When I studied political science back in college, I was surprised to find much of our focus was on the past.
For all practical purposes, the poli-sci most liberal arts majors were forced to take back in the '80s was just another history class. As I gained some experience, I began to understand that looking back in time is one of the key roles of government, not just because "history repeats itself," but because that's how you find out who to blame.
Making it clear to constituents who is to blame for the current state of affairs is the other primary role of politics. I won't go into the secondary roles of the job in this column.
If you have been watching the world economies work to recover from the financial crash that led us into this century, you'll know that I'm right and most politicians are engaged in looking back and pointing fingers.
Turn on any cable news program and if there is a "working" politician on the screen, he or she will comment on the news with something such as:
"This is (insert 'great' if your party is apparently responsible, 'horrible' otherwise) news and just goes to show how hard our party has had to work to bring the country back from the brink of complete annihilation in the wake of the (insert most recent acting president from the other party) administration."
Any comment a politician will make regarding current events will have embedded within it the admonition that the other party was completely and totally responsible.
It's as if they think we only vote against politicians and not for them. I may do that, but I'm sure I'm one of the exceptions to the rule.
Anyway, I think most politicians secretly wish they had a foolproof way to know in an instant whom they can blame for any problem that might spring up during their term in office. Since there are no reliable manufacturers of crystal balls anymore, most politicians resort to rhetoric to sway constituents.
But that may not be true in the U.S. financial services industry in the future.
The government is in process of having assembled — piece by bureaucratic piece — the ultimate electronic whistleblower. And the feds are making our industry put it together for them.
The government’s new focus on whistleblowers
After it became apparent the American taxpayer was blaming the entire government, both Republicans and Democrats alike, for the financial crisis, the new administration created the Financial Crisis Inquiry Commission to give voters a more appropriate object for their hatred. They found it in our industry.
The FCIC uncovered lenders making loans they shouldn’t have, borrowers accepting loans based on inaccurate information, investment banks slicing up risk in arcane ways and then using high credit ratings purchased from the ratings agencies to sell them off to investors.
Watching from the wings were a bunch of impotent bureaucrats who failed completely in their mandate to provide oversight.
Despite the Friends of Angelo program, no politicians were found culpable, but then the commission was a bipartisan enterprise and there aren't enough independents to go around, I guess.
Last January, when Phil Angelides, FCIC chairman and former California treasurer, gave the commission's final report, he told everyone what everyone already knew (except perhaps for the still stunned taxpayer): "This financial crisis was avoidable."
The problem wasn't that people didn't know what was going on, or that it was wrong, he said, it was that no one stepped up to say anything about it.
According to the report: "Countrywide executives recognized that many of the loans they were originating could result in 'catastrophic consequences.' Less than a year later, they noted that certain high-risk loans they were making could result not only in foreclosures but also in 'financial and reputational catastrophe' for the firm. But they did not stop."
They didn't stop. And they didn't speak up. And, for some reason, that surprised people.
What incentive did a loan officer making $400,000 a year have to tell the world that if he only started making loans to people who could repay them he would cut his salary by 75%? Exactly none. There was even less impetus for managers above him, who were making much more. But that was then.
In May, the Securities and Exchange Commission finished its work on the whistleblower rules mandated by Dodd-Frank.
Using a tactic that has worked well for law enforcers for hundreds of years, the federal government promised to pay a bounty for information leading to the indictment of a wrongdoer.
Of course, this is the feds we're talking about, so they made it clear they wouldn't pay unless it was worth at least $1 million to them. If the whistleblower alerts his own company first, he can earn an even higher bonus, even if the company ends up turning itself in.
The new provisions are already bearing fruit. The Labor Department's Occupational Safety and Health Administration, or OSHA — which is in charge of administering whistleblower protections — reported in September that it has seen whistleblower charges jump to 2,339 for Jan. 1 through Sept. 14 of this year, up from 2,319 in 2010 and 2,158 in 2009.
But upon closer inspection, not much good has come out of these cases yet.
Patrick Egan, formerly with TradingScreen, apparently did the right thing when he blew the whistle on CEO Philippe Buhannic. But failure to comply with the rules along with the fact the company isn’t publicly traded and that the problems wouldn't net the SEC $1 million, resulted in Egan losing everything. Buhannic's LinkedIn profile says he's still the chief executive at TradingScreen.
Closer to home, OSHA recently ruled Bank of America must rehire an employee who blew the whistle while still at Countrywide and was fired shortly after the firm was acquired by BofA. OSHA ordered the unnamed (in the press at least) employee rehired and paid back pay of $930,000. That's going to be a dream job, I bet.
Even with big bounties, getting insiders to blow the whistle signaling the end of the game for their own careers is tough.
And now, with more law firms starting up whistleblower practices, it's only going to get more expensive for the government to prosecute these cases. There has to be a better way to get the information the government wants.
Actually, there is a way and the government already knows about it.
The rise of the mechanical whistleblowers
I'm not the only industry observer who has blamed much of the financial crisis on the technology our industry deployed to process loans more quickly.
Sure, Wall Street firms were selling crap to unwary (or just stupid) investors with the blessings of the ratings agencies. Sure, loan officers were making more promises than military recruiting officers and borrowers were doing or saying whatever they had to in order to get to the closing table.
But if we'd still been working on paper, we could never have originated so many crappy loans.
Automated underwriting, loan origination systems with straight-through, all-electronic processing, AMC software to move the valuation numbers, and electronic partner networks that kept deals moving from player to player all the way down the pipeline made it possible for the industry to quickly move bad loans from the cradle to the grave.
We also had great software for quality control and fraud risk mitigation, but those tools weren't embraced as completely, for some reason.
It wasn't until long after the crash that the federal government started paying any attention to industry technology. I suspect, but cannot prove, that it probably started just after Fannie Mae and Freddie Mac went into conservatorship.
The GSEs had been working for years to get lenders to start sending more information electronically. They educated, cajoled, threatened, and did just about everything else they could think of to get lenders to move toward the all-electronic mortgage, or eMortgage as it has been called.
The only thing they didn't do was the one thing that would have worked: give lenders some financial incentive to deliver their files electronically.
Of course, if that had happened, it would have been embarrassingly easy to write a program to scrub the data coming from lenders against any of a number of quality assurance and/or quality control protocols and flag files.
Anyway, once the government took over and started poking around, it quickly became apparent the only reason the financial services industry wasn’t providing data to its largest investors was because there was no rule saying it had to. That rule was quickly supplied and applied first to the collateral valuation process.
As of Sept. 1, any new appraisal report pertaining to a loan ultimately sold to Fannie Mae or Freddie Mac must be completed in compliance with the new Uniform Appraisal Dataset. According to Fannie Mae, the UAD defines all fields required for an appraisal submission for specific appraisal forms and standardizes definitions and responses for a key subset of fields.
Fannie says the UAD program was designed to improve the quality and consistency of appraisal data on loans delivered to Fannie Mae and Freddie Mac, at the direction of the Federal Housing Finance Agency, which the Inspector General has said lacks the resources to oversee the GSEs. On the surface, this does make some sense.
After all, the loans that got most firms in trouble weren't based on the borrower's credit score, but rather on the value of the collateral.
The appraisal report provided the only numbers that could kill most deals. Add that to the fact the average age of a professional fee appraiser is about 60 and most of them are still working their jobs the same way they did back in the 1960s and you come to the conclusion that this wasn't a bad move.
With all of the appraisal data coming in to the government in the same electronic format, bad appraisers, AMCs and the lenders that work with them will be easy to spot. The problem for our industry is that this is the beginning, and it will get worse from here.
The UAD is just one component of the Uniform Mortgage Data Program, which includes the UAD, the Uniform Collateral Data Portal that will reportedly be delivered by Veros, and the Uniform Loan Delivery Dataset based on the MISMO 3.0 standard.
Currently, the appraisal reports must comply with the standards of the UAD, but by Dec. 1, the reports will also have to be delivered electronically. By March, lenders will be required to provide both the appraisal and the loan delivery data electronically in the format required by the ULDD.
By next spring, lenders will be sending Fannie or Freddie about 300 data points related to each loan, along with the electronic appraisal, for each loan they sell. Eventually, the government wants to see 600 data points on each deal the GSEs buy.
Today, these new standards are coming to bear only on conventional loans that are sold directly to the federal government, but anyone who believes the situation won't expand to other types of loans and investors should be polishing up their resume.
With the Consumer Financial Protection Bureau ramping up to speed and with the possibility of getting all of that loan data for every loan in America, believing it won't happen would be like believing the mob when they say they only want to use their shiny new casinos for slot machines instead of table games.
Eventually, everything in the mortgage business will be on the table.