The headline: Elizabeth Warren’s New Housing Proposal Is Actually a Brilliant Plan to Close the Racial Wealth Gap by Mehrsa Baradaran and Darrick Hamilton/Slate October 26, 2018
An excerpt from the article:
“Sen. Elizabeth Warren released a $450 billion housing plan called the American Housing and Economic Mobility Act… The bill is the first since the Fair Housing Act with the explicit intent of redressing the iterative effects of our nation’s sordid history of housing discrimination. …[in which] white families used their home equity to secure small-business loans, send their children to college, or help their children put together home down payments…[as] black families were left exposed to predatory private finance.”
I previously addressed whether home equity was an important source of funding for small business and the wealth-building capacity of one’s children. Long story short: no (see here, here, and here for details). This post will explore the role of predatory lending in exacerbating wealth inequality via its effect on home ownership rates.
First, some background. According to the Federal Reserve, by 2007 subprime borrowers made up about 14% of the mortgage loan market. A subset of subprime borrowers were victims of “predatory lending”, of which there are three main types:
“…making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation; inducing a borrower to refinance a loan repeatedly [loan "flipping"] in order to charge high points and fees each time the loan is refinanced; or engaging in fraud or deception to conceal the true nature of the loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower.” - Roger T. Cole, Director, Division of Banking Supervision and Regulation/Federal Reserve
Note that some loan features that have been decried as predatory, such as adjustable rates and balloon payments, are also found in prime loans. Choosing an adjustable rate loan can be a smart choice for some home buyers. (See here for excellent advice on the matter). Nor are high fees or rates in themselves an indication of predatory lending, given the higher delinquency and default rates of subprime borrowers, who typically have weak or limited credit histories. Some loans require higher rates and fees to offset higher risk. Those would be subprime loans.
Subprime loans did not become a significant part of the mortgage market until the 1990s. They were just 8% of the market in 2002. Since most subprime loans are not predatory, we can assume that before 2003, predatory lending was not a major factor in creating wealth inequality. The US Department of Housing and Urban Development (HUD) came to a similar conclusion in the 2006 report, The Homeownership Experience of Low-Income and Minority Families: A Review and Synthesis of the Literature: “… there is no indication that first-time buyers were systematically using higher cost or riskier mortgage products—at least not as evidenced by data from the American Housing Survey covering the period up through 2003.”
However, subprime mortgages did rise to about 20% of new home loans by 2006. How many of these were the result of predatory practices? Hard to say. Researchers have often inferred predatory lending practices by the prevalence of subprime loans and foreclosures in low-income communities, but that’s absurd. The greater prevalence of subprime loans and foreclosures in low-income communities reflects higher loan risk. Actual fraud or abuse is very hard to substantiate, which is why predatory lending lawsuits have had mixed success. What we do know is that a lot more prime borrowers lost their homes than subprime borrowers, as the following chart makes clear:
Then again, the white-black gap in home ownership widened from about 26% in 2004 to 30% in 2016 - a clear sign that the foreclosure rate among African-Americans has been much higher than among whites. How much predatory loans had to do with this unfortunate trend is anybody’s guess.
Next: The merits, or not, of Elizabeth Warren’s proposed American Housing and Economic Mobility Act.
References:
Herbert CE and Belsky ES. 2006. The Homeownership Experience of Low-Income and Minority Families: A Review and Synthesis of the Literature. Washington, DC: U.S. Department of Housing and Urban Development, Office of Policy Development and Research, available at: http://www.huduser.org/Publications/PDF/hisp_homeown9.pdf
Zywicki, Todd J. and Adamson, Joseph, The Law & Economics of Subprime Lending (December 4, 2008). George Mason Law & Economics Research Paper No. 08-17; University of Colorado Law Review, Vol. 80, No. 1, Winter 2009, pp. 1-86. Available at SSRN: https://ssrn.com/abstract=1106907