Seminar Paper on "Predatory Lending and the Subprime Mortgage Crisis"

Seminar Paper 22 pages (6468 words) Sources: 15

[EXCERPT] . . . .

Predatory Lending and the Subprime Mortgage Crisis

The issues with subprime mortgages are recognized by now, with many evasions and consequences for businesses and financiers in a similar way. A lot of writers have been swift to charge what they call hungry, predatory lenders who oppressed poor, simple and uneducated borrowers. This is expected for the reason that lenders have been blamed of many comparable sins in earlier periods. For instance, the uproar following the printing of Apgar et al. (2006)

, which has been extensively deduces as proof of racial bigotry, is renowned. So far other explanations of the data exist, with Elliehausen & Staten (2004) being a well-known case in point.

Analysts state that minorities disburse bigger overages or yield spreads than Caucasians, nevertheless point the result to dissimilarities in the groups of borrowers more willingly than to racial bias. Arthur (2008) and others dispute that racial discrimination is unsuccessful and that rising opposition is the favored move toward getting rid of discrimination. The tip is that the fundamental economic cause for any inequality is significant if watchdogs and lawmakers are to devise and pass suitable policy to iron out any suspected problem. Although the Hungry, Predatory Lender tale for subprime problems makes for good reading and headlines and even better scapegoats, it is not matching with the statistics. At the very least, there must be much more to the story.

II) Nature of the Problem: Mortgages and Laws

Carrying debt on a house is not necessarily a problem, provided you can manage to pay it. If the only sensible way to purchase a home was to write a $180,000 check and be done with it, most of us would be relegated to rental status for the rest of our lives. But that line between acceptable household debt and detrimental household debt is growing increasingly blurred. Like ownership, affordability has become a slippery concept.

Today more and more middle-class home owners are discovering that-despite the hard sell they got from their bank or mortgage lender-stretching to buy a home can put them in an exceedingly tight financial state. It used to be a fairly safe rule of thumb that if the bank was willing to offer you a mortgage, no matter what your circumstances, you could probably afford it. Taking out a mortgage was a straightforward endeavor. Your income and credit history were vetted by the local bank or savings and loan, you signed up for a fifteen- or thirty- year fixed-rate mortgage, then you made your monthly payments like clockwork until one glorious day you woke up debt-free. Beyond choosing whether to pay ahead of schedule or take the full span of years to own your house free and clear, there really wasn't too much choice involved. Shifts in the mortgage and lending industries over the past twenty- five years mean that today it's become much easier to buy a house, but much harder to hold on to one.

III) Causes -- Local Government Laws and Zoning

From the 1990's to the beginning of the subprime mortgage crisis in 2008, house prices in urban centers in America, increased at a rate of several times the general inflation rate. The trends still show attributes of inflation which had tripled in the span from 1993 to 2007, displaying a yearly increase of around 8%.

We shall investigate and try to deduce why the rates increased at such break-neck rates. The cost of construction could not have been the problem. The consumer price index was growing faster than the construction costs during and after the war, falling well after the period following the 1980's due to progress in technology in the form of more efficient, less costly, innovative methods of construction leading to employment increase for immigrant workers from factories to on-site. The prices of housing have even decreased in recent years, at a steady rate.

One of the factors that led to this unprecedented rise in house prices during the above mentioned period, could be urban housing supply restrictions imposed by local governments. Both the coasts witnessed record prices and inflation in house prices, which incidentally had the strictest land-use laws and restrictions. Comparatively, the South being the lowest and the Midwest area slightly lower than the coasts.

The local governments now trump the courts in matters of land-use laws thus slowly making the Fifth Amendments rights slowly redundant. Density control is now handled by the local governments, overriding court orders, and in places like Dallas. As much as half of approximately 50 restrictions applicable to a private lot, could be attributed to limit densities in residential areas. Dallas zoning laws require that the building be in complete compliance with local restrictions in case of altered exteriors, even though many of them are ushered in, when restrictions are tightened. Provisions like these override significant improvements in the standing stock of housing.

Zoning laws also cracked down on vertical development, thus encouraging "build out" by property developers. While it can be agreed upon that most sensible residents of a metropolis or city would prefer lower-density, however if he wishes more space he can buy bigger lots. One of the reasons for the breakneck speed of housing price increases have been government restrictions on housing supply thus making prices expensive. This might or might not have been intentional, nevertheless, it did deprive millions of middle-class, low and medium income minority people in stringently controlled areas.

It is relatively simple to impose an upper limit on government interventions in local housing that could significantly improve welfare of residents, if it is the wish of the people to live in lower density residential areas, as compared to competitive housing markets. The further the area is from a commercial center, the lower is the residential density of that area, regardless of restrictions. Sacrificing shorter commute times and distance, residents and simply opt for lower density neighborhoods, if density controls are not applicable. Controls make the situation much worse, if they are so restrictive that they make bigger commutes for the residents if there were not there in the first place. According to recent research, residents welfare are quite low, due to the longer distance commutes they face due to the density control laws.

IV) the Racial Factor and Minorities in Predatory Lending

Minorities are also far more likely to be given subprime loans, targeted toward those with low incomes or bad credit and offered at exorbitant interest rates. Roughly 50% of home loans to black and Hispanic households are subprime, compared to less than one- fifth of those issued to white borrowers. This racial gap between sub- prime and prime lending persists even after controlling for borrower income. A white borrower with an income of less than 80% of area median has about the same likelihood of obtaining a prime mortgage as an African-American borrower with an income in excess of 12.0% of area median.

Banks and lenders are more likely to push subprime loans to middle-class black families, most of who would qualify for a conventional mortgage, than to low-income whites do any of these looser lending policies help individual home buyers? Without question, they get us into homes we couldn't have afforded thirty years ago. But they also contribute to the rising percentage of the population who pay over 30% of their income toward housing, making them officially 'house poor.' The 2005 Census showed strong increases in the number of house poor, not just in major urban centers like New York and Los Angeles but in places like Wyoming, Michigan, Round Rock, Texas, and Plymouth, Minnesota.

Though the bulk of this country's house poor remain low income, affordability pressures are moving up the income ladder.

The number of house-poor middle-class families more than quadrupled between 1975 and 2001, and the number of middle-income households with severe housing-cost burdens-those paying more than half their income for housing-went up by 707,000 between 2001 and 2004, to a total of 3 billion. If you add in those who are below middle-income, the figure becomes truly staggering, $5.8 million home owners facing a severe housing burden.

It seems the key lesson to take into the home-buying arena today is twofold. First, despite the promises made by college educations, steady jobs, and the American dream, it is possible for a house to be a poor investment, a liability rather than an asset. Second, when it comes to figuring out whether you can afford a house at all, the bank is not necessarily your friend. Banks have been caught pushing subprime mortgages to those who would still qualify for a regular mortgage, and deliberately issuing mortgages to families they knew couldn't afford to pay them, with the intention of foreclosing then reselling the property.

One of the best things we can do to protect our interests is to educate ourselves on what the various mortgage options mean and the kind of long-term debt we're actually taking on when we sign that dotted line. We need to examine what… READ MORE

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