INTRODUCTION Subprime Loans, Foreclosure, and the Credit Crisis

Home , Federal Home Loan Banks, Foreclosure, Predatory lending, Subprime lending

DECEMBER 2008 Subprime Loans, Foreclosure, and the Credit Crisis What Happened and Why? - A Primer

INTRODUCTION In early October of 2008, the Kirwan Institute convened close to 200 civil rights, housing, and legal activists and scholars for an in-depth look at the subprime and foreclosure crisis, its disproportionate effects on communities of color, and possible path- ways forward. One need that participants articulated was for an introductory primer on the crisis that would dispel erroneous myths, contextualize the crisis, and start a productive discussion on where we go from here. This primer is a response to this re- quest. We are indebted to the expertise, insight, time and ef- fort of all of our conference participants and particularly, those who authored commissioned papers for us on various structural aspects of the crisis: Rick Cohen, Ira Goldstein, and Christopher Peterson. For more comprehensive information on the subprime lending phenomenon and its effect on people and communities of color, please visit our website to view materials – commissioned reports, videos, PowerPoints, and transcripts -- from our October 2008 “National Convening on Subprime Lending, Foreclosure, and Race” at

http://kirwaninstitute.org/events/archive/subprime-convening/index.php. National Convening on SUBPRIME LENDING, FORECLOSURE If you would like to learn more about the initiative or become and RACE October 2nd - 3rd, 2008 involved in upcoming working groups or lend your expertise, Hyatt Regency, Columbus, OH please contact Jason Reece or Christy Rogers at The Kirwan Institute for the Study of Race and Ethnicity. Jason Reece, AICP, Senior Researcher, [email protected] Christy Rogers, Senior Research Associate, [email protected]

Christy Rogers1 Senior Research Associate john a. powell KIRWAN INSTITUTE Executive Director

FOR THE STUDY OF RACE AND ETHNICITY Andrew Grant-Thomas Deputy Director THE OHIO STATE UNIVERSITY Subprime Loans, Foreclosure, and the Credit Crisis ΘΘ Have mortgage loans always been available to everyone? No. Although home mortgages are much more widely available than they were prior to New Deal creations of the Federal Home Loan Banks, the Federal Housing Adminis- tration, the Home Owners Loan Corporation and Fannie Mae in the 1930s, they have historically been denied entirely or offered on different terms to communities of color. In the early 1900s, most mortgages required a large down payment of around 40 percent of the home purchase price.2 The loans had terms averaging between three and six years, often followed by a large balloon payment of the remaining balance. There- fore, “relatively few families could overcome these financial hurdles. Moreover, lenders had both formal and informal policies discriminating against minorities and women. As a result, none but the most affluent men of European ancestry had reliable and wide- spread access to home finance.”3 New Deal legislation trans- formed the industry. The federal government facilitated a vast expansion of home ownership. Mortgages had loan terms of up to thirty years, making monthly payments more affordable; and the down payment shrank to 20% of the home value. The innovative development of federal insurance made lenders more likely to extend credit. However, this expansion of homeownership opportunity was limited largely to white families, through ex- plicit criteria that encouraged all-white neighborhoods in suburban, new housing stock -- and devalued or refused to insure integrated, minority, or old housing stock neighborhoods.4

In the early 1900s, lenders had both formal and informal policies discriminating against minorities and women.

2 Kirwan Institute for the Study of Race and Ethnicity What Happened and Why? These racially discriminatory federal guidelines were then absorbed into private market practices. Refusing to extend credit to low-income communities of color became known as “redlining” due to the red lines drawn on property maps. Below is a redlining map of Philadelphia. Although de jure racial segregation in lending is no longer legal, the patterns and practices of discrimination in housing markets have persisted into the 21st Century.5 With little residential or commercial lending from main- stream banking institutions for decades, isolated communities of color have suffered from high- cost credit institutions that have little competition: payday lenders, rent-to-own, check cashing, and most recently, subprime home loans. Without competitive credit institutions, families lack information about options, making them prime targets for subprime lending. In other words, “the old inequality helped made the new inequality possible.”6 Although de jure racial segregation in lending is no longer legal, the patterns and practices of discrimination in housing markets have persisted into the 21st Century.

ΘΘ What is a subprime loan? There are four basic types of home loans. Conventional, or prime (fixed-rate) loans; government (FHA and VA)-insured loans; low-and-moderate income (“LMI”) targeted prime loans with reduced down payment requirements and greater underwriting flex- ibility (products encouraged by the CRA and the Affordable Housing Goals for government-sponsored enterprises such as Fannie Mae and Freddie Mac); and subprime loans.7 A subprime loan is characterized by higher interest rates (sometimes with a low “teaser” introductory rate that then gets adjusted upward), high fees and points,8 prepayment penalties, balloon payments, and broker solicitation. Subprime loans began in the credit card and auto loan in- dustries,9 then gravitated into home A subprime loan is characterized by higher equity loans, which encouraged interest rates, high fees and points, pre- borrowers to consolidate their consumer debt. Most subprime loans payment penalties, balloon payments, and are a home equity refinancing; only broker solicitation. recently did subprime loans become available for first-time home purchases. Subprime loans typically have much higher delinquency and default rates than conventional loans.10

A Primer - December 2008 3 Subprime Loans, Foreclosure, and the Credit Crisis ΘΘ Are we all offered the same choice of loans? No. In fact, the recent mortgage delivery system has been characterized as separate but unequal: In most instances the new mortgage delivery system has expanded access to prime mortgages on favorable terms, yet all to often lower-income and minority communities are served by a distinctly different set of organizations offering a distinctively different mix of products.11 This dual-delivery system is currently defined less by outright credit denial than by discriminatory terms. In 1999, HUD released a study by the Urban Institute that showed “persistent discrimination among minorities, not just in the rates in which they were re- jected, but in the terms of their loans (price discrimination).”12 People of color are more than three times as likely as whites to have subprime mortgages.

United for a Fair Economy, in Foreclosed: State of the Dream 2008 reports that people of color are more than three times as likely as whites to have subprime mortgages and that high-cost loans account for 55 percent of loans to African-Americans and Latinos.13 Similarly, Fed- eral Reserve studies in 2004, 2005 and 2006 found dispari- ties in the rate that minorities and those living in neighborhoods with significant minority concentrations received subprime loans.14 Even after controlling for income, there is a racial gap in the ability of minorities to secure prime loans. A study by the Center for Responsible lending found that borrowers of color were more than 30 percent more likely to receive a higher-rate loan than white borrowers, even after accounting for differences in risk.15 A HUD study showed that the African American differential is 21 to 42 basis points; for non-white Hispanics, 13-15 basis points, even when controlling for differentials in available household, loan and property characteristics.16 Rick Cohen reports that in Newark’s North Ward and Ironbound neighborhoods, “immigrant groups were targeted by mortgage brokers peddling high cost mortgages to families that could have qualified for conventional financing.”17 Because less than half of immigrants use formal banking institutions, they are easy targets for high-cost mortgage products: The payday lenders, pawn shops, and rent-to-own stores that specialize in immigrant neighborhoods do not help customers build credit histories and generally escape the oversight and regulation of consumer regulatory entities, or, as weak as the protection might be, the Community Reinvestment Act scrutiny by the Comptroller of the Currency or state banking departments of conventional bank lenders.18

4 Kirwan Institute for the Study of Race and Ethnicity What Happened and Why? ΘΘ Were most subprime borrowers first-time borrowers? No. 56% of all subprime loans originated in 2006 were subprime refinance loans.19 These refinance loans had a disproportionate racial impact: “studies comparing neighborhoods by race and income revealed that these refinance loans were disproportionately marketed to African American neighborhoods.”20 People often refinanced to pay down other debt, including higher-cost credit card debt, Over the period 1998 – 2006, the Center for Re- medical care, and educational sponsible Lending estimates that only 9% of all expenses.21 Scholars and activists have been decrying the subprime loans went to first time homebuyers. aggressive – and sometimes predatory22 marketing of these loans to elderly, minority, low-income, and disabled homeowners.23 In fact, because many subprime mortgages are for second homes, over the period 1998 – 2006, the Center for Responsible Lending estimates that only 9% of all subprime loans went to first time homebuyers.24 The CRL study Subprime Lending: A Net Drain on Homeownership finds that “subprime loans made during 1998-2006 have led or will lead to a net loss of homeownership for almost one million families. In fact, a net homeownership loss occurs in subprime loans made in every one of the last nine years.”25

ΘΘ Why were people taking subprime loans, if there were other options? Community-based organizations that offered more fair and sustainable products were being out-competed by the “aggressively marketed, higher-cost subprime loans originated with the latest technology.”26 Also, not everyone understood what they were getting: “brokers and lenders offered loans that looked much less expensive than they really were, because of low initial monthly payments and hidden costly features.”27 The maze of transactions involved in modern financial markets left consumers largely without transparent Community-based organizations that offered information or -- in a more fair and sustainable products were being context where you most need one -- an out-competed by the “aggressively marketed, advocate. When higher-cost subprime loans originated with the brokers became disconnected from latest technology.” both borrowers and lenders and answered (rationally) to their bonus and incentive structure, consumers got pitched the worst possible product disguised as a great deal. Considering credit markets in general, researchers from the Joint Center for Housing Studies at Harvard Univer- sity point out that: Ample evidence has recently accrued that credit markets violate many of the essential assumptions for competitive markets to operate efficiently and fairly. Credit markets involve increasingly complex decisions about heterogeneous products that involve probabilistic judgments. Pricing is not transparent, comparison shopping is costly and difficult, and consumer decisions are prone to systematic and predictable errors in estimating the true probability of certain events that govern the long-term cost of the product and their capacity to repay it.28 Ample evidence has recently accrued that credit markets violate many of the essential assumptions for competitive markets to operate efficiently and fairly.

A Primer - December 2008 5 Subprime Loans, Foreclosure, and the Credit Crisis ΘΘ Could some people who got subprime loans have gotten prime loans? Studies estimate that “up to 35% of subprime borrowers could qualify for prime mortgage loans.”29

ΘΘ Why did brokers push these high-cost subprime loans? The broker’s incentive is to close the loan while charging the highest combination of fees and mortgage interest rates they can get. They have no long term interest in the performance of the loan, because the loan is purchased and re-sold on the secondary market. Further, brokers can be compensated for getting borrowers to pay higher rates than those for which the borrower would qualify. This is known as the “yield spread premium.” Brokers have no long term interest in the performance of the loan, because the loan is purchased and re-sold on the secondary market. ΘΘ What is securitization and how did it affect the mortgage markets? Securitization is the process by which public and private agencies buy home mortgages, deposit large amounts of them in pools of mortgages, and then sell participations in the pools of mortgages to investors on Wall Street.30 Securitization provided a way for capital markets to finance -- and capture some of the profits from – large-scale mortgage lending. The process, dependent upon sophisticated data analysis, spread profits and risk throughout the markets by bundling the mortgages into different pools and selling various securities.31 A securitized mortgage note is actually held by a special purpose vehicle (SPV), a business entity with the sole purpose of holding the pool of mortgages.32 The SPV hires a servicer to collect and distribute payments of principal and interest. Modern securitization began in 1970, with the issuance of the first publicly traded mortgage backed security by the Government National Mortgage Association (Ginnie Mae).33 Legal scholar and securitization expert Chris Peterson observes that: With these new pass-through investment vehicles, investors could hold a share of large (and diversified) numbers of mortgages insured by the government in the case of Ginnie Mae, or guaranteed by the large stable government sponsored enterprises (GSEs) in the case of Freddie Mac and Fannie Mae (who also began securitizing shortly thereafter).34 Because the agencies now guaranteed the principal and interest income of their securities even when mortgagors defaulted, investors saw the securities as a low risk investment even without the assurances of a rating organization, such as Standard and Poor’s or Moody’s.35 Securitization provided a way for capital markets to finance - and capture some of the profits from – large-scale mortgage lending. In efforts to meet growing capital market demand, more loans were issued with little regard for the borrower’s needs.

The private sector’s ability to securitize separately from GSE’s grew after 1975, when rating organizations began rating the securities.36 Subprime lending and securitization became popular quickly on Wall Street, and capital flowed heavily into the securitized mortgage markets. Loans were packaged and sold as quickly as they were originated, and new loans were secured with funding from previous sales.

6 Kirwan Institute for the Study of Race and Ethnicity What Happened and Why? In efforts to meet growing capital market demand, more loans were issued with little regard for the borrower’s needs. Worse yet, some lenders anticipated that the borrower would be unable to repay the loan. This resulted in “equity strip- ping” (where the borrower taps any remaining equity to pay fees or penalties) or a new round of expensive refinancing.37 In the event of a massive wave of foreclosures, the investors take the loss of income from the mortgage pools (while the homeowners and their neighborhoods face the myriad issues related to foreclosed, vacant and abandoned homes).38 A large-scale loss starts the financing cycle spiraling in the other direction: as investors lose money, they have less to use to finance more loans. Banks grow nervous loaning to other banks who may be hemorrhaging assets as well, and credit starts to tighten. Investors will not take this loss In the event of a massive wave of lightly. A recent Wall Street Jour- foreclosures, a large-scale loss starts nal article reported that investors who hold securities backed by the financial cycle spiraling in the Countrywide Financial mortgages other direction. are protesting Bank of America’s home-loan-modification program (modifications of Countrywide loans BofA inherited from its purchase of Countrywide). This program was part of a settlement with various state attorneys general, who had charged Countrywide with predatory lending. Some securities investors are considering litigation, calling for Bank of America to repurchase the loans before they modify them.39

ΘΘ Why weren’t subprime loans better regulated by consumer protection law? Unfortunately, the law has not kept up with the times. Many federal and state consumer protection laws were written before the establishment of privately securitized mortgages, and are not well suited to regulate the subprime market.40 For example, because the Truth in Lending Act (TILA) “presupposes a unitary notion of a single individual or business Many federal and state consumer that solicits, documents, and funds a loan, the protection laws are not well suited most basic term defining the scope of the act does not reflect the simple reality of typical to regulate the subprime market. business practices.”41 More recent legislation, such as The Home Ownership and Equity Protection Act of 1994 (and subsequent state versions of the law), has been criticized for inadequate reach and enforcement.42 A 2006 study found that “the typical [state] law has little impact on the flow of subprime credit.”43

A Primer - December 2008 7 Subprime Loans, Foreclosure, and the Credit Crisis ΘΘ What was the role of deregulation and financial services legislation? Three pieces of legislation are largely credited for setting the stage for a rise in subprime and predatory lending: The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA), The Alternative Mortgage Transaction Parity Act of 1982 (AMT- PA), and the 1986 Tax Reform Act.44 DIDMCA effectively eliminated states’ interest rate ceilings on home mortgages where the lender has a first lien.45 Two years after DIDMCA, the Alternative Mortgage Transaction Parity Act (AMTPA) was passed. AMTPA preempt- ed state statutes that regulated alternative mortgage transactions, such as those with balloon payments, variable rates, and negative amortization. Subprime lending did not grow significantly, however, until after the Tax Reform Act of 1986. Under TRA86, taxpayers could no longer deduct interest from consumer loans, but could deduct interest on loans secured by the taxpayer’s principal (and one other) residence. This “gave consumers an incentive to shift their consumer borrowing that was not secured by their home into home equity borrowing.”46 In the 1990s, aggregate consumer debt rose -- along with housing values. In 1999, 76% of the lending by subprime lending institutions was home equity lending.47 By 2007, subprime loans accounted for 29% Researchers at the Joint Center for Housing Studies at Harvard University of total home loans. The vast majority of note that the growth of the asset- the subprime loans causing today’s massive backed securities and Alt-A Markets is “intertwined with both the surge of foreclosures were issued by institutions and subprime and Alt-A lending and the independent mortgage brokers not covered increasing reliance on the less regulated non-bank channel, from the by the CRA. loan broker to finance companies and independent mortgage banks to private securitization.”48 By 2007, subprime loans accounted for 29% of total home loans.49 In addition, the Gramm-Leach-Bliley Act, passed in 1999, facilitated affiliation among banks, securities firms, and insurance companies, and permitted financial conglomer- ates to cross-sell a variety of financial products to their customers.50 Deregulation, the growth of the securities market and the landmark financial services “modernization” enabled by the Gramm-Leach-Bliley Act created competition with the CRA-regulated loan products. As Judith Bell, President of PolicyLink, explains: The strength of the CRA was significantly weakened in 1999 when financial legislation allowed investment and securities firms to enter the mortgage world. Prior to these changes, the home mortgage industry was fairly simple—banks offered loans, those loans were purchased, held and backed by the General Service Enterprises of Fan- nie Mae and Freddie Mac. The CRA applied to the regulated institutions issuing loans. After the 1999 legislation broke down the firewalls between players, however, the network of firms financing homes included more than 20 types of entities that could purchase, repackage, and securitize loans. Brokers became free agents to recruit these loans for players that made money on high-fee, high-interest transactions. This massive web of financial entities offering, bundling, and trading mortgages was not covered by the CRA. The vast majority of the subprime loans causing today’s massive foreclosures were issued by institutions not covered by the CRA.51

ΘΘ Back up … what is the CRA? The Community Reinvestment Act was passed in 1977 to counter the practice of de- nying credit to low- and moderate-income and minority communities, also known as “redlining.”

8 Kirwan Institute for the Study of Race and Ethnicity What Happened and Why? As CRA expert and law professor Michael Barr explained before Congress, the CRA “encourages federally insured banks and thrifts to meet the credit needs of the communities they serve, including low- and moderate-income areas, consistent with safe and sound banking practices.”52 CRA examiners look at the num- Studies have shown that the CRA improved ber and amount of loans to low- access to home mortgage credit for low-income and moderate-income borrowers and areas, and innovative or borrowers during the 1990s. flexible lending practices, in the “lending test,” when they rate a bank’s CRA performance. Banks are also rated on the amount of their investments, on their innovation, and their responsiveness to community needs under the “investment test” and how well the bank delivers retail banking and community development services under the “service test.” These ratings are taken into account when an institution applies to merge or take over another depository institution, or to start offering new financial services, such as insurance and securities. The regulations therefore have real “teeth” in the industry. Studies have shown that the CRA improved access to home mortgage credit for low- income borrowers during the 1990s. In fact, CRA lenders increased their CRA-eligible home purchase lending faster than those not regulated by CRA from 1993-1999, even controlling for factors such as economic and income growth, low unemployment, low interest rates, innovation, and consolidation.53 A Federal Reserve Board survey conclud- ed that CRA lending was profitable or marginally profitable, and not overly risky.

ΘΘ Did the CRA force banks to issue loans to high-risk borrowers? No. The CRA only applies to banks and thrifts that are federally insured. Most of the loans made by depository institutions which fall under CRA were not higher-priced loans; studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households.54 Independent mortgage brokers not covered by the CRA issued the bulk of subprime loans: According to recent Fed data, 75 percent of higher-priced loans during the peak years of the subprime boom were made by independent mortgage firms and bank affiliates that were not covered by the act.55

ΘΘ Would subprime borrowers have done better with the CRA-regulated loans? Many of them might have. A recent study shows that “mortgage default risk may not be attributed to borrower credit risk only; the high default risk seems significantly as- sociated with characteristics of loans products.”56 What made the difference? “The broker-origination channel, the adjustable-rate terms, and the prepayment penalty … seem to contribute substantially to the elevated default risk among subprime loans.” The study also found that subprime loans from 2005-2006 had higher defaults than those issued in 2003-2004 (47.0% in 2006 vs.16.3% in 2004), probably due to changes in underwriting standards, decline in house prices, and changes in economic conditions. When researchers compared subprime to CRA-regulated loans -- in this study, issued via a program called CAP -- they found that the CAP loans were 70% less likely to default than a subprime loan. When broker-originated subprimes had both an adjustable rate (or ARM) and prepayment penalty, the default risk was between 4 and 5 times higher than the CAP loans.

A Primer - December 2008 9 Subprime Loans, Foreclosure, and the Credit Crisis ΘΘ What happened with Fannie Mae and Freddie Mac? Fannie and Freddie were government chartered, publicly traded companies before their historic takeover by the Federal government in September 2008. They purchased mortgages from lenders to hold or, in most cases, resell as mortgage-backed securities, providing significant amounts of financing for the mortgage lending industry. Currently, Fannie and Freddie guarantee about 70% of all new home loans. They are under “conservatorship,” and Treasury Secretary Paulson is deferring decisions regarding the mission of the companies for the next President and Congress.57 So how did Fannie and Freddie get into trouble? Investigative journalists are just beginning to bring the pressures on the companies to light: The subprime boom was led by investment banks and mortgage brokers, not by government-sponsored enterprises. Fannie and Freddie became unhinged in the middle of this decade when they tried to play catch-up. Their shareholders and managers pushed them to recover the securitization market share they had lost to unregulated investment banks getting absurd AAA ratings for packaging subprime dross. From 2005 to 2008, Fannie Mae purchased or guaranteed $270 billion in loans to risky borrowers — triple the amount in all its earlier years combined.58 Currently, Fannie and Freddie guarantee about 70% of all new home loans. They are under “conservatorship,” and Treasury Secretary Paulson is deferring decisions regarding the mission of the companies for the next President and Congress.

ΘΘ Did subprime loans cluster in certain regions and neighborhoods? The subprime crisis is nationwide, but there is evidence that a group of “risky lenders” clustered their lending in lower income and minority communities.59 Subprime loans go into delinquency and foreclosure more often than prime and FHA loans.60 Therefore, minority and low-income neighborhoods have been bearing the brunt of the foreclosure crisis. For example, The Reinvestment Fund reviewed data in Philadelphia and found that neighborhoods with the greatest concentrations of minorities received the highest percentages of subprime loans. Similarly, in Baltimore, “both minority group members and the neighborhoods where they live are more likely to receive subprime loans than White borrowers and borrowers in predominantly White areas.”61 These neighborhoods were ripe for subprime loans because they were either “equity rich but cash poor,” or starved of prime credit entirely.

Subprime loans go into delinquency and foreclosure more often than prime and FHA loans. The subprime crisis is nationwide, but minority and low-income neighborhoods have been bearing the brunt of the foreclosure crisis.

10 Kirwan Institute for the Study of Race and Ethnicity What Happened and Why?

Although low-income communities of color have been disproportionately impacted, subprime lending occurred in middle class and wealthy suburban communities as well: “As home prices accelerated across the country over the past decade, more affluent families turned to high-rate loans to buy expensive homes they could not have qualified for under conventional lending standards.”62 The states with The subrpime crisis has exacerbated an already the highest foreclosure rates are those with overheated housing significant rise in vacant properties, particularly markets, such as California and in declining or “weak market” cities. Florida. However, Rust Belt cities, rural Southern communities, and small towns – “weak market” regions with struggling economies and depressed housing markets -- may not have the resources to rebound like strong markets do.

ΘΘ What’s the effect of foreclosures? • Lost equity for homeowners • Investors lose income stream • Reversal of gain in minority homeownership rates (which was driving the overall national gain in homeownership rates) • Decline in surrounding property values (and other challenges that come from increased vacancy, such as increased crime and further disinvestment) • Inflated property taxes in high-foreclosure neighborhoods (where property taxes are not adjusted to reflect current market values) mean homeowners may be at risk for overpayment of taxes. High property taxes can scare off future affordable housing buyers, the homes sit vacant, values continue to decline…a vicious cycle that destabilizes entire neighborhoods • Unpaid property taxes on foreclosed homes negatively impact municipal budgets • Future neighborhood revitalization plans are threatened (foreclosures, lost momen- tum, municipal budget cuts)

ΘΘ What are we going to do with all that vacant housing? No one knows for certain. The subprime crisis has exacerbated an already significant rise in vacant properties, particularly in declining or “weak market” cities. As Cohen points out, “nationally, housing vacancies have been increasing steadily since the 1990s, with a significant increase between 2000 and 2004 – The responsible owner can include a CDC, land- largely before the spike in bank, or responsible developers and landlords who subprime mortgage foreclosures.”63 Housing poli- can return the property to productive use, either in cy expert Alan Mallach, in the private market or as affordable housing. his recent report Tackling the Mortgage Crisis: 10 Action Steps for State Government, suggests that states work-

A Primer - December 2008 11 Subprime Loans, Foreclosure, and the Credit Crisis ing to mitigate the impact of foreclosure on neighborhoods should (a) establish creditor responsibility to maintain vacant properties (b) make sure the process is as expeditious as possible (c) ensure that the property is ultimately conveyed to a responsible owner.64 The responsible owner can include a CDC, land-bank, or responsible developers and landlords who can return the property to productive use, either in the private market or as affordable housing.

ΘΘ Does this problem affect renters at all? Absolutely. Many foreclosures are multi-family units: by the end of 2007, roughly one in five new foreclosures involved absentee owners of one- to four-unit rental properties.65 Unfortunately, when a property goes into foreclosure, the tenant “effectively has no rights and can be evicted virtually on the spot.”66 Even if the property is acquired by a bank or servicer, the new owner is not required to honor the landlord’s lease with the tenant. When a property goes into foreclosure, the tenant “effectively has no rights and can be evicted virtually on the spot.” ΘΘ Where do we go from here? The modernization and globalization of financial services and capital markets is here to stay. The question is how to ensure that credit is fair and sustainable for everyone, particularly for marginalized groups who need it most. The Kirwan Institute considers the following questions as highest priority for the next Congress and Administration: • What global intermediaries do we need to manage global credit markets? • What is the revamped mission of Fannie and Freddie? • How can those most adversely affected by predatory credit – low-income communities of color – have an effective voice in these discussions? • How do we improve the chances that homeownership is the road to wealth building, not the road to ruin? • What are the most promising alternative equity-building instruments for low-income families and communities of color? It is also important to note that providing financing for a home does not necessarily advance a robust conception of “fair housing” if the home is in a racially and socio- economically isolated and disinvested area. A recent study showed that loans from regulated lenders tended to decrease segregation, while subprime and manufactured housing loans either had no statistically significant effect or increased segregation. Fair housing must be reconceptualized to encompass not only fair access to credit, but fair access to opportunity-rich neighborhoods and stable home-equity building.67 How do we ensure that credit is fair and sustainable for everyone, particularly for marginalized groups who need it most? Fair housing must be reconceptualized to encompass not only fair access to credit, but fair access to opportunity-rich neighborhoods and stable home- equity building.

12 Kirwan Institute for the Study of Race and Ethnicity What Happened and Why? REFERENCES 1. This paper benefited greatly from review by Jason Reece, Susan Adams, John O’Callaghan, Stanley Hirtle and Thomas J. Fitzpatrick IV, but any errors remain my own. Graphic formatting and design by Samir Gambhir, Senior GIS/Demographic Specialist. Research assistance by Brandon Moss, graduate student in City and Regional Planning at The Ohio State University. This primer is not intended to convey legal opinions or advice. 2. Christopher L. Peterson, “Subprime Lending, Foreclosure And Race: An Introduction To The Role Of Securitization In Residential Mortgage Finance.” Paper prepared for the for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Peterson is citing Kenneth A. Snowden, “Mortgage Rates and American Capital Market Development in the Late Nineteenth Century.” 47 J. ECON. HIST. 671, 675 (1987). 3. Christopher L. Peterson, “Subprime Lending, Foreclosure and Race: An Introduction to the Role of Securitization in Residential Mortgage Finance,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Peterson is citing his book Taming the Sharks: Towards a Cure for the High-Cost Credit Market 81 (2004). 4. john a. powell and Kathleen M. Graham, “Urban Fragmentation as a Barrier to Equal Opportunity.” Chapter 7 of Rights at Risk: Equality in an Age of Terrorism by the Citizens’ Commission On Civil Rights. Accessed at http://www.cccr.org/Chapter7.pdf 5. For overviews of various challenges in housing policy, see Galster, G. (1998). “Residential segregation in American cities: A contrary review.” Population Re- search and Policy Review 7(2): 93-112; Galster, G. and E. Godfrey (2005). “By Words and Deeds: Racial Steering by Real Estate Agents in the US in 2000.” Journal of the American Planning Association 71(3): 251-268; powell, j. (2003). “Opportunity-Based Housing.” Journal of Affordable Housing and Community Development Law 12: 188; Roisman, F. W. (1997-1998). “Mandates Unsatisfied: The Low Income Housing Tax Credit Program and the Civil Rights Laws.” University of Miami Law Review (52): 1011-1050; Turner, M. A., S. L. Ross, et al. (2002). Discrimination In Metropolitan Housing Markets: National Results From Phase I HDS 2000, U.S. Department of Housing and Urban Development; Yinger, J. (1998). “Housing Discrimination is Still Worth Worrying About.” Housing Policy Debate 9(4): 893-927. For an overview of structural racism, see Menendian et. al., “A Report to the U.N. Committee for the Elimination of Racial Discrimination on the occasion of its review of the Periodic Report of the United States of America.” (February 2008) Accessed at http://www2.ohchr.org/english/bodies/cerd/docs/ngos/usa/USHRN2.doc 6. Richard Williams, Reynold Nesiba, and Eileen Diaz McConnell, “The Changing Face of Inequality in Home Mortgage Lending.” Social Problems 52 (2): 188-208 (May 2005). 7. Lei Ding, Roberto G. Quercia, and Janneke Ratcliffe (Center for Community Capital at The University of North Carolina) with Wei Li (Center for Responsible Lending.) “Risky Borrowers or Risky Mortgages? Disaggregating Effects Using Propensity Score Models” Working Paper October 2008. Accessed at http://www.ccc.unc.edu/documents/RiskyBorrowers_RiskyMortgages_1008.pdf 8. At least 300 basis points higher than the relevant Treasury yield for a comparable maturity. (See Ira Goldstein (The Reinvestment Fund) and Dan Urevick-Ackels- berg, “Subprime Lending, Mortgage Foreclosures and Race: How Far Have We Come and How Far Have We to Go?” Paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity at the Ohio State University for its National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008.) 9. Eric S. Belsky and Ren S. Essene, “Consumer and Mortgage Credit at a Crossroads: Preserving Expanded Access while Informing Choices and Protecting Consumers,” Joint Center for Housing Studies at Harvard University. Working paper UCC08-1, last revised February 26, 2008. 10. Lei Ding, Roberto G. Quercia, and Janneke Ratcliffe (Center for Community Capital at The University of North Carolina) with Wei Li (Center for Responsible Lending.) “Risky Borrowers or Risky Mortgages? Disaggregating Effects Using Propensity Score Models” Working Paper October 2008. Accessed at http://www.ccc.unc.edu/documents/RiskyBorrowers_RiskyMortgages_1008.pdf 11. William Apgar et. al. at the Joint Center for Housing Studies, Harvard University. “Credit, Capital and Communities: The Implications of the Changing Mortgage Banking Industry for Community Based Organizations.” March 9, 2004 Report. Accessed at http://www.jchs.harvard.edu/publications/communitydevelopment/ccc04-1.pdf 12. Ira Goldstein (The Reinvestment Fund) and Dan Urevick-Ackelsberg, “Subprime Lending, Mortgage Foreclosures and Race: How Far Have We Come and How Far Have We to Go?” Paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity at the Ohio State University for its National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. 13. Accessed at http://www.faireconomy.org/files/StateOfDream_01_16_08_Web.pdf 14. Ira Goldstein (The Reinvestment Fund) and Dan Urevick-Ackelsberg, “Subprime Lending, Mortgage Foreclosures and Race: How Far Have We Come and How Far Have We to Go?” Paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity at the Ohio State University for its National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. 15. Debbie Gruenstein Bocian, Keith S. Ernst and Wei Li, “Unfair Lending: The Effect of Race and Ethnicity on the Price of Subprime Mortgages.” Center for Responsible Lending, 2006. Accessed at http://www.responsiblelending.org/issues/mortgage/research/page.jsp?itemID=29371010 16. “Mortgage Pricing Differentials Across Hispanic, Black, and White Households: Evidence from the American Housing Survey.” Accessed at http://www.huduser.org/Publications/PDF/hisp_homeown5.pdf 17. Rick Cohen, “A Structural Racism Lens on Subprime Foreclosures and Vacant Properties,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Page 7. 18. Rick Cohen, “A Structural Racism Lens on Subprime Foreclosures and Vacant Properties,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Page 7. 19. Center for Responsible Lending, “Subprime Lending: A Net Drain on Homeownership.” CRL Issue Paper No. 14. March 27, 2007. Accessed at http://www.responsiblelending.org/pdfs/Net-Drain-in-Home-Ownership.pdf. Page 3. 20. Rick Cohen, “A Structural Racism Lens on Subprime Foreclosures and Vacant Properties,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Page 10.

A Primer - December 2008 13 Subprime Loans, Foreclosure, and the Credit Crisis 21. Michael A. Stegman, Allison Freeman, and Jong-Gyu Paik, “The Portfolios and Wealth of Low-Income Homeowners and Renters: Findings from an Evaluation of Self- Help Ventures Fund’s Community Advantage Program.” Community Development Working Paper 2007-02, Federal Reserve Bank of San Francisco (2007), p. 29-30. 22. In a 2002 law review article, Eggert discusses “predatory” loans as encompassing both illegal actions and “those that bedevil the regulators of the lending industry: activities that are legal but, when misused by unprincipled lenders, cause borrowers to pay interest rates and fees higher than the market and the borrowers’ credit rating would justify.” Eggert points out that while a borrower might choose a non-prime option with a potential benefit to them (i.e. pay a higher interest rate in order to get lower fees) during a negotiation, that often these terms are “neither negotiated over nor understood by the borrowers” and thus become tools of predation. For the purposes of this primer, subprime loans can include both “legal but bedeviling” predatory loans and non-prime loans, which are not necessarily predatory. For further reading on predatory lending, see Kurt Eggert, “Held Up In Due Course: Predatory Lending, Securitization, and the Holder In Due Course Doctrine.” 35 Creighton L. Rev. 503 and Kathleen C. Engel and Patricia McCoy, “A Tale of Three Markets: The Law and Econom- ics of Predatory Lending.” 80 Tex. L. Rev. 1255. 23. Kathleen C. Engel and Patricia McCoy, “A Tale of Three Markets: The Law and Economics of Predatory Lending.” 80 Tex. L. Rev. 1255. See Section II.C.2., “Taking Advantage of Information Asymmetries: Locating and Marketing Predatory Loans to Disconnected Borrowers.” 24. Center for Responsible Lending, “Subprime Lending: A Net Drain on Homeownership.” CRL Issue Paper No. 14. March 27, 2007. Accessed at http://www.responsiblelending.org/pdfs/Net-Drain-in-Home-Ownership.pdf. Page 2. 25. Center for Responsible Lending, “Subprime Lending: A Net Drain on Homeownership.” CRL Issue Paper No. 14. March 27, 2007. Accessed at http://www.responsiblelending.org/pdfs/Net-Drain-in-Home-Ownership.pdf. Page 14. 26. William Apgar et. al. at the Joint Center for Housing Studies, Harvard University. “Credit, Capital and Communities: The Implications of the Changing Mortgage Banking Industry for Community Based Organizations.” March 9, 2004 Report. Page 6. Accessed at http://www.jchs.harvard.edu/publications/communitydevelopment/ccc04-1.pdf 27. Prepared Testimony of Michael S. Barr, Professor of Law, University of Michigan Law School, before the Committee on Financial Services, U.S. House of Representation, hearing on “The Community Reinvestment Act: Thirty Years of Accomplishments, but Challenges Remain.” February 13, 2008. Accessed at http://www.house.gov/apps/list/hearing/financialsvcs_dem/barr021308.pdf. Page 8. 28. Eric S. Belsky and Ren S. Essene, “Consumer and Mortgage Credit at a Crossroads: Preserving Expanded Access while Informing Choices and Protecting Consumers,” Joint Center for Housing Studies at Harvard University. Working paper UCC08-1, last revised February 26, 2008. Page 4. 29. Prepared Testimony of Michael S. Barr, Professor of Law, University of Michigan Law School, before the Committee on Financial Services, U.S. House of Representation, hearing on “The Community Reinvestment Act: Thirty Years of Accomplishments, but Challenges Remain.” February 13, 2008. Accessed at http://www.house.gov/apps/list/hearing/financialsvcs_dem/barr021308.pdf 30. Christopher L. Peterson, “Subprime Lending, Foreclosure and Race: An Introduction to the Role of Securitization in Residential Mortgage Finance,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. 31. In many cases, mortgage-backed securities were held by foreign investors, which spread risk beyond the borders of the United States. 32. Kurt Eggert, “Held Up In Due Course: Predatory Lending, Securitization, and the Holder In Due Course Doctrine.” 35 Creighton L. Rev. 503. Page 19. 33. Kurt Eggert, “Held Up In Due Course: Predatory Lending, Securitization, and the Holder In Due Course Doctrine.” 35 Creighton L. Rev. 503. Page 19. 34. Christopher L. Peterson, “Subprime Lending, Foreclosure and Race: An Introduction to the Role of Securitization in Residential Mortgage Finance,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Peterson is citing Richard S. Landau, The Evolution of Mortgage-Backed Securities, in THE SECONDARY MORTGAGE MARKET: A HANDBOOK OF STRATEGIES, TECHNIQUES AND CRITICAL ISSUES IN CONTEMPORARY MORTGAGE FINANCE 135, 135 (Jess Lederman ed., 1987). 35. Christopher L. Peterson, “Subprime Lending, Foreclosure and Race: An Introduction to the Role of Securitization in Residential Mortgage Finance,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Peterson notes in his cite: “Although Ginnie Mae securities are guaranteed by the full faith and credit of the U.S. government, Fannie Mae and Freddie Mac securities are not. Nevertheless, many investors have traditionally regarded the two GSEs as “too big to fail,”—the view that there is an implicit government guarantee of agency securities, if not an actual one. Richard Scott Carnell, Handling the Failure of a Government-Sponsored Enterprise, 80 WASH. L. REV. 565, 630-31 (2005). Whether investors are correct in this view is a matter of growing debate. See id. at 596; Benton E. Gup, Are Fannie Mae and Freddie Mac Too Big to Fail?, in, POLICIES AND PRACTICES IN GOVERNMENT BAILOUTS 285, 310 (Benton E. Gup, ed., 2003).” 36. Kurt Eggert, “Held Up In Due Course: Predatory Lending, Securitization, and the Holder In Due Course Doctrine.” 35 Creighton L. Rev. 503. Page 19. 37. Kurt Eggert, “Held Up In Due Course: Predatory Lending, Securitization, and the Holder In Due Course Doctrine.” 35 Creighton L. Rev. 503. Page 11. 38. Kurt Eggert notes that while it is possible the investors could make money on the foreclosure process (if the amount of the loan was far less than the value of the property), early repayment and foreclosure are the two greatest investor risks. “Held Up In Due Course: Predatory Lending, Securitization, and the Holder In Due Course Doctrine.” 35 Creighton L. Rev. 503. Page 21. 39. Ruth Simon, “Investors Hit BofA Loan Modifications.” The Wall Street Journal, Money & Investing, C1. November 18, 2008. 40. Christopher L. Peterson, “Subprime Lending, Foreclosure and Race: An Introduction to the Role of Securitization in Residential Mortgage Finance,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Page 17. 41. Christopher L. Peterson, “Subprime Lending, Foreclosure and Race: An Introduction to the Role of Securitization in Residential Mortgage Finance,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Page 17. 42. Kurt Eggert, “Held Up In Due Course: Predatory Lending, Securitization, and the Holder In Due Course Doctrine.” 35 Creighton L. Rev. 503. See Section V. A., “HOEPA and Its Flaws.”

14 Kirwan Institute for the Study of Race and Ethnicity What Happened and Why? 43. Giang Ho and Anthony Pennington-Cross, “The impact of local predatory lending laws on the flow of subprime credit.” Journal of Urban Economics 60 (2006): 210-228. Page 226. 44. Ira Goldstein (The Reinvestment Fund) and Dan Urevick-Ackelsberg, “Subprime Lending, Mortgage Foreclosures and Race: How Far Have We Come and How Far Have We to Go?” Paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity at the Ohio State University for its National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. 45. The Federal Reserve Ban of San Francisco Economic Letter 2001-38 (December 28, 2001). Available at http://www.frbsf.org/publications/economics/letter/2001/el2001-38.html 46. The Federal Reserve Ban of San Francisco Economic Letter 2001-38 (December 28, 2001). Available at http://www.frbsf.org/publications/economics/letter/2001/el2001-38.html 47. The Federal Reserve Ban of San Francisco Economic Letter 2001-38 (December 28, 2001). Available at http://www.frbsf.org/publications/economics/letter/2001/el2001-38.html 48. Eric S. Belsky and Ren S. Essene, “Consumer and Mortgage Credit at a Crossroads: Preserving Expanded Access while Informing Choices and Protecting Consumers,” Joint Center for Housing Studies at Harvard University. Working paper UCC08-1, last revised February 26, 2008. Page 21; emphasis added. 49. Rick Brooks and Constance Mitchell Ford, “The United States of Subprime Loans.” The Wall Street Journal Online, published October 12, 2007. 50. F. Jean Wells and William D. Jackson, “Major Financial Services Legislation, The Gramm-Leach-Bliley Act (P.L. 106-102): An Overview.” Congressional Re- search Service, Report for Congress. RL30375. Updated December 16, 1999. http://epic.org/privacy/glba/RL30375.pdf 51. “Scapegoating the Economic Crisis,” by Judith Bell, President of PolicyLink. PolicyLink blog accessed 10/27/2008. 52. Prepared Testimony of Michael S. Barr, Professor of Law, University of Michigan Law School, before the Committee on Financial Services, U.S. House of Representation, hearing on “The Community Reinvestment Act: Thirty Years of Accomplishments, but Challenges Remain.” February 13, 2008. Accessed at http://www.house.gov/apps/list/hearing/financialsvcs_dem/barr021308.pdf 53. Prepared Testimony of Michael S. Barr, Professor of Law, University of Michigan Law School, before the Committee on Financial Services, U.S. House of Representation, hearing on “The Community Reinvestment Act: Thirty Years of Accomplishments, but Challenges Remain.” February 13, 2008. Accessed at http://www.house.gov/apps/list/hearing/financialsvcs_dem/barr021308.pdf 54. Janet L. Yellen, President and CEO, Federal Reserve Bank of San Francisco, “Opening Remarks to the 2008 National Interagency Community Reinvestment Conference.” March 31, 2008. 55. Michael S. Barr And Gene Sperling, “Poor Homeowners, Good Loans.” New York Times Online. Op-Ed published October 17, 2008. Accessed at http://www.frbsf.org/news/speeches/2008/0331.html 56. Lei Ding, Roberto G. Quercia, and Janneke Ratcliffe (Center for Community Capital at The University of North Carolina) with Wei Li (Center for Responsible Lending.) “Risky Borrowers or Risky Mortgages? Disaggregating Effects Using Propensity Score Models” Working Paper October 2008. Accessed at http://www.ccc.unc.edu/documents/RiskyBorrowers_RiskyMortgages_1008.pdf 57. Stephen Labaton and Edmund L. Andrews, “In Rescue to Stabilize Lending, U.S. Takes Over Mortgage Finance Giants.” New York Times Online. Published Sep- tember 8, 2008. 58. Michael S. Barr And Gene Sperling, “Poor Homeowners, Good Loans.” New York Times Online. Op-Ed published October 17, 2008. Accessed at http://www.frbsf.org/news/speeches/2008/0331.html 59. Ira Goldstein (The Reinvestment Fund) and Dan Urevick-Ackelsberg, “Subprime Lending, Mortgage Foreclosures and Race: How Far Have We Come and How Far Have We to Go?” Paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity at the Ohio State University for its National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Page 8. 60. Lei Ding, Roberto G. Quercia, and Janneke Ratcliffe (Center for Community Capital at The University of North Carolina) with Wei Li (Center for Responsible Lending.) “Risky Borrowers or Risky Mortgages? Disaggregating Effects Using Propensity Score Models” Working Paper October 2008. Accessed at http://www.ccc.unc.edu/documents/RiskyBorrowers_RiskyMortgages_1008.pdf 61. Ira Goldstein (The Reinvestment Fund) and Dan Urevick-Ackelsberg, “Subprime Lending, Mortgage Foreclosures and Race: How Far Have We Come and How Far Have We to Go?” Paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity at the Ohio State University for its National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Page 11. 62. Rick Brooks and Constance Mitchell Ford, “The United States of Subprime Loans.” The Wall Street Journal Online, published October 12, 2007. 63. Rick Cohen, “A Structural Racism Lens on Subprime Foreclosures and Vacant Properties,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Emphasis added. 64. Alan Mallach, Tackling the Mortgage Crisis: 10 Action Steps for State Government. The Metropolitan Policy Program at Brookings. May 2008. Accessed at http://www.brookings.edu/papers/2008/0529_mortgage_crisis_vey.aspx 65. Joint Center for Housing Studies of Harvard University, “America’s Rental Housing: The Key to a Balanced National Policy.” 2008. Accessed at http://www.jchs.harvard.edu/publications/rental/rh08_americas_rental_housing/index.html 66. Rick Cohen, “A Structural Racism Lens on Subprime Foreclosures and Vacant Properties,” paper commissioned for the Kirwan Institute for the Study of Race and Ethnicity’s National Convening on Subprime Lending, Foreclosure and Race, October 2-3, 2008. Page 8. 67. Carolyn Bond and Richard Williams, “Residential Segregation and the Transformation of Home Mortgage Lending.” Social Forces 86 (2): 671-698 (December 2007).

A Primer - December 2008 15 For more information on Kirwan Institute, Please contact Barbara Carter | Email: [email protected]

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