Has Commercial Loan Origination Become "Boiler Room-esque?"

JAN 23, 2013 5:31pm ET

In a great interview with Consuelo Mack on WealthTrack.com, John Bogle — the founder and former CEO of mutual fund giant The Vanguard Group — makes very interesting points about the mutual fund business that really resonated.

While talking about the evolution of the Mutual Fund industry, Bogle lamented that it used to be a “profession with aspects of a business, today it is a business with aspects of a profession.” But the point that really struck a chord was that “the idea of fiduciary duty has been superseded by this idea of marketing.”

As one real estate banker recently put it, “Yes, we are underwriting deals very liberally, because if not how would we ever make a loan?” To borrow from Vice President Biden, “With all due respect, that’s a bunch of malarkey.” I have no doubt that borrowers are looking for loans with proceeds exceeding what should be originated; I also understand that if you don’t make the loan, somebody else might and that ultimately it is your job to make loans. But where is your sense of fiduciary responsibility?

Bogle has a good point, one that in my opinion applies to the finance sector as a whole. We are no longer as concerned about making profitable investments as we are concerned with making the fees on any investment.

He goes further to explain that Mutual Funds management companies are owned by large financial conglomerates that “are in business to earn the highest possible return on their capital, and what you want as investor in one of their mutual funds, is to earn the highest possible return on your capital; so when you think of it, those two things, because of the fees, costs, turnover expenses, all the things that go on (marketing) are opposed to one another. No man can serve two masters.”

If Bogle has an issue with the mutual fund business, what would he say to the way CMBS is originated even today? In CMBS origination, the originator (aka the salesman) is essentially the same guy that underwrites your deal, pushes it through committee, funds the loan, and then one to four weeks later, sells it to a third party.

There are those who would argue that it is unfair to compare the two, as mutual funds are sold to consumers and CMBS bonds are sold to educated investors who, in many cases, were consulted prior to origination. This argument is a clear example of the narrow-mindedness of real estate professionals who not only believe they have it all figured out, but that they live in a vacuum.

Making bad loans—by nature of the competition for deals—encourages even more bad loans, further adding to the

backed-up sewage pipe of distressed assets that we are currently wading through. True, nobody in finance signed up to be a roto-rooter; but in order to get the clean water of recovery flowing through our system, finance deal-makers must start sacrificing in the short term — even if secondary market investors are clamoring for more of these drugs known as bad loans.

You may think I am overreacting, but let’s just say that I end up being the one to clean up the mess.