“This lending freeze is not just preventing people like the Sleimans, who have struggled to document their income, from chasing their dreams. It’s bad for the overall economy too…
…Laurie S. Goodman, an expert in housing finance at the Urban Institute, a think tank in Washington, D.C., recently calculated that lenders would have made an additional 1.2 million loans in 2012 had they merely loosened standards to the prevailing level in 2001, well before the industry completely lost its sense of caution. As a result, fewer young people are now buying first homes, fewer older people are moving up and less money is changing hands. Instead of driving the economic recovery, the housing business is dragging behind. “An overly tight credit box means fewer individuals will become homeowners at exactly the point in the housing cycle when it is advantageous to do so,” Goodman and her co-authors wrote in their study, published in The Journal of Structured Finance. “Ultimately, it hinders the economy through fewer new-home sales and less spending on furnishings, landscaping, renovations and other consumer spending.”, Binyamin Appelbaum, “Are Subprime Mortgages Coming Back?”, New York Times Magazine
“It’s really tough to get mortgage and other consumer credit JUST RIGHT, for American borrowers and the economy. And it was wrong to blame the pre-crisis mortgage lenders, when it was a huge housing bubble and bust (that was experienced globally and therefore not primarily created by U.S. mortgage lenders) that caused an entire industry to fail all at once. Yes, the government-mandated “credit box” is far too tight right now and it needs to be loosened some. You want it to be more reasonable? One of the things that is going to need to happen is we need a “no income” loan for borrowers with solid down payments (20% or so) and excellent credit; there is a legitimate need for these equity-based home loans in our new, more self-employed economy. (By the way, the government’s FHA reverse mortgage is a no doc home loan: no income documentation, no assets required, and no credit checked.)”, Mike Perry, former Chairman and CEO, IndyMac Bank
Are Subprime Mortgages Coming Back?
SEPT. 9, 2014
Ali and Mariluci Sleiman wanted to buy a house. The couple, who run a day care service inside their first-floor rental apartment, had outgrown their space in Taunton, a small city in southern Massachusetts. They also wanted to avoid answering to a landlord who might complain about 10 little kids running around all day. They were “desperate to buy a home,” Ali told me. And with good credit and $46,000 in joint income, they hoped they wouldn’t have a hard time getting a loan. So they were disappointed when the bank rejected their application, and then when a local credit union did too.
Six years ago, a deluge of mortgage lending sparked a credit crisis that led to the worst financial meltdown since the Depression. Now, after years of chastened retreat, we are in the midst of a lending drought. Banks have ratcheted mortgage-qualification standards to the tightest levels since at least the 1990s. The federal government — seeking to formalize this new caution — has imposed a host of rules, starting with requiring banks to document that borrowers can repay the loans. “We’ve locked down mortgage lending to the point where it’s like we’re trying to avoid all defaults,” said William D. Dallas, the chairman of Skyline Home Loans, who has three decades of experience in the industry. “We’re back to using rules that were written for Ozzie and Harriet. And we’ve got to find a way to help normal people start buying homes again.”
This lending freeze is not just preventing people like the Sleimans, who have struggled to document their income, from chasing their dreams. It’s bad for the overall economy too. Laurie S. Goodman, an expert in housing finance at the Urban Institute, a think tank in Washington, D.C., recently calculated that lenders would have made an additional 1.2 million loans in 2012 had they merely loosened standards to the prevailing level in 2001, well before the industry completely lost its sense of caution. As a result, fewer young people are now buying first homes, fewer older people are moving up and less money is changing hands. Instead of driving the economic recovery, the housing business is dragging behind. “An overly tight credit box means fewer individuals will become homeowners at exactly the point in the housing cycle when it is advantageous to do so,” Goodman and her co-authors wrote in their study, published in The Journal of Structured Finance. “Ultimately, it hinders the economy through fewer new-home sales and less spending on furnishings, landscaping, renovations and other consumer spending.”
It seems, in other words, as if it might be time for the revival of the subprime-lending industry. Long before these risky loans were blamed, in part, for helping usher in the financial crisis, subprime lending was embraced as a promising antidote to the excessive caution of mainstream lenders. After all, key mortgage rules were first written in the middle of the last century, and they still reflect old-fashioned economic assumptions. It’s still easiest to qualify for a mortgage if a household has one primary breadwinner who is paid a regular salary, has a history of repaying other loans and has enough money saved or inherited to make a significant down payment. Indeed, mainstream lenders have a long history of using race as a proxy for risk, like the refusal to lend in entire “redlined” neighborhoods. Last week, the attorney general’s office in New York filed suit against a Buffalo lender, Evans Bank, saying it redlined an area of east Buffalo that is home to more than 75 percent of the city’s African-Americans. (Evans Bank has denied this charge.) Similar lawsuits have recently been filed in Los Angeles and Providence, R.I. Goodman and her colleagues found that those excluded from credit in 2012 were disproportionately African-American and Hispanic households.
The subprime solution has always been relatively simple. Instead of offering fixed terms to anyone who meets “prime” standards, terms are tailored to borrowers. People who are judged less likely to repay loans are charged a proportionately higher interest rate. Before things got out of hand during the last decade, subprime lending offered opportunity for many people, including minorities and immigrants, whose economic lives, like the Sleimans’, did not conform to the mortgage industry’s traditional expectations.
Most subprime borrowers continue to repay their debts and live in their houses. But even in the industry’s heyday, subprime lending had critics who argued that it deepens underlying economic inequalities between those with money and those who must borrow it. They would prefer to focus on improving economic opportunities or loosening restrictions on housing construction in desirable areas, like coastal cities, where prices are highest. And their arguments have certainly been buttressed by an industry that has a habit of behaving badly — overcharging customers who cannot easily tell the difference between a reasonable-risk premium and an inflated interest rate and persuading investors to pump money into those loans.
The new subprime lenders, however, seem to be trying to rebuild their business in a more cautious manner. Dallas, who created a lending company during each of the last two booms — each time selling before the crash — said that his new venture, Skyline Home Loans, spends about $3,500 on compliance per loan and only approves about two a day. Before the crisis, he told me, he didn’t spend a penny, and a typical underwriter approved 10 loans. Gone, he insists, are the days “where nobody looks at your income or your credit.” He suggested that he was helping some of those 1.2 million deserving Americans become homeowners.
Some experts also agree that access to lending should be broadened. But in order to protect borrowers, stronger institutional measures must be taken. One approach would change the rules of bankruptcy, which currently allow judges to reduce the burden of most kinds of debt but, notably, not primary home mortgages. Jennifer Taub, a professor at Vermont Law School, argues that changing this law would keep lenders on good behavior because they wouldn’t want to end up at the mercy of a bankruptcy judge. “If everyone knows that these are the rules of the game,” Taub told me, “there will be a lot more attention to make sure that the underwriting is proper.” Amir Sufi, an economist at the University of Chicago, and Atif Mian, an economist at Princeton, have proposed a slightly more ambitious plan. During broad economic downturns, they suggest, mortgage payments should automatically drop as area home prices fall. In exchange, lenders would get a share of eventual profits if the price of a home eventually rose again.
In truth, the benefits of homeownership are often overstated. Home values have climbed only a little faster than inflation over the last 125 years, according to data compiled by the Yale University economist Robert Shiller. The kind of house that sold in 1890 for the inflation-adjusted equivalent of $100,000 would sell today for about $134,000. Still, Americans just want to buy them. A recent poll found that 76 percent of Americans considered homeownership “necessary” to be a member of the middle class. When I asked the Sleimans why they wanted to move, their answer was as emotional as it was practical. “This is a good property, but it’s not ours — it’s a rented home,” Ali Sleiman told me. “It does not fit our needs. Or our dreams.” And as long as that is the case, it makes sense for public policy to focus on safety rather than abstinence.
Correction: September 9, 2014
An earlier version of this column misstated part of the name of the law school where Jennifer Taub is a professor. It is Vermont Law School, not the University of Vermont Law School.
Binyamin Appelbaum is an economics reporter for The Times.
A version of this article appears in print on September 14, 2014, on page MM18 of the Sunday Magazine with the headline: Subprime Time?.