Ability To Pay, Not Lack Of Income, Should Be The Lending Standard
Ability To Pay, Not Lack Of Income, Should Be The Lending Standard
Excellent piece by Steven Malanga on City Journal, showing how we've been through this before, starting with Hoover -- the folly of lending to people who don't have the income to justify to a lender to lend to them.
He writes, in "Obsessive Housing Disorder":
Congress passed a bill in 1975 requiring banks to provide the government with information on their lending activities in poor urban areas. Two years later, it passed the Community Reinvestment Act (CRA), which gave regulators the power to deny banks the right to expand if they didn't lend sufficiently in those neighborhoods. In 1979, the Federal Deposit Insurance Corporation (FDIC) rocked the banking industry when it used the CRA to turn down an application by the Greater New York Savings Bank to open a branch on the Upper East Side of Manhattan. The government contended that the bank didn't lend enough in Brooklyn, its home market....The next stop on the road to 2008 was a fateful campaign to lower lending criteria, which, the housing advocates argued, were racist and had to change. The campaign began in 1986, when the Association of Community Organizations for Reform Now (Acorn) threatened to oppose an acquisition by a southern bank, Louisiana Bancshares, until it agreed to new "flexible credit and underwriting standards" for minority borrowers--for example, counting public assistance and food stamps as income. The next year, Acorn led a coalition of advocacy groups calling for industry-wide changes in lending standards. Among the demanded reforms were the easing of minimum down-payment requirements and of the requirement that borrowers have enough cash at a closing to cover two to three months of mortgage payments (research had shown that lack of money in hand was a big reason some mortgages failed quickly).
...As the volume of lending to low-income borrowers increased, the loans became big business. And slowly, the industry began pitching the loans with the same language that the government and activists had long used, and promoting the same debased lending standards. A 1998 sales pitch by a Bear Stearns managing director advised banks to begin packaging their loans to low-income borrowers into securities that the firm could sell, according to Stan Liebowitz, a professor of economics at the University of Texas who unearthed the pitch. Forget traditional underwriting standards when considering these loans, the director advised. For a low-income borrower, he continued in all-too-familiar terms, owning a home was "a near-sacred obligation. A family will do almost anything to meet that monthly mortgage payment." Bunk, says Liebowitz: "The claim that lower-income homeowners are somehow different in their devotion to their home is a purely emotional claim with no evidence to support it."
...Any concern that regulators should tighten standards as the loan volume expanded was quickly dismissed. When in early 2000 the FDIC proposed increasing capital requirements for lenders making "subprime" loans--loans to people with questionable credit, that is--Democratic representative Carolyn Maloney of New York told a congressional hearing that she feared that the step would dry up CRA loans.
...What made it easier to dismiss such ominous failures was that some of the nation's most prestigious financial regulators and researchers, including the Federal Reserve Bank of Boston, got behind the movement to loosen lending standards. In 1992, the Boston Fed produced an extraordinary 29-page document that codified the new lending wisdom. Conventional mortgage criteria, the report argued, might be "unintentionally biased" because they didn't take into account "the economic culture of urban, lower-income and nontraditional customers." Lenders should thus consider junking the industry's traditional income-to-payments ratio and stop viewing an applicant's "lack of credit history" as a "negative factor." Further, if applicants had bad credit, banks should "consider extenuating circumstances"--even though a study by mortgage insurance companies would soon show, not surprisingly, that borrowers with no credit rating or a bad one were far more likely to default. If applicants didn't have enough savings for a down payment, the Boston Fed urged, banks should allow loans from nonprofits or government assistance agencies to count toward one. A later study of Freddie Mac mortgages would find that a borrower who made a down payment with third-party funds was four times more likely to default, a reminder that traditional underwriting standards weren't arbitrary but based on historical lending patterns.
Read the whole thing over at CJ.
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