July 6, 1998

It is impossible to prove, but your guess is almost certainly correct.

Consider what would happen if automobiles were sold like mortgages. When you asked the price, the dealer would say "This is the price of the body and motor only. The transmission system, tires, electrical system, and upholstery must be purchased from "A," "B", "C" and "D". The price you pay at delivery will include the payments to these other 4 firms, and right now we can only provide an estimate of what these payments will be."

The result of this would almost certainly be an increase in the total price of the automobile. If the automobile manufacturer only provided the chassis and motor, it would become indifferent to the prices of the other components because the consumer would be buying them from other firms. Instead, the automobile manufacturer (or its dealers) would have an incentive to use its access to the consumer to collect referral fees from the component manufacturers. Component manufacturers would compete for referrals, which would raise referral fees, and with them the prices paid by the consumer.

In contrast, the home mortgage market is an unbundled market. The consumer must transact separately with providers of component services, as you did. And the entities who control access to the consumer -- the lender, the real estate broker or both -- have no incentive to push down the prices of component services to the consumer. Before passage of The Real Estate Settlement Procedures Act of 1974 ("RESPA"), referral fees were widespread throughout the industry. RESPA, however, made referral fees illegal in real estate transactions.

The weakness of the REPSPA approach is that it does not change the underlying market incentives. While RESPA has eliminated the overt payment of referral fees, the less scrupulous still do it under the table. The more scrupulous seek alternative business practices that allow them to profit from referrals of customers to third party service providers while staying within the law. This has created a good living for RESPA lawyers, but a regulatory nightmare for everyone else including the beleaguered Department of Housing and Urban Development which must administer RESPA.

But even if RESPA worked perfectly, lenders and real estate brokers would be indifferent to the prices paid by consumers for third party services. To foster competition that would benefit the consumer requires the same bundled-product approach that works in the automobile market. Lenders should be authorized to bundle all the services connected to the real estate transaction and sell them as a package. If lenders competed for customers by quoting prices for the entire package of services, they would bargain aggressively with third party service providers for the lowest possible prices. And competition between lenders would force them to pass on the benefits to consumers.

A group called the Consumer Mortgage Coalition which includes many large lenders has been developing a proposal to the Congress to implement just such a scheme. I will keep you posted on its progress.