Keeping Banks out of the Real Estate Business

Consumers and real estate agents were handed a victory on March 11, when President Obama signed into law the Community Choice in Real Estate Act that permanently prohibits banks from entering the real estate brokerage and management businesses.
 
On just scores of levels, this decision made sense.
 
Real estate firms like mine should not be able to control all aspects of the transaction. If banks had been allowed to engage in real estate brokerage, it would have created anti-competitive and anti-consumer concentrations of power within the financial services sector, which would have ultimately increased costs for homebuyers.
 
The big banks have already made a mess of our economy by pushing Congress for the reversal of Depression-era laws which kept them out of the securities business and from selling insurance.
 
The repeal a decade ago of the Glass-Steagall Act, which included banking reforms designed to control speculation, set the bank holding companies loose in the economy. Its repeal allowed for rampant conflicts of interest characterized by the granting of credit – lending – and the use of credit – investing – by the same banks, which led to abuses that had originally produced the Act back in 1933.
 

Suddenly, some homeowners in Northern Virginia who had their mortgages tied to their brokerage accounts at the same bank-brokerage were losing their homes when the Nasdaq plunged 70 percent in 2000.  Not a good thing.
 
The big money-center banks like Citibank possess enormous financial power, by virtue of their control of other people’s money.  President Obama's decision to limit the extent to which they could ostensibly control all aspects of our financial lives -- from banking to real estate --should be limited to ensure the soundness and competition in the market for funds, whether loans or real estate investments.
 
As we have now seen, it is not only investing in stocks that can be risky, leading to enormous losses and threatening the integrity of bank deposits.  Allowing for banks to also control real estate companies might cause the same kind of uber financial mess we're in now.
 
The government insures our bank deposits and could be required to pay huge sums if financial institutions were to melt down as the result of another real estate collapse. A case in point is the 1991 crash of real estate investment trusts which were sponsored by bank holding companies back in the '70s and '80s.
 
Depository institutions are supposed to be managed to limit risk, and their managers were not conditioned to operate prudently in the more speculative securities businesses. Nor should they be allowed to operate in the real estate business.
 

The repeal of Glass-Steagall also enabled commercial lenders like Citigroup -- which back then was the largest U.S. bank by assets -- to underwrite and trade exotic instruments like mortgage-backed securities and collateralized debt obligations, and to establish so-called structured investment vehicles, or SIVs, that bought those securities.
 
The year before the 1999 repeal, sub-prime loans were just 5 percent of all mortgage lending. But by last fall, when the credit crisis peaked, they were approaching 30 percent.  Thus, the repeal contributed to the Global financial crisis of 2008–2009, which has now wiped out $11 trillion in household debt and has forced millions of Americans from their homes.
 
For the past decade, the big bank holding companies operated in a deregulated environment in which the lines between loans, securities and deposits were not drawn clearly enough. They lost market share to securities firms that were clearly not so strictly regulated, and to foreign financial institutions that operated without much restriction from the Act.
 
Imagine if the same catastrophic scenario were repeated if say, Citigroup were allowed to hold in their business portfolios good companies like Re/Max, Coldwell Banker or Long & Foster. Or if Prudential Carruthers Realtors as a separate entity was allowed to be merged by law into Prudential Securities. Just imagine.
 
Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.
 
Controlled Business Arrangements are bad enough for our industry.  In these, a real estate brokerage provides related services through subsidiary companies that operate within the brokerage office. The arrangement allows a broker to provide financing, title and hazard insurance, and other ancillary services without violating the Real Estate Settlement Procedures Act, or RESPA.
 
Oddly, RESPA prohibits Betty Broker from receiving referral fees from mortgage companies, but through a controlled business arrangement still allows her to set up an insurance brokerage company, title company and mortgage banking company within Betty's real estate brokerage, mainly to serve the needs of her real estate customers.
 
Luckily, Virginia's Department of Licensing has been helping the Office of the Insurance Commissioner scrutinize the relationship between real estate broker/owners and their affiliated title insurance companies.  This increased scrutiny is surely welcome for real estate agents and brokers like me, who have no affiliated arrangements and have nothing to fear.
 
Reputable lenders and Realtors like me select third party vendors because their rates are lower, their services are better and there are checks and balances. If they do a bad job, you then just replace them. I tell my customers that a red flag is if a real estate agent or mortgage lender strongly insists on using a specific third party vendor.
 
You should always ask the question: “Can you please tell me exactly what you are receiving in exchange for me selecting this vendor?”  If the answer is “Nothing,” then the answer is correct.
 
Not only does strong-arming raise red flags when it comes to RESPA violations, it’s also a red flag for possible mortgage fraud.
 
Last week I heard that a mortgage lender doing a re-fi in Alexandria was strong-arming an appraiser to make the appraisal come in at around $1.6 million -- despite the fact that larger homes in the neighborhood were not selling at $1 million. The reputable appraiser, to his credit, refused.  Unfortunately, just a few years ago the appraiser would have bent to the lender's request.
 
It would be terrific for everyone involved if we returned to the days where Realtors and lenders selected appraisers and title insurance companies strictly because they offer great rates, awesome service and only a cheap pen or notepad in return for the referral.
 
Imagine how much worse the crisis in the financial sector and our overall economy would be if banks had been permitted to enter into commercial activities such as real estate. Congress should close any other loopholes and pass laws that maintain the separation of banking and real estate and protect the economy from any more risk.
 
Furthermore, I believe there should be a break-up of large banks and financial firms that compromises this process even further.
 
Real estate is a commercial enterprise. Banking is financial in nature. Real estate is commercial. Throughout the years Congress has defended its Depression-era policy that the two should not be mixed.

Banks keep trying to change the definition of real estate. Despite Congressional policy, regulators are slowly blurring the line separating banking and commerce. A case in point is the Office of the Comptroller of the Currency's expansion of the authority of national banks to engage in real estate development and ownership, despite national policy against mixing banking and commerce.
 
Recently big corporations like Home Depot began trying to own credit card-issuing banks, further exploiting the loophole. Again, a bad idea. Congress should close this loophole, preventing the ownership of Industrial Loan Companies, or ILCs, by retailers.
 
Why should we care?
 
Banks should be impartial providers of credit, not powerful, concentrated conglomerates that grow bigger to the detriment of small businesses and consumers. The success of real estate agents like me is determined by how well I can meet the needs of my customers.
 
Give banks the power and they will direct clients to use their services. These practices are wrong and cause the consumer to pay more at best and at worst make fraud easier because there are no checks and balances.