Mortgage defaults are rising, and worse is yet to come. Between now and the end of next year, the interest rates on $660 billion in adjustable-rate mortgages will increase for the first time. Over half of that is in subprime loans — those made to borrowers with weak credit — and is at high risk of default as monthly payments rise.
In a display of too-little, too-late, federal regulators recently tightened lending standards, requiring what should be obvious: that banks have evidence of a borrower’s ability to repay before making a loan. And yet lenders who hope to dodge even tougher oversight continue to defend reckless lending. Their arguments ring hollow on several counts.
Mortgage lenders often claim that subprime loans have allowed millions of Americans to buy a first home. But most subprime loans were for refinancing, not first-time purchases. And as defaults rise, foreclosures are projected to outnumber first-home purchases — for a net loss of homeownership because of subprime lending — according to the nonpartisan Center for Responsible Lending.
Lenders also assert that borrowers with weak credit had no choice other than costly, adjustable-rate subprime loans. But testimony from Congressional hearings suggests otherwise. During the housing boom, borrowers who could have qualified for higher quality, fixed-rate loans were too often steered into dodgier loans. As rising defaults attest, complex loans have not benefited the borrowers. Rather, they met the lenders’ desire for upfront fees and Wall Street’s demand for loans to package into securities for sale to hedge fund clients.
Subprime defenders also assert that in the end, it’s a borrower’s responsibility to repay. Fine. Now let’s talk about the lenders’ responsibility. During the boom, many subprime lenders did not worry about being paid back over time, because they sold many of the loans to Wall Street. Those who made a lot of money on lousy loans don’t stand to lose their houses now that the game is ending.
It’s up to regulators and lawmakers to impose discipline when the market does not. The Federal Reserve, with authority over unfair and deceptive mortgages, should impose rules on all lenders — banks and nonbanks — deeming a mortgage unfair if it’s issued without evidence of a borrower’s ability to repay. Lenders should also be held to suitability standards, akin to the rules for stockbrokers. Brokers cannot recommend stocks that do not fit an investor’s risk profile. Lenders should not be able to offer loans that do not fit a borrower’s credit profile.
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