A variety of problems such as inaccurately stated incomes, vacation or investment homes listed as primary residences, nonexistent additional incomes, faulty appraisals, lending to borrowers clearly unable to repay, and unsupported speculation created the kinds of bad loans that worked their way through the housing finance system and created both the price bubble and its collapse.
A variety of complex ideas have been proposed to prevent a recurrence. Here's another one, perhaps not so complex: Pay mortgage originators only for good loans, not bad ones.
One way to do that is to pay residential mortgage originators only after the loan has matured to the point where default based on misrepresentations by the originator, the borrower, or some other third party is unlikely. Use five years of timely payments as the litmus test for a good loan.
Though that won't solve all of the problems associated with the housing bubble, it should encourage the originator to make good loans, since it would not be paid for the bad ones.
It should lead to a decline in borrower or originator misrepresentations, an increase in the percentage of borrowers who make timely payments and remain in their homes, and a ramping up of trust and confidence in the U.S. residential mortgage market by the secondary market.
To enable independent originators or those just starting in the business to make a living while creating a book of good loans, some means of providing advances for the first five years of this program or for five years after an originator starts up would have to be created. After that, the payments resulting from mature loans should put originators financially in the same position in which they are now, but the loans they originate will be better.
It need not be too complicated. For example, the start-up problem could be addressed by letting brokers borrow against their expected income over the five years; perhaps a market would develop. Or the payment setup for originators could be loaded with payments after the first year — starting with, say, 5% of the amount due and then increasing the rate of payment through the years (10%, then 15%, then 20%) until 50% of the compensation would be paid after the fifth year. Or lenders could advance some small salary to start-up originators, as could large brokerage companies that employed many brokers. That is not uncommon in the insurance industry.
If a default occurred, compensation for the borrower would vest only for the period from closing to default. Lawsuits could always be brought to reclaim payments made for cases in which the default was caused by originator misrepresentation.
The responsibility for compensating the originator would travel with the servicing rights. Good loans that were refinanced or modified would carry with them the obligation to pay the compensation due to the originator as if the refinancing or modification had not occurred.
If the originator works on the borrower's behalf, the borrower would include in the monthly payments an amount appropriate to let the lender pay the broker on each anniversary date.
This compensation plan would encourage originators to ensure that the borrower's income is verified, that the property is denominated correctly as a primary residence or something else, that appraisals are accurate, and that the borrower truly can afford to repay the loan.
It would be in their interest to see that the loan is repaid, or, to put it another way, that loans they know are not going to be repaid are not made.
Under this system, the originator is taking on some of the "ownership" of the loan, since an adverse life event could prevent it from getting full payment. Under the present system, the originator is free of that risk. One would assume that pricing would adjust for that, and independent brokerage houses would have to have sufficient net worth to absorb those events.
This does not address some of the originator issues such as yield-spread premiums, disclosures, or licensing and registration, but solutions to those issues could be accommodated within this compensation system.