Saturday, November 1, 2008

Subprime Scam

A popular explanation for the subprime meltdown is that too many loans were made to uncreditworthy borrowers. Not necessarily.
"In New York City in 2005 and 2006 ... black "affinity marketing" mortgage brokers fanned out through the poorer areas, targeting homeowners with substantial equity in their homes. Edward Jordan, a seventy-eight-year-old retired postal worker, has owned his home since 1975 and was just a few years from paying off his mortgage. He was approached by a broker who told him that he was overpaying; she could get him a rate of only 1 percent. Jordan sought out another broker, who confirmed that that was so, and placed a mortgage for him with Countrywide. Total fees were $20,000.

"After the deal was closed, Jordan, who had trusted the brokers, discovered that the interest rate would quickly escalate to as high as 9.95 percent. When he complained to Countrywide, the firm's loss-mitigation group offered him an interest-only alternative, but at a higher rate, and with steadily escalating principal, so monthly payents would eventually rise to several times Jordan's income. Jordan, who lives solely on his pension, is now afraid he will lose his home. He also happens to have a credit score of 800, which places him among the 13 percent best credit risks in the country. On any construction of the deal, he was robbed by Countryside. The files of the legal services organization in the area where Jordan lives are bulging with cases like these. And the most active lenders were the big national players, like Countrywide, New Century (now bankrupt), and Fremont General."
The Trillion Dollar Meltdown, Charles R. Morris (70-71)

See also "Blaming the Poor" at Commonweal.


Fred said...

It makes me sick to hear such stories of lies and greed.

JACK said...

Actually, if you read the economists out there, they will tell you pretty uniformly that governmental policy had a role. None would pin this whole crisis on that (nor on the specific acts that might have happened under the CRA). But they certainly would point at it as a general symptom of the challenge created by artificially low interest rates. This is not to suggest that the whole thing is the result of bad governmental intervention. Any honest look at the securtization mania that Wall Street undertook can see evidence of market failures, of course.

Again, I can't emphasize enough the importance of analyzing a problem like this with as much detachment from ideology as we can muster. We should neither a priori rule out the lack of good regulation nor the presence of bad governmental action as contributing factors. We should also not lose the insight that Larry Lessig made popular in his work (and he'd hardly be classified anything other than a progressive) that there is more to regulating forces than government. (He always categorized it as law, mores, ethics and archictecture.)

I'd humbly submit that something as complex as an economic crisis in an economy as complex as this one will not be simply explained by a point to the presence of one bad law or the lack of some bit of regulation that, in hindsight, we think would have been sensible.

JACK said...

Oh, and just to clarify what I meant with regard to the CRA: I hardly think that's the linch pin of analysis. I think some are too eager to prove that more regulation is not needed (out of a concern that many bad regulations will come into play) and others are too quick to see regulation as an answer and have locked into a racism response to the CRA argument, not even giving it some merit in how certain components have some truth to it, especially in how the CRA's implementation changed over time. I object to the CRA line of argument because I think it distracts from a larger picture. But I think many who are attacking those pointing to the CRA are suffering from the same defects of ideological attachment as those offering up the CRA as the explanation.

Truth is, we will probably never know what all caused this crisis in terms of a "if we had only done this, none of this would have happened" kind of way.

I also think all conversation would be helped in the end if we were to admit that regulation can be good and bad and that the designation of an actor as "private" versus "public" really has no bearing on whether they will be responsible for good/bad effects in the marketplace.

Sharon Mollerus said...

My comments and example here are not offered as expert analysis, but to take note of lending problems which, especially during the heat of the election, have been frequently caricatured. Some very nasty usurious practices have cropped up which were not permitted when I was in college and when we were starting out.

JACK said...


I'm not arguing that there have been bad actors out there or bad practices. But we lawyers have a saying that "bad facts make bad law". The wisdom behind that statement is that often, in trying to respond to the justly recognized evils of a specific situation, the response is ill-advised and carries with it even worse consequences.

So, no, I certainly wasn't reacting to the specific example, but more the lead in.

You are certainly right that some practices wouldn't have been possible when you started out. Such as what made it possible for me to buy my house. (Although one might speculate on whether housing prices would have run up as much as they did making it necessary for me to use the types of strategies unheard of in past years to avoid paying PMI.) Whether the refinance scam that this unfortunate man suffered is one of them is not possible for me to tell without further investigation.

BTW, sub-prime originally just meant that the rates were below the prime rate. Most everyone who got a mortgage in the past 6 years is a sub-prime mortgage holder under the old definition. Somewhere along the line, people morphed the word and it came to refer to credit-worthiness. Interesting evolution.