Texas Tech Professor Ann Graham over at Banking Law Prof Blog has some tough words for purveyors "liar loans."
Comptroller of the Currency John Dugan addressed the problems with "stated income loans" - observers call them "liar's loans". He reiterates the obvious: When lenders don't verify income, they wink at borrowers who provide the income number necessary to get the loan. That's bad for borrowers who really can't support the payments that will come with the loan and bad underwriting on the part of lenders, inviting loan defaults and charge-offs. These blunt comments are actually mine. If you want to see the Comptroller's more polite version, here's the link:
http://www.occ.gov/ftp/release/2007-48.htm
That's a Texas thing (or "thang," as we say it down here) that Ann has going for her. It's called plain speaking.
No doubt, both Professor Graham and Comptroller Dugan are correct in raising an eyebrow (or four) at the fact that half of subprime loans were "stated income" loans, where income stated by the borrower on his or her loan application is simply accepted "as is" by the lender with no independent income verification. Yet, am I the only person in the country that understands that "stated income" loans and other variations of "quick and dirty" underwriting have been around for years now? When a lender makes a "stated income" loan, it does so knowing that the stated income may be inaccurate. Of course, a borrower who misstates income on a loan application may very well be committing a federal (and state ) crime. Not that criminal offenses are likely to deter people who fail to read their loan documents or their loan disclosures, because it's likely that they won't read the notice on the loan application that false statements on the application are a criminal offense. Thus, I can't argue that these loans don't present a higher risk that the borrower's income may not be sufficient to support the loan payments. They do.
In other words, they're higher risk loans. Which is one of the reasons why they bear higher interest rates and fees. High risk is factored into the pricing. It's called free market, risked-based product pricing. Legitimate lenders make these loans in reliance on other factors (credit scores, credit history, assets, etc.), and expect that a certain percentage of the loans made in this manner will go into default. Not all of them, certainly, although more of them than would be expected with more conventional loans. The lenders who purchase them build the higher expected losses into their pricing models, and as a result price the loans higher than conventional loans.
Professor Graham and Comptroller Dugan are rightly concerned that the abusive use of "stated income" by mortgage originators was, in many cases, part of a scheme to book fees on loans that the originator knew, in his or her heat of hearts, were being made to borrowers who could not repay them. Such abuse needs to be stopped. There's basically no sensible pricing for a loan that is certain not to be repaid. At least, there's no sensible pricing that any borrower could actually afford to pay. Again, such abusive practices need to be stopped.
On the other hand, Comptroller Dugan is speaking for any agency that regulates national banks, and national banks have not been the problem with stated income loans, or subprime loans in general for that matter. Nor are any of the other financial institutions regulated by the other federal baning regulators. Most of the abuses have been found outside the banking business, in the land of the wild and woolly (relatively) unregulated mortgage banker and broker. All the good intentions, guidance and other "crackdowns" by the OCC, FRB, OTS, FDIC and NCUA aren't going to correct the problem of abusive stated income loans.
Let's hope that we don't come to the point where the risk-based pricing of loan products will be so severely constrained, by overreaction to past abuses, that you will kiss subprime residential mortgage lending goodbye. There then will be a segment of the political and consumer activist special interest classes who will be outraged that high risk loans to those with poor credit have dried up. I suppose they'll turn to the government to make or guarantee such loans. The FHA on steroids.
I agree that a "cleanup" is in order. Let's just not throw the baby out with the (admittedly dirty) bath water.
