Seth Goldstein

QUESTIONS AND ANSWERS

Q:  It’s not easy to become an insurance company but it’s easy to become a broker.  So the question is, have you guys attacked any of that piece of it, not just the originations, but also the insurances that accompany them?

Ranieri:  There is nothing that says in the same way you get his lead from online you cannot deliver all this other kinds of information online, which is normally difficult in a traditional process.  Unless the consumer proactively tries to break out of the corral, it doesn’t happen.  Here he’s already out of the corral; he’s online.  You follow?  And I think what you’re going to see is a lead may become simply a sequence of leads.  The lead won’t simply be a lead for a mortgage.  You might sell the lead four times to four mortgage companies; but you may sell that same lead beyond that, because as sure as God made little green apples, there will be a sequence of insurance companies or title companies who want that same information.

Q: This is a question about the Exchange that you have built.  As you and I both know going way back in the lead generation business, it’s a supply driven business so if you can’t get the supply then there’s nothing to exchange.  So even though I agree with Lew that this could potentially be a big win for mortgage brokers because they’re getting more leads, better leads, a price based on the real value … even though I believe it could be a win for the consumer because probably they’re getting well-priced goods and services, I don’t see any reason in the world why any of the companies out there that are generating real estate or mortgage leads would want to cooperate.

Goldstein:  We call them aggregators, and they are generating supply across the industry:  LowerMyBills, Nextag, LendingTree, LoanWeb, Adteractive, there’s a number of them.  Many are quite good and are generating high quality mortgage leads that lenders are purchasing.  The Exchange is open and available to them at minimal cost as an opportunity to discover price and to clear inventory that only has 24 hours before it goes stale.  Some of them may have their own direct relationships where they’ll sell the lead once or twice, but for the third or fourth time they might use the Exchange.  Most of these aggregators purchase their media inventory from publishers.  A consumer of one of these aggregators is typically coming in through a search engine or a banner.  The natural suppliers of this inventory are the newspapers, the search engines, the media companies, all of whom up until now haven’t really had a channel to sell leads directly through.  They have had to sell impressions and trust that they are getting a fair price for their impressions relative to the value of the underlying leads they could be generating.  Many publishers are indeed getting fair prices, but there are some publishers who have relevant search terms or relevant content areas that might monetize better it they were able to go directly to our Exchange.  And so we are committed to enabling both traditional publishers who are capturing the direct attention of the consumer and aggregators who, in most cases, are purchasing media to generate leads. 

Ranieri: In the regular, non-refi mortgage business, that volume is not controlled by an aggregator; as an example, it’s controlled by realtors.   Realtors turn those leads into money simply by, at this point, becoming a mortgage company to convert the lead into their own servicing.  I think I could argue if this process is as efficient and powerful as I believe it will be, they will be a lot better off just accessing our Exchange.  It will be much more cost effective.  Every homebuilder in the country decided they had to become a mortgage company to capture that portion of the revenue.  Our Exchange will give them the ability to exit a business they really never wanted to be in.  They just want to keep that portion of the income that came from the result of building the house.  This gives them a much more cost efficient way of doing that.

Q:  That’s why I’m saying it’s great for the demand side but maybe it’s not so great for the supply side.  If I’m a publisher and I’m making $10,000 a month from an aggregator, why should I drop them and sell leads directly to your Exchange?  I think you’re going to get some resistance.

Ranieri: One of the largest mortgage companies in America at the beginning of all this was Loomis and Nettleton, and they were a monopoly.  They viewed the advent of the mortgages security market as a risk, as something that was competition because in those days mortgage companies were brokers.  They weren’t what mortgage companies are today.  They actually simply brokered a loan between thrifts or between thrifts and pension funds.  And here I was suggesting that mortgage companies become originators:  get into the mortgage business themselves, take the mortgages they create and turn it into a security and sell it.   So that their whole business wouldn’t be going to the Arizona Banking Conference and lining up four new thrifts to sell them into.  But I was preaching heresy.  And this great, giant company, Loomis and Nettleton decided “a pox on my house” and that they weren’t going to change.  And unfortunately it turned out for them that I wasn’t all wrong.  And there’s no longer a Loomis and Nettleton. 

Goldstein: But there were plenty who adapted to the evolution.

Ranieri: It was actually good for mortgage companies.  In fact, if it was bad for anybody it was bad for the thrift who wanted to show up at 10 and go golfing by 3.  The mortgage companies inherited the earth. 

Q: Your comments about refinance product were focused largely on refinancing to a fixed rate product, any thoughts on the option ARM product?

Ranieri:  We’re talking about a very sensitive topic so I’ll just take it on head-on.  Option ARMs in their original design were created for middle income, upper-middle income people who understood the nature of the risk in the option arm and for whom it worked very well because they could manage the risk.  They could de-lever if they so chose.  That was the issue; you could de-lever.  When the option ARM started to be used as a vehicle to qualify the unqualified, it became an abuse, in my opinion.  Actually, the first arm was called a floater.  The first ARM structure wasn’t called an ARM, it was called a floater and the rest of us called them sinkers because in the next cycle they never ever hit par again.  So an option arm in its most aggressive form where you have a 1%, then it rolls to a 1% initial for 90 days, 4% and then it rolls to fully indexed after the year.  And you can choose to stay at 1 percent.  Think about it.  That’s an 85% loan to value and you choose to stay at 1%. In less than two years you’ll be at 115% loan to value and you can’t go anywhere.  I’ll write in blood for any of you who want to have this bet with me.  I will tell you there’s a 100% correlation between equity and foreclosure.  Nobody lets you take a house that he has net equity in and nobody tries to stop you when he has negative net equity.  So you drive a loan up to 115% in two years, unless housing’s appreciating to offset that, you are going to have an unhappy amount of delinquency and loss on foreclosure.  So I think the option arms are a very useful product as long as you don’t use them for what they were never designed for.

Q: Servicing value?

Ranieri:  Servicing value will follow, depending on who’s buying the servicing.  Thrifts were for a very long time very naïve about the risks to certain kinds of consumer and option ARMs and so the option ARMs were 5/8’s of a point regardless of whether they were upper-middle class or being used as a way to qualify the unqualified.  Then the FDIC, the regulators, the federal financial oversight group came out with guidelines and said to financial institutions, banks, credit unions and council and state insurance companies: “If you do this, I have news for you.  You can do it.  We won’t stop you.  It’s not technically illegal, but when we come in, we’re going to ask you to do a series of algorithms and if you cap out in two years we’re going to make you write these things down; we’re going to make you take reserves against it.” And so the aggressive AM arm loans now are trading at pretty substantial discounts to the 5/8s and 3/4s of a point based on those regulatory algorithms.

(Thread 6/6 of RootExchange/s speaker series: #2 June 13, 2006 with Seth Goldstein interviewing Lew Ranieri at NY office of Root Markets)

Seth Goldstein:  One of the issues I think a lot of people deal with in the online advertising market in general and in the Internet lead market specifically is how to evaluate the quality of the lead.   How do you address the quality dynamic?

Lew Ranieri: Define quality, because when you say quality…

Goldstein: Conversion.

Ranieri:  You need to tell me what he conversion rate is, and what loan it’s converting into.  So am I multiplying the conversion rate by 5/8s or a point and a half?  Is it converting into a 30-year, because remember, there’s more than one mortgage market.  There’s the low income FHH market.  There’s the big one, the conforming market.  And then there’s non-conforming like in this world and California much of the product is non-conforming and because of the balances that stuff is generally worth more money.  So again, I just need to know what I’m multiplying it by to figure out the value of the lead.  So if quality is being used by you to simply mean the conversion rate, you need to be able to ascertain independently, unless somebody’s going to guarantee it for you, what the conversion rate is and you need to get enough information to do that effectively.  The mortgage guys will eventually make you pay attention to pricing it this way.

Goldstein: How does this relate to the mortgage market in the ‘80s in terms of ratings agencies and the evaluation of quality?

Ranieri:  We pulled the regulators into it because we needed somebody who had the power to standardize.  The non-agency market, the non-conforming market took longer because we had to do it with money; we had to do it ourselves by imposing rules upon ourselves and then agreeing to abide by the rules we were imposing (and ostracize those who refused by putting them on a black list).  It worked because you want to do business and if everyone else decides to black list you because you’re always monkey-ing around, eventually you decide that it’s not worth your interest to monkey around.  But this takes longer than a regulator saying: “here are the rules, sign this piece of paper, and oh by the way if you monkey around I’m sending you to jail”.  There’s something about those last words, which have the ability to make you pay attention. 

Goldstein: How did the mortgages evolve from being a narrow, housing-specific market to the trillion-dollar bond industry that is has become today?

Ranieri:  Mortgages became a vehicle not simply for housing, for the financing of housing, but it became an asset class for people to invest in.  People use it as a proxy for the movement of interest rates because it’s so big.

Goldstein: Clearly, that was great for Wall Street and Salomon Brothers, but my question is how did that benefit home owners?  How did that benefit the banks?

Ranieri: It’s called liquidity, liquidity, liquidity. I’ve developed a lot of markets, not just mortgages, and in every one of them your knee-jerk reaction is always: “I like my big fat spread, leave me alone. I like it this way, go away.  I don’t want to hear about an exchange.  I don’t want to hear about a security.  I don’t want to hear about standardization.  I’m making a lot of money.”  Markets that grow to the size that I believe the leads business will, these markets never become totally homogenized.  The generic will become the department store special, but there’s always the edges.  I think you will see, in a very short period of time, that the new sex symbol of Wall Street will be the lead trader. 

Goldstein: Ok, but how do consumers benefit?  For example, how did the securitization of mortgages help people?

Ranieri: By lowering the cost.  All of housing rests on two pieces of legislation both of which I helped to write:  The Secondary Market Enhancement Act, which was passed in 1984 and the Tax Bill, which is called Remick, which passed in 1987.  New markets don’t have that security web of regulation.  When we went to Congress and asked Congress to pass a bill, you can imagine the strange looks we got.  We had to agree on the first bill that there would be a “look-back” 4 years later and the look-back said that: if they gave us this bill we would be able to lower the cost of housing by 250 basis points.  And so Congress ordered a review and if we had not met or exceeded that promise, the bill would have died. We ended up lowering the cost of housing by much, much, much more than that. 

So, one of the ways I think the consumer will benefit here is through the democratization of information.  The mortgage business has lived for a very long time by trying to capture the consumer, by trying to keep him fenced in.  So if he comes to me to build a house, I want to sell him my house, but I’m not going to tell him to go call 40 realtors to get a mortgage.  I want him to go to my friendly neighborhood realtor to get a mortgage because I’m going to get some part of that fee.  And I’m probably going to try to sell him homeowner’s insurance as well.  If I have a special deal with Anderson Windows, I’m going to try to get him to upgrade into Anderson.  That’s just the nature of the world.  The web has become the major vehicle of intention information. It’s much more difficult to keep consumers fenced in.  It is easier for him to bracket what is a good loan and what is a bad loan because not only is he getting freedom of access to all of the forms, he’s getting freedom of access to information about people who are prepared to tell him about the risks of a given loan.  RootExchange is in the center of this movement. 

(Thread 5 of RootExchange/s speaker series: #2 June 13, 2006 with Seth Goldstein interviewing Lew Ranieri at NY office of Root Markets)