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Reaching Too Far

Predatory lending played a large part in the financial crisis, but also to blame were affluent homeowners who knowingly bought houses they couldn’t afford.

(originally published by Booz & Company)

The Foreclosure Crisis: Did Wall Street Practice Predatory Lending or Did Households Overreach? (PDF)

Kathy Fogel (University of Arkansas) et al.


Date Published: 
April 2010 

With Congress set to pass the most far-reaching financial reform bill since the Great Depression, it’s worth looking at one of the big questions of the recent financial meltdown: Who should shoulder more of the blame for the housing bubble — predatory lenders or homeowners who borrowed more than they could afford? This paper says it’s the latter. The researchers found that most households in foreclosure were fairly affluent and highly educated, with few or no children, in areas with rapidly appreciating real estate. Although they note that the data does not specifically indicate whether predatory lending may have played a part, because buyers’ motives are nearly impossible to discern, the authors conclude that because the majority of troubled properties were owned by individuals who were comfortable enough to purchase at least a decent house in a decent neighborhood, overreaching homeowners were more culpable in the mortgage crisis.

The authors created detailed profiles of households in foreclosure in the third quarter of 2008 by analyzing huge databases of homeowner demographics and foreclosures from several private real estate information providers, including Acxiom Corporation and RealtyTrac. Using an Acxiom classification system, the authors separated U.S. households into 21 different life-period groups, such as Gen X Singles, Boomer Barons, and Mature Rustics, that categorize individuals by their age, marital status, number of children, and income. By a wide margin, the greatest number of foreclosures were experienced by a group dubbed Cash and Careers, affluent Gen Xers born between the mid-1960s and early 1970s. They tended to invest aggressively in states that were in the midst of real estate booms, including California, Nevada, Arizona, and Florida. Mixed Singles — generally low-income, low-net-worth, and poorly educated individuals — had the highest foreclosure rate, but there were fewer of them. The authors argue that this group would tend to be more susceptible to predatory lending, a practice through which the banks take advantage of the most financially vulnerable households by offering them loans with confusing terms and artificially low initial interest rates. However, because of the geographic distribution of foreclosures (the fact that they tended to be clustered in “hot spots” that attracted higher-income buyers) the authors contend that the crisis was more a result of wealthier people taking on more house than they could afford than low-income buyers signing up for risky loans.

The researchers argue that from a policy standpoint, stronger consumer protection laws and increased regulatory oversight of banks will be insufficient to avert another crash like the most recent financial crisis. They contend that to avoid bubbles in the future, the Federal Reserve would need to recognize and have the ability to limit asset price bubbles. 

Bottom Line:
The recent housing bubble was more the result of affluent and overeager homeowners aggressively seeking questionable loans than predatory banks seeking to dupe vulnerable consumers.

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