PPA786: Urban Policy

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PPA786 Urban Policy

• Class 13
• Mortgage Markets and Predatory Lending

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PPA786, Class 13 Predatory Lending

• Class Outline
• The mortgage market today
• Predatory lending
• The default crisis
• Anti-predatory-lending legislation
• Note This lecture draws on Avery, Canner, and
  Cook, Federal Reserve Bulletin, Summer 2005, and
  Avery, Brevoort, and Canner, Federal Reserve
  Bulletin, December 2007, and on HMDA data
  available at www.ffiec.gov.

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PPA786, Class 13 Predatory Lending

• Its A Wonderful Life
• Mortgage markets used to be simple.
• People opened savings accounts in SLs these
  SLs loaned out their deposits to other people in
  the form of mortgages.
• At any given time, all mortgages were issued at
  the same interest rate but people with credit
  problems were turned down for a loan.

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PPA786, Class 13 Predatory Lending

• New Institutions
• How times have changed!
• Now commercial banks can issue mortgages.
• Most mortgages are now issued by mortgage
  brokers, who do not have deposits, but instead
  raise capital from depository lenders or
  investors .
• Secondary mortgage market institutions (Fannie
  Mae, Freddie Mac) bring investors and borrowers
  together by buying mortgages and packaging them
  into mortgage backed securities, which anyone
  can buy.

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PPA786, Class 13 Predatory Lending

• Types of Service in a Mortgage
• A mortgage offers four types of services
• Mortgage origination (using underwriting)
• Mortgage servicing
• Default and prepayment risk acceptance
• Capital provision
• An SL did all of these things now they are
  often provided by different institutions.

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PPA786, Class 13 Predatory Lending

• The Emergence of Mortgage Brokers
• Mortgage brokers, often working as an independent
  entity, originate a large share of loans and may
  provide the only contact with the borrower until
  closing.
• The mortgage broker plays an important role in
  pricing the loan, and the brokers compensation
  may depend on the interest rate and fees paid by
  the consumer.

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PPA786, Class 13 Predatory Lending

New Institutions
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PPA786, Class 13 Predatory Lending

• The Secondary Mortgage Market
• Of the 20.2 million home loans originated or
  purchased in 2004 by lenders covered by HMDA,
  14.1 million, or roughly 70 percent, were sold in
  2004.
• An unknown number of these loans were (or will
  be) sold on the secondary market in later years.

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PPA786, Class 13 Predatory Lending

• The Role of the GSEs
• Fannie Mae and Freddie Mac are government-sponsore
  d enterprises (GSEs).
• They mainly purchase conventional, low-risk loans
  for purchase or refinancing.
• They bought 35 of the loans purchased by
  secondary-market institutions.
• Other purchasers include banks (8), private
  securitization pools (5), and mortgage and
  insurance companies (9).
• About 11 of purchases are by firms affiliated
  with the original lender.

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

• New Products
• These changes have led to new products.
• Many types of mortgages are now issued, some of
  them, called subprime, at high interest rates.
• Many high-risk borrowers can now get a mortgage
  if they are willing to pay a high rate.
• Lenders buy credit scores and automated
  underwriting systems to predict which potential
  borrowers are most likely to default.

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PPA786, Class 13 Predatory Lending

• New Practices
• With new products come new practices.
• The complexity of todays mortgage market puts
  consumers at a disadvantage.
• Some unscrupulous lenders use misleading or
  fraudulent tactics to collect interest payments
  or fees above competitive levels, which is called
  predatory lending.

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PPA786, Class 13 Predatory Lending

• Types of Predatory Lending
• Questionable or illegal practices include
• Making loans that exceed the borrowers ability
  to pay, sometimes with teaser rates (2/28 or
  3/27 loans)
• Inducing repeated refinancing accompanied by high
  fees (loan flipping),
• Inducing the consumer, through deception or
  fraud, to accept loan add-ons, such as credit
  insurance,
• Steering borrowers qualified for lower-rate
  loans into higher-priced loans
• Overestimating the value of the collateral to
  overstate available equity or induce a consumer
  to pay an inflated price for a home.

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PPA786, Class 13 Predatory Lending

• The Extent of Predatory Lending
• Nobody knows how much predatory lending exists.
• Interest rates are much higher in minority and
  low-income neighborhoods, where household have
  little experience with homeownership.
• But subprime loans are clearly more common in
  places with more credit problems, as one would
  expect with no predatory lending.

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

• Higher-Price Loans and Tract Credit Scores

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PPA786, Class 13 Predatory Lending

• The Default Crisis
• Starting about 2005, the number of defaults, i.e.
  missed mortgage payments, started to increase.
• When payments are missed over several months,
  lenders foreclose, that is, they take over the
  house.
• Re-negotiation is rare the lender holding the
  loan is unlikely to be the party who issued it.
• Millions of homeowners may lose their homes.

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

• Predatory Lending and the Default Crisis
• To some degree, the default crisis may reflect
  the combination of legitimate subprime loans and
  an economic downturn.
• But the most likely villain is predatory lending.
• Thanks to the onerous terms imposed by predatory
  lenders, many borrowers have been unable to keep
  up with their payments.

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PPA786, Class 13 Predatory Lending

• Mortgage Brokers and the Default Crisis
• Many observers think that predatory lending by
  mortgage brokers plays a key role in the default
  crisis.
• The theory is that mortgage brokers do not bear
  the risk because they make their money simply by
  originating the loan.
• This is called moral hazard ( being insured
  against a risk over which one has control)

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PPA786, Class 13 Predatory Lending

• Who Issues Higher Priced Loans?

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PPA786, Class 13 Predatory Lending

• Evidence on Moral Hazard
• A recent paper by Mian and Sufi finds evidence of
  moral hazard.
• Tracts with high loan-denial rates in 2001 and
  without income or employment increases thereafter
  experienced large decreases in denial rates from
  2001 to 2005.
• These patterns were linked to a sharp increase in
  the share of loans sold by originators shortly
  after origination (called disintermediation).
• The result large increases in defaults from
  2005 to 2007.

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

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PPA786, Class 13 Predatory Lending

• HOEPA
• The Home Ownership and Equity Protection Act of
  1994 (HOEPA) was designed to (pretend to) combat
  predatory lending.
• It applies to closed-end home loans (excluding
  home-purchase loans) bearing an APR or
  dollar-amount fees above specified thresholds.
• It imposes restrictions on certain loan features,
  including balloon payments and prepayment
  penalties, and requires improved disclosures for
  consumers.

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PPA786, Class 13 Predatory Lending

• Reforms to HOEPA
• Revisions to HOEPA in 2001 lowered the APR
  trigger for coverage of first-lien loans from 10
  percentage points above the comparable-maturity
  Treasury security to 8 percentage points.
• And adjusted the dollar-amount trigger for fees
  to include amounts paid at closing for optional
  credit insurance products.

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PPA786, Class 13 Predatory Lending

• Loans Covered by HOEPA
• Lenders offer few loans covered by HOEPA.
• In 2004, HOEPA covered only 0.003 of refinance
  or home-improvement loans.
• Just ten lenders (mostly banks) made 37 of all
  reported HOEPA loans.

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PPA786, Class 13 Predatory Lending

• State Efforts to Combat Predatory Lending
• Many states were developing stronger laws than
  HOEPA.
• As noted in the Spitzer op-ed
• In 2003, the OCC invoked a clause from the 1863
  National Bank Act to preempt all state predatory
  lending laws, thereby rendering them inoperative.
• The OCC also promulgated new rules that
  prevented states from enforcing any of their own
  consumer protection laws against national banks.