By Wilt Alston View all 5 articles by Wilt Alston Published 01/22/09  
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Apparently, Monroe County, New York, the county in which I reside, has "Upstate's highest foreclosure rate." At least a piece of campaign mail I received a while back says so. That piece of election propaganda also said, "Predatory lenders brought us to foreclosure... and now we're bailing them out?" Given all the press that "predatory lending" has gotten recently, in light of the fact that legislation — specifically laws like the Community Reinvestment Act — resulted in many of the supposedly sub-prime mortgages and given that the percentage of people receiving these loans who were black, the issue interests me. The pejorative term "predatory lending" and how such scary descriptions are used to justify statist protection of black folk also sparked my interest. According to the more-than-occasionally-correct Wikipedia: Predatory lending is a pejorative term used to describe practices of some lenders. There are no legal definitions in the United States for predatory lending, though there are laws against many of the specific practices commonly identified as predatory, and various federal agencies use the term as a catch-all term for many specific illegal activities in the loan industry. One less contentious definition of the term is "the practice of a lender deceptively convincing borrowers to agree to unfair and abusive loan terms, or systematically violating those terms in ways that make it difficult for the borrower to defend against."[1] Other types of lending sometimes also referred to as predatory include payday loans, credit cards or other forms of consumer debt, and overdraft loans, when the interest rates are considered unreasonably high.[2] Although predatory lenders are most likely to target the less educated, racial minorities and the elderly, victims of predatory lending are represented across all demographics.[3][4] I have no real dispute with much of this. What troubles me, however, is the presumption that the State must protect certain people from taking out a loan that they themselves are seeking in the first place! I rather think predatory lending is when the taxpayer lends the government money to finance the clean-up of a malady that government policy caused. (Actually, in that case lending is a bogus description. That scenario sounds more like theft.) But maybe I'm getting ahead of myself. Who Is the Predator and Who Is the Prey? Let's say you're a banker. In walks a prospective borrower. Let's call him Borrower A. He has a great credit history. He plans to purchase a home for which the asking price and the value are approximately equivalent. (This is, of course, seldom true from the standpoint of Austrian economics, but let's just assume it's true for our example.) The borrower has 20% for a down payment. You make the loan. Everyone is happy. Later, another prospective borrower walks into your bank. Let's call him Borrower B. He has a poor credit history. He plans to purchase a home for which the asking price and the value are approximately equivalent. (Let's maintain the same caveat as above.) This borrower has no money for a down payment, and, using a special program, will actually borrow that money as well. Would a wise lender make this loan? If he did, how long would everyone remain happy? Is it incorrect to assume that the likelihood of Borrower B defaulting is higher than that for Borrower A? While the statistics seem to bear this out, that's not the biggest issue. I'm even willing to concede that everyone might still be happy for a while. Let us now assume that the homes both these borrowers plan to purchase are overpriced due to a bubble from the enhanced demand driven by abundance of easy loan money. Furthermore, legislation has been enacted that requires each lender to make a percentage of loans to borrowers like Borrower B, borrowers to whom he otherwise might not lend. Given this scenario, can one not foresee that the future is somewhat shaky? Too many houses, many of them overpriced, being purchased by people with too low a down payment and questionable ability to pay, with loans guaranteed by the government—what's the downside?! Now let's modify the scenario just a bit to illustrate the real problem with government involvement in the housing market. What if, in this market of increased housing prices driven by increased demand, other people decide to jump into the fray? What if, looking to take advantage of all this "easy loan money" and favorable down payment scenarios, investors begin to speculate in the housing market, buying several houses, each with little to no down payment? Let's call one of these investor/speculators Borrower C. Fast forward a few months, or years. What happens when the housing bubble—the market of higher-than-normal (and increasing) sales prices for the commodity of homes—is followed by a period of lower-than-expected (and decreasing) sales prices for homes? For Borrower A, the value of the home will have to fall by 20% before he is upside-down and in dire financial straights. Borrower B is upside-down immediately. Borrower C is likely to just dump his home(s) and move on. Eventually, the combination of Borrower B's inability to pay and Borrower C's decision to escape the easy money trashes the whole housing market. According to a fascinating study from the Independent Institute, this is exactly what happened during the Mortgage Meltdown of 2007. Quoting author Stan J. Liebowitz, from "Anatomy of a Train Wreck" we find: The bubble brought in a large number of speculators in the form of individuals owning one or two houses who hoped to quickly resell them at a profit. Estimates are that one quarter of all home sales were speculative sales of this nature. Liebowitz continues: Speculators wanted mortgages with the smallest down payment and the lowest interest rate. These would be adjustable-rate mortgages (ARMs), option ARMs, and so forth. Once housing prices stopped rising, these speculators tried to get out from under their investments made largely with other peoples' money, which is why foreclosures increased mainly for adjustable-rate mortgages and not for fixed-rate mortgages, regardless of whether mortgages were prime or subprime. The rest, as they say, is history. That's right. While the CRA (and related statist meddling) did result in many people, some of them minorities, obtaining mortgages for which they otherwise could not have qualified, the meltdown included a bunch of homes bought by people who were not the target of the government's market meddling. Ain't that always the case? The State starts passing out free lunches and people who aren't really hungry get to eat too. In the eventual and inevitable negative aftermath, the folks who were the object of the supposedly noble goals are tarred with the same brush as those who helped cause the catastrophe. Everyone pays for it. Conclusion Let me be clear. People who bought more home than they could afford, or with a much lower down payment than a truly free market would likely have warranted, are just as much to blame as speculators for the mortgage meltdown. However, both they and the speculators simply responded to incentives as any Austrian worth his salt would predict. The real culprit, as I'm certain anyone who has read any of my prose would expect, is the State. When the government seeks to circumvent the market with noble goals financed with other people's money, the result is always a trail of tears. (This time those tears are being wiped away with worthless mortgage paper, probably securitized by Fannie Mae.) Back to my original question, what is predatory lending and what should be done about it? Revisiting the propaganda piece I got in the mail, did predatory lenders bring us to foreclosure, only to be bailed out? The answer to the first question is buried in the answer to the second. So-called predatory lending practices cannot bring the market to foreclosure. Economically, this is specious, nearing idiotic, political rhetoric. If a bank preys on people who cannot pay by, for instance, originating loans to them at higher-than-reasonable rates or with unfavorable terms, only one of two outcomes is possible. One, those people will pay that interest, making the bank a healthy profit. Two, those people will not be able to pay and the bank will lose money. In the case of outcome one, other banks will seek to woo those customers to them, and (you guessed it) competition will drive the loan rates, and the related components of the loan packages in a direction that benefits the people seeking the loans. In the case of outcome two, the bank will eventually have to modify its practices or terms, since banks don't make money when customers default on loans. (That's right, even a "predatory lender" can't make money when people fail to perform.) Well, banks don't make money when customers default on loans unless they can get paid either way. And that brings us full circle. Only the State can guarantee loans. Without those guarantees, banks have to take care of business while they take care of the prospective borrower. Ergo, so-called predatory lending is primarily a result of way too much government involvement in the lending market, plain and simple. |
Also by Wilt Alston:
Do the Economics of Coercion Make Sense? 01/21/10
Are Misplaced Incentives the Inevitable Result of Statism? 08/27/09
What Does "Equal Pay for Equal Work" Mean? 02/25/09
Is Gun Control Racist? 00/00/00
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