Mortgage Mess Started as a PC Problem

 

junky pink house

Little pink houses

Lending 101

There is an old axiom in lending – “Banks only lend money to people that don’t need it”.   Lenders want the highest probability of getting their money back plus interest.   If the risk is higher that someone is not going to pay them back then they want a higher return on their investment.  This allows them to cover the higher default rate and remain in business.  

Unfortunately, this has a non-politically correct catch to it.  Inner city minorities tend to have a lower education levels, shorter life spans due to violent crime and therefore low incomes.  Unfortunately, the risk factors associated with lower income inner city living result in a higher credit risk than middle class and wealthy minorities in the suburbs causing lenders to demand a higher rate of return. 

Enter the race-baiters. 

For years Jesse Jackson and Al Sharpton claimed that the lending system was racist.  They argued that minority “access” to credit was not based on equal opportunity even with the Equal Opportunity Credit Act.   In reality, lending businesses were being prudent by ensuring profitability so they could lend to more people.   They kept their interest rates at a level rate for everyone and demanded that people demonstrate their credit worthiness before receiving a loan.   

Enter the litigious society. 

In America we don’t get into fist fights. Instead we pay lawyers to verbally fight for us and hit where it hurts – right in the wallet.    Law suits started hitting the lenders bottom lines as more people began to win settlements claiming racism in the lending practices throughout the 80’s and 90’s.   Banks responded by opening branches in lower income neighborhoods and giving out small personal loans in the hopes that they might not be the next to be hit.  It was politically correct to market how access to money was getting so much easier.  Yet loans for big ticket items like cars and homes remained tough to get as fear of losing larger loans persisted.  

Enter the unscrupulous lenders.

The opportunists began to knock on the doors of the disenfranchised.  Lenders figured out that they could utilize the subprime market to charge a high rate to minorities that may not understand the loans they were agreeing to.  This way they could provide the “access” to credit yet make massive profits despite the higher default rate.  After all they were selling the American Dream and who is going to question that?  Instead of having the loans backed by hard assets and income it became acceptable to offer “Ninja Loans” with no proof of credit.  In some cases proof you were a tax paying US citizen wasn’t even required.  

The subprime market allowed for the selling of mortgage backed securities.   In other words the loans were packaged up and sold to bidders who were willing to take the risk for higher returns for fees.  If borrower defaulted the mortgage was then their possession.  All was fine as interest rates were stable and lending was liquid.  The banks and brokerages bought the securities and made big money.

  There was only one catch – many of the mortgage backed securities were backing loans that were 1 year, 2 year ARMS and other sorts of variable interest and fee loans.  When Greenspan decided to raise rates to curb rising inflation this triggered many of the loan payments to increase.   Bad for unsuspecting borrowers.   As more began to struggle defaults began to rise.   This left more housing on the market causing the housing bubble to burst.   The devaluation of the houses then left the investors with investments that had no value causing the lending market to tighten bringing us to this point in time.  Bad for us all.

Current times old rhetoric.

Now Jesse Jackson has changed his race politics message by contesting that subprime loans were disproportionately pushed on minorities.  It was estimated  that in 2005 more than 50% of loans agreed to by African Americans and 40% of those agreed to by Hispanic Americans were subprime loans. By comparison only 19% of Caucasian borrowers agreed to a subprime loan. 

Jackson told Congress that “Today’s terms of credit for African American and Latino borrowers are un-American”. “The cost of money for black and brown people is not based on equal opportunity, equal access or equal protection under the law.” So now we’ve gone from access to capital being racist to the cost of capital being racist.  When the credit market tightens will we go back to access being racist?   Maybe its not the lending market that’s the racist.

What now?

  So what started out as a political correctness movement to open up access to capital has now come to bailouts.  Bailouts should not be given to the lenders such as IndyMac and Countrywide. They knew what they were doing.  In fact the heads of the companies should be in jail for causing a crisis worse than Enron out of greed and incompetence. 

I’m not sure that those who couldn’t afford the loans should be bailed out either, they bare a burden of personal responsibility.  Although I do feel for those who are hard working low income people that just wanted a piece of the dream.  I understand it. I was there once. But there are no easy outs. You should not rely on wealth redistribution schemes to get you out of a financial mess when you bite off more than you can chew.  However, we must find a way to plug the holes in this sinking ship because we’re all on the boat.   That’s true no matter what race you are.

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