The True Meltdown Culprit: Unsuitable Mortgages

Foreclosure is usually attributed to mortgage borrowers, not to those who fund the loans. But this time, the blame lies with the mortgage lenders and investors who created an artificial demand for loans, and then came up with inappropriately risky mortgages to feed that appetite.

The debate continues about who's to blame for the mortgage meltdown and foreclosure crisis. But a new study by Local Initiatives Support Corporation (LISC) points to compelling evidence that the culprit was lender underwriting, not loans to low income homeowners.

"Delinquency and foreclosure rates for subprime borrowers were comparable across communities of all income levels," said Michael Rubinger, LISC president and CEO. "This reinforces what years of experience have already told us: Low-income residents are not, by definition, poor credit risks. Unsuitable mortgage products are."

Risky loans a contributing, not major, factor

LISC reviewed delinquency and foreclosure rates by examining information from March 2007 through March 2008, and found that, while subprime defaults outpaced other types of loans, the phenomenon didn't correlate with income. Instead, the data revealed that borrowers across a variety of income brackets fell into foreclosure at similar rates. What the study did conclude, however, was that the major contributing factors were the types of risky loans being sold to homeowners, and a conspicuous lack of underwriting standards.

Only about 30 percent of the subprime loans made during the period studied were to communities with higher poverty rates, while the majority of loans that wound up in foreclosure were made to borrowers in affluent neighborhoods. This is significant because some people have said that the cause of the foreclosure crisis can be traced to the passage decades ago of the Community Reinvestment Act (CRA), which increased investment in low- and moderate-income communities. The report from LISC debunks that notion, and points to the fact that foreclosure prevention policies and efforts need to be directed at risky loans and sloppy lending practices, not at initiatives to provide affordable or low-income housing.

Targets for foreclosure prevention

"This crisis has not been driven by efforts to help qualified families of more limited means become homeowners," Rubinger said. "It instead reflects the decisions some financial institutions made to maximize gains at the expense of sensible risk management. The numbers bear this out. This is about lending practices, not about poor people and communities."

The housing bubble was caused by demand for mortgage-backed securities that provided lenders and investors fast profits, but also consumed gigantic quantities of mortgages that lenders had trouble generating to keep up with investor appetite. As a result, mortgage companies pushed the most profitable investment product mortgages on borrowers without regard to underwriting. They weren't primarily interested in making money from the loans, but instead, from the Wall Street securities that those loans created. But the get-rich quick scheme collapsed, leading to this foreclosure catastrophe.  Now, foreclosure prevention efforts need to target lender regulation and Wall Street oversight if they're to succeed.