved-no ifs, ands, or buts. We've got the documents, come in tomorrow."

Wouldn't you prefer that to someone offering maybe 6.375% or 6.25%, but they ask for your pay stubs, tax returns, your bank statement, and a letter explaining why you missed that Visa payment two years ago?

In 1994 there was almost no alternative other than to compete on price and pray you can outlast everyone else.

Now there's this wonderful alternative. Some are going to seize it, and the ones who do will be the winners.

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