City Pages: The Real Problem with Sub-Prime

by Alex Stenback on September 8, 2005

This week, City Pages runs as their cover story a piece on the Sub-Prime mortgage industry, which chronicles the plight of one family who, with the aid of some unscrupulous lenders, and a couple of wrong turns of their own, basically refinanced themselves into foreclosure.

Now, we are the first to throw stones at the bad operators in the sub-prime industry, who’ve all but embraced fraud as a business model, and quite honestly are pleased that City Pages and others are going after them. BUT, we did want to point out one thing the article gets absolutely wrong, which is its characterization of interest only and zero down mortgages as not only the cause of the problem, but the embodiment of all that is evil, risky, and perverse in the mortgage industry.  This is not the case.

The problem in the sub-prime industry is NOT the products. All mortgages, by their very nature, have risks, and some of them default, for many reasons.  But the article would have you believe that down payment and principal reduction are the sine qua non of responsible, risk-free borrowing, and that absent these two elements, you will not only lose your house, but "may as well just kill yourself now." For the City Pages to assert such a thing is disingenuous, irresponsible, and demonstrates just how out of their depth they are on this topic.

A down payment, or principal reduction payments DO NOT decrease your risk as a homeowner – they accomplish just the opposite – they transfer risk from the bank to you.  Pause for just a moment here and think about that.  Don’t believe it? Let’s point you back to our man Dan Green and his most excellent Mortgage Reports blog, who’s done a great job covering this concept recently:

Equity Increases Foreclosure Risk [mortgage reports]
Want to be Conservative? Go 100% [mortgage reports]

Again, Interest only, "option" ARM’s, and zero down mortgages are not for everybody, but the problem with the sub-prime market is not in the terms or types of loans they offer.  The problem is that many of these lenders (and even some borrowers) are committing fraud, whether through inflated appraisals, falsified income, or both.  Remove the fraud from the equation and you’ve solved much of the problem in the sub prime industry.

{ 4 comments… read them below or add one }

Bill September 8, 2005 at 11:20 am

I read the City Pages article last night with great disdain. Not only did they lump all of the products in, as you said, but they also pretty much lumped all lenders together and then went on to trash one that we all know is scamming left and right. The implication of the article is that all lenders are pulling the kinds of egregious tactics that Ameriquest and others are engaging in. This is patently false. As an employee of a large lender, it bothers me.

Scott McGerik September 8, 2005 at 4:17 pm

Hmm, in retrospect, the risk transfer is obvious. Of course, it had not occurred to me until you pointed it out. Thanks for the insight!

Bill, it is because of the City Pages tendency to lump the good guys with the bad guys (or maybe it is there inability to differentiate between the two) that I stopped reading the City Pages.

Alexis September 9, 2005 at 11:24 am

Reporting that is consistently uninformed is why I stopped reading the City Pages. I couldn’t even make my way through the article, despite my interest and background in the industry.

Dan Green September 12, 2005 at 1:10 pm

I am not sure if it is bad form to comment on an entry after you’ve referenced my blog…

Job well done on this piece. Here in Chicago, the Tribune syndicates a plethora of articles that decry sub-prime as evil. The reality is that the family of sub-prime product fills a void in the marketplace.

The deeper issue is one of governance. Many states — Illinois included — have set their sights on lending reform. Many states now require licensing and have a zero tolerance policy. For example, Illinois requires a full criminal background check on all mortgage originators.

Read between the lines and you’ll realize than prior to June 30, 2005, convicted felons could operate in the Mortgage industry. I can’t think of a single other financial field that would allow this.

Small steps on a state-wide (or federal?) level wil ultimately lead to better service and widespread acceptance of sub-prime as a recognized outlet for non-conforming homeowners.

Thanks again, Alex. Only repeated spotlighting of issues like this will help the press understand.

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