First, do no harm

Writing in Crain's Detroit Business today, a Wayne State University law professor says 1960s race riots led to a "HUD subprime lending debacle" that devastated many of Detroit's neighborhoods in the 1970s.

To address frustrations over slumlords and the low rate of home ownership, Prof. John Mogk writes, "HUD directed tens of thousands of subprime loans into the city's changing neighborhoods to individuals who could not afford the cost of maintenance or resale, resulting in massive foreclosures, abandonments and widespread destruction of stable blocks of housing. These neighborhoods have never recovered."

Mogk says private subprime lenders are having the same impact on Detroit today, and calls for the governor and Legislature to "conduct a full and fair investigation of the mortgage industry, its recent heavy involvement in subprime lending and the impact on borrowers and their communities."

Mogk's analogy is an interesting one, because subprime lenders today are quick to cite the goal of increasing the home ownership rate among minorities -- as stated by Presidents Clinton and Bush -- as a reason legislators should not go overboard in cracking down on risky loans and loose underwriting practices. Lenders -- like HUD in the 1970s -- want to be part of the solution, not the problem (or at least perceived that way).

Civil rights groups and non-profits like the California Reinvestment Coalition scoff at the idea that subprime lenders can help increase the rate of home ownership among minorities. They claim subprime lenders deliberately target minorities for high cost loans.

Those claims are based on data collected by the government and analyzed by the Federal Reserve -- which has said, in effect, we don't have enough data to say whether minorities are deliberately targeted.

If you look at the numbers for 2005, you see that minorities were more likely to take out higher-cost loans (55 percent African Americans resorted to higher-cost loans in 2005, versus 17.2 percent of whites). But in terms of the raw numbers, whites took out more than half of loans classified as higher cost -- 2.7 million out of 4.3 million. The vast majority of higher-cost loans, 3.5 million, were made in majority-white Census tracts.

If minorities are targeted for higher-cost loans, whites are no stranger to these products either. 

Only the most cynical (or paranoid) observer would claim that HUD intended to devastate Detroit and other cities by providing FHA backing for low down payment mortgage in the 1970s. The policy may have been misguided, but let's not forget the impacts of white flight, freeways, and massive "urban renewal" housing projects on inner cities.

Mogt and others who worry about the deeper consequences of mortgage lending aren't necessarily arguing that lenders -- whether government or private -- set out with the intention of causing widespread foreclosures and blighted neighborhoods. Regardless of the intentions, it's the results that matter.

But perhaps the focus on race only muddies the issue of what to do next. What HUD in the 1970s and the subprime loan originators of today may have had in common is not a desire to help (or hurt) minorities or any other group, but a lack of exposure to risk. HUD, because it was playing with taxpayer dollars, and subprime loan originators because they were playing with the money of investors rather than their own.

Some subprime lenders have also been subject to less regulatory scrutiny. A couple of recent reports by Harvard University academics concluded that independent mortgage lenders -- the non-bank, private-label lenders who turn around and sell their loans to Wall Street investors -- operate with less oversight of their compliance with fair lending and anti-discriminatory lending laws.

The reports recommended a more uniform regulatory approach, so that private-label lenders operate under the same rules as federally-chartered banks, and increased oversight of investment firms that securitize and sell mortgage loans to Wall Street investors.

Some lenders support such moves, but want lawmakers to stay away from banning particular loan products or dictating tighter underwriting practices. In their view, the decision of how risky a loan is should be made largely by the borrower and the lender, not the government (a view largely shared by Federal Reserve Chairman Ben Bernanke). 

If lenders are actually bearing the risks of these loans, they aren't going to offer them in a reckless way that produces a speculative run on housing and the inevitable crash that follows. Or so the thinking goes.

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