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Updated Article on Subprime Lending:

I've posted an updated version of my article on the "Law and Economics of Subprime Lending" which is forthcoming in the University of Colorado Law Review. The way things are going, I'll probably have to update it again this weekend. Then next weekend. Then...

Arkady:

The way things are going, I'll probably have to update it again this weekend tomorrow. Then next weekend the day after tomorrow. Then...
9.19.2008 11:02am
Jon Roland (mail) (www):
I have been studying this problem for a long time, and predicted the present difficulties years ago. Many are now calling for regulations and new regulatory powers and institutions, but most seem to be missing the key points of appropriate intervention.

The problem started, in a critical way, in the courts:

First, it stems from judges started accepting affidavits of ownership as proof, instead of requiring the original signed mortgage note, as they have done in past ages. It is this that enabled securitizers to bundle notes and lose track of the individual merits of the notes.

Second, it stems from courts allowing foreclosures to be made too easily, often without notice to the borrower, who first learns about it when he gets an eviction notice, finds he has no defense against eviction, and winds up having to find a new place to live while conducting an expensive fight to challenge the foreclosure, often unable to find who to sue, or perhaps discovering his payments were not forwarded to the new owner of the note, that the servicing agent has gone bankrupt, and he is only an unsecured creditor for the payments he made.

The mortgage problem arose because lenders, expecting continuing rise in housing prices, made loans they expected to foreclose on, because they planned to make their profits on the resale. Courts enabled them to do that by making foreclosures too easy and inexpensive.

The main solution to this problem is to return to judicial supervision of foreclosures, with a requirement of presentation of the original signed note and not an affidavit of ownership, and a defense of having made all payments on time to the last known servicing agent.

These reforms would require lenders to rate each and every note individually, and maintain those ratings in any bundling, so that the bundles can't be traded without the purchaser being able to examine the disaggregated component notes.
9.19.2008 12:19pm
A. Zarkov (mail):
The roots of the sub-prime loan problem lie in decreased underwriting standards brought about by the Community Redevelopment Act, social activism, and government pressure on banks and lending institutions to make loans to blacks and Hispanics in large numbers. Ask yourself: suppose banks had not compromised their lending standards; would we have had a sub-prime crisis? I submit the answer is no. Once standards were lowered, imprudent loans expanded beyond the original target groups to virtually everyone else. Even people with good incomes and credit scores took out option ARMs to trade up in house quality or use their homes as ATMs machines for pure consumption expenditures. One can bring in a blizzard of academic abstraction, but the roots of the crisis lie squarely in the political arena. Just browse through the booklet put out by the Fannie Mae Foundation Reaching the Immigrant Market, (available on the web) and you will see the thought processes behind the push for lowered standards. In my opinion no analysis can be complete and accurate without treating this important and perhaps primary factor.
9.19.2008 12:39pm
PC:
The roots of 25-30% of the sub-prime loan problem lie in decreased underwriting standards brought about by the Community Redevelopment Act, social activism, and government pressure on banks and lending institutions to make loans to blacks and Hispanics in large numbers.

fixt
9.19.2008 12:51pm
J. F. Thomas (mail):
The roots of the sub-prime loan problem lie in decreased underwriting standards brought about by the Community Redevelopment Act, social activism, and government pressure on banks and lending institutions to make loans to blacks and Hispanics in large numbers

What unmitigated, dishonest, and utterly disingenuous bullshit.

No bank, anywhere, at any time was forced to make loans to people who could not verify their income or who had a bad credit rating. The housing bubble of the last seven years ago has nothing to do with bans on redlining or efforts to serve underserved communities. It was based entirely on a classic unsustainable bubble market where investors bet that they could drive prices up by 20% a year and bail out before the bubble burst. It was driven by pure greed and the ability to package and sell the mortgages in MBS. Instead of the mortgage companies making money off the mortgages themselves, they were making money off the transactions, so it didn't matter to them if the homeowners were able to make the payments. Many of these mortgages were designed to fail. Apparently the investors thought since real estate was going up 20% a year that they would be able to get their money back at foreclosure. Of course, like any PONZI scheme, it will all collapse on itself, which is exactly what happened.

Now the taxpayers are left holding the bag.
9.19.2008 12:54pm
A. Zarkov (mail):
"The roots of 25-30% of the sub-prime loan problem..."

Skirting the question. Would the crisis have occurred without decreased underwriting standards? How does a package of high quality loans where each loan has a very low probability of default cause a crisis. You can't have a sub-prime crisis if you don't have sub-prime loans.
9.19.2008 12:57pm
A. Zarkov (mail):
"No bank, anywhere, at any time was forced to make loans to people who could not verify their income or who had a bad credit rating."

Tell me how a bank can increase the number of loans to the black and Hispanic communities without lowered standards? You won't find a direct order, but you will find extreme pressure to improve the statistics. Pressure that takes many forms including threats not to approve mergers unless the stats look better,
9.19.2008 1:03pm
PC:
A. Zarkov: Skirting the question. Would the crisis have occurred without decreased underwriting standards

You are conflating the CRA with the systemic decrease of underwriting standards. Healthy banks can afford to decrease lending standards for a small portion of borrowers because they can hedge the risk. The CRA didn't create option arms and ninja loans. The CRA did not force non-FDIC insured lenders to create CDOs and unregulated CDSs. The CRA didn't tell financial institutions to make risky loans, package them up, and resell them to investors because "real estate always goes up."

If Flip That House had debuted in 2000 instead of 2005 I would lend more weight to the idea that the CRA was the primary cause of this mess, but the timeline just doesn't add up. This is a case of Thar be profits! with no one paying attention to the risk.

I will agree that the root of this problem came from the political arena, but I think you need to look at 1999-2000 rather than 1977 or 1995.
9.19.2008 1:31pm
A. Zarkov (mail):
The argument basically comes down to this. Did lenders make bad loans to comply with the CRA and satisfy the demands of activists and the Fed, or did they make those bad loans simply to get enhanced profits? I argue that both are true. CRA and the activists got the ball rolling, and it took off from there, giving us liar loans, 100% financing, CDOs etc. There's no doubt that the finance industry made huge profits off this and many borrowers were duped into loans they could ill afford. But if we ignore the roots of this crisis we will be doomed to repeat it in another form. As with any system with multiple positive feedbacks, strict cause and effect are difficult to identify.
9.19.2008 11:52pm