Critiquing the WSJ on Subprime: Media Hype That Misses the Point

There is an article in Monday's morning’s Wall St. Journal that is sure to generate a lot of “chatter” online and off, discussing the trend of a significant percentage of subprime loans being originated to people with good credit. The article goes so far as to claim that 55% of all subprime loans (sold to investors) were originated to buyers with prime mortgage credit. The article takes the stance of the borrowers being tricked into subprime loans, didn’t know any better, were victims of fraud, etc. While I don’t discount the fact that many people were in fact hoodwinked, or were steered into bad loans, I don’t think the article is necessarily “balanced” or presents an accurate picture either.

In fact, I’ll even go so far as to say that the article is really aiming to take advantage of the row over the mortgage crisis, but placing all of the blame on “subprime loans and the lenders that originated them”. Not once does the article really place any of the blame on borrowers that willingly took on bad loans, and in many cases were just as guilty as the lender in terms of making bad decisions. A balanced approach needs to be taken on this issue, so we’re able to differentiate between the people who were truly taken advantage of and the people who just made bad decisions.

The following are a couple of the issues I had with the WSJ article:

1. 620 should not be presented as the dividing line between prime and subprime, as a FICO score of 620 means you have bad credit and would have difficulty getting a credit card. Finance Globe is a site that allows people to search for potential credit cards by their FICO score and a score of 620 only qualifies one to receive subprime credit cards and/or student cards with very high rates, 1% of the total credit cards available on the site. The prime/subprime bar should be in the 650/660 range, which would place the percentage of subprime loans being originated to prime borrowers at 20-30%, not the 55% number the WSJ claimed. The mortgage banking association even pointed out to the WSJ that 620 isn’t the dividing line between prime and subprime.

2. Continuing the above you can’t merely use FICO scores as the dividing line for prime/subprime without looking at what’s on the individual’s credit report, because scores only indicate a very general trend, not the full story. Individual A could have a score of 650 due to having a limited credit history, but have a large down payment. Individual B could have a score of 680 and have charged off credit cards, collections, missed payments, etc, on top of having a small down payment. Despite a higher score, individual B isn’t necessarily a lower credit risk. Additional data beyond the FICO score is needed to determine whether or not a buyer is necessarily prime or subprime.

3. During the housing boom between 25-33% of all buyers of homes were speculators, many of these buyers used interest only, ARM or negative amortization loans to purchase their “investment properties”. In reporting the % of subprime loans originated to prime buyers, the WSJ should’ve attempted to factor out these buyers. In fact in an earlier article on subprime loans crossing income strata, the WSJ noted that in 2006 13% of all subprime loans were taken out by speculators. Factoring out speculation knocks the WSJ’s original % down further to 7-17%, not 55%.

4. Many buyers weren’t necessarily steered towards subprime loans they went into them willingly. Prime buyers could use subprime loans to qualify for higher loan amounts, avoid providing documentation of income (in many cases, the borrower lied about their income/committed fraud) and to withdraw more equity from their home then they could with a prime HELOC. In fact, in an earlier WSJ article on the issue, it was reported that subprime loans amongst borrowers with an annual income of $300k or more, grew by 74% in 2006. The same article also noted a trend by affluent families in high-income areas to use subprime loans to purchase homes they couldn’t otherwise afford. Affluent families aren’t exactly forced into buying $600k houses when they can only really afford a $500k house; buyer greed shouldn’t be ignored.

5. Whilst fraud and/or unethical behaviors are the focus of the article, the real issue is that many lenders used very weak underwriting standards. In the earlier article from the WSJ it was noted:”It used to be that high-rate borrowers weren't allowed to stretch as much as conventional borrowers on loan amounts, a reflection of their higher credit risk”. But as home prices rose throughout the U.S. in the early 2000s, lenders grew more willing to let high-rate borrowers get bigger loans as measured against their annual incomes”.

Lenders are supposed to be focused on originating loans buyers can actually pay back, but they abandoned those rules during the housing boom thinking that rapid appreciation would allow buyers to refinance their way out of trouble. Yes there was an element of fraud in the practices of many lenders, but stupidity was a MUCH larger issue with respect to the creation of the mortgage crisis.

Overall, if the WSJ set its FICO score criteria properly and factored out speculators and buyers trying to live above their means, the % of subprime loans originated to prime buyers would probably be under 10%. Additionally, there should’ve been more focus on bad decisions on the part of buyers and bad lending standards. It wouldn’t have made for as exciting of an article, but at least it would’ve provided accurate view of the situation. The surprising thing is that when the Wall St. Journal first covered this story back in October, they presented a much more balanced view of the situation and discussed the role played by both buyers and lenders. This newest article seems designed to capitalize on the media hoopla surrounding the mortgage crisis.

If we’re going to implement measures that will prevent another mortgage crisis from happening, it’s imperative that we look at the situation properly. We’re not going to be able to effectively combat mortgage lending fraud and educate buyers on how to make smart financial decisions, if we engage in hyperbole. Measures need to put into place that will curb bad behavior on the part of lenders AND borrowers.

Disclosure: at the time of publishing the Author didn’t own shares in any of the firms mentioned in this or the referenced articles.

Comments

[the gugg]

I agree in total with the article. Our culture is all about chasing the money, the quick buck, flip that house, bla bla bla. All of these bubbles end with finger pointing and blame. The propaganda turns usually rational people into believers of the quick buck. You too can be rich like Paris Hilton with no money down. In a way this optimism is what makes this country so great, and a bit crazy too. I hope one day as a nation we become a little less selfish.