Here's a good article on the issue, and talks a little about what thebaldguy mentioned regarding legislative intervention:
Irresponsible Mortgages Have Opened Doors to Many of the Excluded
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By AUSTAN GOOLSBEE
Published: March 29, 2007
We are sitting on a time bomb, the mortgage analyst said a huge increase in unconventional home loans like balloon mortgages taken out by consumers who cannot qualify for regular mortgages. The high payments, he continued, are just beginning to come due and a lot of people who were betting interest rates would come down by now risk losing their homes because they cant pay the debt.
He would have given great testimony at the current Senate hearings on subprime mortgage lending. The only problem is, he said it in 1981 when soon after several of the alternative mortgage products like those with adjustable rates and balloons first became popular.
When Senator Christopher J. Dodd, Democrat of Connecticut, gave his opening statement last week at the hearings lambasting the rise of risky exotic and subprime mortgages, he was actually tapping into a very old vein of suspicion against innovations in the mortgage market.
Almost every new form of mortgage lending from adjustable-rate mortgages to home equity lines of credit to no-money-down mortgages has tended to expand the pool of people who qualify but has also been greeted by a large number of people saying that it harms consumers and will fool people into thinking they can afford homes that they cannot.
Congress is contemplating a serious tightening of regulations to make the new forms of lending more difficult. New research from some of the leading housing economists in the country, however, examines the long history of mortgage market innovations and suggests that regulators should be mindful of the potential downside in tightening too much.
A study conducted by Kristopher Gerardi and Paul S. Willen from the Federal Reserve Bank of Boston and Harvey S. Rosen of Princeton, Do Households Benefit from Financial Deregulation and Innovation? The Case of the Mortgage Market (National Bureau of Economic Research Working Paper 12967), shows that the three decades from 1970 to 2000 witnessed an incredible flowering of new types of home loans. These innovations mainly served to give people power to make their own decisions about housing, and they ended up being quite sensible with their newfound access to capital.
These economists followed thousands of people over their lives and examined the evidence for whether mortgage markets have become more efficient over time. Lost in the current discussion about borrowers income levels in the subprime market is the fact that someone with a low income now but who stands to earn much more in the future would, in a perfect market, be able to borrow from a bank to buy a house. That is how economists view the efficiency of a capital market: peoples decisions unrestricted by the amount of money they have right now.
And this study shows that measured this way, the mortgage market has become more perfect, not more irresponsible. People tend to make good decisions about their own economic prospects. As Professor Rosen said in an interview, Our findings suggest that people make sensible housing decisions in that the size of house they buy today relates to their future income, not just their current income and that the innovations in mortgages over 30 years gave many people the opportunity to own a home that they would not have otherwise had, just because they didnt have enough assets in the bank at the moment they needed the house.
Of course, basing loans on future earnings expectations is riskier than lending money to prime borrowers at 30-year fixed interest rates. That is why interest rates are higher for subprime borrowers and for big mortgages that require little money down. Sometimes the risks flop. Sometimes people even have to sell their properties because they cannot make the numbers work.
The traditional causes of foreclosure, even before there was subprime lending, were job loss, divorce and major medical expenses. And the national foreclosure data seem to suggest that these issues remain paramount. The latest numbers show that foreclosures have been concentrated not in places where real estate bubbles have supposedly been popping, but rather in places whose economies have stagnated the hurricane-torn communities on the Gulf of Mexico and the industrial Midwest states like Ohio, Michigan and Indiana, where the domestic auto industry has suffered. These do not automatically point to subprime lending as the leading cause of foreclosure problems.
Also, the historical evidence suggests that cracking down on new mortgages may hit exactly the wrong people. As Professor Rosen explains, The main thing that innovations in the mortgage market have done over the past 30 years is to let in the excluded: the young, the discriminated against, the people without a lot of money in the bank to use for a down payment. It has allowed them access to mortgages whereas lenders would have once just turned them away.
The Center for Responsible Lending estimated that in 2005, a majority of home loans to African-Americans and 40 percent of home loans to Hispanics were subprime loans. The existence and spread of subprime lending helps explain the drastic growth of homeownership for these same groups. Since 1995, for example, the number of African-American households has risen by about 20 percent, but the number of African-American homeowners has risen almost twice that rate, by about 35 percent. For Hispanics, the number of households is up about 45 percent and the number of homeowning households is up by almost 70 percent.
And do not forget that the vast majority of even subprime borrowers have been making their payments. Indeed, fewer than 15 percent of borrowers in this most risky group have even been delinquent on a payment, much less defaulted.
When contemplating ways to prevent excessive mortgages for the 13 percent of subprime borrowers whose loans go sour, regulators must be careful that they do not wreck the ability of the other 87 percent to obtain mortgages.
For be it ever so humble, there really is no place like home, even if it does come with a balloon payment mortgage.
Austan Goolsbee is a professor of economics at the University of Chicago Graduate School of Business and a research fellow at the American Bar Foundation. E-mail:
goolsbee@nytimes.com.
I like that Mr. Goolsbee mentions how these different types of mortgages have been good for many people, as carebear pointed out in reply #32. This article reasserts what has been under discussion here: the problems have arisen from irresponsible lenders and short-sighted borrowers, not from maliciously designed lending schemes. So why should the government be "contemplating a serious tightening of regulations to make the new forms of lending more difficult"?
