By: Peter A. Coclanis
August 7, 2010
Fringe bankers marketed subprime home loans to the poor,then sold loans in toxic bundles to unknowing investors
Until the onset of the Great Recession, most Americans had never heard of subprime markets. With the bursting of the real estate bubble in 2007, one mainstay of such markets, subprime mortgages, became news, receiving much of the blame. Over the past three years, such mortgages and virtually every other aspect of our financial system have been subjected to close scrutiny, numerous abuses have been exposed, and tighter regulation is being put into place.
Although the commanding heights of our financial system - the big investment and commercial banks and "bank-like entities" - have received most of the attention, we've learned a good deal as well about the swampy bottomlands of the system: The subprime world of the poor. Indeed, the difference between the heights and the bottoms is not always what it seems, as Gary Rivlin makes clear.
Ironically, the creation of the subprime mortgage market in the mid-1990s was seen by many as a democratizing reform allowing people with bad credit ratings access, often for the first time, to mortgage loans and home ownership. Risky loan applicants, formerly denied credit by mainstream lenders, could get loans if they were willing to pay higher interest rates.
This notion of risk-based pricing, which was supported by various governmental agencies, greatly expanded the pool of people eligible for mortgage loans. Unfortunately, the loans often proved disastrous for a variety of reasons, most notably because they were often facilitated by fast-buck mortgage brokers who were more concerned with generating loan volume than in ensuring that the loans were viable.
If subprime loans constituted only a small share of the mortgage market at first, by 2006 they comprised fully 29 percent of all mortgage loans. Because many such loans were granted to very risky applicants, including so-called NINJAs - people with "no income, no job or assets" - high failure rates were virtually assured. With unaware, unconcerned, or unscrupulous underwriters increasingly bundling such loans willy-nilly into mortgage-backed securities and selling them to unsuspecting investors, the conditions were set for the toxic financial stew served up in 2007. And it was the taste of that stew that first brought the word subprime to middle-class lips.
By then poor and working-class Americans had known that taste for a long time. Seldom good credit risks on paper, these groups always had to scramble to gain access to capital. When unable to do so through mainstream channels, they had traditionally been forced to rely on friends and family if they were lucky; pawnbrokers and loan sharks if they were not.
The situation changed dramatically beginning in the 1980s, when "fringe bankers" stepped in. Over the past three decades, such upstarts, alternatively referred to as predatory lenders, created a full line of high-interest, high-fee financial services: check cashing, payday loans, rent-to-own furniture and appliance stores, auto-title loans, tax-refund anticipation loans and, of course, subprime mortgages. The fact that many fringe bankers were linked to - and often owned by - mainstream financial institutions (including some of the most prominent names in American banking) will probably surprise few in our cynical times.
In "Broke, USA," Rivlin lays out this depressing story in rich detail. Although his sympathies are clearly with the patrons of fringe bankers, he is fair even to the most predatory of lenders. As a result, his riveting look at the calamitous effects on America demands attention.
Peter A. Coclanis is Albert R. Newsome Distinguished Professor of History and director of the Global Research Institute at UNC Chapel Hill.