Mortgage Lending Is Suffering From Paradigm Paralysis

In researching material for topics of discussion I came across a phrase that really hit the proverbial “nail on the head.” This phrase was “paradigm paralysis.” What you ask, is paradigm paralysis and why was it such a revelation? The answer to those questions are simple.

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Paradigm paralysis is the condition where something, where an individual, business or culture, has an expectation of about how something should be done and something new is introduced that falls outside that pattern, we find it hard to see or accept. In other words, the actions that need to be taken to change accepted patterns are just not taken, even if these actions would produce a better result. Be it individuals, businesses or cultures, we are paralyzed. The reason it struck me as so significant is that this is what has occurred in the mortgage industry and most particularly in the adaptation of operational risk and the redirection of the quality control process.

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The basic mortgage process of evaluating the borrowers and collateral has been around since its inception in the 1930s. However, over the past thirty-five to forty years, it has expanded significantly with the focus on marketing these loan products through capital markets. In 1985, Fannie Mae introduced the first quality control requirements for lenders selling loans to them. The other agencies quickly followed. However, the paradigm they followed when doing so was one of loan inspections with reports providing a data dump that was supposed to help management resolve loan level problems.

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Because of the mortgage crisis that occurred in 2008 and the subsequent regulatory explosion, it was anticipated by many that we would see significant changes in the mortgage lending process. While there has been an escalation of technological support since that time, changes to help address some of the regulatory issues and some minor adjustments to industry processes, including quality control, there has not been any real progress in any of the process paradigms.

Of particular interest to me is the critical changes that are needed in QC. Without a doubt, the quality control standards in place during the build up to the crisis were a critical and significant factor in the collapse that followed. This was not because they weren’t followed but because they were inadequate and antiquated. Yet during this same time period, other industries in the US and around the world were implementing new quality control standards as part of an overall operational risk program. Once implemented, these programs focus on operational process analysis and provide a method to effectively price for the risk of poor controls and processes.

So, why hasn’t the industry moved in this direction? Unfortunately, we continue to have paradigm paralysis and have failed to make some progress in this critical segment of mortgage lending. Until such time as lenders are willing to take responsibility for the management, control and monitoring of the products they produce, the industry will continue to suffer. One can only hope that leaders of the industry will become brave enough to challenge this agency-caused paralysis and make a change for the better.

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