Case for banning subprime mortgages

 
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Between 1994 and 2006, subprime lending grew from $35 billion to $600 billion a year in the United States, amounting to 23% of all mortgage dollars lent. The ensuing subprime mortgage market crash led to severe disruptions in the global financial markets.  By the third quarter of 2007, about 25% of subprime loans were either delinquent or in foreclosure.

A 2008 paper by the Valparaiso University School of Law, “The Case for Banning Subprime Mortgages,” looks at the potential regulation of mortgage interest rates and the restoration of the Federal Housing Administration (FHA) as the primary provider of mortgages to first-time, low and moderate-income home buyers.

The paper’s key conclusions are:

  • The extent to which subprime mortgages increased homeownership is overstated. Most subprime mortgages were made to existing homeowners to refinance debt. Roughly 1.4 million out of 5 to 6 million first-time buyers obtained financing from the subprime mortgage market.
  • The key welfare costs of subprime lending include 2 million home foreclosures, losses in property value, social and fiscal impact on cities where subprime mortgages were concentrated, and higher interest rates incurred by minorities.
  • A recurrence of the subprime crisis could be prevented by limiting first mortgage interest rates to a reasonable range above prime rates or an appropriate index.

The author asserts that banning subprime mortgages does not mean excluding borrowers with marginal credit or no credit history from the mortgage market. Rather, a more prudent and less predatory form of mortgage lending should be made available for these communities.

Tags: economy

Last updated: December 22, 2009

 

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Citation: White, ALan, M. "The Case for Banning Subprime Mortgages," Valparaiso University Legal Studies Research Paper No. 08-06, University of Cincinnati Law Review, 2008, Vol. 77, p.617. Available at SSRN: http://ssrn.com/abstract=1133609.