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Saturday, November 15, 2008

Ethical Subprime Lenders

One big concern I've had about the financial crisis is that it would result in some middle and lower income buyers being excluded from the home ownership market even though those individuals are relatively low risk. So I'm glad to see this type of activity expanding:

The Subprime Good Guys, by Daniel Gross, Commentary, Slate: In recent months, conservative economists and editorialists have tried to pin the blame for the international financial mess on subprime lending and subprime borrowers. If bureaucrats and social activists hadn't pressured firms to lend to the working poor, the story goes, we'd still be partying like it was 2005 and Bear Stearns would be a going concern. The Wall Street Journal's editorial page has repeatedly heaped blame on the Community Reinvestment Act... Fox Business Network anchor Neil Cavuto ... proclaimed that "loaning to minorities and risky folks is a disaster."

This line of reasoning is absurd for several reasons. Many of the biggest subprime lenders weren't banks and thus weren't covered by the CRA. Nobody forced Bear Stearns to borrow $33 for every $1 of assets it had, and Fannie Mae and Freddie Mac didn't coerce highly compensated CEOs into rolling out no-money-down, exploding adjustable-rate mortgages. Banks will lose just as much money lending to really rich white guys like former Lehman Bros. CEO Richard Fuld as they will lending to poor people of color in the South Bronx.

But the best refutation may come from Douglas Bystry, president and CEO of Clearinghouse CDFI (community-development financial institution). Since 2003, this for-profit firm based in Orange County ... has issued $220 million worth of mortgages in the Golden State's subprime killing fields. More than 90 percent of its home loans have gone to first-time buyers, about half of whom are minorities. Out of 770 single-family loans it has made, how many foreclosures have there been? "As far as we know," says Bystry, "seven." Last year Clearinghouse reported a $1.4 million pretax profit.

Community-development banks, credit unions, and other CDFIs—a mixture of faith-based and secular, for-profit and not-for-profit organizations—constitute what might be called the "ethical subprime lending" industry. Even amid the worst housing crisis since the 1930s, many of these institutions sport healthy payback rates. ... Their numbers include tiny startups and veterans such as Chicago's ShoreBank, founded in 1973, which now has $2.3 billion in assets... Cliff Rosenthal, CEO of the National Federation of Community Development Credit Unions, notes that ... "delinquent loans are about 3.1 percent of assets." In the second quarter, by contrast, the national delinquency rate on subprime loans was 18.7 percent. ...

In order to keep their doors open, they have to charge appropriate rates—slightly higher than those on prime, conforming loans—and manage risk properly. ... What sets the "good" subprime lenders apart is that they never bought into all the perverse incentives and "innovations" of the bad subprime lending system—the fees paid to mortgage brokers, the fancy offices, and the reliance on securitization. Like a bunch of present-day George Baileys, ethical subprime lenders evaluate applications carefully, don't pay brokers big fees to rope customers into high-interest loans, and mostly hold onto the loans they make rather than reselling them. ... Clearinghouse's borrowers must qualify for the fixed-rate mortgages they take out. "If one of our employees pushed someone into a house they couldn't afford, they would be fired," says CEO Douglas Bystry. ...

"We're in business to improve people's lives and do asset building," says Linda Levy, CEO of the Lower East Side People's Federal Credit Union. ... The average balance in its savings accounts is $1,400. The typical member? "A Hispanic woman from either Puerto Rico or the Dominican Republic in her late 40s or early 50s, on government assistance, with a bunch of kids," Levy says. Sure sounds like subprime. But the delinquency rate on its portfolio of mortgage and consumer loans is 2.3 percent, and it's never had a foreclosure.

Ethical subprime lenders have to look beyond credit scores and algorithms when making lending judgments. Homewise, based in Santa Fe, N.M., which lends to first-time, working-class home buyers, makes credit decisions based in part on whether borrowers have scraped together a 2 percent down payment. ... Of the 500 loans on Homewise's books in September, only 0.6 percent were 90 days late. That compares with 2.35 percent of all prime mortgages nationwide. ...

Ethical subprime lenders are now expanding beyond mortgages. ... Lending ... money carefully and responsibly to working-class people isn't a recipe for riches or grand executive living. ... Bystry, the CEO of Clearinghouse CDFI, earns a salary of $190,000 .... (Angelo Mozilo, former CEO of Countrywide Financial, was paid $22.1 million in 2007.) For all the growth, this remains very much a niche industry.

Still, the mortgage crisis has provided an opportunity for ethical subprime lenders to expand. ShoreBank has added staffers and in August 2007 rolled out a Rescue Loan program, which aims to move borrowers out of expensive adjustable-rate mortgages into fixed-rate loans. "We really believe we can help people caught in these bad mortgages,"...

    Posted by on Saturday, November 15, 2008 at 11:16 AM in Economics, Financial System, Housing | Permalink  TrackBack (0)  Comments (27)

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