Harvard study: Redesign subprime mortgages to be Dodd-Frank friendly
Researchers at the Joint Center for Housing Studies at Harvard University found that nontraditional mortgages, even subprime loans, when underwritten to fit upcoming regulations under Dodd-Frank can and should still be made in a post-crisis housing market. Eric Belsky and Nela Richardson make the case that when done correctly, lending to low-income and risky borrowers can be viable business. The rise of nonprime lending during the housing boom in the mid-2000s created an unfair test of lending to risky, low-income borrowers. Currently, the data analytics firm CoreLogic reported more than 2.3 million subprime mortgages were delinquent in July, down 12.5% from the year before. But 39.6% of the subprime loan market is 60-days delinquent — 35% of that is 90-days delinquent, 13% of that are now in foreclosure and 3.8% of mortgages are in REO. But according to the Harvard study, not all subprime was created equal. Belsky and Richardson compared loan types and delinquency rates in the third quarter of 2009 and found that some subprime performed better than others. In that quarter, the serious delinquency rate on adjustable-rate subprime mortgages stood at 40.8%. But on fixed-rate subprime loans, the rate was significantly lower at 19.7%. Belsky and Richardson noted that a larger share of subprime ARMs were written than FRMs, but even after controlling the data for vintage loans, fixed-rate subprime still performed better. Who originated the loan was also a factor. Borrowers were four or five times more likely to default when they obtained a subprime mortgage from a broker. Keith Johnson, former president and chief operating officer of Clayton Holdings testified last week before the Financial Crisis Inquiry Commission, that brokers hold much of the subprime fault. "[P]erformance data has shown that the broker model became flawed with greed, fraud and deception," Johnson said. "Low barriers of entry, lack of regulatory supervision or enforcement, coupled with rich incentives for production created an environment that contributed to the surge in defaults." The Dodd-Frank Act and the Consumer Protection Act established minimum underwriting standards, clarified what is to be disclosed on adjustable-rate loans, and prohibited prepayment penalties for all but some fixed-rate mortgages. "When prudently underwritten—and when systemic risk was not ballooning—many nontraditional loan products performed well," according to the study. "It would therefore be wrong to conclude from the poor overall performance of nontraditional prime loans that the products themselves should be prohibited." Write to Jon Prior.