rocket mortgage scares me, but not for the reasons it scares others

Quicken Loans has managed to cause quite a stir with their Super Bowl ad marketing their new app, the Rocket Mortgage.

The commercial touts the reasons why homeownership advocates support increased homeownership. The justification that housing leads to a stronger economy squares with both conservative justifications for a market economy and progressive efforts to increase homeownership for poor and racial minority households. One can argue about the wisdom of making this reasoning explicit as a marketing strategy; but, the ad makes explicit what lots of people already think (part of me wonders if the ad wasn’t aimed at consumers as much as preempting policymakers who might want to regulate interstate products like Rocket Mortgage).

Unsurprisingly, critics pounced on the idea that a smartphone app foretells the return of the housing crisis. I think that they might be right, but for the wrong reasons.

The Rocket Mortgage app draws data from a number of databases to let potential borrowers know how much they could likely get in the form of a mortgage loan. Because underwriting must be at least somewhat dependent on the underlying collateral — the house the borrower is purchasing — the app seems more like bank pre-approval than a guarantee of a loan. And just as pre-approval from a bank does not lock consumers into a loan from that bank, most people end up using the bank from which they get pre-approval. Rocket Mortgage seems to want to do the same. But Quicken Loans realized that most people do not shop around after getting pre-approval; they just apply with the institution who pre-approved them. (If I am wrong about actually granting a mortgage not based on underwriting the underlying collateral, then this is a huge problem.)

The fact that the app is not, itself, a mortgage application undermines many of the criticisms that came out of the commercial, like Dave Weigel’s hilarious (but incorrect) tweet below. While it’s true that lax underwriting standards helped cause the financial crisis, if the Rocket Mortgage app does not actually provide a mortgage then the critique of the app as leading to lax underwriting standards falls short.

That does not mean, however, that the Rocket Mortgage does not cause problems for the economy. The problem derives from the fact Quicken loans wants to increase the market share of people using the actual Rocket Mortgage (not the app). The app provides nothing but a clever (and expensive) marketing device to drive more people to their mortgage product.

At some point, having so many mortgages housed with a single company will be dangerous unless one of two things happens: Quicken Loans holds much more capital in reserve or they find a secondary market to which to sell the mortgages. Capital reserves will limit Quicken’s ability to capture a larger share of the mortgage market. They could bundle their mortgages into residential mortgage backed securities (see, The Big Short). The market for residential mortgage backed securities has shrunk massively, but with enough volume it’s possible that the Rocket Mortgage could create a market to provide an incentive for more players to re-enter that market (let’s hope this time the CFTC regulates them).

If they go the route of not holding the mortgages on their own balance sheet, the re-selling is where the real risk to the financial market comes. Quicken Loans becomes a pass-through; their profit will come on the flow of mortgages that they process, not on the profit the loans produce. They have first-mover advantage and will likely capture some more of the market share; but they won’t be in the position of being the only company to offer these mortgages for long. More companies will attempt to operate in the fast pre-approval market and each of them will be racing to gain market share. They, too, will want to pass the loans through their books and then sell the loans to other firms.

If this comes to pass (which it might not because I am not a housing economist or regulator), the business model for these firms requires selling a constant flow of mortgages. This will create incentives for the underwriting standards to decline because there will not, all of the sudden, be a surge of borrowers who are prime risks. As Bethany McLean and Joe Nocera write in All the Devils Are Here, this incentive is what turned Countrywide from a relatively well-respected lender into the firm that — more than any other — contributed to the mortgage meltdown.

Let’s hope both the market and financial regulators are more up to the task to regulating the market this time around.

2 thoughts on “rocket mortgage scares me, but not for the reasons it scares others”

  1. I didn’t see the commercial and don’t know about Rocket Mortgage. It is Intuit’s mortgage firm? Or is it just a mortgage broker? As people who have bought a home know, pre-approval lets a realtor and a seller know that your offer is “serious” and not going to be tied up in financing questions. Once you are pre-approved for a given amount, the agent only shows you homes you can actually afford. So there is nothing in pre-approval itself that undermines credit standards. To the contrary. It is also true that people tend to get pre-approved through the institution they end up borrowing from; that is rather the point, to speed the time between making an offer and getting a house. In a reputable transaction, there is also an appraisal of the home itself to be sure it is credit-worthy.

    As you say, the danger is in a system where people make money on the transactions and have no interest in whether the loan ever gets repaid. It is still the case that most mortgages are resold and thus, as I understand it, still the case that there is a risk that the secondary market could undermine the system. The only safeguard is if the secondary market does not purchase “bad” mortgages with poor credit-worthiness, which presumably only happens if failed mortgages actually cost people money in the secondary market. Do they?

    I had the misfortune to have a Countrywide mortgage years before the meltdown. (My original lender had sold it to them.) They were crooks then, in that they were holding large escrows, were very slow to release payments from the escrow to tax and insurance (sometimes costing me money due to this slow payment), and paid no interest. There was a class action lawsuit that led me to getting several hundred dollars from them. A mortgage sold to Bank of America had similar nightmares about loan servicing, although by then we qualified to manage our own tax and insurance payments.

    The loan officer at my credit union who handled our most recent mortgage says that the single most frequently asked questions are: (1) will you hold this mortgage or sell it? and (2) who will service the mortgage?

    First-time buyers don’t know any of this stuff.

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    1. OW– Thank you for your thoughtful reply. Quicken Loans was formerly Rock Financial, which which was founded by Cleveland Cavaliers owner and self-appointed savior of Detroit, Dan Gilbert. Intuit bought Rock Financial and then re-branded that portion of the company Quicken Loans, which they then sold back to Gilbert and other investors. Those investors hold the company privately.

      On pre-approval, borrowers should still shop around after getting pre-approval. Speed helps most people in the real estate market (especially agents) but *not* the borrower — better loan conditions serve their interests more. Rules implemented in October as part of Dodd-Frank should help borrowers to shop around. But, as none other than the chief executive of Quicken Loans, Bill Emerson, says:

      “I don’t think consumers are changing the way they shop simply because” they have a new tool to do so, Emerson said in an interview. The process of buying and financing a home is so complicated and emotional, he said, that many people find it easier to simply locate a reputable lender quoting a good interest rate and go with that lender rather than making multiple applications and comparing estimates.

      Many mortgages are still packaged into residential mortgage backed securities, though my understanding is that most are now sold to Fannie Mae or Freddie Mac. The future of Fannie and Freddie is, of course, up in the air. One difference now is that secondary buyers care more about the mortgages that make up the securities even if mortgage sellers (like Quicken Loans) still want volume. That was the check that was supposed to correct the market. As long as investors remain wary of residential mortgage-backed securities, that check will remain in place. But, our nation has a long history of massive land speculation that makes that check seems pretty fragile.

      Sorry to hear about your experience with Countrywide — they do seem like a terrible corporation. You should really read the chapters of McLean and Nocera’s book on Countrywide, it’s a compelling read.

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