Overborrowing

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Friday, Mar 16, 2007

The subprime mortgage situation is reaching a crisis point, warranting multiple stories in multiple sections of the WSJ every day. Here’s what was on page A4 today:
• Subprime Troubles Bite Into Office-Space Sector
• Subprime Mortgage Woes Are Likely to Spread
• Mortgage Woes May Help Revive FHA


The last of those stories is especially interesting, as it recounts the growth of subprime lenders, which used to teasers like low initial rates and interest only payment periods to lure people away from FHA loans, which are subsidized by the government to expand credit offerings for low-income borrowers.


For decades, the FHA was a major backer of mortgage funding for borrowers with poor credit. But the FHA’s share of the market has dropped sharply in the past decade as hordes of aggressive subprime lenders wooed away borrowers with an array of seemingly attractive options, including no-money-down mortgages and interest-only payments. The subprime players also offered faster approvals, instant home appraisals, less paperwork and fewer hassles, winning over consumers even though subprime mortgage rates were generally higher than rates for FHA-insured mortgages.


In other words, bankers chasing profit exploited the sector’s ignorance, greed, laziness, and impatience—but who should be held accountable?


Honky-tonk legend Johnny Horton has a song with a chorus that goes, “If there’s such a thing as overloving you, then overloving you is what I’m gonna do.” I thought of this when I read this EconLog entry in which Arnold Kling speculates about how so many dubious subprime loans were made and to whom. If there’s such a thing as overborrowing, is overborrowing what people are inevitably going to do?


In his post, Kling rejects the idea that the defaults happen particularly in regions where speculation was most rampant, pushing mortgages out of line with wages, and instead argues that subprime borrowers are essentially subprime human beings:


My guess is that the typical defaulter today is not some prudent individual who happened to buy a home that strains his paycheck. Instead, my guess is that the typical defaulter is somebody who is poor at managing spending and credit. Of course, either defaulter is going to appear to be “over his head.”


Is taking out a bad mortgage a personal failing, a de facto proof of vanity (I have to have the biggest house to show people what a successful person I am…) if not outright fraudulence (...and I’ll fudge my income data to get it!)?


The Economist’s blog has a slightly more generous analysis:


Some people, undoubtedly, were just folks with bad credit who were thrilled to find that they suddenly qualified for a mortgage.  Others were people whose income was not stable enough or high enough to get them into a house with a regular mortgage; that group ... priced out of housing in bubbly markets.
Ironically I suspect that the latter group is probably in bigger trouble than the merely chronically irresponsible. The former group probably has the money to make their mortgage payment; they just don’t manage it well. The threat of foreclosure is a great thing for focusing one’s mind on financial matters.
The latter group on the other hand, is almost mathematically certain to be unable to meet their mortgage payment when the rate adjusts, unless there has been some sizable improvement in their financial circumstances. They will have to default if they can’t sell.


I am less sanguine that the chronically irresponsible would suddenly start making payments under the threat of foreclosure—this is a variation on the conservative line of thinking that assumes people need to be disciplined by economic hardship to make prudent moral choices. It seems more likely that the chronically irresponsible lack the fundamentally ability to manage money—its a deficiency of a kind of cultural capital. They lack the training and familiarity with a way of life that generates savings and prioritizes prudence. I don’t think economic hardship instills that cultural capital all of a sudden. It just inflicts suffering.


So the latter group are victims of the bubble, and the former have just been waiting for a reason to be more efficient. It seems more responsibility for the subprime market tanking rests with the “unscrupulous lenders” of liberal rhetoric—the banks that had incentives to make loans without having to worry what effect the loans would have on the recipients or whether they could pay them back—the loans would be immediately sold off to be lumped into CDOs. Under the guise of expanding opportunity to a marginalized group, they effectively exploited them, which is generally what happens in the absence of regulation—advantages are leveragaed against the disadvantaged until they have nothing left to offer. That’s simply the logic of the system.

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