Seth Goldstein

Seth Goldstein:  How does this relates to mortgage leads?

Lew Ranieri:  A lead is nothing more than an opportunity to close a loan and a loan is all about the value of the servicing that’s being created.  One of the most important aspects is what kind of a loan? So, the golden opportunity in the land of refinance leads today is that you can roll a refi not into another ARM which is only worth five-eighths of a point but into a fixed rate loan which is worth a ton more.  A mortgage geek, not a lead geek would tell you to pay a lot more because what you would be rolling it into is a 7- or a 30-year, the value of which is almost twice as much as a traditional ARM.  And there is roughly something in the neighborhood of about $600 billion of this stuff rolling up to the cap, so there’s a lot of refi business.   So for the time being, even with rates going up on the short end, we will have a new generation of refi leads and refi business in general.  But for housing in general, which is slowing down because of the absolute level of rates, you are starting to see some problems.  The most obvious and the most problematic are in the condo market in states like Florida, Arizona, New Mexico, Las Vegas, places like that because we  misjudged the amount of speculative inventory that was out there.  Much of what was sold as legitimate second home inventory turned out not to be a second home, turned out to be spec. 

And now with a perception on the part of the consumer that housing values aren’t going up, that stuff is flying back in our face at extraordinary levels.  To date it’s largely a creature of the condominium market not of the single-family market.  But traditional single-family housing in some markets is struggling.  I’ll give you a personal example.  I live on Long Island and in Merrick, Long Island, a middle-class neighborhood, you never saw a house for sale.  It was always sold before it ever went on the market.  There are now 222 listings in Merrick.  That’s an unheard of situation.  So you are starting to see a slow down in housing and you may see some price decline. 

SG: If you could “short” one type of customer and go “long” another type of customer, what would it be?

LR:  The refi business will go through a cycle maybe, not by volume but by value, because instead of refi-ing in the five-eighths servicing, you’re refi-ing into a point and a half servicing.  Now that’s a pretty good deal.  So, the guys who can keep the volume up, or even three-fourths of what the other volume is, the actual value of the roll will do very well.  I think your industry, the lead industry as far as mortgages are concerned, has to sooner or later make the adjustment to deal with what is the real nature of housing forever, which is not just refi’s.  We’re at a 45-year low in rates.  It’s an easy mathematical bet to say which way rates are going.  Just say up and you’re going to likely be right.  If you’re at a 45-year low, in that environment refi will go back to its more traditional role and the vast volumes will be in the traditional process of housing: new construction, home improvement and resale. The lead business has to adapt to that business because that is the business.  That is the one that will be there year in and year out.  It will only expand and diminish on the margin and the value of the asset created is the more valuable asset in the first place.  The first lead guys who figure out how to cut the Gordian knot and do new construction will be successful. 

It’s kind of interesting to me to look at the fact that nobody wants to buy leads for new construction because the mortgage guy has the world turned on its head.  But the new home purchase lead is a more valuable asset!  It’s got the most servicing, value, plus the person who buys the house is likely to buy all the insurance programs.  The refi guy isn’t buying insurance; he’s already bought them.  So a lead for a new construction lead is worth more than the lead for a resale buyer and certainly infinitely more than the lead for a refi.  And yet, in the RootExchange spot market today, that’s the least valuable lead and the one that frequently goes unbid for.

(Thread 4 of RootExchange/s speaker series: #2 June 13, 2006 with Seth Goldstein interviewing Lew Ranieri at NY office of Root Markets)

SG: Go back 30 years, and it’s 1976.  What was the mortgage market like prior to securitization?

LR: We made a lot of money then.  In many ways it looks like the lead generation business in that there were no simple definitions for a basic mortgage.

SG: What was the perception of a mortgage back then?

LR: Well, there wasn’t a mortgage-back security then.  The first mortgage-backed security (MBS) was created in 1979 and it was a total failure.  It’s now the biggest market in the world but it didn’t start so well.  The MBS was created for Bank of America at the end of 1978 / early 1979 after seven years worth of work and it was a AAA-rated security and the deal was a total bomb.

SG: And what did you have to do with it?

LR:  Eat it. The mortgage security market grew up over a long period of time and required a safety net of regulations and customs to support them.  The mortgage security business existed inside my head.  It was no such thing and we were fortunate enough to make it happen in a few years.

SG: How did you see a mortgage differently than other people perceive them?

LR:  The system that came out of WWII was a specialized system of lends.  So, banks because their liabilities were short-term through money markets, made short-term loans.  They’d lend to corporations on a floating rate or fixed basis.  Insurance companies, because they made life policies, which were very long and therefore were long-term liability, made the infrastructural loans.  They lent to corporations and they’d build highways because they had long-term liabilities.  Thrifts were chartered for a special purpose, to support the soldiers coming home and the need for new family formation housings. Thrifts were specialized housing lenders.  So you would go to your friendly neighborhood thrift and get a mortgage and he’d put it in the portfolio and never be seen again.  Mortgage was not an asset you could trade because everybody had his own underwriting criteria, even his own documents. The first problem with this thrift was to figure out how to take this amorphous mass of things and turn it into a vehicle that could be traded; which is again a terrific analogy to the lead generation industry today.  The leads business, whether you talk about mortgage leads or credit card leads or car leads, is the same sort amorphous mass of things.  They are not designed to be traded, but rather to be moved in a first mover way – I sell it to a guy who then tries to originate the loan, he puts it away and end of story.  But you don’t hear anybody trying to create a futures market on leads or short a lead or write an option on a lead or guarantee a conversion price or all kinds of things that more normal markets would do.  They’ll come.  All of those things will come.  That’s our vision for RootExchange.

SG: How did you force standardization?

LR:  Money: the same way the leads business will do it.  If you look at the pricing of a lead versus the value of the underlying asset and assume a reasonable conversion rate, they are much more attractive as an origination channel than wholesale or retail or builder or realtor or any one of the normal mortgage channels.  The real issue is the conversion rate.  And so a mortgage company could pay a tremendous amount more for a lead if he had any confidence in the conversion rate,  because of the disparity between the value of the servicing and what people pay for leads.  If the conversion rate is 1-2%, just do the math yourself.  If the two of them convert, and you’re converting as you would now in refi land into 7/1 servicing, then it’s worth a point and a half and you’d pay a lot for leads. 

SG: More than 30 or 40 bucks.

LR: Yes.  Well, think about, it’s simple math.  A 7/1 is worth 1.5%.  Think about 1.5% and then attach whatever conversion rate you want and see what you can pay for leads.  I mean, that really should be the math because of what you’re converting into.  Right now there are very few traditional 1 year ARMs, but if you want to use those as a California ARM, that servicing is worth, actually right now it’s close to three-fourths because there’s so little of it but normally it’s worth five-eighths.  So work backwards.  You can go to a screen.  You can go to Bloomberg and look at the value of the servicing.  People buy and sell servicing all day so you can tell what the end value of whatever you’re talking about is by simply looking at the servicing and then if you want to make a simple algorithm, just times it by the conversion rate. 

SG: So does price discovery and quality discovery help move the mortgage leads market into and through securitization?

LR: Yeah, markets are like humans. They like the way things are done, they’re used to it.  So you need to pull them off that inertia in some way and it’s usually the old fashioned American way.  It’s called money.  You generally get people to pay attention because you’re willing to pay for it.  If the market can’t pay you, you’ll do it the way you’ve been doing it for 20 years because it’s comfortable and you know what the risks are.  We used to say:  “We know who the pioneers are.  They’re easy to identify.  They’re the guys in the road with the arrows in their back.”  So unless I give you a financial incentive to go and try to do it differently, you don’t want to volunteer to be one of the guys in the road with the arrows in your back. 

(thread 3 of RootExchange/s speaker series: #2 June 13, 2006 with Seth Goldstein interviewing Lew Ranieri at NY office of Root Markets)

SG: Will the housing bubble burst?

LR:  I do not believe almost anywhere in the country this supply demand situation is so out of whack that you’re going to see a traditional bust.  Mortgage lines rarely actually bust.  In fact, I think that in the entire history of mortgages post WWII, we’ve only actually had five busts.  When mortgage markets reach a problem, they generically stop going up and stay the same for 5 or 6 years. That’s how they work themselves out.  They rarely drop out of bed.  In the five instances where mortgage markets have dropped out of bed, it was because of extraordinary circumstances.  Texas during the 80’s when the oil patch blew up and people left Houston hand over fist so the reason housing went down so much is not that interest rates were too high or the price of the house was too high, there was just nobody to sell them to.  I mean, there were more people trying to sell houses than there was anybody to sell them to.  That was the same situation in Southern California in the early 90’s when the inland empire looked like it was about to become Atlantis.  It wasn’t a matter of rates; it wasn’t a matter of anything other than just overcapacity and lack of buyers at any price.  So, housing’s slowing down, but I don’t expect it to be a disaster.  I think where there may very well be problems, significantly in the sub-prime area.  Sub-prime is a creature of the last 5 or 6 years.  It historically has never really existed so it did not exist through a cycle.  This will be the first cycle, and the combination of high loan values and somewhat aggressive underwriting makes those loans susceptible to even a marginal decline in housing values. 

(thread 2 of RootExchange/s speaker series: #2 June 13, 2006 with Seth Goldstein interviewing Lew Ranieri at NY office of Root Markets)