Prime subprime borrowers

by Rob Horning

3 December 2007


This should come as a shock to no absolutely no one: The Wall Street Journal had a research firm crunch the numbers and determined that many subprime loans were issued to borrowers who likely would have qualified for better rates and fewer fees. In 2005, people with credit scores that would have qualified them for conventional loans

got more than half—55%—of all subprime mortgages that were ultimately packaged into securities for sale to investors, as most subprime loans are. The study by First American LoanPerformance, a San Francisco research firm, says the proportion rose even higher by the end of 2006, to 61%. The figure was just 41% in 2000, according to the study. Even a significant number of borrowers with top-notch credit signed up for expensive subprime loans, the firm’s analysis found.

How could this have happened? The ever-rational consumer would have shopped around for the best deal, right?

Hardly. The brokers closing mortgages were given lucrative incentives for writing subprime loans and ARMs and the other now notorious credit products, so they had every reason to preserve the ignorance that all of us generally have when it comes to the credit market and to exploit our vulnerability in a time when we are making one of the most significant decisions of our lives, purchasing property.

Many borrowers whose credit scores might have qualified them for more conventional loans say they were pushed into risky subprime loans. They say lenders or brokers aggressively marketed the loans, offering easier and faster approvals—and playing down or hiding the onerous price paid over the long haul in higher interest rates or stricter repayment terms.
The subprime sales pitch sometimes was fueled with faxes and emails from lenders to brokers touting easier qualification for borrowers and attractive payouts for mortgage brokers who brought in business. One of the biggest weapons: a compensation structure that rewarded brokers for persuading borrowers to take a loan with an interest rate higher than the borrower might have qualified for.

This handy interactive graphic shows a lenders rate sheet and the yield spread premiums agents could earn by bullying or tricking borrowers into loans at terms worse than they theoretically qualified for. Basically, lenders use financial incentives to prompt agents to put people into shitty loans, with bad rates and prepayment penalties and unwieldy fees. Who’s on the side of the borrower? Basically, no one. It was pretty much caveat emptor in the midst of a real-estate-buying frenzy when everyone was telling everyone else how they had to act fast and buy something, anything, before all the deals were gone and how housing prices were never going to go down again, since after all, they’re not making any more land.

It’s almost unreasonable to fault mortgage brokers for being negligent and unethical. They are in the real estate racket; that’s what it’s all about. You don’t get into real estate out of a love for human kind and a dream of a better world. You do it because it seems like a good way to make a lot of money. And when greed is what gets you through your work day, why wouldn’t you prey on the ignorance of your clientele? It’s nothing personal, after all, just business. So one could argue that unscrupulous lending practices should be restrained by law—to a larger degree than they are already. In other words, the set of what counts as unscrupulous needs to be expanded to encompass what lenders likely consider to be standard operating procedures—it would be legislating away their right to whatever profit they can grab, and once you’ve done that, what stops the state from interceding in the economy with all sorts of price controls: rent control, caps on food prices, medical expenses, and legal fees, and so on. Ethical cases could be made for any of these kinds of intervention, but capitalism, when it comes down to it, isn’t arranged to be ethical and doesn’t function with elastic definitions of fairness.

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