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In a recent story published on BusinessWeek’s website, the subprime mortgage industry is taken under the microscope and picked apart, bit by scandalous bit. The article, entitled “Sex, Lies, and Subprime Lending,” presents many of the familiar excesses of subprime lending (pressure from investment banks and mortgage-backed securities brokers, data manipulation by loan officers) with a new twist: that’s right, a Babylonian saga of loan officers and mortgage lenders exchanging sexual favors for subprime loans to unqualified borrowers. For what purpose? Commissions of course.
At this point, it would be virtually impossible to further demonize the world of subprime lending. It doesn’t get much worse than the predatory and sinful actions that are described by the “Sex, Lies, and Subprime Lending” article. So do these tales of excess spell an end for the subprime lending industry?
The simple answer is yes and no. Everyone now understands that the much of subprime loan origination functioned on the sort of irrational exuberance that are often induced by bubbles in economies. That bubble is burst, and the lending practices that went along with it have all but disappeared. Subprime lending, however, has been in practice for over two decades, gaining traction in the 1980s after Congress eased lending laws for first-time home buyers. For a bubble to exist, there has to some sort of substantive material to prop it up.
An article written for Slate by Daniel Gray highlights a number of virtuous institutions in the business of lending to subprime borrowers, some of whom have also been able to turn million dollar profits for the services. These include credit unions and other community-based banks, and CDFI’s (Community Development Financial Institutions), and they do share a few things in common with the Ameriquests and Countrywides who are now infamous for inflating the housing bubble. Most significantly, they intentionally look past the credit scores of applicants in determining creditworthiness. Where they differ is what they look for in applicants, which is significant.
Where the Ameriquests and Countrywides were willing to manipulate and disregard data in order to originate loans, the CDFI’s simply used a different set of criteria when evaluating applicants. These criteria included their ratio of savings to income, affordability of the house in relation to income, and their ability to manage their budgets and monthly bills.
These institutions also do not incentivize lending or bundle and re-sell loans, and thus were able to avoid the excessive risk taken on by others in the subprime industry. Tellingly, their delinquency and foreclosures statistics are much lower than the national average. For example, compared to the national rate of subprime delinquencies as cited by the Mortgage Bankers Association, which is nearly 19 percent, the National Federation of Community Development Credit Unions delinquency rate is 3.1 percent. That is an absolutely staggering difference. For Clearinghouse CDFI, a California-based institution, the difference is even greater. Less than 1 percent of their subprime loans have been foreclosed on, compared to the national average, which is over 11 percent. Clearinghouse, a for-profit company, expects to report record profits, proof that trickle-up economic
While the era of the subprime bubble may have ended, responsible subprime lending will, and should be, a part of any healthy economy. For further macroeconomic insight into the virtues of this sort of lending, I would point you to the success and benefits generated by the microfinance industry in the developing world, for which Bangladeshi economist Muhammad Yunus won the Nobel Peace Prize 2006. Responsible microfinance lending, which conceivably includes the practice of subprime lending in the developed world, is an example of trickle-up economics having a perceivable and beneficial effect on society. And correct me if I’m wrong, but isn’t that why we chase the promise of economic growth?
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