The Responsibility of the Wholesaler

Before we can discuss the responsibility of the Wholesaler in this mortgage market, we first need to define what the wholesaler does. We know that once a mortgage is originated and closed, it will eventually wind up in the secondary market. It will become part of the portfolios of the GSEs or a MBS on Wall Street. The mortgage will move from the originating entity though an intermediate entity until it finally makes its way to the investor. An entity whose primary job is that of an intermediary, is called the wholesaler.

The wholesaler doesn’t deal with the consumer; the broker or banker does that. The wholesaler bundles mortgages and sells them to either a GSE or Wall Street firm who will then proceed with the securitization. The wholesaler is obligated to pool mortgages to meet the specific standards of the company. They pass on these same specifications to the originating entities they work with.

Wholesalers will buy closed mortgages from bankers or they will underwriter mortgages for brokers. A banker will use a wholesaler for an expanded product line. They may not originate enough of a particular mortgage type to warrant selling to them directly, so they will utilize a wholesaler instead. Or they may use a wholesaler during times of heavy volume of originations. A broker needs a wholesaler to place his mortgages since he doesn’t have direct access to the GSEs or Wall Street.

The long-term success of a wholesaler is dependant on how accurate they are in writing their underwriting specifications and how diligently their staff follows their investors’ guidelines. If the investor’s requirements are interpreted liberally, the quality of the pools of mortgages will suffer. If their staff isn’t kept informed of changing standards, they can easily be approving mortgages that cannot be pooled. If the staff is overworked or additional manpower is brought in that isn’t properly qualified, the wholesaler’s ability to function suffers.

While the mortgage market was rapidly expanding and Wall Street grew more hungry for mortgages they could securitize, the wholesalers got caught up in the momentum. To meet the record setting volume of business, additional personnel needed to be hired and current employees were working longer hours. This caused the quality of the mortgages to suffer. As commonly happens in industry, the production volume became more important than the quality of the finished product. As the quality of mortgages quickly began to fall, the wholesalers found themselves holding mortgages they couldn't sell. This forced many out of business.

These issues can easily be addressed. Internal communications improve, new employees gain experience and the workload for all employees becomes more manageable. The increased workload was responsible for only a portion of the problems we see.

If the wholesalers were doing their job properly, the problems we’re realizing today would be much less severe. We keep hearing that the originators placed people into mortgages they couldn’t afford. Wall Street was buying mortgages at such a rapid rate, they didn’t care what they were buying. Originators wanted their commissions by hook or by crook and Wall Street needed product to securitize. I have no argument with these statements. I only question the magnitude of the impact of bad originators and greed on the Street.

Wall Street needed mortgages; there is no question about it. They wrote underwriting standards that were generous; again, no argument. The wholesalers were in the position to maintain a narrow interpretation of those standards and should have. The perfect example of this is the "stated income" mortgage, which has now been dubbed the “liar’s loan”. When this product was originally designed, it was meant for business owners, individuals whose financials are not consistent from year to year, thereby making it difficult for them to qualify for a loan under traditional underwriting standards. In an effort to minimize the risk associated with mortgages of this type, a higher down payment was required. This higher down payment not only put more of the borrower’s personal funds ito the transaction, it was also a way to confirm that the borrower has proven fiscal responsibility by saving up the required assets.

In their drive to increase volume, Wall Street began to work with lower down payment requirements and began accepting salaried employees under a stated income program. Here’s where the wholesaler’s responsibility is. An applicant who is putting a small down payment on his purchase and is working in a fast food restaurant probably isn’t making the $100,000 a year that is "stated" on the application. The wholesaler needed to be responsible and use good judgment by not approving this applicant. The mortgage may have technically met the standards but the wholesaler wasn’t doing his job. The standard wasn’t written for mortgages to be granted to individuals that have no ability to make the payments.

Now let’s look at it from the originator’s position. Let’s assume that the originator didn’t care about the applicant and was only interested in making his commission on the mortgage. The application is taken and then submitted to the wholesaler. If the wholesaler were doing his job responsibly, the application would be declined.

Bottom line is that wholesalers were not doing their jobs. They were solely concerned with production figures. Refering back to my example, a wholesaler would have been afraid to decline this loan for two reasons. First, the fear that the wholesaler down the block would close on it anyway. Second, fear that the originator would no longer submit mortgages to them. This logic is the reason so many wholesalers are now out of business.