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Subprime Rate Loans And The Current Mortgage
Foreclosure Crisis
The subprime market is intended to provide home loans to
people with impaired or limited credit histories. However,
there is evidence that many families who receive subprime
mortgages could qualify for prime loans, but are instead
“steered” into accepting higher-cost subprime loans. The
belief that some subprime loan recipients’ could qualify
for prime rate loans suggests that some borrowers are
overcharged for mortgage credit, above what their riskbased
price may warrant. If this is true, the overcharges
drain money from homeowners and communities.
To what degree prime eligible borrowers misplaced into
subprime has contributed to the foreclosure crisis is unknown.
Also unknown is the extent of illegal steering occurring on a
prohibited basis, i.e. whether borrowers are steered to higher
cost subprime rate loans on a prohibited basis, such as race
or ethnicity. 8 The subprime misplacement question, steering
issues as well as fraud concerns highlights the need for
effective regulatory enforcement by the lending regulatory
community. 9
The Federal Reserve and other federal bank regulators
have been criticized by lawmakers for lax regulation of the
mortgage market. On July 18, 2007 the New York Times
reported that “Representative Barney Frank, chairman of
the House Financial Services Committee, threatened to strip
the Federal Reserve of its authority to write rules against
mortgage abuses if the central bank did not act quickly.” The
article further reported that Christopher dodd, who leads
the Senate Banking Committee, said that “a chronology of
regulatory neglect allowed the problems in the subprime
market to go unchecked.”
many factors contributed to the growth of subprime lending,
such as increases in capital made possible by securitization,
8 mike Hudson and E. Scott Reckard, more Homeowners with Good
Credit Getting Stuck in Higher-Rate Loans, L.A. Times, p. A-1 (October
24, 2005). For most types of subprime loans, African-Americans and
Latino borrowers are more likely to be given a higher-cost loan even after
controlling for legitimate risk factors. debbie Gruenstein Bocian, Keith S.
Ernst and Wei Li, Unfair Lending: The Effect of Race and Ethnicity on the
Price of Subprime mortgages, Center for Responsible Lending, (may 31,
2006) at http://www.responsiblelending.org/issues/mortgage/reports/page.
jsp?itemId=2937 1010;
9 The terms “bank regulator” or “lending regulator” is used
interchangeably to refer to the enforcement arms of: the Board of
Governors of the Federal Reserve (FRS or Fed) regulating lending affiliate
of bank holding companies and state chartered member banks; the
Federal deposit Insurance Corporation (FdIC) regulating state-chartered
non-member banks; the Office of the Comptroller of the Currency
(OCC) regulating national banks; the Office of Thrift Supervision (OTS)
overseeing federal savings and loans and federal savings banks; the
National Credit Union Administration (NCUA) regulating federally charted
credit unions and department of Housing and Urban development (HUd).
an increase in risk-based pricing facilitated by technological
advances, and the deregulation of the banking industry.” 10
Banking deregulation enabled lenders to offer more
varied loan products, which were attractive to more varied
consumers, and further gave incentives for more lenders to
enter the market. Numerous laws opened the door for the
development of the subprime market. Following is a synopsis
of various laws and party Administrations that contributed to
the growth of the subprime mortgage market:
depository Institutions deregulation and monetary Control
Act (“dIdmCA”). dIdmCA, 1980 (Carter Administration)
• Helped the Savings and Loan (“S&L”) industry stay
competitive with non-federally chartered banks where
consumers received higher rates of return.
• Enabled the S&Ls to recoup the higher interest rates they
were paying by allowing them to preempt state usury laws for
loans to consumers secured by first liens on their homes.
Alternative mortgage Transaction Parity Act, 1982 (Reagan
Administration)
• Extended federal mortgage-lending regulations to most
residential loans, including the permitted use of variable
interest and balloon payments. At the time this law helped
to standardize a wide variety of variable rate mortgages.
Nevertheless, it left room for lenders to create variable rate
loans that would be more risky in a Subprime context.
Tax Reform Act of 1986 (“TRA”) (Reagan Administration)
• Increased the demand for mortgage debt because it
prohibited the deduction of interest on consumer loans,
yet allowed interest deductions on mortgages for a primary
residence as well as one additional home. This fueled the
growth in home equity lending, a major component of the
subprime lending industry.
Financial Institutions Reform Act of 1989 (“FIRREA”) (Bush,
George H.W.)
• Addressed the costly S&L failures of the 1980’s and created
incentives for S&Ls to operate as thinly capitalized mortgage
brokers relying on the secondary market for loans.
Gramm-Leach-Bliley Act, 1999 (Clinton)
• Permitted financial service providers to merge with
insurers.
10 Howell, Benjamin, Exploiting Race and Space: Concentrated Subprime
Lending as Housing discrimination, California Law Review, January, 2006.
Page 3 of 27 The Demographic Impact of the
Subprime Mortgage Meltdown