Did Racist Subprime Lending Cause The New York Foreclosure Crisis?

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Did racist lenders intentionally steer minorities into more expensive subprime loans? And did this behaviour ultimately backfire, causing the foreclosure crisis?

That’s the crux of the argument made in the NYT, in its long piece about foreclosures and minorities:

Black buyers often enter a separate lending universe: A dozen banks and mortgage companies, almost all of which turned big profits making subprime loans, accounted for half the loans given to the region’s black middle-income borrowers in 2005 and 2006, according to The Times’s analysis. The N.A.A.C.P. has filed a class-action suit against many of the nation’s largest banks, charging that such lending practices amount to reverse redlining.

“This was not only a problem of regulation on the mortgage front, but also a targeted scourge on minority communities,” said Shaun Donovan, the secretary of Housing and Urban Development, in a speech this year at New York University. Roughly 33 per cent of the subprime mortgages given out in New York City in 2007, Mr. Donovan said, went to borrowers with credit scores that should have qualified them for conventional prevailing-rate loans.

For anyone taking out a $350,000 mortgage, a difference of three percentage points — a typical spread between conventional and subprime loans — tacks on $272,000 in additional interest over the life of a 30-year loan.

The piece, which is well worth reading, goes onto discuss the devastating effect of foreclosures on minorities.

Ok, “Reverse Redlining” is what the NAACP charges here. Unlike in the past, when lenders might’ve drawn a red, DO NOT LEND line around minority neighborhoods, now the charge is that they intentionally targeted those neighborhoods with seductive balloons and teasers that looked like a good deal, but when would come around to bite the borrower in the arse. And voila: foreclosure crisis.

For now let’s accept the premise as true, that a fair number of minority lenders were steered into these loans, even though they might’ve qualified for a conventional loan. As noted above, the difference isn’t trivial. $272,000 over 30 years is more than $700 a month.

But in terms of the relevance to foreclosures, the question: Does it follow that because a borrower took out a subprime mortgage, they were more likely to default? Or to put it another way, if that borrower had taken out a conventional mortgage, would they not have defaulted?

This the NYT didn’t try to answer. But when you’re talking about a crisis of foreclosures, and you make a charge like “reverse redlining,” it’s a pretty important, if not the fundamental question.

Intuitively, you’d guess that the connection isn’t significant. We know, for example, the most mortgage modifications fail. In other words, more most families facing foreclosure, the problem is not the ability to make their high monthly payments, the problem is the ability to make any significant monthly payments. What’s more, the government has been pushing like crazy to let credit-worthy make refinances. If the main problem for these homeowners, is that their subprime interest rates are too high, given their credit scores, they should be in position to refi, no?

If anything, the subprime/minority scandal would make sense in a different universe, where we never entered into a deep recession and housing prices continued to grow for another 30 years. Then we might’ve said: What the hell, why were all these minority families put into such expensive mortgages, as if they were major credit risks? Why has this black family been paying $750 more per month for the last 27 years than the white family that makes the same amount and has the same credit score?

Indeed, that would’ve been quite the scandal. But that isn’t what happened.

These foreclosed mortgages didn’t last anywhere near their full potential lifespan. And actually, to the extent that a significant part of their lifespan was during the initial teaser period, many of these lenders may have lost much less than if they’d been in conventional, fixed-rate mortgages right from the start.

It’s also worth noting that the data is not one-sided. A paper released in April, 2009 by the Federal Reserve Bank of New York (embedded below) disputed the claim that minorities were steered towards more expensive neighborhoods, though it does note that subprime lending was more prevalent in metropolitan areas, where there was a presumption that housing prices would continue to ascend.

Thus the thinking on the part of loan officers may have been benign (albeit naive). If this house is going to grow in value significantly over the next few years, why not give the lender a cheaper interest rate for the first, and then when the balloon payment kicks in, they can just refi. Actually, we know a lot of people both on the lending and the borrowing side of the equation thought that way when taking out subprime loans.

And indeed the NYT piece hints at this, as many buyers felt they were taking part in the restoration and revitalization (read: gentrification and asset price inflation) of these neighborhoods.

In the end, the problem here is that the NYT blithely asserts a causal link between subprime lending and the foreclosure crisis, but as any stats student will tell you (annoyingly so, sometimes) it’s easy to confuse correlation and causation. The correlation is indisputable (we think). The causal part: not so much.

Minority Interest Rates

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