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October 23 2012

Harbingers of Crisis Now Calling for Subprime Revival

WASHINGTON — Two housing advocates who raised some of the earliest warnings in 2005 about the impending housing crisis are calling for a return to subprime lending.

Bob Gnaizda and John Hope Bryant realize it's a bit of a head-scratcher. Nevertheless, they are making the rounds in Washington and on Wall Street to promote their prototype for a responsible, alternative mortgage for less-than-prime borrowers.

"Talking about 'subprime' today is like talking about the devil," Bryant, the chief executive of Operation HOPE who serves on the president's advisory council on financial capability, said in an interview. "Nobody wants to use the word subprime, but frankly, we think that's the future."

Bryant and Gnaizda, the general counsel for the Black Economic Council, the Latino Business Chamber of Greater Los Angeles and the National Asian American Coalition, say the pendulum has swung too far in the other direction in the wake of the subprime crisis. Enhanced regulatory scrutiny has made lenders reluctant to offer loans to borrowers without pristine credit histories and hefty down-payments. That has had the unintended effect of redlining low- and moderate-income — and often black and Hispanic — borrowers.

Borrowers with lower incomes and those receiving smaller loans were more likely to receive higher-priced loans in 2011, according to a Federal Reserve analysis of Home Mortgage Disclosure Act data. Black and Hispanic borrowers also faced notably higher denial rates than Asian or white borrowers, the data showed.

Gnaizda and Bryant are proposing what they call the Dignity Mortgage, a loan that could be made to non-prime borrowers with built-in protections and incentives for both borrowers and lenders.

Under the proposal, Dignity Mortgages would only be available to people who complete certain financial literacy training, who have an income of 120% or less than the regional poverty level, and who are buying homes at 95% or less than the median price in the region.

In order to adjust for risks, lenders would be able to charge 1.25% above the lowest prime rate for a 30-year fixed-rate mortgage. If, however, the borrower makes timely payments for the next five years, the rate would be lowered to the lowest fixed-rate at the time, and the 1.25% premium would be applied to reduce the homeowner's principal.

In addition, a borrower could take advantage of a "reset clause" that would allow him to suspend payments temporarily during an emergency — such as job loss or the death of a spouse — provided he has made timely payments for a certain period of time.

And the kicker: if the loan met all of the above terms, Fannie Mae and Freddie Mac would be required to purchase the loan with limited or no recourse against the bank.

Bryant and Gnaizda suggest that the loans could represent only 20% of the market for the first three years, and should be treated as the equivalent of qualified mortgages for the purpose of calculating capital requirements.

Gnaizda, the former general counsel for the Greenlining Institute, said lenders should also be able to get credit for the loans under the Community Reinvestment Act, not only for lending but for service and investment.

Ultimately, the Dignity Mortgage could be a benefit to both borrowers and lenders, Bryant said.

"You get your dignity back, (and) you get a chance in a capitalist society to reset your life without being called a bum or being pursued financially, or your credit ruined," Bryant said. "And the lender gets to not have Wall Street cite a bad credit and have the regulators call for more capital.

"Maybe, just maybe, if we bake that in, you can actually sell that into the secondary markets and the GSEs and create a new norm," he said.

Gnaizda and Bryant, along with National Asian American Coalition President and CEO Faith Bautista, said they've been meeting with high-level officials at the banking agencies, and may appeal to lawmakers or the White House for support.

Bryant insists such loans wouldn't require legislative action, just a change to current regulations.

They also need banks on board — large institutions — that would be willing to pilot test the program. Gnaizda said they have shared the proposal and received feedback from eight financial institutions, ranging from $1 billion of assets to $300 billion, including Wells Fargo & Co. (WFC), Regions Financial Corp. (RF), U.S. Bancorp (USB) and Union Bank N.A.

The challenge, Bautista said, is that both sides are waiting for the other to make the first move. Banks don't want to wade into this area without assurances that regulators are on board with the loans, and regulators often are reluctant to weigh in on an untested product.

"When you talk to the regulators, they're waiting for the banks to do it, and when you talk to the banks, they're waiting for the regulators to give them a green signal," Bautista said.

Gnaizda said many of the bankers they've spoken with are positive about the concept and don't believe that the problem of lower lending rates for African-American and Hispanic borrowers lies with them.

"They don't want to redline and we agree with them that we don't think they do, but they said there are unintended consequences of many federal rules and regulations," he said.

One banker, who reviewed the proposal but asked not to be identified because his company is not affiliated with the program, said he agreed with Gnaizda and Bryant's hypothesis — the cost of managing risks makes lending to borrowers with checkered financial histories next to impossible right now.

"How do you insulate from problems? Big down payments and bullet-proof FICOs," he said. "It's the end consequence of everyone trying to drive the banking industry to no mistakes, no losses, nothing."

He said he would need "very clear bright lines" that would prevent Fannie and Freddie putbacks if the loan met certain criteria.

Jason Stewart, the director of research at Compass Point Trading & Research, said the loans would have to be guaranteed by the government for the program to be feasible.

"Otherwise, under Basel III or any other regulatory capital scheme it's going to be very punitive," he said. "If you remove the government guarantee, there's no chance it happens."

But a government guarantee comes with its own problems, including who pays if the mortgage becomes delinquent.

"This is completely at odds with what the market has been saying about introducing private capital and reducing government support," Stewart said. "It just doesn't seem to fit in with what [Federal Housing Finance Agency Chairman Ed DeMarco] wants to do."

Still, Stewart said, there are investors looking for lenders who can originate subprime mortgage loans "at a risk-adjusted rate that makes sense."

"This is a great business right now," he added. "It's not a dirty word if it's done properly."

Bryant said he knows the proposal will meet resistance, but it's just a starting point for a conversation.

"What nobody can say is that this is a stupid idea," he said. "We vetted it with the regulators — nobody said this is crazy. There's no piece of this that's a poison pill that absolutely just can't be done."