Financing Community Development: Learning from the Past, Looking to the Future; Summary of the 2007 Federal Reserve System Community Affairs Research Conference
Mester, Loretta J., Business Review (Federal Reserve Bank of Philadelphia)
The conference was organized around six key questions: (1) Is subprime loan pricing fair or predatory? (2) Are legislative remedies to limit predatory lending really remedies? (3) What determines who defaults or goes bankrupt, and how do they fare? (4) What should and can be done to enhance borrowers' knowledge of their credit risk? (5) Does the financing of small businesses differ for minority-owned businesses and for businesses in low-income areas? and (6) Can alternative financial services products help the underbanked? Although the research did not provide definitive answers to these questions, the presentations and discussions did advance our knowledge and provided several interesting avenues for further research. *
Jeffrey Lacker, president of the Federal Reserve Bank of Richmond and chair of the Conference of Presidents' Committee on Research, Public Information, and Community Affairs, opened the conference. He pointed out the value of careful, objective research on consumer financial markets, which have experienced much innovation in recent years. Financial innovation creates opportunities but also entails risk. Lacker would like researchers to study borrowing and other household financial decisions from an ex ante viewpoint, that is, to look at the full distribution of possible outcomes and their relative probabilities. Otherwise, it is difficult to know whether any particular credit market product beneficial on net or whether the benefits of any proposed method for curtailing adverse outcomes outweigh the costs from restricting credit that the method may entail. He also pointed out one of the limitations of the data collected under the Home Mortgage Disclosure Act. Even with recent enhancements, these data include information from lenders only and do not contain much information about borrowers, so Lacker is pessimistic about their usefulness for understanding the effectiveness of credit markets. Lacker suggested that researchers try to partner with credit rating bureaus so that lender-supplied data can be combined with data on households to better illuminate borrowers' credit decisions and outcomes. In his view, further research will help us better understand the costs and benefits of market practices and government interventions.
Indeed, turmoil in the subprime mortgage market took center stage in mid-2007, underscoring the importance of further research on this market segment. Six papers at the conference studied various aspects of the subprime mortgage market, including pricing, possible predatory practices and policy responses, foreclosures, and delinquencies.
SESSION 1: IS SUBPRIME LOAN PRICING FAIR OR PREDATORY?
"Predatory Lending Practices and Subprime Foreclosures: Distinguishing Impacts by Loan Category," by Morgan Rose, examines the foreclosure behavior of subprime mortgages. While the rise in subprime mortgage lending has increased access to credit for some borrowers, it has also raised concerns about possible predatory pricing practices within this market segment. The recent increase in subprime mortgage foreclosures has prompted calls for more regulation to curb predatory lending, and some municipalities and states have passed such legislation. But distinguishing predatory lending from legitimate lending is a difficult task. Rose's analysis indicates that the impact of prepayment penalty periods, balloon payments, and reduced documentation--characteristics often cited as consistent with predatory lending--on the foreclosure behavior of subprime refinance and home purchase mortgages is not at all straight forward. To the extent that these factors are not associated with foreclosures resulting in loss of wealth and tax base, the empirical basis for some of the new regulations enacted at the municipal and state level is questionable. These laws might restrict legitimate access to credit for low-income borrowers without offering much benefit. …