“Letting the dandelions grow”

Today’s Wall Street Journal has exactly the kind of story I’ve been hoping to eventually see about the troubles with subprime lending. It’s a case study by Mark Whitehouse about subprime lending’s impact on a block in a Detroit minority neighborhood. Lenders, having detected lots of untapped equity in the neighborhood (itself a product of discriminatory lending practices in the past — “redlining” — which forced blacks to buy homes outright or put down big down payments), decided to unleash a massive marketing campaign in order to earn risk-free fees for writing a bunch of lucrative adjustable-rate loans, which could be packaged and resold on Wall Street.

Suddenly, mortgage lenders saw places like West Outer Drive as attractive targets for new business, because so many families either owned their homes outright or owed much less on their mortgages than their homes were worth. Lenders seeking to tap that equity bombarded the area with radio, television, direct-mail advertisements and armies of agents and brokers, often peddling loans that veiled high interest rates and fat fees behind low introductory payments. Unscrupulous players had little reason to worry about whether or not people could afford the loans: The more contracts they could sign, the more money they stood to make.

Generally speaking, lenders used deceptive sales techniques or preyed on the borrowers’ financial ignorance.

“A lot of people were steered into subprime loans because of the area they were in, even though they could have qualified for something better,” says John Bettis, president of broker Urban Mortgage in Detroit. He says a broker’s commission on a $100,000 subprime loan could easily reach $5,000, while the commission on a similar prime loan typically wouldn’t exceed $3,000.

Borrowers were easy pickings, as well, because many feared financial insecurity stemming from downturns in manufacturing and the auto industry. They could be sold a line of credit as a way of maintaining a standard of living in the face of economic adversity.

For many who already owned their homes, offers of easy credit came at a time when a severe economic downturn had left them in need of money to maintain middle-class lifestyles. Since the year 2000, the decline of the auto industry has cost the Detroit metropolitan area about 20,000 jobs a year, helping turn the shopping areas near West Outer Drive into scenes of defunct businesses, payday lenders and liquor stores. According to the latest data from the Internal Revenue Service, households in the 48235 ZIP Code reported an average adjusted gross income of $32,902 in 2004, up slightly from $32,817 in 2001 but down 6% in inflation-adjusted terms.

A few of the locals quoted in the story seem willing to take responsibility for accepting the credit on bad terms — “I knew better than to be stupid like that”, “A lot of people took the cash. I wish I’d never done it myself” — but it sounds as though the evidence is strong that advertising created a destructive demand for credit, leading those with the least-stable long term economic future into the most-destabilizing of all possible loans. It’s hard to see the sense (other than the cold, hard business sense, that is) in giving the loans that are most difficult to keep up with to the people least likely to have the means to do it. It’s pretty depressing that they then blame themselves for falling into the trap.

After detailing how many homes on the block are affected, Whitehouse suggests some of the consequences.

Both Ms. Williams and Mr. Walker have found themselves in a predicament now common among homeowners in Detroit: They’ve tried to sell their houses, but can’t find buyers willing to pay what they owe on their mortgages. After two years on the market, Ms. Williams says her house has attracted a high bid of $140,000, nowhere near the $211,000 debt she must settle to avoid eviction. That leaves her with no option but to abandon the house — the worst possible outcome for the neighborhood, because it means the property could end up gutted with a big red debris bin out front….

Now in foreclosure, Ms. McNeal has until early July to come up with the money or be evicted. She doubts she can sell the house, and the missed payments have dented her credit to the point where she can’t get another loan. So she’s letting the dandelions grow.

And just like that the neighborhood begins to slide past the point of salvation, at least for a generation or two: As one of real estate agents quoted remarks, “Nobody’s going to want to buy into a neighborhood with 20% foreclosures.” The question is whether the easy money from subprime loans delayed the inevitable or inflated the bubble so that it would pop more easily, and once and for all.