Even after the CJR demolished it, John Carney lays out his full theory on how the CRA caused so many subprime loans here. I think this is an important point to clarify, as it’s going to float out there in the popular consciousness. It’s a good question why so many people gave out so many questionable loans, and it is natural for people to think someone made them; I think Megan concedes the argument but still wants to see the CRA dismantled. I think the CRA is worth defending, so let’s look at the argument closer.
Carney acknowledges two key points: (1) CRA loans were very profitable for the banks in question and (2) most subprime loans were from places with no CRA coverage. He thinks that CRA loans looked so profitable that subprime lenders wanted in on that, so they duplicated their efforts but to no avail.
A subprime loan is not a slightly worse CRA loan.
Subprime loans aren’t like CRA loans. Carney focuses a lot on the LTV numbers, but that is only one characteristic of a subprime loan. My favorite chart of the subprime data:
80% of the subprime mortgages expired in 30 months; they perpetually had to be refinanced. 75%+ of subprime mortages had a prepayment penalty. This is not at all what CRA loans looked like. CRA rooted for solid, longer-term mortgages. If they ever rooted for a lot of prepayment penalties and fees to get tacked onto their loans, I’ve never seen it.
Another important statistic – in Massachusetts 60% of subprime defaults were originated in prime mortgages. So a large chunk of subprime loans were really prime loans that were collapsing. Either the breadwinners were experiencing “income volatility” or their spending was out of control or whatever. Capturing the disintegrating middle-class on terrible terms is not an objective of the CRA.
I’m going to go into some new research about a favorite topic around here, the roles the consistent refinancing, prepayment penalties and fees did to change the mortgage market, and how a consumer’s bill of rights that took us back to 1982 would be a great move. In case you don’t trust a pseudonymous blogger with a free wordpress account, it’s where the elite research is going to converge when discussing this in my humble opinion. Here’s Did Prepayments Sustain the Subprime Market? by Bhardwaj and Sengupta from the St. Louis Fed:
Using loan-level data on subprime mortgages, we present evidence on the uniqueness of subprime mortgage design. We show that the viability of such products was predicated on the appreciation of house prices. In a regime of rising house prices, a borrowers avoided default by prepaying the loan…Gorton (2008) argues that lenders designed subprime mortgages as bridge-financing to the borrower over short horizons for mutual benefit from house price appreciation…Subprime mortgages were meant to be rolled over and each time the horizon deliberately kept short to limit the lenderís exposure to high-risk borrowers.
The rationality is nothing like that of a CRA loan. It was something new, something about consistent refinancing with a huge amount of fees and penalties, using jumps in the interest rate to force prepayments. They were bad-faith loans, loans that were not meant to be repaid back, unlike a CRA loan.
“Wait, Mike. I’m getting a weird sense of déjà vu. I feel like I’ve heard this before.”
“A loan that wasn’t really meant to be paid off. but instead to be paid off enough with high interest rates with higher jumps to force additional payments to occur, and with a lot of the value coming from fees and penalties.”
That does sound familiar.
“Hey wait – that’s how credit cards work!”
Good metaphor. Indeed, the logic of a subprime loan looks disturbingly like the logic of a credit card. If we had to backwards out what motivated someone to go ahead and try to make these subprime loans, you’d have to say they looked at the profitable credit card market and said “ya know what, let’s design a mortgage that looks exactly like that.” The credit card model is about as far away as you can get from the CRA model – and it is very easy to imagine subprime lenders licking their lips at the sweet profits the credit card companies were making moreso than the tiny CRA market.
Update: Barry just placed a $100,000 bet saying someone could not convince a jury over him about this issue. God bless the internet.