Thursday, October 11, 2007

We're All Subprime Now

Today, blogger Tanta, who writes for Calculated Risk, today wrote about predatory practices in the mortgage industry in HMDA Data on High Priced Loans. A clip:

This whole dynamic may be hard for the WSJ and its fellows in the Big Paid Media, so let me explain this very clearly. In 1975, some folks accused lenders of redlining, which means not granting credit at all to some people. The lenders said they weren't doing that. Congress passed HMDA, and then there was actual data about geographic lending patterns to analyze instead of anecdotes. Once we got some HMDA data under our belts, the Community Reinvestment Act came into being (in 1977) precisely because it was clear that redlining had been going on. CRA in essence forces lenders to show that they are willing to make loans in neighborhoods in which they are willing to take deposits (i.e., those deposits need to be "reinvested" in the neighborhood they came from in the form of loans, not just mortgage loans, to that neighborhood. You can't extract deposits from poor people and use them exclusively to fund loans to rich people.) CRA does not mandate price levels, or even address the question of price levels.

You may be surprised to hear this, but over time accusations of discriminatory lending practices did not go away. In a number of cases, "mystery shopper" tests were performed, in which a white applicant and a black applicant each applied for credit at the same instutition with identical credentials (employment, income, credit history, loan terms), and the results showed that black applicants were more likely to be turned down. This cast some doubt on the lenders' claims that loan rates in minority neighborhoods were a function of the lower credit quality of those borrowers. That became a hypothesis in need of some testing, you see, not an accepted explanation.

So the 1989 revision to HMDA forced collection of demographic data, for the precise purpose of testing the assumption that poor and minority people are just always bad credit risks. This resulted, as you might expect, in conjunction with CRA and other fair lending laws, in much higher rates of home mortgage lending in those areas that were once redlined.

But were these poor and minority people happy, at last? Why no, they weren't. Turns out, anecdotal evidence began to emerge that while these good people were finally getting loans, they were getting them at much higher interest rates than higher-income folks and whites generally got, and that this could not be accounted for by the difference in creditworthiness of the borrowers or the quality of the collateral (the latter proxied by census tract).


The bottom line is, as [Calculated Risk] notes, that "high-risk" lending was everywhere in the boom years. Of course there is a desire to collapse it all into the easy category of "subprime." And there has for a long time been a lot of political pressure to keep the association of "subprime" and "urban minorities" in place, because it has functioned as a good excuse for the subprime lenders (they "help" the poor and minorities, remember?). My view is that a whole lot of parties are very interested in maintaining rather than seriously analyzing a lot of faulty assumptions about risk, rates, and borrower credit characteristics. If this ain't "just a subprime problem," then an entire debt-based economy in which even the middle and upper middle class cannot afford homes given [real estate] inflation and wage stagnation is suddenly in question. The last thing certain vested interests want to hear is that, basically, "we are all subprime now."

My favorite comments:

At least then, when they say the problem is contained to subprime, they'd be correct.
daveNYC | 10.11.07 - 10:47 am |

What about the revelations coming forward that a lot of these sub-prime loans were to people who would/could /should have qualified for prime loans. My gut feeling is that the lending industry realized that there was more money to be had in the sub-prime market and rationalized the use of the product by telling borrowers your can always refinance. So while I can see the possibility that we are all becoming sub-prime candidates because of high LTV due to lack of down payments or low rates to buy the MacMansion, I cant help but feel it was the lenders looking to sack the borrower for higher fees and on top of that being bale to book unrealized profits from the fully adjusted loans. Now there is a racket!!
formerly known as... | 10.11.07 - 11:41 am | #

Down where the rubber met the road, '04-06 subprime was a broker-dominated and refinance-oriented business. Those brokers tend to chase after big fish. Which would you rather do? ONE loan for a cardiologist with a bunch of lates thanks to the ex-wife or TEN deals involving city bus drivers with gambling problems, immigrant cleaning ladies with thin credit files, single moms with three jobs, dancers with cash wages and voracious drug habits? - oh, wait, that's alt-a - anyhow, you get the gist. It's not that subprime was ever AIMED at low-income - quite the contrary - it's just that median income of those with impaired credit happens to lower.
Shnaps Parlor

The last paragraph raises an interesting point. We have been told that FICO scores are not related to race, sex or economic status. However, it is also true that women, minorities and lower-income individuals not only have less economic power as a group, but also are at a greater risk that the above examples and medical problems/debt are more likely to adversely affect their ability to pay their bills. Hence, lower credit scores.

The end result is that it contributes to the disparity between the wealthiest (who have the highest credit scores, due to the ability to weather unexpected expenses, and therefore who borrow at lower interest rates), and the poor (whose credit scores crash after one adverse event and have to borrow at higher interest rates). (BTW: I have been meaning to write about how banks charge fees on small balances that can quickly sap wealth from poor patrons.)

The answer is to provide social insurance on some costs (medical debt and education) and living wages that allow for even the poorest to save for the future. There are some costs which cannot be defrayed: rent, electricity and natural gas, food, transportation and personal hygiene. Even the lowest wage should be enough to cover these costs and provide enough to save for the future.

1 comment:

P M Prescott said...

Let's see if I've figured this out? What you're saying is that since the lending institutions were being accused of discrimination against minorities by refusing to lend to them, and legislation was passed to require them to give loans, the institutions decided to discriminate against everyone by charging higher interest rates and fees, basically making everyone fall into the catagory of high risk.