Subprime lending misconceptions

By Kevin M. Cuff  |  July 22, 2007

EVEN MORTGAGE lenders cannot get their arms around the dramatic changes in the industry over the past several months. The fall of the subprime mortgage market and the subsequent resetting of underwriting guidelines, increases in foreclosure filings, and consumer anxiety have been dramatic to both borrower and lender alike.

During the past year, nearly 50 subprime lenders nationwide have gone out of business primarily because of aggressive purchases or writing mortgages that investors were not willing to fund. Community activists, state regulators, and legislators have demanded answers from the industry as to why and how this happened and what will be done to remedy affected homeowners.

The complexities of the mortgage market have fostered many misconceptions, particularly of the subprime market.

Subprime lending sprang up overnight.

Today's subprime mortgage market was the result of innovative yet high stakes political decisions by President Bill Clinton and Housing and Urban Development Secretary Henry Cisneros to push homeownership to record levels. Homeownership gains were not to be made on the backs of conventional borrowers but rather through emerging market penetration of black, Latino, and Asian immigrant/first-time home buyers and through HUD's instruction of the Government Sponsored Enterprises of Fannie Mae and Freddie Mac to employ strategies to fund more loans by providing more credit primarily to credit-blemished borrowers. Wall Street was guided by Federal Reserve Chairman Alan Greenspan, whose economic wizardry spurred unprecedented loan performance. There was more money, more credit, more homes, and more wealth.

So what happened? Primarily, the real estate market cooled. Following unprecedented productive years (857,000 loans closed in Massachusetts in 2005), there were fewer new borrowers. Mortgage professionals were left to fight for every loan. Companies overextended themselves, and Wall Street began to refuse the responsibility for underperformance. Crash!

Subprime lending is predatory.

As complex as the policy was to increase homeownership, it is equally complex to distribute blame for its failing. Mortgage brokers steered borrowers to loans that they could not afford. Appraisers inflated their objectivity under lender pressure to drive real estate prices. Lenders relaxed underwriting standards and failed to uphold the consumer's ability to repay. Real estate agents drove up market prices because mortgage rates were at historic lows. Wall Street bought securities regardless of underwriting standards because of performance. Government regulators were driving toward unattainable homeownership levels. And consumers wanted loan amounts to feed their lifestyle and housing wants, disregarding prudence in favor of the bigger.

Subprime lending is prejudicial.

For more than 30 years, the lending industry has embraced a pricing system based upon risk. Today, there is a diversity of product and a network delivery system contributing to a saturation of credit, from banker, lender, and broker. The subprime market emerged and thrived through a cocktail of sophisticated credit delivery to the underserved, coupled with performance through higher pricing. In a strong real estate market, consumer and lender alike celebrate this formula. Critics of the risk-based system however, are quick to fault denial of access in the boom years and racism (redlining) in the bust. Industry acceptable census track information provided by the Home Mortgage Disclosure Act shows that conventional loan denials of black and Latino borrowers over 60 percent of the time are due to poor credit and debt/income ratios regardless of income.

The mortgage market does not care about consumers. The Massachusetts mortgage industry has supported corrective actions to the subprime market on every front. It has warned consumers of its peril through a major media campaign. It has participated with regulators in proposing greater barriers to entry. It has supported the licensing, preparation, education, and testing requirements for residential mortgage loan officers. It has called for (and received) a summit of the state's top foreclosers in order to negotiate cram downs and structure a refinancing program. It has called on the state lending agency, MassHousing, to join in efforts to provide greater access to refinance programs for distressed borrowers. It has partnered with community organizations in support of home-buying counseling and financial literacy. And, it has considered community-lending programs that would provide the appropriate types of loans to the appropriate consumers.

A reformed subprime market is here to stay. The demand for access to credit and the overall performance of subprime loan pools articulating the consumer's ability to repay outweigh any argument denying access. Over regulation of the industry would result in greater denial of access and restrict mostly eligible low to moderate income black and Latino first-time homebuyers. This would result in racial disparities in mortgage lending.

There is much to be done to improve mortgage lending, but the biggest disservice to consumers would be a retraction of access to credit, which would deny many the chance to live the American dream.

Kevin M. Cuff is executive director of the Massachusetts Mortgage Bankers Association and chairman of the Massachusetts Fair Lending Coordinating Committee.