Subprime and predatory lending are the most controversial and visible topics involving the Community Reinvestment Act and fair lending. If we are to establish good public policy on this matter, it must draw from all three components of the CRA Triangle community groups, regulators, and the industry. There must be a constant give and take, a dynamic tension, among this trio, and no one interest should overpower the others.
Whereas community groups may have traditionally been outgunned by the financial industry, the opposite is the case in the current subprime and predatory lending debate. We have witnessed a nonstop stream of horror stories from predatory-lending victims on the television networks and in the print media.
Community groups have been very successful in getting the ears of regulators and legislators as well as the eyes of news media cameras in calling for tougher action, including new regulations and laws at the city, state, and federal level.
There is much more to come.
What is missing from this debate is a unified subprime industry voice, something that is crucial if we are to set sound public policy. The lack of an advocate for the more than $10 billion-a-month sector is apparent; the news media, conference organizers, and congressional panels all have problems finding industry representatives for comments.
Representatives of community groups and regulators/legislators are eager to discuss subprime and predatory lending, but representatives of leading commercial bank, thrift, mortgage bank, and other financial industries want to avoid being associated with such topics. This lack of a subprime-industry advocate is a serious problem with potentially serious public-policy ramifications.
A major reason for this is the confusion between subprime and predatory lending. These inherently good and bad concepts have been linked as a common evil. Community groups, probably more than anyone else, are responsible for this confusion.
For example, in recent congressional testimony the head of a national coalition expressed concern over the exponential growth of subprime (and potentially predatory) lending. Another national community group recently issued a study lambasting predatory lending and financial apartheid, but all the supporting data referred to subprime loans.
Some misguided souls even malign subprime lending directly. For example, a community representative turned professor, who recently completed his PhD dissertation on the Community Reinvestment Act, criticized a prominent professor because he has ties to the subprime industry as a result of his association with a firm that sells mortgage origination software to prime and subprime lenders alike!
This confusion between predatory and subprime lending, and, worse yet, the stigmatizing of the latter may have the perverse effect of limiting the availability of credit to low- and moderate-income individuals and areas.
Well-meaning public officials, under pressure from vocal community groups, may be throwing the CRA baby out with the predatory bathwater.
These and other problems for subprime lenders will only get worse unless there is some leadership and unification within the industry. I suggest it consider the approach taken by another subprime industry, namely junk bonds, that came under heavy assault roughly 10 years ago.
Junk bonds, like subprime loans, are defined as below-investment-grade paper. Both involve lending at high interest rates to clients who have exhausted other traditional (and cheaper) financing alternatives. And, just as some subprime lenders have conducted predatory activities, there are and have been abuses in the junk bond industry, which have been addressed by judicious legislation and/or regulation.
Of course, there are obvious differences between financing individuals and small businesses in the retail market and funding huge corporations in the money market. What is the same is the need for fair access to capital by all, even when higher risks warrant much higher rates and tougher terms.
Our successful and envied system of capitalism is driven by market forces, not Washington bureaucrats determining loan rates and terms. Community representatives must realize these economic facts of life; otherwise they will fall into the credit allocation trap and provide the enemies of the CRA with ample ammunition to kill it.
Regardless of whether you accept my analogy between the subprime lending and junk bond industries, we can learn something from how Michael Milken sold junk bonds to a skeptical public when the bonds were under considerable attack.
First, he used the term high-yield to stress the bonds positive feature. Subprime lending could be called high-cost lending to highlight the reality of the transaction from the perspectives of both the borrower and lender, or even legal last-resort lending.
However, I prefer high-risk lending, as it better reflects the lenders utmost concern and the borrowers circumstances in bringing about the loan request.
Second, Mr. Milken organized a Washington lobbying group, the Alliance for Capital Access, which harnessed the various views of the industrys key players. Industry groups with interests in subprime lending should sponsor a similar alliance for high-risk lending to ensure a balanced perspective in public policy. This way, the news media and others finally would have one source to turn to for the official industry stance.
Third, Mr. Milken trumpeted the most successful junk bond borrowers (e.g., Continental Airlines) that otherwise would not have survived. A high-risk-lending alliance could do likewise publicize the stories of credit-damaged and distressed borrowers with bankruptcy, tax, divorce, medical bills, or other financial problems who used high-risk loans to rebuild their lives and credit.
This would be a welcome relief from the parade of elderly borrowers we see on prime-time TV who have been stripped of their home equity by unscrupulous lenders.
These Milken proposals will not stop additional local, state, or federal regulations and legislation in subprime lending, but may ensure that they are more balanced.