(This is Part 3 of a three-part series. See Part 1 and Part 2.)
In previous articles, I pointed out that competition for title business is directed not at borrowers but at Realtors, lenders and builders who have referral power. Competition thus often results in kickbacks to referrers rather than lower prices to borrowers. Recent years have seen a proliferation of legalized kickbacks through “affiliated business arrangements” (ABAs), which are costly to develop, as well as sham ABAs that pretend to be legal but aren’t.
The fundamental reason for the dysfunctional market is that borrowers must pay for title insurance that protects the lender, which is a historical anomaly that never made any sense. If lenders had to pay for their own protection, kickbacks would disappear overnight. To accomplish this, I proposed federal legislation that would require lenders to pay for their own insurance, as other businesses do.
In April 2006, the House Committee on Financial Services, chaired by Rep. Oxley, R-Ohio, held hearings on title insurance. The papers prepared for the hearings reveal the attitudes of the various groups with an interest in title insurance.
Vested Interests in Existing Arrangements: The paper submitted by ALTA, the trade association of title companies, includes some interesting background materials such as a history of the industry. On the issue of what is wrong with the industry today, its position is very clear. There is nothing wrong with the industry except illegal kickbacks and sham ABAs, and its main policy prescription is that HUD and the states should redouble their enforcement efforts.
The position of ALTA is seconded by the National Association of Realtors, which is the largest of the trade groups participating, and by RESPRO, which is the smallest. RESPRO is a trade association of firms that participate in ABAs. These groups would adamantly oppose my proposals.
Mortgage lending groups did not participate in the hearings. However, the likelihood that they would support a legal requirement that they pay for their own title protection is low.
A Voice in the Wilderness: The most interesting testimony at the hearing came from Douglas R. Miller, CEO of one of the few title agencies remaining in Minnesota that is not part of an ABA. His prices are well below those charged by the affiliated companies, but:
“Service excellence and price are now meaningless in my market. Instead, we have a system that rewards real estate professionals for manipulating their clients into selecting the highest-priced title companies. We are stopped at the door at most real estate brokerage houses in town. They have their own “affiliated” title company and don’t want to hear about us…Consumers are carefully guarded from information about competing title companies, and agents are chastised if they recommend a title company other than their in-house company.”
Minnesota may be an outlier in the extent to which ABAs have come to dominate the market. It is the direction toward which other markets are trending, however, with increasing support from HUD.
HUD, a Public Guardian? HUD is responsible for enforcing RESPA, which means it has the unenviable task of shutting down sham kickback arrangements. But it also has a broader if less well-defined mandate to reduce settlement costs, a goal that is not furthered by the pursuit of sham kickbacks. Most of Miller’s problems, after all, are caused by ABAs, which generate legal kickbacks.
In the paper submitted for the hearings, HUD referred to a 1980 study that concluded that title insurance was not provided to consumers “at a price which approximates the cost of efficiently providing these services…” It went on to say that nothing has changed since then. But the major part of the paper is directed to its enforcement efforts directed against sham kickbacks.
HUD simply ignores the lack of congruence between its enforcement obligations and the policy objective that that enforcement is supposed to further but doesn’t. At the conclusion of the paper, instead of informing Congress that the current rules will never reduce settlement costs, it asks for more power to enforce those rules.
Consumer Groups: The Consumer Federation of America, on behalf of itself and five other consumer groups, documents the large gap between the direct costs of producing a title policy and the price paid for the policy by the borrower. They support two potential remedies, one of which is to require that lenders purchase their own title policies. The second is to have the states guarantee title, as is done now in Iowa.
While the Iowa system has merit, it would have to be adopted by each state, some of which would surely muck it up. Lender-pay could be implemented by the federal government, and it would work.
The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.