Predatory lenders, who were blamed as one of the major factors for the subprime mortgage crisis, in fact only played a minor role in the housing crash, researchers from Ohio State University found in a new study. Subprime mortgages are home loans given to people with low credit ratings.
Predatory lenders approved risky housing loans to unqualified buyers and were said to have contributed significantly to the economic crisis in 2008. They were among the so-called ‘banksters’ many believe were responsible for the financial meltdown that hit the world’s financial system.
However, a study carried out by Itzhak Ben-David and team found after studying the anti-predatory lending program that it only brought down default rates slightly, while causing serious market disruptions.
The study was published in the Journal of Financial Ecnomics.
Subprime crisis would have occurred without predatory lenders
Ben-David, an associate professor of finance at Ohio State University’s Fisher College of Business. said:
“Our results suggest that even without any predatory lending during the housing boom period, we still would have had a subprime crisis.”
“Predatory lending was responsible for only about a quarter of the default rate, suggesting it wasn’t the most important driver of the subprime crisis.”
Ben-David and team gathered and examined data from a pilot anti-predatory lending program that had been passed by the Illinois legislature and was implemented in 2006 in Chicago in the middle of the housing boom.
The program required some people with low credit ratings who had applied for mortgages or risky loans to submit their loan offers for review by financial counsellors. The counselors identified loans with very high interest rates, unaffordable loans as far as the borrowers’ financial situations were concerned, and loans that appeared to be fraudulent.
The aim was to steer mortgage/loan applicants away from unsuitable offers. However, the advice did not have to be heeded.
The pilot anti-predatory lending program was implemented in 10 zip codes in the Chicago area. Ben-David and colleagues compared loan applications in these ten areas to another ten demographically similar areas where the program did not exist.
The program had a considerable impact on mortgage loans in the 10 zip codes. Mortgage loans dropped by nearly half, mainly because people who specialized in risky loans moved to other areas.
Ben-David said:
“Many lenders decided they just didn’t want to deal with the new regulations and exited the market. Many of these lenders had some characteristics that could be tied to predatory lending.”
Loans issued in the areas where the pilot program was being run were much less likely to feature risky characteristics and tended to be granted to borrowers with higher credit ratings.
Default rates remained high, despite the pilot program
However, the program only reduced default rates modestly, the researchers found. The default rate in the communities where the pilot program was active dropped from 27% to approximately 20%.
Ben-David said “A default rate of 20 percent is still quite high. Our findings suggest that predatory lending was responsible for only about a quarter of mortgage defaults in the targeted area.”
Although the program drove out bad lenders, it did not expel bad loans. “They eliminated predatory loans, but not reckless loans,” Ben-David said. “People still bought homes that they couldn’t afford and lenders were still willing to approve their mortgages.”
The pilot program ended within four months because of strong opposition, even though it was supposed to have lasted four years. Opposition came from those in real estate, as well as local residents and community leaders.
Ben-David explained that many people saw the law as an infringement on an individual’s right to pursue the American dream of owning a home. “In the end, the program had good intentions but came at a very high cost for the limited benefits it provided.”