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Thursday, April 26, 2007

Regulatory Response Update: Hit Me Again

by Tanta on 4/26/2007 10:30:00 AM

James Surowiecki in the New Yorker ("Subprime Homesick Blues") makes a plea for maintaining access to subprime lending:

But what’s often missed in the current uproar is that while a substantial minority of subprime borrowers are struggling, almost ninety per cent are making their monthly payments and living in the houses they bought. And even if delinquencies rise when the higher rates of the 2/28s kick in, on the whole the subprime boom appears to have created more winners than losers. (The rise in homeownership rates since the mid-nineties is due in part to subprime credit.) We do need more regulatory vigilance, but banning subprime loans will protect the interests of some at the expense of limiting credit for subprime borrowers in general. And while the absence of a ban means that some borrowers will keep making bad bets, that may be better than their never having had the chance to make any bet at all.

I don't, really, know what to say to someone who thinks there's an outright ban on subprime lending on the table, or who writes "even if delinquencies rise when the higher rates of the 2/28s kick in." The theory is, you see, that the "higher rates of the 2/28s" are the higher rates needed to make up for the higher delinquencies. It's usually called the "risk premium." If people can't afford to pay the risk premium, that suggests that their risk cannot be priced: there are no loan terms that the borrower can afford that will also cover the cost to the lender of the borrower's likelihood of default. The traditional response to a request for credit that cannot be adequately priced is to deny the request. Continuing to lend at a discount to the true premium seems like a curious way to avoid losses, but one undoubtedly makes it up on volume.

In any case, we certainly wouldn't want a regulatory regime that makes it hard for subprime borrowers to gamble on real estate. Of course, you'd have to define "winning the bet" before you'd conclude that the House sometimes loses, and some of us aren't sure that making outrageous house payments equal to 50% of your take-home on time for 30 years for a depreciating property is properly classified as "winning." Before I'd get all fired up about letting the punters punt, I'd want to know if this is Monte Carlo or Three-Card Monte.

On the other hand, it makes more sense than just asking all the sellers to stop selling until the buyers get desperate again.