January 29, 2013
Agarwal and Evanoff have released a draft of Loan Product Steering in Mortgage Markets. They sought to determine whether there was empirical support for the frequent anecdotes of credit steering in the literature about predatory lending. They find such support. They find evidence
consistent with institutions steering customers to affiliated lenders that provide more-expensive loan products. Specifically, we find that steered loans have an annual percentage rate (APR) 40–60 basis points higher than that of non-steered loans after controlling for various borrower and loan characteristics. Given the average APR for the sample of loans is 6.5%, a rate 40–60 basis points differential is economically significant. We also find that the steered customers perform better on their mortgages—consistent with them being lower-risk, better-qualified borrowers than those normally associated with their eventual loan products. Specifically, we find that the probability of steered loans being delinquent is 1.4–2.0 percentage points lower than that of non-steered loans. Again, given an average delinquency rate of 5%, this differential is also an economically significant result. (22, footnote omitted)
While I am not in a position to evaluate their empirical findings, I question the following: “We also find that steered loans are often placed in private securitized pools—much more so than being held in portfolio or sold to the housing GSEs. This is consistent with the steering taking place in an attempt to satisfy the demands of investors looking for highly rated mortgage-back securities.” (22) This assertion does not appear to take into the robust literature about the market for lemons which would suggest that originators would try to keep the lower risk mortgages for their own portfolios. It also does not appear to account for how securitizers actually structure MBS in order to achieve a high rating (using techniques such as overcollateralization, subordination and insurance to do so). In other words, securitizers do not need low risk mortgages to make low risk MBS if they can otherwise provide credit enhancements as part of the structure of the MBS.
The authors state that their results are “the first explicit evidence of systematic mortgage lending abuse during the run-up in the housing markets.” (1) They also demonstrate the difficulty in regulating away predatory behavior from the mortgage markets as profit-seeking holding companies appear to have developed techniques to achieve net profits even while one subsidiary took actions that appeared to be inconsistent with its own quest for profits. This should give regulators at the CFPB something to think about.