the case for banning subprime mortgages

7/31/2019 The Case for Banning Subprime Mortgages

1/38Electronic copy available at: http://ssrn.com/abstract=1133609

VALPARAISO UNIVERSITYSCHOOL OF LAW

LEGAL STUDIES RESEARCH PAPERSERIES

May 2008

(Draft)The Case for Banning Subprime Mortgages

FORTHCOMING,U.CIN.L.REV.(2008)

Alan M. White

This article can be downloaded from http://ssrn.com/abstract=1133609



THE CASE FORBANNING SUBPRIME MORTGAGES

Alan M. White

Abstract

While the subprime mortgage boom was in full swing, itsbenefits to American society were widely touted. Subprimemortgages were said to have increased homeownership. Thesubprime effect was supposed to have been especially strong forlow-income and minority families previously unable to buy homes.The democratization of credit was also attributed to subprimemortgages.

The empirical data do not support these welfare claims. TheU.S. homeownership rate increased somewhat between 1994 and

2007. Subprime mortgages, however, were mostly made toexisting homeowners to refinance debt; very few were made tofirst-time home buyers. The number of homes lost due to subprimeforeclosures significantly exceeded the new homeowners added bysubprime mortgages. Subprime mortgages also displaced the saferand lower-cost FHA loans that would otherwise have been made.Conventional prime mortgages for purchases fully accounted forthe observed increase in homeownership.

The welfare harms caused by subprime mortgage lending arereadily measurable. They include the direct impact of more than

two million foreclosures on families, the resulting property valuelosses, the social and fiscal impact on cities where subprimemortgages were concentrated, the price discrimination resulting inblack and Latino homeowners paying unnecessarily high rates,and the broader impacts on the credit markets and the economy.

The disastrous consequences of subprime mortgage lendingwere in part the result of deregulating mortgage interest rates.

Assistant Professor of Law, Valparaiso University, B.S. Mass. Inst. ofTech., J.D. N.Y. University. Thanks to Britt Gwinner of the World Bank,

Kathleen Keest and Keith Ernst of the Center for Responsible Lending, andJoachim Duebel of Finpolconsult for their comments.



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Similar harms can be prevented in the future by re-imposingreasonable interest rate limits on first-lien mortgages. FHAshould be restored to its role as the primary provider of mortgagesto first-time, low- and moderate-income home buyers.

I. INTRODUCTION

Imagine a home loan bank. A bank with a better idea. Insteadof hiring armies of underwriters with green eyeshades to size uploan applicants, scrutinize their documents, calculate their incomeratios, and turn down lots of requests, this bank will use a newapproach. Everybody gets a mortgage. The bank will want anappraisal of your home. So long as the loan (or the combination ofloans) is for less than the home value, your loan is approved. Allyou have to do is sign a piece of paper certifying that you theborrower are convinced that you can afford to repay the loan. The

payments will not fully amortize the loan, but you can refinancelater. The bank will give you detailed documents explaining howthe loan works, and will rely entirely on you to decide whether youcan afford it. If you miscalculate,1 it is your own fault, not thelenders.

The only catch? The interest rate will be 3% to 5% higher thanfor prime loans, and the origination fees will be considerablyhigher as well. This higher price, combined with lax underwritingand risky product features, rather than any distinguishing borrowercharacteristics, is what sets this bank apart from its competitors.

This imaginary bank became real in the U.S. between 1994 and2007. By the time the music stopped, the Bank of Subprime madeover a trillion dollars in loans.2 After the music stopped, there was

1 Behavioral science research suggests that borrowers will consistentlyoverestimate their ability to repay loans, underestimate the probability of lifeevents that would prevent repayment, and discount future payment obligationshyperbolically. See Lauren E. Willis, Decisionmaking and the Limits of

Disclosure: The Problem of Predatory Lending: Price, 65 MD. L. REV. 707

(2006).2 Damian Paletta & James R. Hagerty,Fed's New Rules On Mortgages Draw

Hostility WALL ST.J., Dec. 19, 2007, at A1.


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BANNING SUBPRIME MORTGAGES 3

a run on the Bank, and by December 2007 it was virtually shutdown.

3

Was the Bank of Subprime a good idea? The events of thesecond half of 2007 in the U.S. credit markets have demonstrated

that it was not. Subprime mortgage lending as constructed from1995 to 2007 did far more harm than good, was much worse thanavailable alternatives, and should be prevented from ever comingback. This form of housing finance and consumer credit should bereplaced with something else entirely.

The fundamental principle, now to be written into law by theFederal Reserve Board,4 that banks lending other peoples moneyshould take care to determine that the borrowers can pay it back,went out the window in the subprime mortgage lending spree.Between 1994 and 2006 subprime lending volume grew from $35

billion to $600 billion a year, and to 23% of all mortgage dollarslent in America.5 By the third quarter of 2007, 24% of allsubprime loans, and 30% of subprime adjustable-rate loans, wereeither delinquent or in foreclosure.

6

While the warning signs of the foreclosure crisis were clear bylate 2006,

7subprime loans continued to be securitized in large

3 Id.; Subprime Rebound Not Expected Any Time Soon, INSIDE B&CLENDING, Dec. 14, 2007.4 Truth in Lending, 73 Fed. Reg. 1672 (proposed Jan. 9, 2008) (to be codifiedat 16 C.F.R. pt. 226).5 ELLEN SCHLOEMER, WEI LI, KEITH ERNST & KATHLEEN KEEST, CENTERFOR RESPONSIBLE LENDING, LOSING GROUND: FORECLOSURES IN THESUBPRIME MARKET AND THEIR COST TO HOMEOWNERS 7 (2006),http://www.responsiblelending.org/pdfs/foreclosure-paper-report-2-17.pdf.6 MORTGAGE BANKERS ASSOCIATION OF AMERICA,NATIONAL DELINQUENCYSURVEY Q307 (2007). Delinquencies and foreclosures are reported separatelyby MBA, and neither category includes the loans in the other. Thus, to say that19.59% of subprime ARMs were delinquent on September 30, 2007 is a half-truth because it does not include the additional 10.38% that were in foreclosure(and therefore also delinquent).7 Monica Perelmuter, Standard and Poors Reexamines Risks of Early

Payment Defaults in U.S. RMBS, Standard and Poors, Jan. 23, 2007,

http://www2.standardandpoors.com/spf/pdf/events/SPRexaminesRisksofEarlyPaymentDefaults.pdf.


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numbers until August 2007. In the first quarter of 2007, subprimeloan securitizations were running at the brisk clip of $100 billionper quarter. From September 2007 through December 2007, lessthan $30 billion in subprime mortgages was securitized.

8Most of

those were underwritten to the standards of FNMA and Freddie

Mac or FHA, meaning that the true, nonconforming subprimemortgages have virtually disappeared, apart from the banks that arewilling to use their own capital to make them.9

How could such an obviously flawed lending model survive forso long? The reasons are numerous and complex.10 The keyfactors included the deregulation of usury limits for mortgages,11the fragmentation of mortgage underwriting, origination, servicingand investment as a result of securitization, and the failure of U.S.regulators to protect either investors or consumers in this market. 12Until 2007, these problems remained below the surface, because

8 Research Report, SEC. INDUSTRY. & FIN. MARKETING ASSN RES. Q.(SIFMA, New York, NY), Nov. 2007, at 5-6, http://www.sifma.org/research/pdf/Research-Quarterly-1107.pdf. Note that SIFMA defines subprimemortgage-backed securities as home equity loan asset-backed securities (ABS),and includes only jumbo and Alt-A securitizations in its definition of RMBS(residential mortgage-backed securities.) Not all reports categorize agencyRMBS, jumbo (i.e., prime mortgages whose amounts exceed the Fannie andFreddie limits), Alt-A and subprime in the same manner, resulting indiscrepancies in the reported numbers for volume and market share of eachsector in any given year or quarter. Another industry newsletter reported thatsubprime securitization volume declined from $24 billion in June 2007 to $7billion in October 2007. INSIDE MBS&ABS 2, Nov. 23, 2007.9 Countrywide, the largest originator of subprime loans in 2006, announcedthat its subprime loan originations for October 2007 were $42 million, comparedto $3 billion in October 2006. Countrywide Reports Fewer Loans for October,N.Y.TIMES, Nov. 14, 2007, at C1.10 John Kiff & Paul Mills, Money for Nothing and Checks for Free: Recent

Developments in U.S. Subprime Mortgage Markets (IMF Working Paper No.07-188 2007), available at http://ssrn.com/abstract=1006316; EDWARDGRAMLICH, SUBPRIME MORTGAGES: AMERICAS LATEST BOOM AND BUST(2007).11 Cathy Lesser Mansfield, The Road to Subprime HEL Was Paved withGood Congressional Intentions: Usury Deregulation and the Subprime Home

Equity Market, 51 S.C.L.REV. 473 (2000).12. Yuliya Demyanyk & Otto van Hemert, Understanding the Subprime

Mortgage Crisis (February 4, 2008), http://ssrn.com/abstract=1020396.


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no matter how many mortgages went unpaid, losses on subprimemortgages remained at apparently acceptable levels. A typicalsecuritized pool of subprime mortgages in this period, while itconsisted mostly of 30-year loans, was paid off in five to sevenyears, because of prepayments. During the life of these mortgages,

as many as one of every eight mortgages ended in foreclosure,13but the aggregate losses to investors typically were less than 5%for the life of the loan pool, or less than 1% per year. 14 Whileprepayments make the math a bit more complex than might beapparent, it was not too difficult to calculate how much extrainterest needed to be charged during the five to seven years tocover losses equal to 5% of, for example, a $1 billion loan pool.Subprime borrowers were persuaded to pay 300 to 500 basis points(3% to 5%) more than the going price for prime mortgages,

15only

a small fraction of which was needed to cover losses.

This system worked only for so long as loan pools could havelifetime default and foreclosure rates approaching 15%, while onlylosing 5% of the original principal. Once home values reachedtheir maximum, and every conceivable unsustainable, interest-onlyor negatively amortizing mortgage was made, the pyramid schemeinevitably collapsed. The subprime mortgage loans made in 2006are projected to result in investor losses of 10% or more toprincipal.

16Subprime loans made in 2007 are looking even

worse.17

13 Schloemer,supra note 5, at 11.14 Alan M. White, Risk-Based Pricing: Present and Future Research, 15HOUSING POLY DEBATE 503,507-08(2003).15 GRAMLICH,supra note 10, at 17.16 Glenn Costello, Drivers of 2006 Subprime Vintage Performance, FitchRatings, Oct. 2007, at 7, available at http://www.fitchratings.com/corporate/reports/report_frame. cfm?rpt_id=353344.17 Ariel Weil & Arnita Shrivastava, US Subprime Mortgage Market Update:September 2007, MOODYS, 2007, available at

http://www.moodys.com/moodys/cust/research/mdcdocs/03/2007000000444240.pdf?frameofref=structured.


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[MARCH 2008]6

I. THE WELFARE EFFECTS OF SUBPRIMEBENEFITS

While the Subprime boom was in full swing, its benefits toAmerican society were widely touted. Subprime mortgages, it wassaid, had increased homeownership.18 The increase had been

especially good for low-income and minority families previouslyunable to buy homes.19 The making of loans to people who hadpreviously demonstrated an inability to handle credit was touted asdemocratization of credit, an appealingly inclusionary value.While some expressed concern in the early part of the period aboutforeclosure rates, the benefits of subprime were widely believed tooutweigh the harms.

20

The problem with this received wisdom about the welfareeffects of subprime is that it was taken on faith. None of theproponents was ever asked to substantiate these claims empirically,

and if they had been, the task would have proved to be daunting.Before turning to a discussion of what kind of mortgage marketregulators and lawmakers should shape in the future, it is essentialto assess the magnitude of the real benefits and the real costs thatthe Bank of Subprime imposed.

18 E.g., Legislative and Regulatory Options for Minimizing and MitigatingMortgage Foreclosures: Hearing Before the H. Comm. on Financial Services,110th Cong. (2007) (testimony of Ben S. Bernanke, Chairman, Fed. Res.) (Theresulting increase in the supply of mortgage credit likely contributed to the risein the homeownership rate from 64 percent in 1994 to about 68 percent nowwith minority households and households from lower-income census tractsrecording some of the largest gains in percentage terms.). A few monthsearlier, the Chairman was less equivocal: The expansion of subprime mortgagelending has made homeownership possible for households that in the past mightnot have qualified for a mortgage and has thereby contributed to the rise in thehomeownership rate since the mid-1990s. Ben S. Bernanke, Speech before theFederal Reserve Bank of Chicagos 43rd Annual Conference on Bank Structureand Competition (May 17, 2007), available at http://www.federalreserve.gov/newsevents/speech/ bernanke20070517a.htm.19 GRAMLICH,supra note 10, at 2-3.20 See, e.g., Predatory Lending Practices: Hearing Before the H. Comm. on

Fin. Services, 106th Cong. 25 (2000) (Testimony Of William Apgar, Asst. Sec.,Housing, and Commn., FHA).


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A. Increasing Homeownership?

As an initial matter, it is important to point out thathomeownership may or may not improve a particular familys

welfare, as compared with renting a home. There is considerableevidence that low-income families, and the minority poor inparticular, do not achieve the same wealth gains or income benefitsas the middle class as a result of owning a home.21 Moreover, low-income homebuyers often have to live in more distressedneighborhoods, and pay more of their income for housing, than ifthey had rented.22 Even assuming that homeownership is anunambiguous benefit, the contribution of subprime mortgagelending to achieving its benefits was negative, not positive.

1. Few Loans to First-Time Buyers

The claim that the Bank of Subprime increased overallhomeownership in the U.S. is weak at best. First, most subprimemortgages were made to people who already owned a house, not tofirst-time home buyers.

23The subprime product was really a home

equity loan, used in many cases to refinance credit card debt or

21 Alan Mallach, Lower Income Homeownership, the Subprime LendingIndustry, and the Public Good: a Conceptual Inquiry, HOUSING POLICYDEBATE (2008)[submitted check for citation or cite working paper].22 Id.23 The joint report on predatory mortgage lending issued by HUD and theTreasury Department in 2000 found that:

Generally, subprime mortgages serve as a source of home-collateralized consumer credit, and thus can also be thought of as partof the subprime consumer credit market. The primary purpose of over50 percent of first lien subprime mortgages and up to 75 percent ofsecond lien subprime mortgages is debt consolidation and/or generalconsumer credit, not home purchase, home improvement or refinancingthe rates and terms of a mortgage.

U.S. DEPT. OF HOUSING &URBAN DEVELOPMENT & U.S.DEPT. OF TREASURY,CURBING PREDATORY HOME MORTGAGE LENDING 26 (2000) [hereinafterHUD/Treasury Report]. In most years no more than one-third of subprimemortgages have been purchase loans, while two-thirds have been refinancings.Souphala Chomsisengphet & Anthony Pennington-Cross, The Evolution of the

Subprime Mortgage Market, 88 FED.RES.BANK OF ST.LOUIS REV. 31, 41-43,(2006).


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simply to support consumption. While this is a different possiblebenefit, it needs to be measured separately.24 Even among thesubprime mortgages for home purchases, not all were made tofirst-time buyers, i.e. new additions to the ranks of homeowners.Many were made to buyers who were selling one house and buying

another. The Center for Responsible Lending has estimated thatonly 1.4 million first-time buyers obtained their homes through asubprime mortgage.25 This can account for only a small portion ofthe 5 to 6 million households added to the ranks of homeowners inthe past dozen years.

2. Subprime Foreclosures Reduced Homeownership

Second, in each year from 1998 to 2006 inclusive, the numberof completed subprime mortgage foreclosures has exceeded thenumber of first-time homebuyers who used a subprime mortgage.

The Center for Responsible Lending estimates subprimeforeclosures in that period of 2.4 million, so that the net loss inhomeownership resulting from subprime mortgages was greaterthan 900,000 homes.26 While prime and FHA loans also resultedin some foreclosures, the foreclosure rate for subprime mortgagesis consistently far higher and must be considered in evaluating anypossible contribution of Subprime to homeownership. With a netloss in homeowners resulting from subprime mortgages, it wasprime and FHA mortgages that had to make up the difference toyield an aggregate increase.

3. Most Buyers Used Prime or FHA Mortgages

Third, prime mortgage lending increased by much more, indollar volume and numbers of mortgages, than subprime, in theperiod from 1994 to 2005 when an actual increase in thehomeownership rate took place. The overall homeownership rate

24 See infra Part I.C.25 CENTER FORRESPONSIBLE LENDING, SUBPRIME LENDING: ANET DRAIN ONHOMEOWNERSHIP, (2007), http://www.responsible lending.org/pdfs/Net-Drain-

in-Home-Ownership.pdf [hereinafter NET DRAIN].26 Id.


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fluctuated from 63% to 66% between 1970 and 1994.27 From its1994 level of 63.8%, the rate rose to 69.1% in 2005, beforedeclining in 2006 and 2007 to 68.2% as of the third quarter of2007.

28The 68.2% translates to 75 million owner-occupied homes

out of about 110 million total homes.29 The 5-percentage point

increase from 1994 to 2005 thus represents roughly 5.5 million netnew homeowners. If we are seeking a cause for the increase, itmakes sense to look at the 1994 to 2005 period, leaving out 2006and 2007, during which subprime made its most dramatic gains inmarket share, but homeownership did not increase.

Between 1994 and 2005, subprime mortgage volume wentfrom $35 billion to $625 billion.30 At the same time, conventionalprime mortgage volume increased from about $717 billion toalmost $3 trillion annually.

31 Was it the nearly $600 billionincrease in subprime mortgages, or the $2 trillion increase in prime

mortgages, that caused the homeownership rate to increase by afew percentage points?

27 U.S. CENSUS BUREAU, HOUSING VACANCY SURVEY, TABLE 14,

HOMEOWNERSHIP RATES FOR THE U.S. AND REGIONS: 1965 TO PRESENT,availableathttp://www.census.gov/hhes/www/housing/hvs/historic/histt14.html(last visited Feb. 27, 2008).28 Id.29 U.S.CENSUS BUREAU,HOUSING VACANCY SURVEY,TABLE 4,HOMEOWNERVACANCY RATES BY UNITS IN STRUCTURE, BY QUARTER: 1968 TO PRESENT,available athttp://www.census.gov/hhes/www/housing/hvs/historic/histtab4.html (lastvisited Feb. 27, 2008).30 GRAMLICH,supra note 10, at 6.31 GRAMLICH, supra note 10, at 6; Alan Greenspan & James Kennedy,

Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences 23 (Fed. Res. Board Fin. and Econ. Discussion Series,Working Paper No. 412005), http://www.federalreserve.gov/Pubs/feds/

2005/200541/200541pap.pdf. The estimates in this paper are somewhat higherthan the MBAs origination figures.


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Figure 1:

Prime Mortgages, Subprime Mortgages and Homeownershi

(dollars in billions)

0%

20%

40%

60%

80%

100%

1994 1998 2000 2005 2007

$0

$500

$1,000

$1,500

$2,000

$2,500

Homeownership

Subprime volume

Prime volume

Sources: Homeownership - Census Housing Vacancy Survey; SubprimevolumeGramlich; Prime volume - Statistical Abstract of US, Table 1163Mortgage Originations and Delinquency and Foreclosure Rates 1990 to 2006,based on MBA data.

4. Subprime Displaced Better, Cheaper FHA Mortgages

The fourth problem with the increased homeownership rateclaim is that for Subprime to have caused an increase, we have tocompare the homeownership rate to what it would have been ifthere had been no Bank of Subprime. The foreclosure losseswould be one aspect of such a comparison. Another effect of therise of Subprime was that the market share of FHA-insuredmortgages plunged from 19% to 6% of the mortgage market andplummeted in absolute numbers as well.32 By displacing FHAmortgages, the Bank of Subprime drove good loans out with bad

loans. Put another way, any new homeowners for which Bank ofSubprime can take credit might otherwise have gotten FHAmortgages.

The FHA mortgage program, in existence since 1934, isspecially designed to make homeownership possible for first-timebuyers who have not previously had access to mortgage credit. In2005, 80% of FHA mortgages were made to first-time home

32 U.S. GOV. ACCOUNTABILITY OFFICE, FED. HOUSING ADMIN.: DECLINE INTHE AGENCYS MARKET SHARE WAS ASSOCIATED WITH PRODUCT AND PROCESS

DEVELOPMENTS OF OTHER MORTGAGE MARKET PARTICIPANTS (June 2007)[hereinafter GAO study].


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buyers33 (compared to 9% for subprime mortgages).34 It hasminimal down payment requirements (3%) and flexible (but real)underwriting standards.35 FHA, unlike Subprime, insures investorswho hold the mortgages against losses from defaults andforeclosures. Who pays for this insurance? The taxpayer? No.

The FHA insurance program is entirely self-funded from insurancepremiums paid by the homeowners, and in fact results in a negativesubsidy (i.e., produces revenue for the Treasury).36 Unlike the 200to 500 basis points above prime mortgage rates paid at the Bank ofSubprime, the FHA program charges insurance premiums ofbetween 25 and 100 basis points, i.e., adds 0.25% to 1% to thehome buyers interest rate, which is otherwise comparable to primerates.37 FHA is both cheaper and better targeted to increasehomeownership.

The Bank of Subprime flooded the market with brokers and

originators touting the ease and rapidity of loan approval, and FHAcould not compete. FHA is flawed in a number of respects,including its still somewhat cumbersome underwriting process.On the other hand, FHA has avoided the risk layering practices ofsubprime lenders, including the making of loans without incomedocumentation. It is easy to see why realtors and mortgagebrokers, anxious to attract customers and close mortgages, wouldgo to Bank of Subprime for quick and easy approvals, when theyotherwise might have gone to FHA lenders. Subprime mortgageswere also far more profitable than FHA, creating incentives for

33 Id. at 6.34 NET DRAIN,supra note 25.35 See HUD HANDBOOK4115.1, section 2-4B (Mortgage Credit Analysis forMortgage Insurance) Oct. 20, 2003; GAO study,supra note 32.36 CONGRESSIONAL BUDGET OFFICE, COST ESTIMATE, F.H.A.MODERNIZATION ACT OF 2007 (2007), http://www.cbo.gov/ftpdocs/87xx/doc8700/sFHAbill.pdf.37 12 U.S.C. 1709(c)(1) (2000); see Expanding American HomeownershipAct of 2007, H.R. 1852, 110th Cong. (1st Sess.) 6-8 (2007) (pending FHA

reform legislation would increase the FHA risk premium to permit risk-basedpricing).


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lenders to steer FHA-eligible borrowers to higher-cost subprimemortgages.38

The displacement effect is not easy to measure. FHA, unlikeBank of Subprime, does require that a borrower not have too many

delinquent debts in the recent past. However, FHA does not use afixed credit score as a cutoff, and makes significant numbers ofloans to borrowers with FICO scores below 620.39 On the otherhand, Bank of Subprime made nearly half of its loans to borrowerswith FICO scores above 620.

40Thus, of the 1.4 million first-time

buyers who bought a house with a subprime loan between 1998and 2006,41 many, if not all, might have obtained an FHAmortgage. While subprime mortgages are not by their naturespecially targeted to first-time buyers or minorities, the FHAprogram, prior to the explosion of subprime, played a key role infinancing first-time purchases by minority families.42

Finally, it is worth noting that during Subprimes heyday, theU.S. homeownership rate increased only marginally, in historicalterms. The percentage of American households owning theirhomes went from 43.6% in 1940 to 64% in 1980, largely as aresult of the FHA insurance program.

43By 1975 the

homeownership rate reached 65%, before declining somewhat in

38 Gretchen Morgenstern,Inside the Countrywide Lending Spree,N.Y.TIMES,Aug. 26, 2007, at C1 (citing one borrower who received a 9.75% rate subprimeloan with a 3% origination fee, instead of a 7% FHA mortgage with 0.125% infees, resulting in a monthly payment of $2387 instead of $1829).39 U.S.DEPT. OF HOUSING AND URBAN DEV.,FHAS IMPACT ON INCREASINGHOMEOWNERSHIP OPPORTUNITIES FOR LOW-INCOME AND MINORITY FAMILIESDURING THE 1990S3 (2000) (noting that in 1996, 25% of FHA borrowers hadFICO scores below 620).40 Rick Brooks & Ruth Simon, Subprime Debacle Traps Even Very Credit-Worthy, As Housing Boomed, Industry Pushed Loans To a Broader Market,WALL ST.J.,Dec. 3, 2007, at A1.41 NET DRAIN,supra note 25.42

U.S.DEPT. OF HOUSING AND URBAN DEV.,supra note 39.43 Richard K. Green & Susan M. Wachter, The American Mortgage in

Historical and International Context, 19 J. OF ECON. PERSP. 93, 97 (2005);

Kerry D. Vandell, F.H.A. Restructuring Proposals: Alternatives andImplications, 6 HOUSING POLY DEBATE 299 (1995).


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the following decade.44 The recent uptick from 1994 to 2005 ishighly unlikely to have been brought about by the advent ofsubprime mortgages, and the gains would likely have been largerwithout the Bank of Subprime.

B. Increasing Minority Homeownership?

The overall rate of homeownership and the rate of minorityhomeownership have increased slowly for the past decade or so.The gap between the two rates, however, has hardly narrowed.The Federal Reserve Boards Survey of Consumer Finances(SCF) reported that overall homeownership went from 63.9% in1989 to 69.1% in 2004, a gain of 5.2%. For nonwhites andHispanics, the rate went from 44.4% to 50.8% in the same period,a gain of 6.4%.45 The data from the Census Bureaus housingsurvey are similar.

While minority homebuyers were more likely than whites touse a subprime loan, the vast majority all homebuyers continuedrelying primarily on conventional low-cost mortgages to buyhomes. One study found that in 2001 subprime mortgagesaccounted for 5.1% of home purchases by whites and 9.6% ofpurchases by minoritiesa significant disparity, no doubt.

46On

the other hand, that left 90% of minority homebuyers having usedprime or FHA mortgages to become homeowners. Similarly, thestudy found that the average interest rate paid by first-time buyerswas not significantly higher for blacks and Hispanics than it was

for whites, between 1995 and 2003.47 The authors concluded that

44 Robert B. Avery, Gregory E. Elliehausen, Glenn B. Canner & Thomas A.Gustafson, 1983 Survey of Consumer Finances, 70 FED.RES.BULL. 679, 682 (1984).45 FED. RES. BOARD, 2004 SURVEY OF CONSUMER FINANCES, SUMMARYTABLES 1989 TO 2004 (2004), availableathttp://www.federalreserve.gov/pubs/oss/oss2/2004/scf2004home.html#tables.46 CHRISTOPHERE. HERBERT &ERIC S.BELSKY, U.S. DEPT. OF HOUSING &URBAN DEVELOPMENT, OFFICE OF POLY DEV. & RES., THE HOMEOWNERSHIPEXPERIENCE OF LOW-INCOME AND MINORITY FAMILIES: A REVIEW ANDSYNTHESIS OF THE LITERATURE 33 (2006), http://www.huduser.org/

Publications/PDF/hisp_homeown9.pdf.47 Id. at 33-36.


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the concentration of minorities in the subprime mortgage markettook place largely in the refinance segment, rather than forpurchase loans, especially in the case of first-time buyers, whereaffordable lending programs stimulated by banks obligationsunder the Community Reinvestment Act have been targeted.48

While there is no known study quantifying the contribution, ifany, of subprime mortgages to minority homeownership, there isresearch identifying other factors that have contributed to theincrease. One study found that from 1970 to 1990, the FHAsingle-family mortgage program increased homeownership forblacks by 1.37 percentage points, and by 3.66 points at the 90thpercentile of affordability (i.e. the most marginal buyers).

49

Another study credited the Clinton Administrations initiativeswith narrowing the minority homeownership gap in the periodfrom 1994 to 2000.50 This latter study also reviews the extensive

literature on the racial wealth and home owning gaps; the gap hasfluctuated over time, and is caused by a wide variety of economicand demographic factors. For example, the general progress ofcollege-educated blacks in the economically favorable conditionsof the 1990s contributed to the increased home-ownership rate.51In other words, many blacks and Latinos are able to buy homes thesame way that whites do, with conventional mortgages, as theireconomic condition improves. A recent and exhaustive study ofthe persistent race gap in homeownership found that:

48 Id. at 36. See William C. Apgar & Mark Duda, The Twenty-FifthAnniversary of the Community Reinvestment Act: Past Accomplishments and

Future Regulatory Challenges, FED.RES.BANK OFN.Y.ECON.POLY REV.159,June 2003, http://www.newyorkfed.org/research/epr/03v09n2/0306apga.pdf.49 ALBERT MONROE, HARVARD JOINT CENTER FOR HOUSING STUDIES, HOWTHE FEDERAL HOUSING ADMINISTRATION AFFECTS HOMEOWNERSHIP (2001),http://www.jchs.harvard.edu/publications/governmentprograms/monroe_w02-4.pdf.50 GEORGE S. MASNICK, HARVARD JOINT CENTER FOR HOUSING STUDIES,HOME OWNERSHIP TRENDS AND RACIAL INEQUALITY IN THE UNITED STATES INTHE 20TH CENTURY 8-9, (2001), http://www.jchs.harvard.edu/publications/

homeownership/ masnick_w01-4.pdf.51 Id. at 19.


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During the 1990s, most subprime loans were used torefinance existing mortgages and so were not used to spurincreases in homeownership. . . . Although subprimelending activity among minorities has increased markedlyin recent years, we should emphasize that it is not clear

whether this trend represents an increase in the availabilityof mortgage financing or whether minorities are payingmore than necessary for their loans.52

One thing that we can say with confidence about Subprime,however, is that home losses due to foreclosures as a result ofsubprime lending will be far greater for minorities than for whites,because of the overrepresentation of minorities in the subprimerefinance market.

53

C. Democratizing Credit?

Proponents of Subprime claim that it has democratized credit,i.e., made credit available to individuals who would otherwise havebeen forced to do without.

54The usual evidence cited is the rapid

growth in dollar volume of subprime lending. The difficulty withthis factoid is that it could be explained in a variety of ways that do

52 Donald R. Haurin, Christopher E. Herbert & Stuart S. Rosenthal,Homeownership Gaps Among Low-Income and Minority Households, 9CITYSCAPE 5, 16-17 (2007), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1032187.53 Vikas Bajaj & Ron Nixon, For Minorities, Signs of Trouble in

Foreclosures, N. Y. TIMES, Feb. 22, 2006, at A1; GEOFF SMITH,WOODSTOCKINSTITUTE,KEY TRENDS IN CHICAGO AREA MORTGAGE LENDING:ANALYSIS OFDATA FROM THE CHICAGO AREA COMMUNITY LENDING FACT BOOK (2006),available at http://www.woodstockinst.org/publications/research-reports/5/5/date/DESC/ (follow Key Trends hyperlink); NEIGHBORHOOD ECON. DEV.ADVOCACY PROJECT,HOMEMORTGAGELENDINGANDFORECLOSURESINTHREE

NEW YORK CITYNEIGHBORHOODS:BEDFORD-STUYVESANT,BROOKLYN, CYPRESS

HILLS,BROOKLYN,JAMAICA, QUEENS (2002), http://www.nedap.org/resources/documents/finalNYMCnarrative.pdf; SCHLOEMER,supra note 5.54 Alan Greenspan, Fed. Res. Chairman, Remarks at the EconomicDevelopment Conference of the Greenlining Institute, San Francisco, California

(Oct. 11, 1997), available athttp://www.federalreserve.gov/boarddocs/speeches/1997/19971011.htm.


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[MARCH 2008]16

not mean more people are getting credit, or that any additionalborrowers were previously unable to get credit. The most obviousis that consumers who already had credit, in some cases lots andlots of credit, increased their existing debt by getting subprimemortgages. If one million consumers with $100,000 mortgages are

persuaded to refinance them into $200,000 subprime mortgages,the volume of subprime lending will increase by 100%. In somesense, aggregate access to credit has doubled. But the number ofconsumers with access to credit will have increased by exactlyzero. Merely increasing the total debt of American consumers is adoubtful benefit.55

Debt consolidation was a central thrust of subprime marketingpitches. Brokers targeted homeowners with significant credit carddebt for cash-out refinancing loans. These consumers obviouslyhad plenty of access to credit already; they were simply persuaded

to trade credit card debt in for mortgage debt, in many casesallowing them to pile on even more credit card debt in anultimately unsustainable borrowing spree.56

Former Federal Reserve Board Governor Mark Olsondescribed the democratization of credit as follows:

Over the past two decades, the proportion ofhouseholds using credit has risen dramatically. Evidencefrom the Federal Reserve's SCF shows that the proportionof all households with outstanding debt increased 5

percentage points between 1983 and 2001. During thesame time, the median debt level of households more than

55 See TERESA A. SULLIVAN, ELIZABETH WARREN & JAY LAWRENCEWESTBROOK,THE FRAGILE MIDDLE CLASS: AMERICANS IN DEBT (2001).56 See, e.g., Jonathan Karp, Mortgage Relief Plan Divides Neighbors, WALLST. J., Dec. 17, 2007, at A1 (citing one family that refinanced three timesbetween 2004 and 2006, increasing the mortgage debt from $500,000 to$835,000 before walking away); see also REN S. ESSENE & WILLIAM APGAR,HARVARD JOINT CENTER FORHOUSING STUDIES,UNDERSTANDING MORTGAGEMARKET BEHAVIOR: CREATING GOOD MORTGAGE OPTIONS FOR ALL

AMERICANS (2007), http://www.jchs.harvard.edu/ publications/finance/mm07-1_mortgage_market_behavior.pdf.


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doubled, to about $40,000, with most of this volumeincrease relating to mortgage debt.

The SCF findings indicate that one result of theongoing financial-market changes has been the

democratization of credit. A review of the use of creditacross income groups over the past two decades shows thelevel of debt has increased sharply in all income groups,and the median level of debt has doubled for each group.Notably, the strongest growth in the proportion of familieshaving any debt occurred in the lowest two quintiles of theincome distribution, with the proportion increasing byabout 20 percent in each group.57

The actual data from the SCF (table 1) does support theproposition that credit access to all types of credit products has

increased steadily, but not dramatically, over the past two decades.It is less supportive of the claim that access to mortgage credit hasexpanded significantly, or has expanded particularly in the periodof the subprime lending boom, from 1995 to 2004. Nor does itappear that minorities and low-income consumers have gained anymore access to credit than the population as a whole. The race gapin mortgage access has remained fairly constant.

The category showing the most significant gains from 1989 to2004 was credit card balances reported by minorities and thelowest-income groups. Unquestionably, the gap in access to, and

usage of, credit cards between whites and minorities closed duringthat period. By 2004, three out of four families had credit cards,while only 58% of those families reported carrying a balance onthe card (other than current month purchases).58

57 Governor Mark W. Olson, Remarks at the America's Community Bankers2003 National Compliance and Attorney's Conference and Marketplace, SanAntonio, Texas (September 22, 2003), available at http://www.federalreserve.gov/boarddocs/speeches/2003/20030922/default.htm.58 Brian K. Bucks et al., Recent Changes in U.S. Family Finances: Evidence

from the 2001 and 2004 Survey of Consumer Finances, FED.RES.BULL., Mar.

22, 2006, at A31. It should be noted that the SCF is a consumer survey, andconsumers underreport their credit card balances by a factor of two, i.e. they


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[MARCH 2008]18

Table 1: Percentage of families with debt, by category of debt

and family demographics59

1983

1989

1992

1995

1998

2001

2004

Mortgage debt - all 37%

39.50%

39.10%

41.00%

43.10%

44.60%

47.90%

Mortgage debt:Lowest incomequintile

n/a

7.60%

10.40%

10.40%

11.20%

13.80%

15.90%

Mortgage debtWhite NonHispanic

39%

43%

42.80%

44.10%

46.80%

47.60%

51.90%

Mortgage debt -Nonwhite orHispanic

27%

28.90%

27.80%

30.20%

31.00%

35.60%

37.40%

Credit card debt -all n/a

39.70%

43.70%

47.30%

44.10%

44.40%

46.20%

Credit card debtlowest income

quintile

n/a

15.30%

23.40%

26.00%

24.50%

30.30%

28.80%

Credit card debtNonwhite or hispanic

n/a

34.40%

42.10%

48.00%

43.50%

47.60%

46.70%

Credit card debt -whites

n/a

41.50%

44.20%

47.10%

44.30%

43.30%

46%

To the extent subprime credit is driven by credit score models,a credit score is necessarily required to obtain a subprimemortgage. In order to have a credit score, a consumer needs tohave had several previous credit accounts. One of the principalmarketing themes of subprime lenders was to encourageconsumers with multiple credit card accounts to refinance the

credit card debt with a mortgage refinance loan. These consumersby definition already had access to a mortgage and a variety ofcredit cards. There is no question that the percentage of thepopulation with access to credit cards, particularly in the lowerincome strata, has increased, but that does not advance the claimthat subprime mortgage lending has democratized credit. The

owe twice as much as they say they do when surveyed. JONATHAN ZINMAN,FED.RES.BANK OF PHILADELPHIA,WHERE IS THE MISSING CREDIT CARD DEBT?CLUES AND IMPLICATIONS (2007), http://www.philadelphiafed.org/pcc/papers/2007/D2007sept_zinman-missing-credit-card-debt.pdf.59

FED. RES. BOARD, supra note 45, at Table 11; Bucks et al.,supra note 58; Avery et al.,supra note 44, at 857.


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causation could be reversed. The wider availability ofconventional mortgages, increased homeownership and credit carddebt could have caused the boom in subprime mortgage lending.The subprime mortgage boom was proof less of credit beingdemocratized, than of credit having metastasized.

To put the question another way, what would the access ofAmerican consumers to credit have looked like if mortgage usurylaws had remained in place through the 1990s and subprimemortgage lending were not possible? The advances in creditscoring and the proliferation of credit cards would still have takenplace. The number of homeowners would have been greater, as aresult of a stronger FHA program, less competition for low-costmortgage programs targeted at first-time buyers, and fewerforeclosures. True, property values might not have climbed asrapidly, home purchases in 2006 and early 2007 would have risen

more slowly or declined, and the ability of homeowners to extractequity would have been reduced. The overall indebtedness ofAmericans might be less now. But there is simply insufficientevidence to conclude that in the absence of the subprime mortgageindustry, fewer Americans would have access to credit or ownhomes.

II. THE WELFARE EFFECTS OF SUBPRIMECOSTS

While the benefits of Subprime are doubtful, the costs are not.

The aggregate welfare costs that Bank of Subprime has imposedare dramatic and easily measured. They include the direct cost toaffected homeowners of foreclosures, the lost income and equityresulting from economic rent-seeking and price discrimination(i.e., loan fees and interest rates set well above competitive costsand profit) and the external costs to neighborhoods andcommunities of the foreclosure disaster.

A. Foreclosures and Home Losses

Estimates of the total number of families who will lose homes

as a result of subprime mortgages vary widely. We know that by


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[MARCH 2008]20

May 2005, nearly a half a million owner-occupied homes hadalready been foreclosed and sold as a result of subprime loansmade from 1998 to 2004.

60We also know for sure that as of

September 30, 2007, about 516,000 more subprime residentialmortgages were in foreclosure and an additional 336,000 were

ninety days or more delinquent.61 In calendar year 2007 alone,foreclosure sales were completed on another 300,000 subprimemortgages.62 Many more FHA and conventional mortgages wereon the road to foreclosure. The housing bubble brought on bysubprime lending, and its subsequent collapse, certainlycontributed to the rise in foreclosures across all categories ofmortgages. The point-in-time foreclosure statistics, unfortunately,do not tell us how many homes have been or will be lost as thesubprime crisis plays out.

The Center for Responsible Lending estimated in December

2006 that 2.2 million homeowners would eventually lose theirhomes as a result of subprime mortgages made from 1998 through2006.63 That estimate was based on actual loan performance dataobtained in late 2006, and could not take account of the subsequentsignificant deterioration in subprime mortgage default rates.

As for the external costs imposed on communities, they toohave been estimated in a number of studies, and will run in thetens, if not hundreds, of billions. The Center for ResponsibleLendings estimate is that 44 million homes adjacent to, or near,homes foreclosed by subprime lenders will lose an aggregate value

of $223 billion.64

Studies in Philadelphia, Chicago, and elsewhere

60 SCHLOEMER,supra note 5, at 16 (statistics available in Table 6).

61 MORTGAGE BANKERS ASSOCIATION OF AMERICA, supra note 6, at 4. TheMBA sample represents 80% of the total market. To calculate the numbers inforeclosure, the reported rate of 6.89% was applied to the sample size of 5.99million, and then divided by 80% to extrapolate to the total mortgage market.62 Bill Longbrake & Anthony T. Cluff, Prime and Subprime ResidentialMortgages 2007 Loss Mitigation Activity by HOPE NOW Alliance Servicers 7(Feb. 2008) http://www.fsround.org/media/pdfs/NationaldataFeb.pdf .63 SCHLOEMER,supra note 5.64 CENTER FORRESPONSIBLE LENDING,SUBPRIME SPILLOVER:FORECLOSURES

COST NEIGHBORS $223 BILLION; 44.5 MILLION HOMES LOSE $5,000 ONAVERAGE (2007), http://www.responsiblelending.org/pdfs/subprime-spillover.


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have tabulated the devastating cost to entire neighborhoods andcities of the subprime foreclosure tidal wave.

65In addition to the

loss in property values to neighborhoods, subprime foreclosuresare taxing municipal resources, undermining the property tax base,and burdening already-burdened social service providers, and

increasing crime.66 The impact is not randomly distributed aroundthe nation, but is concentrated in a few states and in urban centers.

The home losses affect not only the mortgage borrowersthemselves, but also many tenants who are being displaced bymortgage foreclosures filed against their landlords.

67The

subprime meltdown also has brought about substantial job lossesand economic impacts as a result of widespread mortgagecompany bankruptcies and closures.

68

B. Rent Seeking and Price Discrimination

Apart from the impact of foreclosures, subprime mortgageshave also resulted in billions of excess interest being paid byhomeowners who could have qualified for prime rate mortgages.The Wall Street Journal examined the credit scores of subprimeborrowers in a large database of mortgages made from 2000 to2007, and found that the share of loans made to borrowers withprime credit scores gradually grew from 41% to 61%.

69Similar

findings have been reported from the early years of the subprime

pdf. See also Dan Immergluck & Geoff Smith, The External Costs ofForeclosure: The Impact of Single-Family Mortgage Foreclosures on Property

Values, 17 HOUSING POLY DEBATE 57 (2006).65 IRA J.GOLDSTEIN,THE REINVESTMENT FUND,LOST VALUES: ASTUDY OFPREDATORY LENDING IN PHILADELPHIA (2007), http://www.trfund.com/resource/downloads/policypubs/Lost_Values.pdf; Immergluck & Smith, supranote 64.66 See Kathleen C. Engel, Do Cities Have Standing? Redressing the

Externalities of Predatory Lending, 38 CONN. L. REV. 355 (2006); DanielImmergluck & Geoff Smith, The Impact of Single-Family Mortgage

Foreclosures on Neighborhood Crime, 21 HOUSING STUDIES 851(2006).67 John Leland,As Owners Feel Mortgage Pain, So Do Renters,N.Y.TIMES,Nov. 18, 2007, at A1.68 Vikas Bajaj, A Cross-Country Blame Game, N.Y.TIMES, May 8, 2007, at

C1.69 Brooks & Simon,supra note 40.


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[MARCH 2008]22

boom.70

The result is that millions of homeowners paid interestrates of 3% to 5% greater than necessary for them to obtain credit.A single year of the subprime interest premium (at 3% over primerates) on the $600 billion in mortgages originated in 2006 wouldbe $18 billion. Half of that may have been paid by homeowners

qualified for lower-cost prime mortgages.

While there is no doubt that many prime-credit borrowersopted for subprime loans in order to avoid income documentation,get speedier approval, or get a larger loan amount, the fact remainsthat in the absence of subprime lenders, many of thesehomeowners could have obtained at least some of the credit theysought on less risky terms and at significantly lower cost.

Subprime mortgages were made disproportionately to minorityconsumers, across the spectrum of income and credit quality. For

some lenders the black/white disparity in subprime vs. primelending was as high as ten to one.71 Numerous studies using HomeMortgage Disclosure Act (HMDA) data have quantified theracial disparities in subprime lending.72 The Federal ReserveBoard staff in its analysis noted that even after controlling for

70 White,supra note 14, at 516-17.71 JIM CAMPEN ET. AL., WOODSTOCK INSTITUTE, PAYING MORE FOR THEAMERICAN DREAM: A MULTISTATE ANALYSIS OF HIGHER COST HOMEPURCHASE LENDING 4(table2) (2007),available athttp://www.woodstockinst.org/publications/research-reports/ (follow Paying More hyperlink).72 Manny Fernandez,Racial Disparity Found Among New Yorkers With High-

Rate Mortgages, N.Y. TIMES, Oct. 15, 2007, at B1; JIM CAMPEN,MASSACHUSETTS COMMUNITY &BANKING COUNCIL,BORROWING TROUBLE?V:SUBPRIME MORTGAGE LENDING IN GREATER BOSTON, 2000-2003 (2005),http://www.masscommunityandbanking.org/PDFs/BorrowingTrouble5.pdf; PaulS. Calem, Jonathan E. Hershaff & Susan M. Wachter,Neighborhood Patterns ofSubprime Lending: Evidence from Disparate Cities, 15 HOUSING POLY DEBATE603 (2004); Marsha J. Courchane, Brian J. Surette & Peter M. Zorn, Subprime

Borrowers: Mortgage Transitions and Outcomes, 29 J.REAL EST.FIN.&ECON.365 (2004); NATIONAL COMMUNITY REINVESTMENT COALITION, THE BROKENCREDIT SYSTEM: DISCRIMINATION AND UNEQUAL ACCESS TO AFFORDABLELOANS BY RACE AND AGE (2003); DEPARTMENT OF HOUSING AND URBANDEVELOPMENT, UNEQUAL BURDEN IN CHICAGO: INCOME AND RACIAL

DISPARITIES IN SUBPRIME LENDING (2000), http://www.huduser.org/publications/pdf/chicago.pdf.


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income and other relevant factors, higher-rate subprime mortgageswere significantly more likely to be made to blacks than whites.

73

The most extensive study of the racial price disparity insubprime mortgages combined HMDA data with credit scores and

other relevant variables, and found that even controlling for creditqualifications, blacks and Latinos were significantly more likely toreceive higher-cost subprime loans than comparable whiteborrowers. For example, black borrowers with a high credit score(680 FICO) and a loan to value ratio between 80% and 90% werenearly three times as likely to have a subprime mortgage thanwhites in that category.74 No study to date has attempted toquantify the race premium paid by black and Latino families onsubprime mortgages, but there can be no doubt that it too, is in thebillions.

C. Predatory Lending, Moral Hazard and Fraud

As subprime lending expanded, so too did the phenomenon ofpredatory lending.

75While definitions of predatory lending vary,

and it includes rent-seeking, price discrimination and making loanswith an unreasonable risk of foreclosure, predatory lending alsorefers to making mortgage loans, particularly refinance loans, thatare not suitable or appropriate for the borrower, using fraud and

73 Robert B. Avery, Kenneth P. Brevoort & Glenn B. Canner, Higher-PricedHome Lending and the 2005 HMDA Data, FED. RES. BULL., Sept. 2006, atA123.; Robert B. Avery, Glenn B. Canner & Robert E. Cook, New Information

Reported under HMDA and Its Application in Fair Lending Enforcement, FED.RES.BULL.,Summer 2005, at 344.74 DEBBIE GRUNSTEIN BOCIAN, KEITH S. ERNST AND WEI LI, CENTER FORRESPONSIBLE LENDING, UNFAIR LENDING: THE EFFECT OF RACE ANDETHNICITY ON THE PRICE OF SUBPRIME MORTGAGES, 11 (table 2) (2006),http://www.chicagofed.org/cedric/2007_res_con_papers/car_26_bocian_ernst_wei_li_the_effect_of_race.pdf.75 HUD/Treasury Report, supra note 23; Kathleen C. Engel & Patricia A.

McCoy, A Tale of Three Markets: The Law and Economics of PredatoryLending, 80 TEX.L.REV. 1255 (2002) [hereinafterTale of Three Markets].


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[MARCH 2008]24

deception.76

Subprime mortgage lending created a market inwhich predatory lending could flourish.77

The subprime mortgage sector has been plagued by fraud.78

The sell to distribute model created incentives for originators to

deliver loan volume with little or no regard for whether loanswould be repaid or foreclosed. Particularly as lending volumeexploded in 2005 and 2006, the fragmented market structurepromoted an environment where originators and brokersincreasingly misrepresented loan terms to borrowers, andborrowers, originators and brokers increasingly lied aboutborrowers income, property value and other qualifications.79 Theprevalence of no-doc loans, i.e., subprime mortgages madewithout requiring any written verification of borrower incomeand/or assets, fostered a climate in which borrowers income,assets and property value were routinely falsified.80 No-doc or

liar loans reached a level of $276 billion in 2006, accounting for46% of all subprime mortgages.81

In sum, subprime mortgage lending, using the sell-to-distributemodel, funded by private securitization,82 proved to causeenormous harm to American home-buyers, homeowners, investorsand workers. On the benefit side of the cost/benefit equation, thecontributions of subprime lending to consumer welfare aredoubtful at best.

76 Id.77 GOLDSTEIN,supra note 65; Willis,supra note 1.78 Michael Corkery,Fraud Seen as a Driver In Wave of Foreclosures, WALLST.J.,Dec. 21, 2007, atA1.79 The Impact of Poor Underwriting Practices and Fraud in Subprime RMBS

Performance, Fitch Ratings Special Report (2007), available athttp://www.fitchratings.com/corporate/reports/report_frame.cfm?rpt_id=356624.80 John Leland, Officials Say They Are Falling Behind on Mortgage FraudCases, N.Y. TIMES, Dec. 25, 2007, at A18; Bob Ivry, Subprime `Liar Loans'

Fuel Bust With $1 Billion Fraud (Update1), Bloomberg News, April 25, 2007,http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aonxuz3OYw Lg.81 Ivry,supra note 80.82 By private securitization I mean securitization that does not rely on thegovernment-sponsored enterprises (GSEs).


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III. THE MORTGAGE MARKET AFTER THE CRASH

A. Left Unregulated, What will the Subprime Market Bring Us

Next?

Now that the voodoo of mezzanine Collateralized DebtObligations (CDOs) has been exposed,83 and the bond ratingagencies have been humiliated by having to massively downgradepreviously-issued ratings on 2005 and 2006 subprime mortgagebonds,84 it is unlikely that Subprime will come back in preciselythe same form it existed in 2006. On the other hand, the workingsof the private-label securitized subprime mortgage market haverevealed that many people can make many profits85 for a

83 FT.com, CDOs and Subprime Debt, Jul. 1, 2007, http://www.ft.com/cms/s/1/098854 da-2802-11dc-80da-000b5df10621.html.; JosephR. Mason & Joshua Rosner, Where did the Risk Go? How Misapplied Bond

Ratings Caused Mortgage-Backed Securities and Collateralized DebtObligation Market Disruptions (SSRN Working Paper Series, 2007), availableathttp://ssrn.com/abstract=1027475; The Role of Credit Rating Agencies in theStructured Finance Market: Hearing Before the Subcomm. on Capital Markets,

Insurance and Gov. Sponsored Enterprises of the H. Comm. on Fin. Servs.,110th Cong. (2007) (Testimony of J. Kyle Bass, Managing Partner, HaymanAdvisors L.P.), http://www.house.gov/apps/list/hearing/financialsvcs_dem/bass.pdf [hereinafter The Role of Credit Rating Agencies]. Mr. Bass testimony isone of the clearest explanations of the role of rating agencies and mezzanineCDOs in masking subprime mortgage risk, particularly for foreign investors, andmaking the 2004-2007 boom in subprime lending possible.84 Mark Pittman, Moody's Downgrades $33.4 Billion of Subprime Bonds(Update 3), Bloomberg News, Oct. 11, 2007, http://www.bloombergtv.com/apps/news?pid=20601087&refer=home&sid=aH3v9Fjptv4s; Richard Beales,Saskia Scholtes & Gillian Tett, Failing grades? FINANCIAL TIMES, May 16,2007, http://www.ft.com/cms/s/0/4cfb5b30-0413-11dc-a931-000b5df10621.html; Floyd Norris,Market Shock: AAA Rating May be Junk, N.Y.TIMES, Jul.20, 2007, at C1; The Role of Credit Rating Agencies,supra note 83 (Testimonyof J. Kyle Bass, Managing Partner, Hayman Advisors L.P.).85 Jack Guttentag, Another View of Predatory Lending (Wharton Fin.Institutions Center, Working Paper No. 01-23-B, 2000), http://fic.wharton.upenn.edu/fic/papers/01/0123.pdf (providing data on mortgage broker profits);Gretchen Morgenstern, Inside the Countrywide Lending Spree, N.Y. TIMES,

Aug. 26, 2007, at C1 (Countrywide Mortgage earned double to triple the profitson subprime mortgages as on prime mortgages).


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[MARCH 2008]26

considerable amount of time, while making overpriced, unsuitableand risky mortgages to homeowners and home buyers. There islittle reason to believe that another cycle of credit expansion,loosening underwriting and hunger for yield will not produce asimilar set of dangerous products, albeit at a reduced volume.

While U.S. policy makers, lobbied heavily by the securitizationand mortgage industry, resist re-regulating consumer mortgages,observers outside the U.S. understand quite clearly that thecollapse was a result in part of regulatory failure.86

Indeed, even in the collapsed market of the fourth quarter of2007, subprime lenders have successfully securitized pools ofmortgages containing some of the unsuitable and risky featuresthat led to the meltdown. For example, Wells Fargo Banksuccessfully brought to market a pool of 2,021 loans totaling $337million in subprime mortgages on October 31, 2007.87 Most of the

loans were 2-year fixed, 28-year adjustable-rate mortgages (2/28ARMs) with teaser rates, i.e. significant payment shock aftertwenty-four months. The Prospectus includes this warning:

Investors should note that substantially all of theadjustable-rate Mortgage Loans were originated at ratesbelow the sum of the index at origination and the relatedgross margin [the Teaser Rate]. In addition, on the firstadjustment date following the origination of the adjustable-rate mortgage loans, the mortgage rate can increase by asmuch as 5.000% per annum. The underwriting standards of

the originator in determining a borrowers ability to paygenerally (i) allows debt-to-income ratios higher thanFannie Mae and Freddie Mac standards, (ii) looks at theTeaser Rate on the adjustable-rate mortgage loan and not

86 Cracks In The Faade: America's Riskiest Mortgages Are Crumbling. HowFar Will The Damage Spread? THE ECONOMIST, Mar. 22, 2007, at __ (notingthe regulatory failure, but cautioning against overregulating).87 Citigroup Mortgage Loan Trust 2007-WFHE4, Prospectus Supplement(Form 424B5) (Oct. 22, 2007) [hereinafter Prospectus Supplement]. The loansappear to have been originated, for the most part, in May and June of 2007, but

sold to investors in October, well after the general collapse of the subprimesecuritization market.


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the related fully-indexed mortgage rate and (iii) generallydoes not include tax and insurance payments.

The factors described in the preceding paragraph may resultin the adjustable-rate mortgage loans experiencing

increased delinquency, foreclosure, bankruptcy and lossthan other mortgage loans.

88

The rating agencys presale report predicts losses over the lifeof the loan pool of 6.6% to 7.1%.

89Given loss severities in the

range of 40%, that means that the rating agency, the lender and theinvestors all know perfectly well that 15% to 17% of these loanswill result in foreclosure, short sale or other disastrous outcome forthe homeowner.

The Wells Fargo pool consists of:

About 70% 2/28 teaser-rate ARMs About 6% of the loans are interest-only About 77% featured a prepayment penalty About 7% had less than full income documentation About 24% had loan-to-value ratios above 90%, and 20%

had Combined LTVs above 95% (including 2ndmortgages)

About 26% of the loans are in two states, California andFlorida

About 30% of the borrowers had FICO scores below 600 About 22% of the borrowers had debt to income ratios

above 50%

About 34% of the loans were originated by brokers.90

All these layers of risk are precisely the loan features that havebeen pointed to time and time again as contributing to thedisastrous default and foreclosure rates of the 2006 and early 2007

88 Prospectus Supplement,supra note 87.89 Presale Report, Citigroup Mortgage Loan Trust 2007-WFHE4, Moodys

Investor Services, Oct. 2007.90 Prospectus Supplement,supra note 87.


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[MARCH 2008]28

subprime originations.91

Securitized subprime loans also presenttremendous difficulties when it comes to prevention offoreclosures through workouts with borrowers.

92

By its nature, the private, uninsured securitized subprime

market is based on two related models. Non-bank mortgagelenders and brokers originate mortgages to distribute them, i.e., sellthem into a secondary market without retaining any interest in theirfuture performance. Borrowers take out loans that often includenew cash advances with the expectation, or at least the economicnecessity, of refinancing them within two or three years. Theoriginate-to-distribute model and the borrow-to-refinance modelare inherently unsustainable. We should have no confidence thatafter the temporary hiatus of 2007 and 2008, the fundamentaldefects of this market will self-correct.

One of the recognized causes of the subprime collapse of 2007is the phenomenon known as disaster myopia.93 When majorlosses to investors occur infrequently, market prices will not reflectthe risk of such events. Over time, lessons learned in earlierfinancial crises are unlearned. The market, left to its own devices,is unlikely to correct permanently all the flaws in subprimemortgage lending and achieve the appropriate goals of a nationalhousing finance policy.

But if we are to regulate, how should it be done? The firstquestion to ask is what sort of mortgage products will achieve the

national goals of expanding homeownership (to its reasonablelimits) and keeping low-cost, safe home mortgages readilyavailable for all who qualify. Those who claim that the marketwill provide these solutions have a heavy burden of proof. Theyfirst need to explain the results of our national experiment in

91 Drivers of 2006 Subprime Vintage Performance, Fitch Ratings, Nov. 13,2007; Statement on Subprime Mortgage Lending, 72 Fed. Reg. 37569 (July 10,2007).92 Seeinfra notes 102-105 and accompanying text.93 Jack Guttentag & Richard Herring, Disaster Myopia in International

Banking, PRINCETON ESSAYS IN INTL FIN., Sept., 1986, at ___.


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deregulation, conducted on American homeowners and cities, overthe past fifteen years.

B. The Product we Wantthe 30-year Fixed Rate AmortizingMortgage

Prior to the Great Depression, and the Homeowners Loan Actenacted in its wake, the standard mortgage product in the U.S. wasa five-year interest-only balloon loan.

94Homeowners were

dependent on frequent refinancing to sustain theirhomeownership.95 This was an excellent product for speculators,as the 1920s real estate bubble demonstrated, but not a goodaffordability product for middle class Americans. TheHomeowners Loan Corporation (HOLC) and the FederalHousing Administration (FHA) mortgage insurance programsolved the problem by introducing the concept of a fifteen- or

twenty-year (later to become 30-year) fixed-rate amortizingmortgage.96 The HOLC purchased large numbers of existingballoon mortgages and converted them to amortizing mortgages,with capital raised by U.S. Treasury borrowing. FHA providedinsurance for new long-term mortgages. An ordinary workingAmerican could make a down payment on a home, and then repaythe loan for the balance with fixed monthly payments that wouldeventually result in complete repayment. The fixed payment overthirty years, combined with the prospect of rising incomes, maderepayment a good bet and default a low risk. The governmentinitiative in insuring these mortgages led to their widespread

adoption in private markets.

The Bank of Subprime has touted the benefits of innovationin re-introducing non-amortizing mortgages,97 i.e., loans where the

94 Green & Wachter,supra note 43, at 94.95 Green & Wachter,supra note 43, at 94.96 Green & Wachter,supra note 43, at 95; MONROE,supra note 49, at 6.97 See Regina Lowrie, Chair, Mortgage Bankers Association, Statement inresponse to Federal Guidelines on Nontraditional Mortgage Products (Sept. 29,2006), available at http://www.mortgagebankers.org/NewsandMedia/PressCenter/45371.htm:

Innovative, nontraditional mortgage products have allowed morepeople than ever to explore the possibility of homeownership,


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homeowner pays only the interest, or even less, and then faceseither a large lump sum payment or the prospect of rapidlyincreasing payments,

98with no assurance of having the income or

means to finish paying. These innovations are not homeaffordability productsthey are their opposite. If not banned, they

should be relegated to a small niche of wealthy and sophisticatedhomeowners who understand them and can afford to take the risk.

It is essential that the new mortgage market be structured sothat an accountable authority (a role for which bond ratingagencies are ill-suited) is responsible for the delicate balancebetween access to credit and assuring reasonable levels of defaultrisk. The U.S. has never really confronted the question of whatrisk of default is acceptable, but it is a fundamental policy questionthat must be answered. In my view, the acceptable risk for first-time home buyer loans would be considerably higher, perhaps as

much as a 10% to 15% failure rate, than is the acceptable risk forrefinance loans and home equity loans made to families whoalready own a home. The notion of regulating purchase-moneymortgages differently than refinance mortgages already hasachieved some recognition in the law,99 and is a sound basis forpolicy making.

contributing to the nearly 70 percent rate of homeownership. Theguidelines propose a one-size-fits-all underwriting standard that willunnecessarily choke industry innovation and diminish consumerchoice.

Id.98 The so-called option-ARM, for example, is a mortgage where theborrower pays LESS than the monthly interest each month, at first. The unpaidinterest is added to the principal, and then after five years or so, the larger loanbalance is amortized over the remaining loan life, leading to dramatic paymentincreases. U.S. GOV. ACCOUNTABILITY OFFICE, ALTERNATIVE MORTGAGEPRODUCTS: IMPACT ON DEFAULTS REMAINS UNCLEAR, BUT DISCLOSURE TOBORROWERS COULD BE IMPROVED, HIGHLIGHTS OF GAO 06-1112T (2006);Interagency Guidance on Nontraditional Mortgage Product Risk,71 Fed. Reg.58609 (Oct. 4, 2006).99 See, e.g., 15 U.S.C. 1635 (200X) (providing a three-day rescission periodfor non-purchase mortgages but not purchase mortgages).


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C. Fair Lending

The post-Subprime mortgage market should, insofar aspossible, eliminate credit apartheid, and prevent racial steering andexploitation of perceived price insensitivity of minorities. To

accomplish this, opportunities for price discrimination, i.e.,charging different prices to different borrowers for essentially thesame product, should be minimized. Overly complex pricestructures, including prepayment penalties, deceptively low initialinterest rates for artificially short periods, and the like, should beprohibited or discouraged. Safe and simple mortgage productsshould be promoted through the government-sponsored enterprisesand that portion of the private sector willing to emulate them.

Thus, the goals of our national mortgage policy should be:

1. Promoting the thirty-year fully amortizing fixed ratemortgage as the single-family home finance product of choice,especially for first-time and low- and moderate-income buyers.

2. Assuring that the responsibility for oversight of mortgageunderwriting rests with an entity that can be flexible andresponsive to market changes, but that is also accountable forpreserving the careful balance between credit access and prudentrisk management.

3. Breaking down and preventing racial disparities in mortgage

pricing.

IV. THE COMPONENTS OF ANEW REGULATORY REGIME

A. New Improved FHA

Steering low- and moderate-income home-buyers to FHA has anumber of obvious benefits in achieving the goals I propose. First,FHA is low cost relative to subprime. The FHA insurancepremium currently costs borrowers less than 1% per annum,

compared to the 200 to 500 basis points charged by subprime


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lenders.100

In addition, up front points and fees are limited, and aretypically less than 1% of the loan amount, compared to the 5% to7% origination and broker fees charged by subprime lenders.

Second, FHA has a successful track record of foreclosure

prevention and loss mitigation. One can see even in thecatastrophic delinquency numbers for the third quarter of 2007 thatFHA has far fewer foreclosures as a percentage of delinquenciesthan subprime. As of September 30, 2007, 15.74% of FHA loanswere delinquent or in foreclosure, but only 2.22% of those were inthe foreclosure category. At the same time, 23.57% of subprimeloans were in both categories, with 6.89% in foreclosure.101 Thispattern has held true over the time that the MBA survey hascovered the subprime foreclosure rates.

FHA is in a much better position than subprime investors to

develop and implement foreclosure prevention initiatives. FHAhas established programs to compensate mortgage servicersfinancially for successful loss mitigation, i.e., foreclosureprevention workouts.102 Similarly, FNMA and Freddie Mac areable, in their role as insurer for the loans they securitize, to takeinitiatives to encourage more workouts.

103In contrast, subprime

servicers have great difficulty getting authorization from investorsto work out delinquent mortgages, and there is no single entityrepresenting the investors in securitized subprime mortgages ableto take initiatives to encourage foreclosure prevention, much lessoffer financial incentives to servicers.104 The initiative negotiated

by the U.S. Treasury Department and negotiated with theAmerican Securitization Forum, encouraging voluntary action byservicers to modify a limited category of subprime loans, is not,

100 See supra note 37 and accompanying text.101 MORTGAGE BANKERS ASSOCIATION OF AMERICA,supra note 6, at 5.102 ABT ASSOCIATES, INC., AN ASSESSMENT OF FHAS SINGLE FAMILYMORTGAGE INSURANCE LOSS MITIGATION PROGRAM 18-22 (2000), http://www.abtassoc.com/reports/20007197399621.pdf.103 E.g., Kate Berry, New Lawyer Incentives to Encourage Workouts, AM.BANKER, Nov. 9, 2007, at 17.104 Kurt Eggert, Comment: What Prevents Loan Modifications, 18 HOUSINGPOLY DEBATE 279(2007).


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and could not be, a mandate or even an incentive program, giventhe nature of the private mortgage-backed securities market.

105

This contrast is inherent in the structure of the FHA-insured, GSE-funded market on the one hand, versus the private securitizedsubprime market on the other.

Third, FHA is designed to achieve the goals of increasinghomeownership and democratizing mortgage credit. FHAunderwriting rules permit the use of nontraditional creditreferences, such as proof of paying rent and utilities on time, forconsumers who do not have credit cards or other traditional creditaccounts typically appearing in a major bureau credit report.106

As of this writing, both the U.S. House of Representative andthe Senate have passed different versions of FHA Modernizationlegislation.107 Senate Bill 2338, the FHA Modernization Act of

2007, was passed by the Senate on December 13, 2007. Itincreases the maximum mortgage amount from its previous limitof roughly $200,000 to the FNMA conforming limit, which variesregionally but can be as high as $420,000. The bill reduces thedown payment or equity requirement from 3% to 1.5%. The billalso increases the cap on up front mortgage insurance premiums,currently set at 2.25% per annum, to 3% under 1709(c)(2) topermit more risk-based pricing.

Given the levels of defaults already experienced in the FHAprogram, it is not clear that higher-priced, riskier loans need to be

made by reducing down payments and other credit qualitystandards. Already as of December 2007, without any rulechanges, FHA loan applications have doubled, to an annual rate of1.4 million, over the prior year, largely as a result of the

105 Edmund L. Andrews, Mortgage Aid, Within Limits, N.Y. TIMES, Dec. 6,2007, at A1.106 See HUD HANDBOOK,supra note 35, at section 2-4B.107 Emergency Home Ownership and Mortgage Equity Protection Act of 2007,

H.R. 3609, 110th Cong. (1st Sess. 2007); FHA Modernization Act of 2007, S.2338, 110th Cong. (1st Sess. 2007).


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disappearance of subprime mortgage lending.108

Increasing loanlimits will help extend the reach of FHA to higher-cost marketslike Southern California, but will not especially targethomeownership increases to low-income buyers. Whatevermisgivings there may be about redesign of the FHA program, it

remains true that the program is closely monitored, brokers mustmeet integrity and solvency requirements, the insurance fund isaudited annually, and there is public oversight of the program thatcan, at least theoretically, preserve the balance between inclusionand risk in home financing.

B. Banning Subprime Lending

Subprime mortgage lending in its present form becamepossible only when usury laws setting maximum interest rates on

first lien mortgages were preempted or repealed.

109

The moststraightforward way to prevent subprime mortgage lending is tolimit first mortgage interest rates to a reasonable range aboveprime rates or an appropriate index. The HMDA reportingthreshold of three percentage points above Treasury securities ofcomparable maturity would serve the purpose.

110To alleviate

concern that FHA and the government-sponsored enterprises mightwant the flexibility to charge higher rates for certain categories ofmortgage loans, authority could be given to an appropriate agencyto set the interest rate ceiling(s) annually. The rate-setting agencywould take into account developments in the market and the policygoals of expanding homeownership and credit access withoutpermitting the price discrimination and excessive risk that were thehallmark of Subprime.

Although junior lien mortgages contributed indirectly todestabilizing first lien subprime mortgages, the massive harm to

108 Peter G. Miller, FHA Mortgage Guide, November Originations Up, Up &Away, Says HUD, Dec. 13, 2007, http://www.fhaloanpros.com/2007/12/fha-mortgages-november-originations-up-up-away-says-hud/; Bob Tedeschi, FHA

Loans Stage a Comeback, N.Y.TIMES, Apr. 22, 2007, at K13.109 Mansfield,supra note 11.110 12 C.F.R. 203.4(a)(12) (2007).


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consumer welfare was caused almost exclusively by first liensubprime mortgages. Junior mortgage loans by their nature mustbe underwritten on the basis of repayment ability, and cannot bepriced and securitized based primarily on real estate values. Theyare priced at higher rates in both the prime and subprime market,

but appear to be less subject to the risks and abuses than first lienmortgages. Junior mortgages are not an instrument of housingfinance, they are a form of consumer credit, and can be regulatedas such. To prevent a recurrence of the disastrous consequences ofthe Bank of Subprime, it is sufficient to effectively ban first lienhigh-cost mortgages.

While there are many excellent proposals for incrementalreforms that would reduce the harm done by subprime mortgages,the question remains why any first mortgage subprime lending, inthe form it has existed until now, should be tolerated. Reform

proposals not already under consideration by the Federal Reserveor Congress include imposing a duty on brokers to determine thesuitability of mortgage products for customers before sellingthem,

111creating mortgage price bidding systems,

112and

increasing liability of secondary market assignees for borrowerclaims.113 The difficulty with these proposals is that to a greatextent, the opportunity for excessive risk in product design, pricediscrimination, predatory lending and fraud are inherent in theprivate securitization and sell-to-distribute model of the subprimemarket.114 It is certainly conceivable that a broad range of reformswould force non-GSE securitized mortgages to look more like

FHA mortgages, but the need to allow first mortgages at priceswell in excess of FHA mortgages remains unclear.

Banning subprime loans does not mean banning mortgageloans to borrowers with marginal credit, or no credit history.

111 Engel & McCoy, Tale of Three Markets, supra note 75.112 Willis,supra note 1.113 Kathleen C. Engel & Patricia A. McCoy, Turning a Blind Eye: Wall Street

Finance of Predatory Lending, 75 FORDHAM L.REV. 102 (2007), available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_ id=910378.114 Id.; Christopher L. Peterson,Predatory Structured Finance 28 CARDOZO L.REV. 2185 (2007).


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Community development financial institutions have beensuccessful in making mortgage loans to previously excludedborrowers at market interest rates, with acceptably low defaultrates.

115FHA lenders, and conventional lenders seeking to expand

their markets, already accept nontraditional credit information,

such as rent and utility payment history.116 On the other hand,there are some consumers whose credit histories and paymentability are so weak that they should be offered credit counselingbefore being offered loans.

C. Meeting Needs for non-Purchase Consumer Credit withoutSubprime Mortgages

Access to consumer credit, if one is not fussy about the terms,has ceased to be a problem in the United States. Credit cards are

available to just about anyone across the socioeconomic and creditquality spectrum. Credit card issuers have made available trillionsin unused credit lines, in the vain hope of persuading consumers toshift their card usage to the more generous bank.117 Thepromiscuity of credit card issuers is second only to the subprimemortgage lenders.

118Total consumer credit, not including

mortgage or home equity loans, reached nearly 2.5 trillion dollars

115 Preserving the American Dream: Predatory Lending Practices and HomeForeclosures: Hearing Before the S. Comm. on Banking, Housing and Urban

Affairs, 110th Cong. (2007) (testimony of Martin Eakes, CEO, Center forResponsible Lending and Center for Community Self-Help),

http://banking.senate.gov/_files/ACF250E.pdf; Apgar & Duda,supra note 48.116 See Andrews, supra note 101; Barry Wides, Community Developmentsonline, No Credit? No Problem!: Taking the Nontraditional Route To Bring

Borrowers into the Prime Mortgage Market, http://www.occ.treas.gov/Cdd/newsletters/summer05/cd/nocredit.htm (last visited Feb. 25, 2008).117 The Effect of Current Credit Card Industry Practices on Consumers:

Hearing Before the S. Comm. on Banking, Housing and Urban Affiars, 110thCong. (2007) (testimony of Travis B. Plunkett, Legislative Director, TheConsumer Federation of America, Consumer Action and Consumers Union),http://www.consumerfed.org/pdfs/Credit_Card_Senate_Testimony_01-07.pdf.118 Katherine M. Porter, Bankrupt Profits: The Credit Industrys Business

Model for Postbankruptcy Lending (Univ. of Iowa Legal Studies, ResearchPaper No. 07-26, 2007), http://papers.ssrn.com/sol3/papers.cfm?abstract_id

=1004276 (most consumers just emerging from bankruptcy are offered creditcards, as well as other forms of secured and unsecured debt).


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in October 2007$922 billion of which was revolving credit,composed primarily of credit card debt.

119

Home equity credit has the advantage of being cheaper thanunsecured credit, such as credit card lines, precisely because the

borrowers home is at risk. While there is certainly a welfare gainto a consumer who uses home equity credit wisely, home equitylines of credit remain widely available to borrowers withreasonable repayment ability.120 Certainly, more can and shouldbe done to make safe, affordable credit products available tominorities and low- and moderate-income consumers.

CONCLUSION

Let us be clear. Banning subprime mortgages does not meanprohibiting the credit market from serving previously excluded

groups, or from lending to the poor, or to minorities. Mortgageloans made by the Bank of Subprime in the 1994 to 2007 boomwere subprime not because of the nature of the borrowers, many ofwhom had excellent credit ratings, but because of the nature of theloans. It was the loans that were subprime, not the borrowers. Theproducts peddled by the Bank of Subprime were dangerous,unsuitable, unsustainable, and highly amenable to fraud. TheAmerican experiment in mortgage deregulation has producedmillions of foreclosures, billions in home equity and investorlosses, and immeasurable damage to the fabric of the nationscities. It is not an experiment that should be continued or repeated.

119 FED. RES. BOARD, FED. RES. STATISTICAL RELEASE, G.19 (CONSUMERCREDIT), Dec. 7, 2007.120 Home equity lines of credit and junior lien mortgages outstanding reached

$1 trillion in 2006. FED. RES. BOARD, FED. RES. STATISTICAL RELEASE, Z.1(FLOW OF FUNDS ACCOUNTS OF THE UNITED STATES), Mar. 8, 2007.

the case for banning subprime mortgages

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