Academics including Ken Thomas of the Wharton School and Robert Litan of the Brookings Institution have spread myths recently about the role of subprime lending. Lets explore some of them.
Myth 1: Subprime lending has been responsible for record homeownership rates among minorities and lower-income groups.
An invigorated Community Reinvestment Act and community-lender partnerships not the advent of subprime lending have spurred banks to make record numbers of home mortgage loans to minorities and lower-income borrowers. In 1990, low- and moderate-income borrowers received 18% of home mortgage loans made by lending institutions. That rose to 26% by 1995 and 30% by 1999.
Notice that the largest increase 8 percentage points occurred from 1990 to 1995, before the huge spike in subprime lending. When subprime lending took off from 1995 to 1999, the share of mortgage loans received by low- and moderate-income borrowers climbed only 4 percentage points.
The recent Department of Treasury study required by the Gramm-Leach-Bliley Act of 1999 found that banks made more home mortgage loans in geographical areas in which they made Community Reinvestment Act agreements and established partnerships with community groups. The study also concluded that CRA-covered banks had a considerably smaller share of the subprime market than the prime market.
Myth 2: By and large, subprime lending is priced efficiently.
A study by the Research Institute for Housing America, an offshoot of the Mortgage Bankers Association of America, found that minority borrowers are more apt than whites to receive subprime loans, even after controlling for credit risk factors. Freddie Mac estimates that up to 30% of the subprime loans they have purchased were made to borrowers qualified to receive prime loans. Fannie Maes CEO claims that half of subprime borrowers should be receiving lower interest rates. Accordingly, Fannie Maes Timely Payment Rewards product offers subprime borrowers rates that are 2 percentage points lower than prevailing subprime rates.
The assertions of overall pricing efficiencies in the subprime market are untested, disingenuous, and misleading.
Myth 3: Proposed legislation is counterproductive.
The subprime market is plagued with a segment of predatory lenders that discriminate on the basis of price and load-up loans with abusive terms unrelated to compensating for risk. For example, single-premium credit insurance or the up-front financing of credit insurance products is much more costly to borrowers than if they were to purchase life or disability insurance independent of the mortgage transaction.
Steep prepayment penalties, high balloon payments, and negative amortization on high-interest-rate loans are also abusive practices that were not needed for the prime-rate homeownership boom among lower-income and minority borrowers in the 1990s.
Economists differ on the extent to which regulation and legislation is needed to eliminate market imperfections. But when the imperfections such as natural monopolies appear to be impervious to other approaches, legislation and regulation are called for.
My group, the National Community Reinvestment Coalition, believes that certain lending practices are so exploitative that they need to be outlawed. Homeownership counseling can help borrowers shop for better loan rates, but why should we warn borrowers about single-premium credit insurance when we believe that such a product is inherently harmful? Why should we counsel borrowers against high prepayment penalties and balloon payments on high-interest-rate loans when limiting these features does not choke off good credit, but only eliminates abusive lending?
It is time for Congress to enact predatory-lending legislation introduced by Rep. LaFalce and Sen. Sarbanes. These carefully crafted bills aim to prevent such lending without blocking underserved populations access to credit.
Mr. Taylor is president and chief executive officer of the National Community Reinvestment Coalition, Washington.