RESPA: The Anti-kickback Law that Encourages Kickbacks
In the beginning of June, 2013, we were quoted in a nationally syndicated Washington Post story on kickbacks (click here). Follows is our more indepth analysis of this issue that could be serious enough to drive us into the next foreclosure crisis.
“Kickbacks harm consumers by hampering fair market competition and by unnecessarily increasing the costs of getting a mortgage,” said Consumer Financial Protection Bureau (CFPB) Director Richard Cordray. “The CFPB will continue to take action against schemes designed to let service providers profit through unscrupulous and illegal business practices.” These were comments made after the recent and highly publicized $118,000 enforcement action against Paul Taylor Homes, a Texas homebuilder.
Unfortunately, kickbacks pervade residential real estate and the latest and highly publicized case against Paul Taylor Homes represents only a tiny fraction of the problem that exists nationwide. Rather than sounding off a warning to would be kickback payers, this enforcement action sends an approval message loud and clear to an industry that is already swarming with profits from illegal kickbacks. It also demonstrates how the CFPB’s hands are tied.
Because of RESPA’s 1 year statute of limitation, the CFPB was only able to prosecute Mr. Taylor on 32 transactions going back to 2010 (one of the slowest construction years in decades). However, Mr. Taylor’s kickback scheme had been in existence since 1999 and had seen some of the most profitable years ever in real estate. Paul Taylor’s website brags of annual sales in excess of $90,000,000 back in 2006. Mr. Taylor likely made tens of millions of dollars in profits from his alleged kickback scheme. To would be violators, a $118,000 fine serves as encouragement to violate the law.
Is There a Difference Between Illegal Kickbacks and Controlled Business?
Builders have been heavy handed in “persuading” buyers to use their controlled business arrangements (CBA’s) like in-house mortgage and title services or the fake versions of those firms called shams. As a result, builders have a capture rate that often exceeds 80%. For about a decade (possibly still going on today), they were offering free $15,000 plus upgrades conditioned upon the consumer using their builders’ in-house mortgage and title services. Since title and mortgage and title fees cost far less than the fake incentives, in essence the builders were punishing consumers and charging them more for the house if they selected their own mortgage and title services.
The industry spin was endless. Builders would proclaim that there was increased efficiency in using their in-house services and then cite the speed at which their deals closed. Legislators fell for the spin and ignored the fact that mortgage and title firms are gatekeepers to the transaction and that speed is not how you measure the value of mortgage and title services. Rather, accuracy at spotting and calling attention to problems that could later plague consumers and lenders is a better measure – a commission and profit killing metric that Realtors and builders detested. Also ignored were the high fees consumers were forced to pay in order to realize the “free” upgrades.
Does it even matter whether the builder’s mortgage and title company is a Taylor Homes sham or a “legalized” controlled business arrangement? Isn’t it true that both hamper fair market competition and increases the costs of getting a mortgage? Isn’t it true that both give the builder undue influence over these safeguard services?
If Mr. Taylor had set up a legal affiliated mortgage and title company he would still have been able to steer his customers to those services, eliminate competition, cause an unsafe transaction environment, and he would have been successful in over-charging for those services. He actually would have had more control over the decision making process of a CBA that he owned, than he actually did in his alleged sham.
If the goal is to have open competition and safer transactions, then it is time to separate safeguard services from those success fee motivated practitioners who only get paid if the transaction closes. If the goal is to avoid another mortgage foreclosure crisis, then it is time that legislators stepped up and cut the cord between the real brokerage and builder industries and the industries that are designed to stop bad transactions from occurring. Consumers should be able to rely upon the fact that the money they are paying these safeguard services is not just an assurance fee to ensure that the builder can close his lien ridden house quickly and charge more for that “service.”
In our opinion there is little to distinguish between illegal kickback schemes and legalized controlled business arrangements. CBA’s allow builders and brokerage firms to actually own these safeguard services and steer their customers and clients into their over-priced and fixed outcome “gatekeeper” services.
Where’s the Data?
We believe that CBA’s and kickback schemes together comprise far more transactions than the industry would admit. A mere search of their websites or marketing materials typically gleans little information about any affiliations. In addition, these arrangements are required to make few and inadequate disclosures to consumers providing them with an untimely notice that serves little purpose. We believe that vulnerable consumers are the most susceptible to being steered into a CBA or a sham, but have even seen the most savvy consumers successfully misled. We believe that CBA’s are responsible for mortgage defaults, reduced efficiencies, higher fees, risk shifting to consumers, and have reaped havoc on competition.
The industry argues that CBA’s improve efficiencies and prices and they quote from expensive self-produced studies littered with data collection flaws collected from their own members. However, their arguments lack logic. Economic theories are unanimous in stating that removing competition causes prices to go up and service to suffer, not the inverse. Why have these industry studies not been challenged?
There are no studies on the role controlled business had in the mortgage meltdown, yet the conflicts of interest and its potentials are obvious. There are no meaningful studies on the capture rate of CBA’s (the industry has an interest in understating those figures). There are no studies on the impact CBA’s have had on the prices of title and mortgage nor on the harm they have caused to competition. In addition, there are no studies on the other bad practices that exist in residential real estate, like dual agency, open houses, pocket listings and bribes that leave consumers without representation on an investment decision that when made poorly has already proven to result in severe sacrifices to individuals, families and communities. However, there are a lot of industry sponsored propaganda designed to spin all these bad things as something that they are not.
The race to the next real estate bubble seems to be starting and consumers are subjected to more atrocious betrayals and self-serving “advice” that affect their investment decisions than ever before. Do we really believe it will help consumers make wiser investment decisions if their highly paid expert is neutered in an agency relationship that suddenly renders the agent incapable of negotiating on behalf of their own client? Dual agency, pocket listings, anti-syndication, price fixing and controlled business are just a few of the highly complex business practices that seem geared towards eliminating consumer safeguards rather than enhancing them. And, very few people understand the significance of these issues.
At the very least, Realtors, builders, and attorneys should not have close relationships with mortgage and title firms. Barriers need to be set up separating the success fee based practitioners from the gatekeepers. At the very least, meaningful data needs to be collected.
The CFPB is Doing a Good Job
We give the CFPB credit for doing the impossible; finding a violator in Paul Taylor Homes within the short one-year statute of limitations. The problem is, only the sloppy kickbacks are going to be found. What about all those other schemes for which there are no paper trails? Bonuses to Realtor managers who have high client capture rates? Better commission splits to Realtors who refer business to in-house mortgage or title? Discounts on rent to Realtors who refer business? There are an endless supply of possible arrangements. So long as Practitioners are in a position to exploit their fiduciary relationships and are permitted to mislead consumers and laws do not prevent them from doing so, this will continue to be a serious problem.
The CFPB’s hands are tied. What good can they do if the laws for which they are charged with enforcing encourage illegal, anti-competitive and unsafe conduct? At the very least, the CFPB should be able to penalize law breakers in a meaningful way. A one year statute of limitations and a $118,000 disgorgement of one year’s worth of profits does not accomplish that when the violator likely made away with many millions of dollars in profits from the scheme for more than a decade.
There is only one thing worse than kickbacks in residential real estate and that is arrangements in which the Realtors and builders actually own the mortgage and title businesses that are in place to stop bad deals. It is their job to stop the bad deals from happening. When done well, they are not well liked by those who make a living only when a transaction closes. Legislators and regulators seem to have forgotten that mortgage and title services are important safeguards to the residential real estate transaction. So long as success fee based practitioners like real estate brokerages and builders have a say (or worse, an ownership interest) in these firms, the more assured our invitation to the next foreclosure crisis becomes.