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Wednesday, April 04, 2007

Predatory Borrowing?

As the subprime mortgage loan market deteriorates, mortgage brokers have taken a lot of heat for their lending practices. Should borrowers shoulder part of the blame?:

Subprime Homesick Blues, by James Surowiecki, The New Yorker: ...In the past year, more than two dozen subprime lenders have shut their doors. ... As concerns grow that the subprime crisis could spread to the rest of the housing market, pundits and politicians looking for a culprit have seized on [subprime lenders], charging them with causing the crisis with their “predatory lending” practices, duping tens of millions of homeowners into borrowing more money than was good for them.

The backlash against the subprime lenders is understandable, since their business practices were often reckless and deceptive. ... Many of the lenders hid their troubles from investors, even as their executives were dumping stock.... And there’s plenty of evidence that some lenders relied on what the Federal Reserve has called “fraud” and “abuse” to push loans on unwitting borrowers.

For all that, “predatory lending” is a woefully inadequate explanation of the subprime turmoil. If subprime lending consisted only of lenders exploiting borrowers, after all, it would be hard to understand why so many lenders are going bankrupt. ... Focussing on lenders’ greed misses a fundamental part of the subprime dynamic: the overambition and overconfidence of borrowers.

The boom in subprime lending made huge amounts of credit available to people who previously had a very hard time getting any credit at all. Borrowers were not passive recipients of this money—instead, many of them used the lax lending standards to make calculated, if ill-advised, gambles. ... Most of these people ... were betting that they would be able to buy the house and quickly sell it. Similarly, last year almost forty per cent of subprime borrowers were able to get “liar loans”—mortgages that borrowers can get simply by stating their income, which the lender does not verify. ...

While some subprime borrowers were gaming the system, many just fell victim to well-known decision-making flaws. “Consumer myopia” led them to focus too much on things like low teaser rates and initial monthly payments rather than on the total amount of debt they were assuming. ... People were willing to trade the uncertainty of what might happen in the long run for the benefit of owning a house in the short run.

Another thing that led subprime borrowers astray was their expectation that housing prices were bound to keep going up, and therefore the value of their house would always exceed the size of their debt. This was a mistake...

The result of all this is that many subprime borrowers would have been better off if lenders had been more stringent and not granted them mortgages in the first place; that’s why there have been countless calls for the government to ban or heavily regulate “exotic” subprime loans... But what’s often missed in the current uproar is that while a substantial minority of subprime borrowers are struggling, almost ninety per cent are making their monthly payments and living in the houses they bought. And even if delinquencies rise when the higher rates ... kick in, on the whole the subprime boom appears to have created more winners than losers. (The rise in homeownership rates since the mid-nineties is due in part to subprime credit.) We do need more regulatory vigilance, but banning subprime loans will protect the interests of some at the expense of limiting credit for subprime borrowers in general. And while the absence of a ban means that some borrowers will keep making bad bets, that may be better than their never having had the chance to make any bet at all.

And here's David Altig at macroblog highlighting Bruce Webb's comments on subprime loan markets:

Bruce Webb On Subprime: Good, Bad, And Ugly, by David Altig, macroblog: I really don't intend to make a habit out of simply reposting reader comments, but these remarks from Bruce Webb are just too good to not pull up top:

We'll see how this all shakes out. Right now the argument for and against sub-prime pretty much parallels that over firearms:

"Guns don't kill people. People kill people."

Well yes. But having that loaded gun under your pillow while you and your wife have a drunken argument in bed maybe mighta contributed to the tragedy.

I believe in gun rights. I also believe in gun control. I have a lot of the same attitude towards sub-prime. It did put a lot of people into houses. It also put some people into houses with mortgages they couldn't afford.

Now part of that was straight out predation. But a big part is that the economic incentives were all set up in a way that encouraged writing the loan.

And if you look at it dispassionately the market has reacted to that reality and fairly harshly. Because the reality is that the first and continuing victims of the sub-prime crash has been sub-prime lenders. It is not clear whether a disproportionate amount of sub-prime borrowers are going to lose houses or end investors lose huge amounts on those bundled securities. What we do know is that New Century's stock is sitting at .94 and they have this rather terse statement on their website: http://www.ncen.com/

"New Century Mortgage Corporation and Home123 Corporation are unable to continue the origination or funding of mortgage loans, and no new loans are being accepted."

We saw it start a few months back, sub-prime lenders started going to the wall, the smaller players were dropping literally overnight. The way things are shaping up Wells-Fargo may have this sector all to their own pretty soon. Countrywide is looking shaky.

But this doesn't mean that the loan products didn't make sense in the right hands and in the right markets. In any market correction there is some ugliness at the margins. Obviously sub-prime had its day in the sun and it got awful cloudy awful fast here in 2007. But I would hope we would not overreact. The market seems to be doing a pretty good job taking out the participants who pushed the limits either on the borrowing or the lending side. Sure there are real victims out there, lets just be sure we know how to separate the suckers from the players.

Boy, I wish I'd said that.

My view is somewhat similar, another look at regulation of these markets is in order, but we need to be careful not to reduce access to credit in the process.

    Posted by on Wednesday, April 4, 2007 at 02:35 AM in Economics, Housing, Regulation | Permalink  TrackBack (0)  Comments (19)


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