Consumer Law & Policy Blog

Costs and Benefits of Subprime Lending

By Alan White

The new paper by Todd Zywicki and Joseph Adamson reasserts the received wisdom that subprime mortgage lending had significant consumer welfare benefits, specifically that it increased homeownership and provided access to credit to previously excluded groups. I was disappointed to find that the sources cited do not provide any more empirical support for this folk wisdom than has been previously offered elsewhere. I have argued that subprime mortgage lending did no such thing, i.e. was in no way responsible for the slight increase in homeownership in the 1995 to 2005 period (homeownership is now going down, thanks to subprime foreclosures), in a paper I posted a while back. In my view, subprime mortgage lending had the net impact of reducing homeownership, and displacing cheaper and better home financing, especially for low-income and minority groups. I tried to survey the available research and empirical data and to look at other variables that have affected homeownership and the volume of consumer credit in the relevant period, including data from the Survey of Consumer Finances, the Census Housing Survey and other available sources. If it were true that subprime mortgages had produced significant welfare benefits, then I would agree with the conclusion that regulation needs to proceed carefully. I don't believe the evidence is there, if the question is examined carefully, although I am very interested in seeing empirical evidence to support the hypothesis that subprime mortgages improved aggregate welfare. A note on the specific sources in the continuation.

The Law and Economics of Subprime Lending

Todd Zywicki and Joseph Adamson of George Mason have a new article at SSRN offering a conservative law-and-economics take on the subprime mortgage lending crisis. After a lot of back and forth, the paper's basic point is that policymakers shouldn't do anything in response to the current crisis until we know much more about how to "balance the cost and benefits" of subprime lending. Here's their abstract:

The collapse of the subprime mortgage market has led to calls for greater regulation to protect homeowners from unwittingly trapping themselves in high-cost loans that lead to foreclosure, bankruptcy, or other financial problems. Weighed against this catastrophe are the benefits that have accrued to millions of American families who have been able to become homeowners who otherwise would not have access to mortgage credit. Although the bust of the subprime mortgage market has resulted in high levels of foreclosures and even problems on Wall Street, the boom generated unprecedented levels of homeownership, especially among young, low-income, and minority borrowers, putting them on a road to economic comfort and stability. Sensible regulation of subprime lending should seek to curb abusive practices while preserving these benefits.

This article reviews the theories and evidence regarding the causes of the turmoil in the subprime market. It then turns to the question of the rising foreclosures in that market in order to understand the causes of rising foreclosures. In particular, we examine the competing models of home foreclosures that have been developed in the economics literature - the "distress" model and the "option" model. Establishing a correct model of the causes of foreclosure in the subprime market is necessary for sensible and effective policy responses to the problem. Finally, we review some of the policy initiatives that have been suggested in response to the crisis in the subprime market. Because new regulatory interventions will have costs as well as benefits, until the causes of the market‘s problems are better understood it may be that the best policy in the short-term is to do little until well-tailored regulatory approaches are available.

Huge Upswing in Credit Card Borrowing

by Christopher Peterson

New fed numbers are out showing Americans sucked down 6.9 billion dollars in new credit card debt, increasing outstanding consumer credit to $2.52 trillion during the month of January. This increase was double the $3.7 billion increase in the previous month of December--despite holiday sales.

This seems like a very ominous development to me. One suspects that this increase in borrowing is causally related to credit tightening in mortgage and home equity lending, and also that consumers facing foreclosure are turning to credit cards to stave off financial collapes. Distressed debtors that are shifting their living expenses into credit card borrowing are going to face high default interest rates and could be setting themselves up for a harder fall.

I hope the credit card lenders have their models figured out. As financial refugees from the mortgage market flee into the waiting arms of credit card lenders, it seems like there is the potential for subprime securitization problems to echo into credit card receivables. January's increase in credit card borrowing makes me wonder if the normally sophisticated credit card lenders' underwriting may finally come up short. Just a tip to all those Norwegian villagers, hedge fund managers, and investment bankers hoping to not look like Bear Sterns: Post-bubble vintage credit card recievable backed securities are a sucker bet.

Check out Patrick Deneen's interesting blog post for more thoughts.

Bushvilles springing up

The Consumerist today features a BBC video making the rounds of the blogosphere. The video reports on tent cities springing up in Southern California, occupied by former homeowners, victims of the foreclosure crisis. Another video report on the phenomenon is here. Reuters wrote a story on the tent cities in December. Today's L.A. Times story details the efforts of Ontario CA officials to keep the population of its tent city under control. Update: Here is a a story about a Nevada family camping out after their home was foreclosed.

We Need a Single Agency to Regulate Consumer Credit Transactions

by Jeff Sovern

Today's edition of the Pittsburgh Post-Gazette has an essay I wrote which they gave the headline "The Private Sector: U.S. Needs Agency to Watch Consumer Credit."  It appears below.  In the version below, I reinserted, in brackets, a sentence that the paper deleted (which may be more meaningful to readers of this Blog than the general public anyway).

As proposals proliferate to address the subprime mortgage crisis, and as the crisis itself spreads beyond subprime loans, it may help to step back and ask a fundamental question: What government agency is responsible for regulating consumer credit transactions?

The answer, unfortunately, is almost as complicated as the mortgage crisis itself -- and that in turn has contributed to the problem.

At the head of the list is the Federal Reserve Board, which has the power to bar some predatory lending practices and also fashions rules governing what lenders have to tell borrowers about loan terms. The theory is that these disclosures will enable consumers to avoid unwise borrowing (worked well, didn't they?).

These disclosure rules are enforced by the Office of the Comptroller of the Currency (OCC), the Fed itself, the Federal Deposit Insurance Corp. (FDIC), the Office of Thrift Supervision (OTS), the National Credit Union Administration Board (NCUA) and the Federal Trade Commission (FTC), among others. The OCC also claims the power to prohibit some lenders from engaging in predatory lending. The FDIC originated the Bush administration plan to freeze so-called "teaser rates," while the Treasury Department shepherded the plan through.

Confused yet? It gets worse. When states attempted to prohibit predatory lending, the OCC, OTS and NCUA all ruled that the state laws did not apply to federal lenders. Federal courts have upheld this position, while state lenders, which preferred to be free of the state laws, surrendered their state charters and became federal lenders, immunizing them from state law. [Georgia, not to be outdone, provided that its own state predatory lending statute was preempted as to Georgia lenders as well.]

What Happened to the Arbitration Clauses in the Subprime Litigation?

Last week, Alan blogged here about the Navigant Consulting Report on suits by consumers, among others, against subprime lenders.  The Times covered the report today in an article here.  I'm wondering how borrowers have been able to file these suits.  Did the loan agreements not include arbitration clauses?  If they did, how have the borrowers managed to get around them?  Or is it just that the lenders haven't yet moved to dismiss on the ground that the matter should be heard by an arbitrator?  Anyone know?

Frank proposes FHA short refi bill

Congressman Barney Frank, Chair of the House Financial Services Committee, has announced a mortgage rescue plan: a bill to permit FHA to insure refinance mortgages. The discussion draft is available here. FHA would insure new mortgages for up to 90% of the current home value, on condition that the existing mortgage holders agree to write down the existing mortgage debt to that amount. Eligible homeowners would be owner-occupants financially unable to make payments on their current mortgage(s), and may be delinquent on their current mortgage. An intriguing new auction process would allow existing mortgage holders to bid for refinance guarantees for a reduced principal payoff. The bill separately authorizes grants and loans to states for purchasing foreclosed homes, to prop up the housing market and deal with housing abandonment.

While the Bush administration has opposed bailouts, the proposal is conceptually similar to the one being offered by John Reich, director of the Office of Thrift Supervision.

Times Articles on Subprime Crisis, Debt Collection, the CPSC Bills, Reverse Mortgages, and Online Privacy

I've accumulated a huge backlog of recent Times articles on consumer law issues, so here goes an attempt to reduce the backlog.

Many of the articles involve the mortgage crisis and plans to do something about it.  For example, the lead article in today's Times is headlined "White House Offers Plan to Ward Off Credit Crisis."  Here's an excerpt:

The plan, which relies primarily on state regulators and private industry to tighten their oversight of financial markets, calls on states to issue nationwide licensing standards for mortgage brokers.

The plan would also require lenders to make more complete disclosures about payment terms to home buyers. And it would curtail possible conflicts of interest at companies that assign levels of risk to packages of mortgages that are sold to investors.

* * *

But in many ways, the plan relies on the same market participants — from mortgage brokers to credit-rating agencies and Wall Street firms — that government officials and other experts blame for the current crisis.

Desparately Seeking Data

By Alan White

Unlike many other economic indicators, foreclosures are not surveyed or reported by the Federal Reserve, the Bureau of Labor Statistics, or any government agency. Trying to measure the extent of the problem requires Google skills and detective work. Two recent reports from HOPE NOW and the states' Foreclosure Prevention Working Group offer some clues but leave many important questions unanswered. For example, many investors around the world would like to know not only how many homes are foreclosed and how many mortgage loans have been modified but also the loss severities, i.e. just how much less than the mortgage balance is recovered on foreclosure sales. These data are available only in hard-to-get monthly remittance reports for individual pools of mortgages.

The two available reports on foreclosure outcomes tell somewhat different stories. HOPE NOW tells us seemingly good news, that in the fourth quarter of 2007 nearly as many mortgage loans were modified (141,000) as were terminated with a foreclosure sale (147,000). The state regulators, on the other hand, tell us that for the month of October 2007, 126,000 foreclosure sales were completed and only 27,300 mortgages were modified. The Fed yesterday sent a letter encouraging banks to report their foreclosure prevention efforts voluntarily in a uniform manner, but has not yet taken on responsibility for compiling and reporting this critical information.

Should Congress step in with federal aid to purchase or refinance mortgages? How deep will the losses ultimately be? Should foreclosures be delayed to permit more time for workouts? A well-designed, objective and timely (preferably monthly) government survey of foreclosure activity and losses would be extremely helpful in answering these important questions.

Of Bailouts and Rescues

By Alan White

Today's Wall Street Journal reports that Treasury Secretary Paulson, on behalf of the Bush Administration, categorically rejects any plan to "bail out" homeowners facing foreclosures with federal dollars, displaying a remarkable blind faith in the unregulated market in the face of an unfolding catastrophe. While it would be foolish to write Treasury checks to pay off inflated mortgage balances on depreciating homes, no one is suggesting such a plan. Several rescue proposals would provide loans to homeowners, not handouts, and would require investors to absorb losses, not reward their recklessness.

As my colleague Jeremy Telman points out on the ContractsProf blog, there is little coherence to the Administration's position on "bailouts" -- they also call the bankruptcy strip-down bill a "bailout", although it would actually force investors to absorb more losses in Bankruptcy court, and require homeowners to repay their loans.

The savings and loan bailout of the 1980s required payment in full, ultimately by taxpayers, of the (mostly commercial) mortgages involved, because the capital came from S&L depositors, whose deposits were FDIC and FSLIC insured. In contrast, the investors in subprime mortgages bought mostly uninsured securities (although the private bond insurers who backed some subprime deals are now in trouble, creating problems for other parts of the economy and prompting proposals to bail out the insurance companies.) Sensible rescue plans call for mortgage balances to be reduced to the current deflated value of the home before being refinanced or restructured, either by a Federal lender like the old HOLC or Federally-insured lenders under the FHA program. The haircut on the mortgage balance will result in losses to the investors, not a bailout. Properly managed, a rescue program would mitigate investor losses by avoiding the cost and delays (and further home value losses) of foreclosures, and would stabilize home values, by preventing more foreclosed homes from coming on the market and driving prices down further. While some rescue plans would leave investors with their losses, others would provide investors some upside recovery if the homes' values went back up and homeowners eventually sell at a profit. Obviously, the devil is in the details. The announcement of the plan, and the negotiation of mass mortgage buyouts, will have a significant effect on home values.

The alternative, doing nothing, means that we will continue to see 10 foreclosures for every loan modification, that the homes with brown grass and for sale signs will continue proliferating, and that the financial system's downward spiral will continue.