Toxic loans 'designed to fail' spur harder line

The Baltimore Sun

Last week's crackdown on toxic mortgages is not one of those regulations that harms one piece of the economy in exchange for greater good in another. It's a pure benefit, despite what the Mortgage Bankers Association would have you believe.

"This is a strong statement that will help curb abuses, but will likely also constrain consumer credit choices," association Chairman John M. Robbins said Friday.

Yeah, it'll constrain consumers from choosing products likely to ruin them and cost their lenders. The new rules on "subprime" mortgages set by banking regulators last week are too late to stop the newest batch of heartaches, but they'll prevent problems the next time the housing market goes berserk.

Saying "yes" to almost any borrower who walks in the door - even if his income is inadequate, even if the house he wants is too expensive, even if he offers no proof of solvency - is not consumer-friendly.

It generates a nice origination fee for the banker. It produces revenue for the people who bundle the loan into a bond. And it makes a tidy commission for the broker who sells the bond to a pension fund, insurance company or some other sucker.

But it is anti-consumer in just about every way possible.

The most obvious harm occurs when borrowers default on payments, lose their homes and risk landing in bankruptcy proceedings.

Thanks to a surge in subprime lending the past three years, thousands of homeowners are in this situation. The portion of subprime loans in foreclosure proceedings hit 2.43 percent in the first quarter, according to the Mortgage Bankers Association, the highest in almost five years. Subprime loans whose payments were overdue neared 14 percent.

No, nobody held a gun to their heads when they took out loans.

But subprime borrowers, who ordinarily don't have the track record to qualify for the cheap terms seen on TV and in the big print, are unsophisticated almost by definition. They have low incomes. They're often single mothers or elderly. They're an easy mark for pushy salesmen, and they should be the first constituency regulators think about.

"Thousands of middle- and lower-income Americans were basically tricked into borrowing, even though the loans themselves are designed to fail them," New York Democratic Sen. Charles E. Schumer said at a hearing on subprime mortgages on Capitol Hill last week.

Recent subprime loans have come with enough bells and mousetraps to baffle a Rockefeller. At first they don't require monthly principal repayments. Then they do. Initially they come with below-market interest rates, which soon increase to follow the seesaw London Interbank Offered Rate or some other esoteric mark.

More than two-thirds of the subprime loan contracts analyzed by the Center for Responsible Lending included prepayment penalties, which exact a ransom if borrowers want to refinance into a more affordable product.

In short, the central motive for many subprime loan originators seems to have been to "qualify" and sign borrowers as quickly as possible and worry about the consequences later. Or never.

In more than a third of the subprime loans examined by the Center for Responsible Lending, originators required little or no proof of the borrower's income.

Owed billions

As recently as this year's first quarter, 57 percent of the loans originated by Columbia-based Fieldstone Investment "were underwritten with little or no supporting documentation of the borrowers' income," the company said in a regulatory filing. Fieldstone was owed more than $2 billion from such borrowers as of March 31.

Why would originators approve a loan "designed to fail," as Schumer describes it? The answer is that many offices, unlike Fieldstone, immediately sold all or most of the loans. Then, when they go bust, it's somebody else's problem.

This is the second way subprime loans hurt consumers. Not everybody holding the subprime bag is a high-roller hedge fund, such as the Bear Stearns vehicle that recently had to be bailed out with $3 billion in loans after subprime bonds went sour.

Sometimes they're retail investors, such as shareholders of the Regions Morgan Keegan Select High Income Fund, which holds about 14 percent of its portfolio in subprime bonds, according to Business Week. As the subprime market has deteriorated, the fund has lost 3 percent so far this year. That's not high income!

Fieldstone's shareholders are surely even less thrilled. The company has lost half its value in a year and is about to be sold off.

The third way subprime lending hurts consumers is all around us: the cost of housing. Who helped bid those prices into space in the first place? People scoring mortgages they shouldn't have gotten to buy houses they couldn't afford. If you really want to help low-income homebuyers, don't stoke the bubble with dodgy credit and put houses out of reach.

More evidence

So the new rules from the Federal Reserve, the Federal Deposit Insurance Corp. and other regulators, which apply to most but not all lenders, make sense in multiple ways. Lenders must now get more evidence that borrowers aren't lying about their finances. And borrowers must show they can afford payments even after low, teaser rates expire and market rates kick in. Earlier this year, the Mortgage Bankers Association's Robbins ostentatiously warned that tighter regulation "could harm the very borrowers that we all wish to protect."

Doesn't look like he has too much to worry about.

jay.hancock@baltsun.com

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