Where Do Social Engineers Get Off Commenting on the Subprime Mess?

This is a fantastic article on the causes behind the meltdown in the mortgage market. If you are wondering why the Democrats aren't holding Congressional hearings, this is why:

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By KERRI HOUSTON | Posted Wednesday, February 20, 2008 4:30 PM PT

As the subprime mortgage crisis continues to expand and the FBI begins to investigate unorthodox mortgage qualifying guidelines, the causes of the crisis are yet to be examined outside the paradigm of lending practices and within the context of do-gooderism gone awry.

Economists define predatory lending as creditors deceiving households into borrowing more than they are able to pay back, implying deception and lack of transparency.

Yet this phrase is being attached by coercive utopians with increasing frequency and decreasing accuracy to any financial transactions that includes a low-income borrower. As with any phrase tossed willy-nilly into a mix of financial reality and social engineering, it is impolite to unearth and impolitic to assault.

Two forms of lending currently are in the sites of self-proclaimed lending reformers: mortgages and short-term consumer loans. In an ironic twist of economic fate, it appears that those criticizing the latter may have contributed to the current pain of the former.

The fair housing movement forced adoption by the government and secondary lenders of unrealistic homeownership goals and ineffectual qualifying guidelines, thus creating an artificial lending environment now causing great harm to the very borrowers it purports to assist.

The best example is North Carolina, where regulatory and social-economic policy combined to increase bad debt and decrease available credit for low-income borrowers.

When public policy is based on emotion and not sound fiscal principles, personality and bad judgment often play critical roles.

Meet Martin Eakes, social activist and founder of North Carolina's Self-Help Credit Union and the Center for Responsible Lending. Although Self-Help's main activity is providing subprime loans, Mr. Eakes lobbied North Carolina's legislature to pass "predatory lending" reform on its subprime lenders and to outlaw other forms of consumer loans.

It appears that the only subprime loans that Mr. Eakes condones are his own. Coincidentally, his credit union industry is gearing up to start competing with some forms of the payday-style lending that he regularly attacks.

In 1998, Self-Help entered a very profitable venture with the left-wing Ford Foundation and secondary mortgage market giant Fannie Mae to provide mortgage loans to North Carolina's low-income families. After Ford granted $50M of risk capital to give Self-Help's clients the down payments these borrowers did not have, Self-Help then originated the loan, and finally, Fannie Mae purchased the loans from Self-Help.

The deal was made by then-Fannie Mae Chairman Franklin Raines, who resigned in 2004 for allegedly overstating earnings to ensure inflated bonuses for himself and other executives. Raines remains a target of federal government investigations and lawsuits, yet Eakes has publicly stated that Raines was "not dishonest in any way. . . . You will not find scandal there."

Under Eakes' lending reforms, North Carolina leads the U.S. in foreclosures. In a year-over-year comparison, the state's foreclosure rate outpaced the nation with a whopping 146% increase vs. 94% nationwide.

Limiting other forms of lending also has consequences. According to a study by Donald Morgan of the Federal Reserve Bank of New York, banning "payday" lending hurts consumers needing short-term loans. Unlike subprime mortgages that allowed borrowers to simply state income and assets without providing proof, payday borrowers must provide documents demonstrating the ability to repay.

In further contrast to the mortgage industry, short-term consumer lending is booming and very profitable. As a lender can't make money unless debts are repaid, it's clear that consumers are overwhelmingly repaying as agreed.

The Fed report noted that regulation increases consumers' cost, and in states where there is a wide competition between lenders, interest rates and fees are lower.

Since these loans were banned in the state in 2005, North Carolinians have suffered more utility service disruptions, bounced checks and bankruptcies. Despite these alarming statistics, Eakes and his fellow activists are pressuring other states, Virginia and Ohio in particular, to ban short-term consumer lending.

Waving the banner of race and income discrimination, Eakes contributed to a highly charged political backdrop that resulted in President Bush implementing federal goals in 2002 to increase homeownership by 5.5 million households by 2010. This helped open a Pandora's box of subprime lending vehicles that meets the "predatory" definition of extending credit to those who cannot afford it.

From January to November of 2007, more than 1 million homes entered foreclosure. Not only are homeowners losing their homes, but even renters paying as agreed are being evicted as lenders reclaim properties. Depending on the state, 48% to 69% of these foreclosed loans come from the subprime market.

"Subprime" refers not to interest rates, but to borrower quality, as low-income applicants often have poor credit, unstable employment history, and limited assets. Because of increased risk, they are unable to get favorable rates and are often drawn into loans with low short-term introductory terms. When these mortgages adjust to market rates, the borrower no longer qualifies for the loan he already has and can no longer pay.

As a gifted down payment and no requirement to actually prove income were the only way to move them into mortgages, many borrowers were lured into a false prosperity for which they were neither prepared nor equipped and are now suffering through foreclosure.

Mortgage lending, when it readjusts to market forces, will again access risk on proven underwriting principles. The natural adjustment of the market will in turn provide mortgages to low-income borrowers at terms that realistically meet their financial needs and allow long-term home ownership.

The mortgage crisis is a result of many factors. But in crafting lending reform, policy makers must ensure that the North Carolina consumer credit model is not be replicated.

Social engineers should not be allowed to influence legislative decisions about consumer practices or play loosey-goosey with underwriting criteria. Prudent fiscal policy should not be replaced with political intimidation by those who demonstrate that sound judgment is less important that achieving social goals at all cost.

Houston is a public policy analyst and president of Institute for Liberty, a free-market think tank headquartered in Northern Virginia.