Demonizing The Mortgage Industry

In today’s Chicago Tribune, Steve Chapman points out the hypocrisy that has been exhibited by many on the left in response to the problems in the sub-prime mortgage industry and the increasing number of foreclosures on such loans:

In the old days, financial institutions that refused to lend to people with low incomes or imperfect credit were accused of victimizing the needy. Today, financial institutions that make many loans to those same people are found guilty of the same crime.

Back in the 1960’s and 1970’s, lenders who refused to lend to people with risky financial portfolios were accused of “redlining” — which was the supposed practice of refusing to lend to anyone within certain geographic areas, usually areas dominated by minorities — or of outright racism in their lending practices. In reality, what lenders were usually doing was responding in a rational way to both the prospective borrowers in question, and the rules and regulations they were forced to deal with.

First of all, poor people, whether they’re minorities or not, are not good credit risks. They aren’t regularly employed, they don’t have significant assets, and they usually have financial obligations that make the idea of being able to meet a mortgage payment often unrealistic. Lending someone in such an economic state hundreds of thousands of dollars to buy a home would be an incredibly stupid business decision, unless the loan were structured in such a way as to protect the lender from the increased risk of default.

And that’s where # 2 comes in…….

Second, because of banking and lending regulations in the 1960s and 70s, lenders were often restricted in the terms they could offer to borrowers. Interest rates, typically the best way of counteracting credit risk, if not capped, were at least highly regulated, and banks were not permitted to offer anything much more than the typical 30 year fixed rate conventional loan.

When the mortgage industry was deregulated, thanks in part to the people who were complaining about so called “redlining” and discriminatory lending, lenders were able to non-traditional mortgages that permitted people who otherwise would have been locked out of the opportunity to purchase a home the ability to do so. One can argue about whether or not people like this are making the right choice when they take on the responsibility of home ownership, but they’re all adults, and, in the end, they’re the ones who accept financial responsibility when they sign on the dotted line.

As Chapman points out, the mere fact that some of these subprime borrowers are defaulting on their obligations is not a condemnation of either the subprime market itself, or the mortgage industry as a whole:

[T]he fact that some borrowers are behind on their payments is no condemnation of the system that furnished them credit. They are in the subprime market, after all, because their credit history or income suggests they are bad risks, and it’s no shock to find that some of them turn out to be exactly that.

Precisely, and more importantly, all the press about the increase in foreclosures among such borrowers ignores a broader reality:

[T]he overwhelming majority of subprime customers handle their obligations just fine. At last count, fewer than 14 percent of them were delinquent, meaning that 86 percent were not. Most people pay what they owe, and those who don’t suffer the consequences. Absent consequences, fewer people would repay, and mortgage providers would demand higher rates to lend to the remainder.

And that, ultimately, is what the free market, individual liberty, and being an adult in a free society are all about — accepting the consequences of your actions.

But it doesn’t, unfortunately, end there. Details below the fold:

Instead of letting the system work itself out, though, Democrats like Senator Chuck Schumer insist that the state must act:

Schumer hopes to avert future foreclosures by insisting that homeowners demonstrate they have the income to afford not merely the initial payment, but the highest one they eventually will face. He also plans to spare current borrowers by spending tax revenues for their benefit — as well as vigorously pressuring private financial institutions to “direct resources” to this worthy end. The money would go to non-profit entities, so they can help debtors and creditors reach terms to prevent foreclosure.

Lenders already have good reason to work out bad loans, so they don’t get left holding a property that, in today’s market, may be worth less than the mortgage. If it’s true, as Schumer claims, that many borrowers could qualify for cheaper loans, they are free to go get them — and mortgage brokers have ample incentive to seek those customers out. The senator’s bizarre assumption is that absent federal intervention, these parties will blunder around without a clue.

In fact, most of them know what they’re doing. A recent study for the National Bureau of Economic Research found that thanks to improvements in the mortgage market during the last 35 years, “Households are now more able to buy homes whose values are consistent with their long-term income prospects.”

But, you see, Chuck Schumer thinks he knows better than you do what’s in your best interest.

That is precisely what collectivism is all about.

  • http://na Eric Mortensen

    Senator Dodd and the coming “savoir” FHA?

    Well, from what I read, Sen, Dodd has a great plan to change the operationg rules governing the FHA, and allow them to take over the adjustable rate loans (coming due for reset)…. and convert them to fixed rate loans. So, the FHA moves “bigtime” into the mortgage / refi biz, if Dodd has his way?

    Yesterday, it was the NY Federal bank which went into the asset-backed / commercial paper biz, accepting ” that paper” as collateral on loans to banks. ( this is a FIRST, in history).

    LOTS OF RULE CHANGIN’ GOIN’ ON …more govt intervention / less private operation – is this more like Communism / Socialism, or what? Whatever did happen to the private marketplace?

    Back to the FHA / Sen. Dodd … It was my original idea that if a BAILOUT of the adjustable rate homeowers was to be done, well, why not just give em’ each $15,000 , to allow them to buy-out of the adjustable loan ( refi penality)…and allow them to go to a private lender, to refi… i.e. let the marketplace work. Don’t have the govt. involved “from soup to nuts”…holding the “paper”, too.

    But then, it occured to me that 63% of those loans were “liar loans”, so those individuals might not even qualify for a refi-to- fixed loan, esp. with the tougher lending stds, going into place (now that the horse is out of the barn).

    So, hahahaha…yeah, I guess Dodd has a point – perhaps the govt. will (have to) be the one to hold it’s nose, look the other way…not ask for proof of income…and just ‘do the dirty deed…refi anything and everything that’s crawling out there…. Do anything to keep the 2 million homes from going into foreclosure, adding to the (already) huge supply of unsold homes.

    Of course, those loans do have that sticky “refi penality” attached…. and those lenders who made those loan contracts (or the ones now holding them), will want the “refi penalty” money, won’t they?

    You’re probably looking at $30 Billion to “buy out” those refi-penality clauses…I don’t think the lenders will simply hand over their portfolios to the FHA, without being compensated…they want that $30 Billion, right? ( and perhaps that’s why Wilbur Ross suddenly has an interest in owning some mortgage company assets? … I believe he’s already a ‘partner’ now, in Accredited Home Lenders? you’d have to check the news to see exactly what Wilbur is up to – but if he sees the FHA handing out money, to cover those refi penalities, well… money is money)

  • http://na Eric Mortensen

    hmmm…well “savior” (not “savoir”…sounds French)sorry bout’ that…may be other spelling errors – so, be kind. Spelling not my strong suit.

  • Joshua Holmes

    And that, ultimately, is what the free market, individual liberty, and being an adult in a free society are all about — accepting the consequences of your actions.

    Of course, we don’t live in anything like a free market. Where did the banks get their lending capital? What role does the Federal Reserve play? What role do Freddie Mac and Fannie Mae play?

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  • Larry Scherer

    Very well written and quite accurate,

    Any way to obtain a reprint to send to my clients.


  • Kerrie Woodruff

    In reading the original post and subsequent comments, it doesn’t seem any of you understand lending or liberty for that matter including the original author.

    “Redlining” is a discriminatory practice that denied loans and credit to minorities only because they were minorities and is a blight on this industry. It has nothing to do with income level because “Poor” is a relative term. Someone making $10 an hour today would have been deemed middle class in the 1960’s and 1970’s. “Poor” is not a consideration of risk either because I have closed loans for people at this income level for homes well within their budgets and established qualifying ratios and they are still making their payments on time as well as there are many “wealthy” people with incomes over $100,000 that are in default.

    The current credit problem is the result of lenders relaxing qualifications for borrowers with, in some instances major credit issues and lacking job histories, to obtain loans easier and generally without down payments. Most of those loans being “hybrid” adjustable rate mortgages providing 2 or 3 years of a low fixed rate which would convert to an adjustable rate adjusting either once or twice a year based on the LIBOR index. This provided home ownership for many people that otherwise wouldn’t have a prayer to buy a home. In the financial markets, we all say past performance is not indicative of future results however, you cannot teach old dogs new tricks. People, who demonstrate an inability to manage money and credit, rarely learn. The other anomaly is a major value increase in these indexes driving interest rates up once these loans hit the adjustment period causing substantial payment increases. Since many of these loans allow for very flexible and generous qualifications, once the adjustments hit, the loans became unaffordable.

    Senator Schumer is correct in proposing that qualification should be based on the worst case scenario for the loan and with more conventional guidelines. Qualification for these loans has been based on an absolute best case scenario i.e. an interest only payment based on a 40 year payment amortization ignoring past collections and other credit issues. The banks created this mess by basically offering free money and probably don’t deserve to be bailed out but the government has some responsibility to protect the economy.

    FHA does not make loans or hold the paper. All they do is provide an insurance policy for the lender against default. Since they are providing the insurance, they have the ability to dictate what they’ll insure and that is what is in negotiation now- what is an acceptable credit and payment history and what is not. FHA loans are bought and sold, held and serviced by all the major lenders.

    Fannie Mae and Freddie Mac buy the loans that meet their guidelines but do not lend.

    Liberty is about personal responsibility- from the individual to the corporation. The banks need to accept the responsibility as well as the people that accepted these loans.

    That personal responsibility also extends to becoming educated about the subject you choose to discuss otherwise, as it has been attributed to Mark Twain, it is better to be thought a fool than to open your mouth and remove all doubt. This lesson provided to you free of charge and absent of malice by a liberal