Seth Goldstein

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)

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)