The Pebble and the Avalanche

Thu, 2006-Sep-28, 20:49

During a lecture I gave earlier this year, I was asked about the effects of disaggregation on the finance industry, and I answered by pointing to the increasing specialization in the industry.

As might be expected, criminals have found gaps in the system. An article in the Wall Street Journal and elsewhere details an alleged mortgage scam in Virginia. After you disaggregate, you must take care that your interfaces remain intact:

Fraud has proliferated as lenders increasingly deal with borrowers through brokers and other intermediaries rather than having face-to-face relationships. "Lending is becoming more anonymous," says Rachel M. Dollar, a Santa Rosa, Calif., attorney... A lawsuit filed in December 2004 in federal court in New York by South Brooklyn Legal Services, a nonprofit law clinic, alleged that Argent Mortgage made a $425,000 loan arranged by participants in a foreclosure fraud scheme even though the application was incomplete and a title-insurance company warned the lender something was amiss with the deal... "The red flags were as strong as you can get," says Jessica Attie, a staff attorney with the clinic's Foreclosure Prevention Project. In court papers, Argent denied it was at fault in the case, which it settled in April.

The problem goes beyond brokers and the lack of face-to-face meetings. Banks now have dozens of branches, and the days of just a handful of bankers in any given town — a small group who could sense when something was wrong — are long gone. In today's market, companies originate mortgages, others purchase them from the originators, still others package them and even sell the principle and the interest separately. Title companies, home inspectors, credit bureaus, and others all play a part. Leaving aside the issues of moral culpability or legal culpability of the mortgage originators, the losses they will take in this case argue that it's time to look to how they manage the disaggregated pieces of their businesses.