Journal of Real Estate Finance and Economics, 23:3, 305±307, 2001
# 2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
Comment: The Economic Functions of Referrals and
National City Bank, Cleveland, Ohio
Real estate transactions are the largest single purchase that most individuals will ever
undertake. For this reason, the role of middlemen in such transactions is the subject of
scrutiny. Individual borrowers want and need to be sure the transaction is fair. Brokers
want to ensure their income by charging fees for services provided, and service providers
want their fair share of transactions that are in the hands of the middlemen.
The joint concepts of disclosure and informed consumers have formed the basis of the
regulatory framework for the past 30 years. The theory is that consumers are able to make
meaningful comparisons, and in fact they do make those comparisons in their shopping for
®nancial products and services. For the most part, this regimen has served consumers well
when it is used as intended. Recent discussions of the consumer disclosures mandated by
Regulations Z and M illustrate this: the disclosure of an APL is intended to provide the
consumer with the ability to make a meaningful comparison between a loan and a lease
transaction. Whether consumers actually exhibit this rational behavior with any degree of
consistency is a topic for another, less theoretical research paper. Recent discussions about
reforming the Real Estate Settlement Procedures Act (RESPA) and the Truth in Lending
Act (TILA) have attempted to provide purchasers in real estate transactions with a simpler
and more meaningful set of disclosures. Current public policy is guided by the principle of
an informed consumer who, with the appropriate tools, can make decisions that are the
result of comparisons between terms offered by a variety of service providers.
In ``The Economic Functions of Referrals and Referral Fees,'' Peter F. Colwell and
Charles M. Kahn raise a legitimate challenge to the conventional theory. Their theoretical
article examines the role of middlemen in real estate transactions. Speci®cally, it examines
the fees that might be charged in such transactions if they were not prohibited by RESPA.
Among its other requirements, RESPA prohibits the payment of referral fees in real estate
transactions, permitting only speci®c fees that are directly related to the provision of
services. Fees must re¯ect the actual costs of providing services, and neither the
middleman nor the lender is permitted to mark up the fees of the service provider unless
speci®c additional services are provided.
Disclosure has been at the core of consumer policy for the past 30 years, since the
passage of the Truth in Lending Act. Consumers' right and ability to make informed
decisions, using appropriate tools that have been prescribed by law to facilitate his
understanding, is fundamental. Colwell and Kahn, however, propose that not only are there
situations where RESPA's fee prohibitions might be socially undesirable; there are
situations where it may not be desirable to disclose them to the borrower.